Valuations for estate, succession planning

Estate planning

Closely-held, family owned business make up nearly 90 percent of all businesses in the U.S. However, many business owners overlook the value of their business when making an estate plan, thereby, affecting the impact on the owner's estate and the resulting tax obligations. This can have severe financial consequences. In determining the fair-market value of a business entity, current tax law requires more than a simple calculation. The methodology, theory and empirical evidence behind the fair market value determination must be in accordance with tax law and must be well documented.

Unfortunately, it is only after an owner's demise that the true understanding of the businesses tax liability comes to light oftentimes surprising the family members with a tax liability they are not prepared to pay and resulting in other family assets having to be liquidated, leaving a non-liquid business to the heirs and oftentimes no one to run it.

Estate planning is the process of anticipating and arranging for the disposal or transfer of an individual's property and assets. Estate planning typically attempts to eliminate uncertainties over the administration of probate and maximize the value of the estate to the designated beneficiaries in a manner that minimizes the taxes levied by taxing authorities. A business valuation is essential to preserving assets of individuals for future generations.

By conducting a periodic business valuation, the owners and beneficiaries can better understand the effects of estate taxes. The valuation also provides a starting point for an owner and their professionals (qualified estate planning attorney, wealth advisor, CPA, etc.) to evaluate potential alternative ownership transfers; provides a starting point for the valuation of gifts; and can help protect against future questions from the IRS. (A properly prepared business valuation by a qualified valuation professional helps to defend or avoid all together IRS challenges that could overturn an estate plan, exposing the estate to penalties, voiding of statutes of limitations or disputes among heirs.)

Unlike the appraisal of real estate and the like, a business valuation not only looks at comparable sales transaction data (when available), but also requires an in-depth multidimensional analysis of the company's operations, its management, industry, financial performance, economic environment, just to name a few.

The process of valuing a business is further complicated by the fact that not any two companies are so alike that a cookie-cutter approach to valuation can be employed. Therefore, each company must be looked at individually. In doing so, industry information is scrutinized, analytical procedures employed, and reasonable assumptions based on specific facts of the business as well as sound professional judgement are used in every business valuation. By doing so and by following these procedures dictated by various governing bodies such as the AICPA and the IRS, a business valuation professional can provide the information necessary for a business owner's team of qualified professionals to structure a complete estate plan.

An estate tax planning valuation needs to be clear about the interests being valued. Discounts from net asset value must be documented. The most common discounts are for a minority interest and the lack of marketability.

A professional business valuation report documents the methods used to arrive at these discounts to comply with the IRS guidelines described in Revenue Ruling 59-60. Each situation is different and a valuation professional needs to carefully consider which discounts apply and to what extent.

Business owners, high net worth individuals, and executors should substantiate the estate and gift tax planning process by engaging, at a minimum, a qualified attorney, a financial planner with tax knowledge, their CPA, and a qualified valuation firm to value their assets. This will ensure that the value determined is supportable.

Succession planning

Similar to estate planning, succession planning is a tough and critical challenge for a family to face. Succession requires change, and change is often met with resistance. A business valuation provides an opportunity for the business owner to create a multi-generational institution that embodies the business owner's mission and values long after they are gone. Additionally, this institutional philosophy assists family and closely held businesses in multi-generational planning by helping them address issues related to both ownership succession but also management succession planning and leadership development as well. To not perform this type of exercise and do nothing, the owner's asset could tragically be depleted. One which often times took a lifetime of sacrifices and hard work to build.

The most effective and successful estate and succession plans are managed and orchestrated by a team of specialized professionals consisting of estate planning attorneys, wealth and financial planners, CPAs and valuation experts. The business valuation process is an integral part of these plans and should not be overlooked. If fact, a business valuation is arguably the first place to start.

Darrin Maddox is the owner of Eastern Sierra Professional Group and has over 20 experience as a CPA, and is a Certified Valuation Analyst. Contact him through his company's Web site at www.esprogroup.com.