GIVE THE RIGHT answers and you can win big bucks on many TV game shows. Typically, the host only allows about 15 seconds for the contestant to give the right answer.
OK, try this quick quiz: What is the most valuable asset you own? Hands down, almost every business owner answers, "My business."
Good! Next question. What's your business worth? Silence! Yes, the final and most common answer is no answer, whether you have 15 seconds or 15 months to think about it.
What happens in real life when those same business owners or their families must value the business? Stuff happens! Things like gifts of the family business stock to the kids; death (requiring valuation for estate tax purposes); or divorce (where valuation becomes an expensive legal battle).
Or, how about buying or selling a business? The wrong valuation can rob you and your family of hard-earned dollars. It can even cause your business to be sold to pay taxes.
Here are three business valuation myths that I hear from business owners and their families when I consult with them: the business is worth book value (usually this value is too low); the value is eight to 10 times after-tax earnings (usually this value is too high); an S corporation is worth more than a C corporation (a corporation that pays income tax) because an S corporation doesn't pay income tax. This is plain wrong. There's no difference in value.
Visualize this: Two piles of stock are in front of you. One pile is made up of publicly traded stock, such as Microsoft, IBM and Exxon Mobil Corp., with a total value of $4 million. The second pile is the stock of Your Family Business Inc. (YFB Inc.), also worth $4 million by the "right" valuation method, i.e., a valuation with which the IRS would agree.
Think for a minute. Which pile is worth more? Right, the first pile — the publicly traded stock. Just call your broker and you can have the full $4 million in your bank account, less the broker's commission, in a few days. What about the value of the second pile — YFB Inc. stock? Well, the fact is that for tax purposes the courts give you a discount for general lack of marketability of about 35%, or about $1.4 million.
So, for tax purposes, the stock of your $4 million family business is only worth $2.6 million. Surprise! Even the IRS has come around to agree with such discounts. The discount will save your estate about $700,000 in estate taxes.
What is the most common reason for valuing a family business? Hands down, it's when dad, mom or both want to transfer the business to the business kid(s) now while dad is still alive. Dad usually has three basic requests for his professionals:
- "Make sure my lifestyle (and my spouse's) can be maintained for life";
- " I want to control my business (and my other assets) for as long as I live"; and
- "Transfer my business to my kids tax-free (no income tax, capital gains tax or other taxes)."
Yes, all three basic requests are easy to accomplish if you employ the proper tax-strategies. The core strategies are: a well-done valuation that is acceptable to the IRS; a recapitalization that creates voting and nonvoting stock; and creation of an intentionally defective trust in order to avoid all taxes on the transfer of nonvoting stock to the kids.
But we need some readers to volunteer their family businesses so we can structure some plans and then write about them in future columns. Real names will be withheld. Don't worry about your exact facts. Maybe you have only one kid in the business; maybe two or more; maybe some in the business, some not; or maybe no kids in the business and you want to sell the business to one or more key employees, who, of course, don't have any money.
Just two ground rules. First, you really want to transfer your business to your kids, other family members or employees. I won't do this exercise on hypotheticals. Second, your business has a real fair market value of $3 million or more (your best guess of what a real buyer would pay). Just call me at 847/674-5295 and let's chat about your exact situation.