What Are The Different
of Your Business?
[fname], all business owners want to know the 'value' of their business.
You, as an exiting owner, need to understand that the value of your company
is a 'range concept' - there is no single value for the shares of
your privately held business.
The easiest way to understand this range of values concept is to begin with
the differences between an internal transfer and an external transfer
of your business - see the chart below.
You will observe that internal transfers,
such as Employee Stock Ownership Plans (ESOPs), Gifting programs, and
Charitable Transfers are governed by a valuation standard called Fair
Market Value. A Fair Market Valuation appraisal is completed by
professional evaluators who render a single 'point in time' value for your
You will also see that external transfers
are measured by what different types of market players are willing to pay
you for your business. For example a financial buyer, such as a private
equity group, may be willing to pay you the 'investment value' for
your business – this is the value to them as an investor in your enterprise.
This valuation assumes that the financial buyer is not already in your
business or a similar line of business.
A market-buyer who is in your business, or a similar line of business, may
be able to pay you a 'synergy value.' What this simply means is that
this type of buyer may be able to reduce certain costs, or take advantage of
certain efficiencies achieved by acquiring your business. For example,
selling your business to a competitor may allow that buyer to reduce
overhead associated with financial and sales operations because they already
have their own systems and people in place to handle those aspects of the
business. These types of cost cuts or efficiencies are called 'synergies',
hence the term 'synergy value'.
Synergy value is theoretically the highest value that you can receive for
your business. However, only 5% of businesses will successfully
sell to an outside buyer. So we see that an understanding of the 'range of
values' concept becomes relevant to the majority of exiting business owners.
There are advantages and disadvantages to both internal and external exit
strategies plans. In short, a sale to a synergistic buyer causes you to lose
control of the business as well as forfeit any future value in the business.
A sale to a financial buyer, such as a private equity group, will
generally cause you to sell strategic and financial control, but may
leave you the opportunity to continue running the day-to-day operations
(operational control), whereby your salary and benefits continue. And,
you may also be able to maintain a minority stake in the ownership of the
business, thereby participating in the future value of the company that you
continue to build. Participating in future value and receiving continued
income should be included in the 'value' of the exit strategy plan that you
A sale to an ESOP or a gift to a charity or to family is measured
under the Fair Market Value standard. All things being equal, this Fair
Market Value standard is lower than the market values of investment and
Fair Market Value is a standard of measuring a company's value that is used
by the tax courts and the Internal Revenue Service (IRS) when evaluating a
'stated' value for a business. In terms of standards and processes, fair
market value is the most structured type of valuation. The process for
determining the fair market value of a company is derived from IRS Revenue
Ruling 59-60 which defines fair market value as “the price at which property
would change hands between a willing buyer and a willing seller when the
former is not under any compulsion to buy and the latter is not under any
compulsion to sell, both parties having reasonable knowledge of the relevant
facts . . . the hypothetical buyer and seller are assumed to be able and as
well as willing, to trade and to be well informed about the property and
concerning the market for such property.”
From this definition came a series of steps that are used by professional
evaluators to determine the fair market value of your business.
So again, the fair market value does not necessarily reflect the premiums
that can be achieved when an exiting owner decides to sell to an outside
buyer such as a competitor or a private equity group. But even though the
overall value may be lower, the exiting owner may experience much more
flexibility and continued control with an internal transfer using the fair
market value standard.
In short, internal transfers do not include an 'outside' party. Therefore,
the exiting owner has the ability to construct a plan for their exit that is
customized. Whether that exiting owner is negotiating with their management
team, or selling shares to an ESOP, or transferring a portion of their
wealth to family members or to charities, their ability to control the
transaction is increased. The trade-off for this increased control is
[generally speaking] a lower value for the business.
In conclusion, when formulating your exit strategy plan a few very important
points can be highlighted for your consideration:
1) Most businesses will not successfully sell to an outside party, so
it makes sense to begin to understand 'internal' transfer strategies and
2) The internal valuation of Fair Market Value will generally produce
a lower overall value for the business, but the ability to control the
transaction, as well as potential savings on taxes and professional fees may
more than make up for this diminished value.
3) Professional appraisers are used to determine Fair Market Value
whereas Market Value is determined through a sales process
whereby your company is offered to the buying or investing marketplace and
whatever that marketplace is willing to pay you for your business is the
Market Value that you receive (from this amount you need to also determine
your taxes and professional fees that are owed).
An exiting owner is well served in understanding that the 'value' that they
receive for their business may not be the most important factor to consider
in their exit strategy planning. Beyond the entrepreneur who knows that they
want to sell to a competitor for the highest price, there are millions of
other business owners who have strong incentives to pass their businesses to
managers, co-owners, family, and charities of their choosing. Although these
transfers may not yield the highest sales price, they may ultimately produce
an outcome that is much more favorable to that exiting owner's personal
As always if you need some advice, you're
welcome to email me of call me here at the office at 281-993-4530.
Charles Wilson, CPA/CFF, CGMA, CBEC
Charles Wilson, LLC
307 S. Friendswood Dr, Ste B-2
Friendswood, TX 77546
Charles Wilson, CPA/CFF,
CGMA, CBEC is a Certified Business Exit Consultant and is affiliated with
Pinnacle Equity Solutions, Inc., an Exit Strategies Training and Solutions
company. Parts of the content in this email are taken from previous
Pinnacle Equity Solutions, Inc's. newsletter library and website in
accordance with Charles Wilson's certification in Pinnacle's Certification
and Membership Program. All Copyrights are the properties of Pinnacle Equity
Solutions, Inc. and Charles Wilson, LLC and their respective owners.