A business appraisal could make an enormous difference in assessing your clientÃs financial plans.
Three years of anemic economic growth and falling equity prices have taken their toll on the sprawling but less visible market for privately held businesses. That makes an accurate business appraisal all the more important because it helps small-business owners understand the value of what usually is their largest asset: their company, says John P. Murphy, a senior vice president for Atlantic Management Co. Inc., a valuation firm based in Portsmouth, N.H.
The gap between perception and reality probably has widened in recent years, as evidenced by the dramatic decline in merger and acquisition activity. Unfortunately, many small-business owners don't know what their firms are worth and wait too long to get appraisals-or never get one. That can result in a nasty surprise when they or their heirs find they are getting a lot less money from the enterprise than expected, experts say.
Philip M. Hamilton, a certified public accountant and business appraiser whose Austin, Texas, practice focuses primarily on business valuations, tells this real-life nightmare: A friend's husband had a 50% interest in each of three businesses. He and his partner did not have a buy-sell agreement, which could have made it clear how the value of the firms would be determined. They had not purchased life insurance on each other to cover buying out the other's interest. They had not had professional business appraisals done. The friend's husband became terminally ill and died in January. The three businesses turned out to be worth about $400,000, but the widow was shocked to learn that she was getting $30,000 for her half.
Unbeknownst to the woman, her husband of 25 years-who most recently had been earning $100,000 annually-had agreed at one point that $30,000 would be paid for his share when he died.
Hamilton doesn't think the husband intended to shortchange his wife. But he does think the man didn't know what his businesses were worth. A financial advisor would have been able to play a key role in this story-and others like it-having a happier ending, he says.
"An advisor could say, 'Let's get a buy-sell agreement, let's get an idea of what the company is worth, and let's put in for life insurance,'" Hamilton says.
Getting an idea of value is an important part of that package, but most small-business owners don't get appraisals done unless there's a specific reason, such as a divorce or a buyout, Murphy says. But a valuation done in advance of life-changing events may benefit business owners in many ways and help their advisors make better recommendations.
Although an appraiser should be independent, Murphy adds, he or she can still work as part of a team with an advisor and provide a lot of helpful feedback. "A good valuation will go into the value drivers and subtractors," Murphy says. "It will not only provide the value, but the analysis will tell the owner and the advisor the issues and factors that are driving the value and the issues that are taking away from it."
Many advisors rely on people specializing in business valuations and certified by one of the industry's national associations (see sidebar) to perform a good appraisal. But planners sometimes get help valuing businesses from others, too.
Philip J. Capell, an advisor and lawyer who is president of Piermont Financial Inc. in Melville, N.Y., says he tends to refer his clients to appraisers he knows personally, have good reputations and are in good standing with the Internal Revenue Service. "Some clients say, 'Why can't my accountant do it, someone who is on the payroll?' In some circumstances, that may suffice, but generally a business appraiser is the way to go," he says.