An independent valuation can provide business owners, executives, and directors with a baseline value and a set of tools to better understand the company’s position in the market, its competition, and its key value drivers. These metrics can be vital for setting goals, enhancing value, developing a succession plan, selling your company, and attracting new investors, and for other reasons we outline below.
Enhancing ValueFor privately held companies, shares of stock are not publicly traded in an open market, so indications of value are not easily obtained. An independent valuation can provide this information. But why would a privately held company need one? As mentioned above, valuations are performed for a host of purposes, including selling or acquiring a business, gifting shares, divorce, death, or litigation.
While an independent valuation establishes value as required by the specific events listed above, should you wait until such an event occurs before obtaining one? The answer is that there is no need to wait to know your company’s value. A baseline value assessment can assist owners and investors alike with developing strategies and goals. A valuation can also help you better understand what is working and what isn’t.
An initial independent valuation might help you establish specific goals as part of your larger business strategy. Then, an annual valuation would allow you to measure and track performance against those goals, create accountability for your employees, and help you understand your position in the market.
Developing a business strategy isn’t the only reason to obtain an independent valuation. You may wish to know your company’s value in order to set up succession planning, whether you’re gifting shares to family, arranging the sale of the business to another company, or by selling the company to employees through an employee stock ownership plan (ESOP).
Whether an independent valuation is required or not, it can prove to be extremely beneficial and provide you with a great deal of knowledge.
Private equity groups (PEGs) invest billions of dollars in entrepreneurial ventures. Many of these transactions are structured so that owners and management teams receive rollover equity or noncash incentives (such as stock options) as part of their compensation packages. Equity compensation can be a useful tool in aligning the interest of the company with the interest of the former owners or employees. To the extent the company does well and the stock price appreciates, the former owners, directors, and members of management who hold shares in the new company increase their wealth through the sale of those securities.
Equity compensation is subject to certain rules, however, and valuation is a key component of those rules. For example, Section 409A of the Internal Revenue Code addresses the taxation of deferred compensation. Recipients of options could be taxed according to the extent options are “in the money” when granted. The “in the money” portion could be deemed current income and is subject to being taxed as such. This taxable portion, if any, depends on the value of the company’s underlying stock. That value is established by “qualified appraisals” issued by an independent party. In other words, employees who receive equity compensation need to know the company’s value for their own tax purposes. Although this tax consequence impacts employees, the company could be responsible for failing to withhold and pay appropriate taxes.
Similarly, if your company is required to maintain GAAP-compliant financials, you may need to comply with ASC Topic 718, Compensation – Stock Compensation, when issuing equity as compensation to employees. The standard outlined by ASC Topic 718 provides guidance on how to account for noncash or share-based payments on company financial statements. In many instances, valuations are required in order to determine the value of the award issued as compensation as of the grant date and to establish the liability on the income statement.
Likewise, if your company is backed or owned by PEGs, you might seek an independent valuation to properly account for an acquisition. In many instances, PEGs invest in “platform companies” and grow that platform company by acquiring similar or related companies. To comply with ASC 805, the platform company must allocate the purchase price to the various assets acquired, which are then recorded on the buyer’s financial statements. A purchase price allocation which assigns value to all the acquired tangible and intangible assets (and goodwill), is generally performed by an independent party using specific methodologies developed for this purpose.
Companies backed by PEGs may also benefit from an independent valuation for fairness or solvency opinions. While not widely applied to privately held companies, fairness opinions—which are not required—can be an important aspect of a board of directors’ due diligence when entering into a transaction. This may be especially true if the shareholder group is diverse and members represent differing interests, which may be the case for companies with complex capital structures, including preferred classes of stock. In contrast, solvency opinions are required by statute in certain situations. In both scenarios, the use of independent advisors is critical to establishing credibility.
Fortunately, not all situations requiring independent valuations are as severe as death and taxes. The receipt of stock options, a successful acquisition, and the sale of a company offer good opportunities for independent appraisals. While the reasons for obtaining independent valuations may vary—particularly among PEG-backed companies—the results are clear. Independent valuations yield the information needed to meet legal, filing, and fiduciary requirements.
If you have comments or questions about this article, or if you would like more information on this subject matter, please contact us.