Insights: Article

The Importance of Valuation

By   Chad Flanagan

March 07, 2018

Creative group of business people

Do you know how valuable your company is? No, we’re not talking about how much you think it’s worth. We’re talking about an independent appraisal of the worth of your company and how much it would potentially sell for. Welcome to the world of business valuation.

Why does this matter?
For one thing, it’s beneficial to have a qualified appraisal of the Company’s stock to provide stockholders with an estimate of their shares and their investment in the Company.

Further, a valuation is important for any stage business because it prepares you for a transaction triggering event, even when you don’t see one in your near future. Plus, you know what they say about best laid plans …

What do we mean by transaction triggering events? Here are just a few ideas:

  • Shareholder/employee quits
  • Shareholder/employee is fired
  • Shareholder retires
  • Shareholder wishes to sell stock
  • Shareholder becomes disabled
  • Shareholder death
  • Shareholder divorce
  • Company bankruptcy

When these types of things happen, they can cause a shift in your business and its future. It’s amazing how quickly your plans for your business may change when affected by these types of events. That’s why we recommend you consider including a well-defined valuation process in your buy-sell agreement.

Fine, tell me more.
One way to go about this is to choose a single appraiser now (not when the transaction triggering events have already occurred). Then have the appraiser conduct annual or periodic valuations of your business. This enables all shareholders to know and understand the value of your business throughout its lifecycle.

Why choose an appraiser early on? Well …

  • Selected appraiser will maintain independence with respect to the process and render future valuations consistent with terms of agreement and with prior reports.
  • Appraiser valuation process is known by all parties at the outset.
  • All parties know what will happen when a trigger event occurs, rather than scrambling to put together a game plan.
  • Because the appraiser must interpret the ‘words on the pages’ in conducting the initial appraisal, any issue regarding lack of clarity or terms would be resolved. Subsequent appraisals, either annually or at trigger events should be less time consuming and expensive than other alternatives.
  • Parties should gain confidence in the process.
  • Parties will always know the current value for the buy-sell agreement (this is helpful for planning all-around).
  • Appraisers’ knowledge of the company and its industry will grow over time.
  • This process creates a means of maintaining pricing for other transaction, enhancing “the market” for company shares.

Why do I have a feeling there’s more …
Because there is. Other things you should probably be consider but haven’t probably thought about include:

  • How are shares of your company purchased or funded? Where will the money come from?
  • Who buys the shares? Other shareholders? The company? A combination?
  • The Company has a number of life insurance policies. Is the insurance adequate?
  • Are there other financial resources available to buy the shares?
  • What are the terms of the transaction? (down payment, interest rate, security, etc.)
  • Are there any restrictions on share payments under the company’s loan agreements?

As you can see, there are a number of potential issues that could result in your buy-sell agreement being a “ticking time bomb.” So it’s important to discuss these issues early and often with your shareholders and your business advisors.