If you own a business, proper planning is necessary to make sure that the business will continue after your death, and that your estate will be distributed properly. Planning for a business in an estate is difficult and requires careful attention. In this Notes I will talk about valuation, and in later Notes will discuss buyout agreements and other issues.
One of the first questions is how much the business is worth. The fair market value of a business is the net revenue it will produce. This can be adjusted upward or downward by taking into account future prospects of the business, including the general economy, the level of existing competition, and the difficulty, such as the cost of equipment, of entering the business.
Often the owner of a small business may undervalue it or overvalue it - sometimes by a great deal. A small business owner will overvalue his business by counting the revenue produced without an allowance for his own compensation.
The owner of a small business wears many hats - salesman, purchasing agent, personnel manager, advertising manager, collection manager, office manager, chief executive officer and research director, to name a few. Hiring someone with some of these abilities may be expensive, and hiring someone capable of all of these functions may be impossible. If you subtract from the earnings of the business a fair salary for the owner, the result may be a negative figure, and the business is worth only the value of the assets.
Sometimes the value of a small business can be determined by the sale of similar businesses, but this is tricky. Location may be a big factor, and apparently similar businesses may have substantially different reputations or other factors that dictate value.
The client's accountant, who has followed the business for a number of years, may be the best person to evaluate the business. This is particularly true if he or she has provided services to others in the same business, and is familiar with the local area.
In the next Notes I will discuss other issues having to do with the small business and its relation to the estate plan. We will be happy to work with you on estate planning or business continuation matters.
