It is a pretty straightforward matter to check the value of your IBM stock. Just pick up the morning paper and bingo, you have the daily value of most any widely held, publicly traded stock.
What about the value of your shares of stock in a closely-held corporation? This is not such a simple matter. Your shares may represent 100% ownership of a business you built or partial ownership of a business you invested in, inherited or received an interest in as a result of some other settlement.
There are many important reasons for knowing the value of your closely- held stock. Obviously if you are contemplating the sale of your interest, the current value is important. It is often assumed that the marketplace, “what a willing buyer will pay a willing seller”, establishes the price. That’s true, but that process is a negotiated one and the party with the most knowledge can use it to their advantage. Being in possession of an independent valuation and the facts that support it can be an invaluable negotiating tool.
Other common reasons for needing a current valuation of your closely-held stock include estate planning, shareholder agreements, recapitalizations, employee stock plans and property settlements. An important but often overlooked reason is just simply the need to know. If you are the owner, it can be comforting to have an outsider’s opinion of the value of your firm as you develop your plans for the future.
Regardless of the method employed for the valuation of the closely-held company, several factors, including expectations for its industry and the economy, will influence the results. The degree and dispersion of control is a significant factor in the closely-held firm. All other factors being equal, a controlling interest will command a higher per share price than a minority interest.
The valuation will also be influenced by the importance and continuity of the management. The intangible value of a business (excess of total value over appraisal value of net assets) will be discounted in the event of loss of key management. The tax implications of the assignment of values to assets can effect the valuation to both parties in the event of a sale.
With these general factors in mind, there are several well accepted methods which can be used to estimate the fair value of a closely-held business. For certain businesses, an Accepted Industry Method is commonly used. This would be appropriate for businesses such as health care facilities where a “per-bed” basis is used or a professional corporation which may be valued as a multiple of billings.
The Assets Method requires that all the company’s assets and liabilities be adjusted to current market values. For example, a ten year old building may have cost $200,000 and is currently carried at $100,000., but its present worth is $350,000. Once the net appraisal value has been determined, an adjustment is made if the company’s actual rate of earnings, based on the appraised value, is above or below an industry average rate of return.
The Comparable Price Method uses the price/earnings ratio of similar publicly held companies. The earnings of the subject company are adjusted for extraordinary items such as owners compensation and the resulting value is subjected to a discount to reflect the lack of marketability of the closely-held stock.
The Income Method capitalizes earnings over a five to seven year history. When employing this method it is important to consider the cyclical nature of the industry and insure that both the high and low points of the cycle are represented.
The Discounted Cash Flow Method involves forecasting the expected cash returns from the business over a five to seven year period. This method is appropriate for stable concerns whose earnings and cash flows are reasonably predictable. These amounts are then discounted by a projected risk adjusted rate of return.
Valuing a closely-held business requires professional judgment and consideration of a number of objective and subjective criteria. It is not an exact science. The validity of the result will be determined by the suitability of the method chosen and the facts that support the final valuation. Because its your business, you just might want to know what its worth.
Joe Driscoll is a management consultant whose column appears regularly in the Monday Herald.