How to Avoid Valuation Traps

Regardless of whether you decide to keep or sell your business, you need to know what it is worth and how its value affects you and your family’s financial profile and peace of mind. Valuation is both an art and a science. You can help dictate the valuation of your business by the way you position your business succession.

Three Types of Valuation

There are three basic valuations to consider in your planning: estate, financial and strategic.

An estate valuation may be appropriate for a business owner with a taxable estate. In this case, the owner may bifurcate between voting and non-voting shares. He or she may want to move minority, non-voting shares to the children and grandchildren.  A valuation for a non-voting, minority share of an illiquid privately held company will be significantly less than the 100% ownership interest. Depending on the factors and risks associated with the business, a 20% to 40% discount could be applied vs. a financial valuation.

A financial valuation could be considered a cash flow driven valuation or measured based on future earnings. If you plan to acquire a partner, sell to an Employee Stock Ownership Plan (ESOP), or a private equity firm, you should analyze the full fair market value of the enterprise, then determine the appropriate discount, if any, that should be applied.

A strategic valuation is typically used when an industry buyer will pay a premium above a financial valuation in order to create synergies and a strong competitive position for the combined companies. Thus, knowing the dynamics of the industry, the buyers, their motivation and willingness to share some of the benefits of the combination could provide a premium and deliver the highest value.       

Depending upon the best strategic positioning of your family wealth, all three valuations may come into play during the planning process. It is crucial to carefully design your business succession plan so that you do not set unintended valuation “traps”, which could hinder the effectiveness and increase the costs of your transition.

Where to Find Insight

Your PNC corporate and wealth team has a the experience and financial modeling tools to help you “fast forward” down the road of life when you are determining your company’s value. Take the guesswork out of the equation and make sure your team understands your objectives. They can outline your options so you can gain control of perhaps the most important financial decision you will make during your lifetime.

Please contact your PNC representative to further explore Business Succession Planning.