How to Maximize Valuation Discounts When Factoring Company Value
Utilizing key business valuation discounts can be very helpful when passing a percentage of a company to a family member or key employee.
By Mitch Reitman
Many people think of business valuation as a “rough estimate” or “best guess.” While it is true that a large percentage of security companies are not worth much more than their recurring monthly revenue (RMR) times a multiple, valuation is a profession. In fact, even the multiples that we hear thrown about are the indirect results of careful, well-reasoned valuations of the large aggregators in our industry.
While valuators are not licensed, most are professionals and have adopted standards that govern business valuations. Though this may not matter to the small business owner just trying to “find out a multiple” of RMR, the standards come into play when a business is being valued for reasons such as secession planning, divorce, partner disputes and others.
Many organizations, such as the American Institute of Certified Public Accountants, have created professional standards that their members adhere to and follow. In addition to professional standards, valuations are also affected by case law, most of which has been decided in the tax and divorce courts.
When we perform a valuation for a security company or systems integrator, we consider various discounts. Two of the most common discounts are for lack of control and lack of marketability. We encounter these quite often when determining the value of a less than 100% interest for a minority owner or newly anticipated stockholder. The reasoning behind these discounts is that a minority owner typically cannot effect the sale of the entire business (lack of control) and may not be able to sell its interest to whomever they want, and, even if so, the minority interest is not worth as much as a majority interest.
Utilizing these two discounts is very helpful when passing a percentage of a company to a family member or key employee. If we can legitimately lower the value of the stock, we can save the recipient income of estate taxes. These discounts are also valuable when the majority stockholders seek to set a price for the buyback of a minority owner.
Unfortunately the Internal Revenue Service does not like these types of discounts and has proposed regulations that effectively eliminate them between family members and trusts. Note that these regulations are proposed and have not yet gone into effect. Although they do not pertain to decedents who die before the regulations are final, they will most probably affect existing trust agreements and other agreements that call for interests to be gifted at the time of a decedent’s death. The regulations may even effect the estates of decedents who die less than three years before they go into effect.
If you have not developed a secession plan, are contemplating giving stock to family members, or are involved in a dispute of fair market value of your company, you should consult your tax advisor to discuss moving forward before the regulations go into effect (if they go into effect at all).
Mitch Reitman is Managing Principle of Fort Worth ,Texas-based Reitman Consulting Group and a member of SSI‘s Editorial Advisory Board. He can be contacted at (817) 698-9999 or firstname.lastname@example.org.
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