Fair Market Value

Did you know that over 98% of business owners do not know what their business is worth?

Planning for the future for your business or your life, in general, is difficult when you don’t know how much your most valuable asset is worth. This is the reason for understanding what “Fair Market Value” is, and how it relates to your business.

The IRS Revenue Ruling 59-60 reads like this “The fair market value of the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.”

An individual who is interested in acquiring a business should request all relevant facts about the business. This is usually not the case though. Traditionally, a prospective buyer is requesting bank statements to verify its cash flow. 3-5 years of taxes or financial statements is another request. Then, the potential buyer can determine if there is growth and that the business is bringing in revenue. Believe it or not, this is how many businesses are sold. Negotiations are made with a portion of the information, but not all.

We would argue that bank statements and financial statements is the preliminary stage of analysis, and would never recommend someone stop there. We are yet to check databases on what companies of like kind have sold for, we haven’t adjusted for potential salaries that are related to family members, and we haven’t based our determination on why the business owner is selling. The most important question to address, do the financial statements reflect real owners compensation?

This additional type of analysis is necessary when considering the purchase of a business. It is also important to the seller, so expectations can be managed when selling their largest asset. A calculation of value can address these essential elements, and help business owners plan accordingly.

We all want our businesses to grow in value, and when the time comes to be worth every dollar we put into it and more. Why we would make a decision without knowing all the relevant facts is beyond me. Always work with a valuator who considers all the relevant facts, and avoid cutting corners. As the distinguished firefighter would say;

If you think it’s expensive to hire a professional to do the job, wait until you hire an amateur.

Red Adair

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