Valuing a Business and How It Affects Estate Planning

Valuing a Business and How It Affects Estate Planning

By |2017-08-08T19:22:29-07:00Friday, May 05th, 2017|Estate Plan|0 Comments

As you’ve long known if you follow my blog, it’s important to know your financial net worth. One part of that is knowing your small business’ value. This can be critical to creating an estate plan that works for you. But how do you figure out what your small business is worth, and why does it matter for your estate plan? This post answers those questions.

Business Valuation Generally

Valuing a small business is a complicated task. Business appraisers have several methods available to do so. One method looks at the small business’ assets and liabilities. Another method considers the annual income earned by the business, and often requires multiplying that income by some number. These methods are more complex than I’ve made them sound, but they’re often just the first step in figuring out a business’ value for estate-planning purposes.

Premiums and Discounts

The next step in valuing a business—or, more precisely, in valuing an ownership interest in the business—is to apply certain premiums or discounts. These account for differences in control and marketability. For example, a 51% interest in a business worth $2 million would actually be worth more than 51% of $2 million, because 51% is a controlling interest in the business. In contrast, a 10% interest in that business would be worth less than 10% of $2 million, because the owner of the 10% interest lacks control over the business. The value may also be affected by a discount for lack of marketability. For most small businesses, there isn’t a market where the business can be easily sold. Consequently, an interest in the company isn’t worth what it would be if, for example, the company were listed on a stock exchange. These premiums and discounts are an important consideration when valuing your business and in crafting an estate plan.

How Business Valuation Affects Your Plan

Here’s why your business’ value is important for estate planning: the value of any business interest you own at your death will be included in your gross estate for estate-tax purposes. That’s true regardless of whether you own the business outright, through a business entity, or in a living trust. So, if your business is worth enough that, combined with your other assets, you might be liable for estate tax, you need to have a plan to minimize or eliminate that liability.

I alluded to one strategy for dealing with a small business when the estate tax is a concern in a post from last month. Namely, you may want to transfer interests in your small business to your children while you’re still alive. In some cases, it may make sense to do so even if the value of that gift exceeds the annual gift-tax exclusion amount (currently $14,000). Because of the valuation discounts described above, such gifts may allow you to transfer those partial interests at a lower valuation than if you wait until death to transfer your entire interest. Of course, this strategy involves trade-offs, and one of those trade-offs is giving up the potential for stepped-up basis in the transferred ownership interest.

As you can see, these are not decisions that can be made in the abstract. Instead, they must be made in the context of a particular business and a particular estate. That’s why you should contact a knowledgeable and experienced estate-planning attorney to help you understand how your business affects your estate plan.

About the Author:

Bridget Mackay is a Petaluma estate planning attorney who has been practicing law since 1996. She is a member of the Sonoma County Bar Association, California State Bar Association Trust and Estates Section and on the Board of the Sonoma County Women in Law. She also sits on the Board of the Cinnabar Arts Corporation in Petaluma. Connect with Bridget on Google

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