Business Valuation Proposal

Transcription

1 Nationwide Life Insurance Company One Nationwide Plaza Columbus, OH Business Valuation Proposal Prepared for: Presented by:, Prepared on: July 29, 2015

2 Page 2 of 8 Important information This report discusses several business succession planning alternatives. All of them are based on assumptions disclosed in the report and information you provided. Any changes in the assumptions or information you provided will change the results. The use of any of these alternatives in the report does not constitute a recommendation by Nationwide. They simply show the potential effect of that alternative on your business, personal finances and possibly your estate. Growth rates were either provided by you or are default rates used by Nationwide. The valuation reported by Nationwide is not necessarily the value of the company. It is only intended to be a starting point for discussion. A formal valuation engagement can establish a fair market value of the company, but even then the final valuation will be based on the arm's length negotiations between the seller and buyer. The seller and buyer should consult legal, tax and financial counsel for assistance in determining the appropriate value. The term Proposal, as used in this report, is not a recommendation that the specific business succession planning alternative should be put in place. Just as with the valuation, it represents a starting point for developing a specific plan. Several factors will go into the determination of the specific plan to which the seller and buyer agree. The seller and buyer should consult legal, tax and financial counsel for assistance in determining the appropriate structure for the succession plan. Business succession planning goals are subject to change as circumstances change. Your succession plan should be reviewed at regular intervals, and more frequently as circumstances change. Federal income tax laws are complex and subject to change. The information in this paper is based on current interpretations of the law and is not guaranteed. Neither the company nor its representatives give legal or tax advice. Please consult your attorney or tax advisor for answers to specific questions. Life insurance is issued by Nationwide Life Insurance Company or Nationwide Life and Annuity Insurance Company, Columbus, Ohio.

3 Page 3 of 8 Determine the value of your business Short of engaging in arm's length negotiations with an actual buyer, there isn't a precise way to determine the value of the business. There are several different recognized ways to arrive at a value of a business, and all of them are dependent on the judgment of the professional valuator doing the valuation. Circumstances that may require you to value your business include when you execute a buy/sell agreement, for bonding purposes, to secure a loan, and for gift and estate tax purposes. If you own the business when you pass away, it will be included in your estate and will be subject to federal estate tax. If your estate tax return is then audited, the Internal Revenue Service will seek to value your business at its highest and best value, and the representatives of your estate will seek to value it as low and conservatively as possible. Therefore, for estate and gift tax purposes, it is in your best interest to determine the lowest, but most defensible value. Here are descriptions of five of the most commonly used approaches for valuing a business. Book Value: This is the net worth of the business - assets minus liabilities. Both assets and liabilities must be appraised and adjusted to their fair market value. The appraisal will vary based on whether it is for liquidation purposes, or the business is valued as a going concern. Straight Capitalization:The value equals the amount of capital an investor would have to invest to yield the current average profit of the business, at a given capitalization rate. Excess Earnings, Capitalization Method:This method assumes that some of the earnings are attributable to the book value of the business. Earnings in excess of a conservative rate of return on the book value are capitalized at a capitalization rate, and then added to the book value. Excess Earnings, Goodwill Method:As with Excess Earnings, Capitalization, this method assumes that some of the earnings are attributable to the book value of the business. Earnings in excess of a conservative rate of return on book value are calculated and multiplied by the number of years the business's goodwill is expected to last. That amount is then added to the book value to determine the total value of the business. Discounted Future Earnings:This method is used when historic earnings are not thought to be a reliable estimate of future net cash flow. Each year's estimated future profit is discounted back to a present value using a present value factor. In addition, the estimated capitalized level profit is calculated and discounted back to a present value. The book value of the business is added to all the discounted values, and the total is the value of the business. It's important to note that the average of the five valuation methods is not considered an acceptable valuation. Also, a professional valuator should be engaged to determine the best valuation method and value.

4 Page 4 of 8 Assumptions for estimated valuation Business Name: Financial: Book value $380,000 Average annual taxable income $500,000 Adjusted average profit $650,000 For calculations: Discount rate 30.00% Long-term sustainable growth rate 5.00% Capitalization rate 25.00% Conservative rate of return 5.00% Expected life of goodwill 5 Annual growth rate 10.00% Years future earnings forecasted 5 Data listed above has been drawn from information supplied and/or assumptions from the Life Illustrator case design.

5 Page 5 of 8 Estimated business valuations Book Value Book Value $380,000 Straight Capitalization Adjusted average profit $650,000 Capitalization rate 25.00% Business value $2,600,000 Capitalized Excess Earnings Adjusted average profit $650,000 Book value $380,000 Conservative rate of return x 5.00% Conservative return on book value $19,000 - $19,000 Excess earnings $631,000 Capitalization rate 25.00% Capitalized excess earnings $2,524,000 Book value + $380,000 Business value $2,904,000

6 Page 6 of 8 Estimated business valuations (continued) Excess Earnings, Goodwill Approach Adjusted average profit $650,000 Book value $380,000 $380,000 Conservative rate of return x 5.00% 5.00% Conservative return on book value $19,000 - $19,000 Excess earnings $631,000 Expected life of goodwill x 5 Excess earnings due to goodwill $3,155,000 Book value + $380,000 Business value $3,535,000 Discounted Future Earnings Future Value Discounted Value (at discount rate) First year estimated earnings $715,000 + $550,000 Second year estimated earnings $786,500 + $465,385 Third year estimated earnings $865,150 + $393,787 Fourth year estimated earnings $951,665 + $333,204 Fifth year estimated earnings $1,046,832 + $281,942 Terminal value fifth year capitalization rate $4,187,326 + $1,127,769 Book value + $380,000 Business value $3,532,087

7 Page 7 of 8 Comparison of business values Book Value Straight Capitalization Excess Earnings, Capitalization Excess Earnings, Goodwill Discounted Future Earnings $380,000 $2,600,000 $2,904,000 $3,535,000 $3,532,087 Average: $2,590,217 * * Note that the average of the five valuation methods isn't considered an acceptable valuation. Also, a professional valuator should be engaged to determine the best valuation method and value.

8 Page 8 of 8 Valuation Guidelines The price set in a buy/sell agreement can determine the value for tax purposes, provided it meets the requirement set forth in Section 2703 IRC and the related case law. However, when auditing of the income tax return reporting the transaction, the IRS can challenge the valuation if it doesn't appear to the IRS that it reflects the fair market value of the business. In other words, the buy/sell agreement may be binding on all parties, but the IRS can still contest the valuation and propose additional tax if it feels the value in the agreement isn't correct. Revenue Ruling defines fair market value as "the price at which 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." While conceptually clear, that definition is far too ambiguous to be valuable in actually valuing a business. Revenue Ruling is foundational in providing guidance in valuing businesses for purposes of buy/sell agreements and estate and gift taxation. It states that although several methods or formulas are available for valuing a business, no there is no single way to value a business, and all facts and circumstances relevant to the business must be considered in determining a value. It lists several factors that must be considered: The nature of the business and its history, from inception to date The economic outlook for the overall economy and that particular business or industry The capacity of the business to earn a profit The ability of the business to pay a dividend Whether the business has goodwill or any other intangible value Sales of interests in the business and the size of the interest to be sold The price of the stock for publicly traded companies in the same or similar line of business How each of these factors is weighted, or considered, will depend on the circumstances of the business, but all of them must be considered. Life insurance is issued by Nationwide Life Insurance Company or Nationwide Life and Annuity Insurance Company, Columbus, Ohio. Nationwide, the Nationwide N and Eagle and Nationwide is on your side are service marks of Nationwide Mutual Insurance Company Nationwide CLM-0882AO (03/15)