Short Answer…
Yes.

The Concept of Business Valuation
Whether you own a business and want to sell it, or else you’re an entrepreneur who desires to buy an existing small business, somehow or other you need to know what the company is worth.  On the selling side, the plan is to make the price low enough to attract a bevy of buyers, while making sure you’re not giving away potential profits.  From the buyer’s standpoint, you want to assess the value of a business in comparison to its posted cost.  The price you pay for a small business can seriously affect months or years of down-the-road profits, so this factor is not to be taken lightly.  In many cases, a seller will engage the services of an expert to determine a reasonable market value.  Buyers oftentimes hire their own experts to assess the price of a business they wish to acquire.  These dueling experts may arrive at vastly different figures.  Their ability to compromise can result in a mutually satisfactory transaction for both buyer and seller, but much of that process may be based upon what method each side uses to arrive at a price.

Determining the Value of a Business
There are three reasons why an owner of a small business will hire someone to determine its value—a pending sale, some sort of lawsuit, or else tax and estate-planning issues.  For the purposes of this article we are concerned only with the first, but the process is the same no matter why a valuation is required.  There are three basic methods experts use to value a business:

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Why Business Valuation Is Important
The process of arriving at an accurate assessment when valuing a business is perhaps the most challenging aspect of any prospective small business purchase.  A seller has arrived at a specific price he or she wants for the company, and one must determine if that business value is accurate.  Pay too much, and you will struggle to make a profit.  Pay too little—well, there’s hardly a down side there, but the scenario is unlikely at best.  There are several ways to value a business; choosing the most appropriate one for your situation—and ensuring that it’s accurate—can make the difference between success and failure.

Three Basic Approaches
Small business valuation generally falls into one of three categories:

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Fair Pricing for Buyers and Sellers

Whether you are planning to buy an existing business or expect to sell one you currently own, one of the biggest challenges involves deciding on a fair price.  As the buyer, if you pay too much, you risk damaging future profit by digging too deep a hole early in your ownership cycle.  As the seller, asking too little unfairly discounts the investments you made that created a successful business.  Additionally, an improperly priced company sends the wrong message to potential buyers.  If a business is being sold for significantly less than its true value, potential owners will immediately sense that something is wrong.  This is hardly the way to attract a group of qualified buyers.

Abandon the Dartboard

Believe it or not, one of the most common ways people price a business for sale is by guessing.  “Well, I paid X dollars ten years ago and made Y dollars a year in profit, so I’ll figure a 10 percent annual increase in value and sell it for Z dollars.”  Good luck convincing a savvy buyer that the price tag you posted is an accurate one.  One of the dangers of putting the wrong value on a business involves a concept called “shelf life.”  The longer your business remains unsold, the likelier it is you will sell it for far less than its true worth.  Let’s say you guess that your business is worth $1 million.  Maybe it is -maybe it’s not.  But because you have no facts to back up your claim, your company stays on the market for months and months.  As you get more anxious to sell, you keep dropping the price until a buyer surfaces.  That is neither a profitable nor a sensible exit strategy.

Revenue Versus Profit

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On February 17, 2009 President Barack Obama signed the “American Recovery and Reinvestment Act of 2009” (“ARRA of 2009) into law.  Section 1251 of the bill temporarily reduces the recognition period for “built-in” gains tax (BIG tax) on S Corporations from 10 years to 7 years for the 2009 and 2010 tax years.

Why is this important? 

Historically, if you were a shareholder in an S Corporation that converted from a C Corporation and sold the company within 10 years of the date of conversion, you would be subject to BIG tax.  For 2009 and 2010, that 10 year “recognition period” has been reduced to 7 years.  So, if you sell your S Corporation in 2009 or 2010 and it has been converted from a C Corporation at least 7 years prior, you will avoid the 35% BIG tax.  Companies originally organized as S Corporations have never, and remain, not subject to BIG tax.

A Closer Look

When you sell a C Corporation the proceeds from the sale of the assets are owned by the corporation.  They get taxed once at the corporate level (35%) and then again upon distribution to the shareholders where they are taxed at your personal rate.  This effective “double tax” makes it advantageous for the shareholders of a C Corporation to convert to an S Corporation prior to sale.  In an S Corporation the proceeds from sale are “passed through” directly to the shareholders and taxed ONLY at their individual tax rates.

Since the result of converting a C Corporation to an S Corporation is a reduction in revenue for the IRS, the IRS states that the conversion must occur prior to the recognition period or the proceeds from sale will be taxed on a prorated basis.

Example:

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Those of us who own businesses, corporations, and commercial or residential investment real estate assets are often reluctant to sell because of capital gains taxes associated with the sale. But what other choice do we have other than a property exchange directed by a Qualified Intermediary? Is there another way to deal with the capital gains tax deficits that so many investors experience when they sell their real estate assets? The answer may lie in the Deferred Sales Trust™.

This capital gains tax deferral tool could save you thousands of dollars, and at the same time, you would then have the opportunity to potentially make a profit on the money you would have paid to Uncle Sam in the year of the sale. Obviously, this strategy is gaining popularity among those who have highly appreciated assets that are marked for sale. You too can potentially take advantage of this program once you understand how it works.

The process starts when a property owner sells its property to a trust owned by a third party company. The trust sells the property or stock. Next, the trust “pays” you. The payment isn’t in cash, but with a payment contract called an “installment contract.” The contract promises to make payments to you over an agr­eed period of time. There are zero taxes to the trust on the sale since the trust “purchased” the property from you for what it sold it for. The payment is made with an installment contract which makes payments to you over an agreed period of time.

The options on when and how payments can be made are flexible. You may have other income and don’t need the payments right away. The tax code doesn’t require payment of the capital gains until you start receiving installment payments.

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These time tested techniques will do much to enlighten you to discover “hidden information” and relevant data as you prepare your 2008 Year-End Income Tax Returns. Whether you are a C Corporation, S Corporation, in Ministry, an LLC or LLP, Partnership or proprietorship looking beyond the numbers is the best way to discover critical and insightful news to help make wise and informed financial and business decisions. Whether you have a CPA prepare the return for your business or you chose to “go it alone” seeking out and utilizing this data will make you a wiser and more dutifully informed owner and entrepreneur. Evaluating and staying abreast of these key ratios, components and insights well help you steer clear of financial disaster:
 

Limit Debt Payments

We are continually exhorted to limit our debt payments but our society and now even our government has gotten on the band wagon of debt is good. In fact even the recent $15,000 “tax credit” announced by the IRS is not really a credit at all but a loan, as these monies will have to be ultimately repaid. By limiting your debt payments, you allow yourself to both have discretionary spending, to take advantage of opportunities, and to fulfill your mission statements and dreams. For the only way to have money, is not to spend it. A good general rule of thumb goes back to the old days of mortgage lending when debt could not exceed 25% of aggregate income and cash flow. In a bad economy a better goal would be 15% and when it is anticipated that interest rates are going to rise, then limiting your total debt payment to less than 10% would be prudent and advantageous. If we do not limit our debt then we will certainly become its slave.
 

Avoid Credit

If there is a key item on this list, it would be to avoid credit in its entirety.

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Choosing an Entity Type Which is Best for You and Your Business.

If you have just made the hardest decision of opting to go into business for yourself or if you have owned your own business for years, having a working knowledge of how your overall tax bill is determined can cost or save you thousands. Making the right decision for your business will be critical to both your short terms success as well as eventually how comfortable your retirement might be. To this end, setting up the right entity from day one is your best bet to ensure you pay no more taxes than are legally necessary. The job of your most trusted adviser, your CPA, is to assist and guide in this process being sure to ask questions and contemplate issues you might not have even known to be a concern. As a business owner or running your business, the options will appear to be daunting but these parameters will do much to “lift the veil’ on whether you want your business to be an S Corporation or an LLC.

Limited Liability Company.
Limited Liability Companies/LLC’s are legal in most, if not all, states where their respective legislatures approved them.  LLC’s allow for some flexibility options that are not allowed in some other entity selections as well as some liability limitations that are not otherwise available for professional service companies, those where professionals, such as physicians, are required to have a professional license in order to practice.

Advantages of being an LLC include:

• Ease of formation. LLC’s do not require a Board of Directors or an election of Officers.
• Anyone or entity can have ownership in an LLC. This allows other corporations or those who are not citizens of the United States to be owners.
• Unlimited number of owners.

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CPA Teaches Your Tax Payment/Filing Responsibilities

Paying Your Taxes/Extensions…The IRS Requires us to Pay as We Go

Since World War II, the IRS has been a pay as you go system. Prior to that time, the IRS simply collected their monies at the end of the year when one’s annual tax return was filed. Many entities by virtue of their tax treatment as flow through entities do not pay any income taxes when the returns are filed but rather the income is communicated to the partners via a K-1 which is a part of the return. The entity’s partners are then responsible for reporting their portion of the earnings on their personal/appropriate returns. Thus there are many entities such as Partnerships, LLC’s, LLP’s, an S Corporations for which no income taxes are due when these returns are filed. 

C Corporations are responsible for paying their taxes as they go and they do not have the ability to pay all of their taxes at year end and still avoid assessed penalties and interest. Thus, it is critical to tax plan several times a year to determine the ultimate amount of year end liability due and to take appropriate measures to plan accordingly. For S Corporations and individuals we suggest that you tax plan at least twice annually. At that time it is also advantageous to review a client’s internal finances and obtain their projections of profits for the rest of the year. By utilizing this information as well as by being aware of their personal return issues, itemizations, exemptions, etc. you are able to get an estimate of what your taxable income and your tax will be.Both the IRS and states require you to pay as you go thus requiring you to pay enough in estimates for the taxes due on the profits/taxable income generated.

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