As we’ve said before, buyers’ and sellers’ perspectives of the value of a business differ greatly. Both seek a good deal, the buyer wanting to pay as little as possible and the seller wanting maximum profit for the business he built with sweat and tears. Both perspectives have validity and are understandable. Therefore, using a sound method for determining actual value makes good sense.

Creating Value

The following factors create value in a business:

• A good recent profit history
• Good condition of company facilities, accuracy of books, employee morale, goodwill in the community.
• Demand for a specific type of business
• Current economy – the more investment capital available, the better the demand for purchasing good businesses
• Transferability of company assets. If intangible assets make up the bulk of the business’ assets, buyers question the viability since the asset may not transfer well to new owners
• Future profit potential – where is this business in the marketing cycle? Is the market pretty well saturated? Will the products become obsolete? Or is the business relatively young?
• Special circumstances of buyer or seller. If either the buyer or seller needs the sale, the resulting price changes based on the need. If the seller needs to sell, the price decreases. If the buyer needs a business investment, the price probably increases.
• Special terms available. Buyers may pay more for a business with special financing terms such as: less cash down, seller financing, lower payments at the start of the loan, etc.
• Tax consequences. Sellers experiencing a huge tax debt based on a sale stick harder to their asking price.

Valuation Methods to Avoid

While a “rule of thumb” might give you the ballpark price of a certain type of business, avoid using it to actually determine price. There is no such thing as a “one size fits all” in business. Location, inventory, the current state of the economy and many other factors toss “rule of thumb” rules right out the window

Comparable Sales once again provides a bench mark for the value of a business, but by no means provides a good sales price. No business is like another even if they sell the same product. The condition of the business, both physical and internal structure, changes from business to business

Reliable Valuation Methods

The adjusted book value balance sheet method of valuation provides a good look at value. (Note: Three balance sheet methods exist in accounting, book value, adjusted book value and liquidation value. Book value varies depending on accounting methods used, liquidation value really looks at the value at disillusion of a business.) Adjusted book value takes into account possible allowable but deceptive accounting methods. It looks at valuating the business assets in their current condition less current liabilities. Adjustments might also be made for obsolete inventory or inventory in poor condition, old accounts receivable, current market value of real estate, age and condition of furniture and fixtures.

The income statement method of valuation provides the most meaningful approach of valuation to the buyer. The buyer wants not only value, but cash flow, in order to remain a viable business. The discounted cash flow method looks first as historical cash flows and then projects future cash flows. Future cash flows are discounted to current value with a calculation for the residual value of the business at the end of the future cash flow projection. However, even the balance sheet and income statement methods of valuation are not without error. Looking at both methods of valuation along with viewing comparables and “rule of thumb” figures may give the buyer the most accurate point in which to start negotiations.

The Limited Liability Company (LLC) started out slow as a business entity. Wyoming, the first US state to implement this form of business ownership, passed legislation in 1977 adopting the LLC. It took another 5 years before the next state, Florida, enacted LLC ownership. Fortunately for many business owners, the LLC adoption spread like wild fire in the 1990s. By 1997 every state and the District of Columbia accepted this form of business ownership; Hawaii was the last state to jump on the LLC band wagon.

A limited liability company offers owners limit liability for a business’ debts and contractual obligations much like a corporation, with a less complicated formation. Unlike a corporation, a LLC passes all income and losses through to its owners like partnerships. Unlike a partnership or sole proprietorship, the creation of a LLC requires a state filing and designation of at least one officer. In a sense a LLC is a hybrid of a corporation and partnership.
 
Below we list some general advantages and disadvantages of the LLC entity. However, because state laws differ, these lists may or may not apply to the state in which you operate.

Advantages of a LLC

• The income from a LLC passes through to the owners, usually meaning a reduced income tax on income and avoidance of the corporation double taxation where income is taxed at the corporation level and again when distributed to individuals.
• Owners of the LLC receive legal protection from the debts and acts of other members of the LLC.
• A LLC requires only one owner (in most states)
• A LLC can continue after the death of its owners
• Setting up and continued operation of a LLC requires far less paperwork than a corporation.

Possible Disadvantages of a LLC

• Income received from a LLC is subject to self-employment taxes
• Sale of more than 50% of the capital and profit of a LLC within a 12 month period terminates the LLC for federal income tax purposes.
• An LLC with losses greater than 35% passed to non-managers of the company may not be able to use the cash method of accounting.
• Each state’s laws regarding the LLC entity differs, possibly creating confusion for entities operating in more than one state.
• An LLC with less than two members is treated not as a partnership but as a sole proprietorship.

The New York Times ran a story in the business section on May 8, 2008 which demonstrates how business students and existing businesses benefit through collaboration. Stetson University business marketing students teamed up with Complete Parachute Solutions Inc., providing fresh marketing ideas and market research which helped Complete Parachute discover new markets and new methods of marketing.

The students provided Complete Parachutes information as to how a Democratic President might affect their business and also found new overseas markets for the company. They also spent time critiquing the company’s website and provided recommendations for making the site more user friendly and with better navigation.

The Kauffman Foundation, formed by Kansas City’s dynamic Entrepreneur, Ewing Kauffman, also encourages this type of collaboration. Vice President for Entrepreneurship, Bo Fishback cites how students research and find answers for companies interested in marketing new products.

Didi Davis Food in Ipswich, MA used a college consulting program at Babson College for putting her new business featuring gourmet condiments on track. Her business didn’t even have a business plan until she teamed up with students. Their first recommendation brought Mrs. Davis and her business into the “real world” with the recommendation for a proper accounting system. The Masters Degree student, Aditi Chowdhary, who headed the team, found the venture gave her management expertise she expects to use in her family business in India after graduation this week.

Stetson’s program is so popular with those contemplating starting a business or needing consulting work from students that Dr. Oliphant reports turning away requests from those wanting a “free diagnosis”.

When buying or selling a business in Wisconsin, the transfer may affect your unemployment insurance. For example, if you purchase at least 25% of an existing business in Wisconsin, you may continue using the unemployment insurance account of the previous owner if you choose. The previous owner’s low unemployment insurance rate may be attractive, decreasing the amount of taxes you pay.

If you choose continued use of the previous owner’s unemployment insurance account, ensure the previous owner paid all previous taxes owed and that you make timely application. See http://dwd.wisconsin.gov/UITAX/trans.htm for application deadlines. Also investigate whether any former employees are currently receiving unemployment benefits; if former employees currently receive benefits, these payments get charged to the account you assume. This may cause rate changes in the future.

If you are a current Wisconsin employer, the rate of any account assumed is combines with your current rate for an adjusted new unemployment insurance rate. If you choose not to assume an unemployment insurance account, use your current account if you already have one. Wisconsin unemployment insurance assigns new accounts to those without a previous account.

When You Must Assume an Unemployment Insurance Account

Spouses, parents and children must take over the unemployment insurance account of a business transferred to them. A business changing entity types, current partial owners assuming additional ownership and subsidiaries merging with a parent corporation must also continue use of the previous unemployment insurance account.

When a business transfers ownership, the Wisconsin Unemployment Insurance agency must be notified, regardless of whether the new ownership continues using the previous unemployment insurance account.

When s Business Transfers Occur:

Sales, leases, business reorganizations, mergers, consolidations, foreclosures, inheritance and bankruptcies usually signal a business transfer.

Sales of corporate stock, corporate name changes, transfers of employees or payroll and sales of assets in the normal course of business are not business transfers.

BusinessWeek Online reports a rise in business bankruptcies with more businesses filing for the month of April 2008 than any time since the 2005 change in bankruptcy laws. April 2008 averaged 263 commercial bankruptcy filings per day compared to April 2007 when the average daily commercial filings were 158.

Hedge funds and large banks experienced a huge financial crisis in 2007 when fool hardy sub-prime loans; some economists believe these troubles hit the small business community in 2008, but if these instruments passed on any affect to small businesses, it wasn’t from poor investments, but rather the inability to stay afloat when credit dried up.

Unfortunately, many businesses attempt survival on credit cards. In a credit crunch, interest rates on credit cards take a big bite on monthly cash flow. Banks, after the slaps faced with sub-prime mortgages, tightened their lending standards, making it difficult for small businesses to find additional working capital. It’s a warning to all businesses that conserving capital for a rainy day means survival in hard times; failure to do so means the probable demise of the business.

The number of failing businesses could easily be much larger than shown in the above statistics because businesses without creditors simply close down. More and more businesses also avoid court and the bankruptcy stigma by out-of-court settlements. The business owners simply meet with creditors and work out an agreed settlement. In both of these situations, businesses failed but weren’t reported in the Automated Access to Court Electronic Records (AACER) system reported on by BusinessWeek.

Many of the reported failed businesses may be those involved in residential building and residential real estate in states like Florida and California. With the huge profits realized in residential real estate in these states, building was at an all time high. Don’t expect things to even out for awhile in the residential market. The housing market isn’t expected to settle down for at least another year with some warnings of a housing market down trend expected for about 5 years.