A previous post on this blog discussed how an executor of a will or a trustee of a trust can put a correct value on some common types of property a person may hold when he or she dies. This process is important for a variety reasons and may rightly be called one of the most important things an executor or trustee will do as part of his or her duties.
One thing the previous post did not discuss was how to value a family business, which, in the vast majority of cases, is not publicly traded. Putting a value on this type of business is not just a matter of looking up stock prices, but, on the other hand, a person’s share in a family business could be the most valuable piece of property in that person’s estate.
Like any other piece of property, the true value of a family business is what a buyer is willing to pay for it on the open market. In many cases, though, the surviving family members will have no desire to sell the business. In this case, even if all of the family members are getting along, it may be best to get an accountant or other expert who has experience evaluating the net worth of businesses.
Still, a person can get a good estimate of a business’s value using a formula. The first step in this formula is to figure out the dollar value of the seller’s “discretionary earnings.” These earnings are not just the profit shown on the business’s tax return, as that number is often reduced by certain expenses that are not strictly necessary but that reduce the tax burden on the business.
Typically, a business will sell for one to three times the value of “discretionary earnings,” depending on the type of business and other circumstances. Furthermore, the value of any real estate the business owns and certain other types of property, like cash, should get added in to the sale price. Any debt or liability a hypothetical buyer would have to assume when buying the business should be subtracted.