Academic journal article Journal of Accountancy

Valuing Closely Held Businesses

Academic journal article Journal of Accountancy

Valuing Closely Held Businesses

Article excerpt

VALUING CLOSELY HELD BUSINESSES

When the owner of a closely held business dies, one of the most important estate tax considerations is the value of the business. Because the stock of such a corporation is held by a small number of shareholders (sometimes only one), this stock is not widely traded and a market value is not readily available.

VALUATION FACTORS

While acknowledging that this process is inexact, the Internal Revenue Service has set out eight factors that should be carefully considered in determining the value of any closely held corporate interest. These factors are not given equal weight; they must be evaluated within the context of each company's situation. In addition, they are somewhat general; even using the same factors, different overall values may be reached.

The nature and history of the business. This should include consideration of all aspects of a company's business, its products or services, operating assets and facilities, capital structure, sales records and management track record.

The economic outlook of the industry. This analysis involves evaluating a company's economic position with respect to its current competitors as well as future prospective competitors. After a company's position within its own industry has been considered, the economic conditions in related industries and conditions in the national economy may be part of the analysis.

The stock's book value and the company's financial condition. Since book value usually reflects historic or acquisition cost, it is not necessarily a good indication of the fair market value of assets underlying the stock. However, it can serve as a starting point in a value analysis.

A variation might be to use asset valuation, that is, the actual fair market value of the underlying corporate assets.

The company's earnings capacity. This involves potential future earnings as well as current earnings and should include consideration of the nature of the company's business and the risks involved. For businesses that sell products or services to the public, usually this factor is by far the most meaningful.

Critical to this determination is the key employee concept. The rate used to value a company's earnings capacity may be discounted if the owner was the company's key employee and if much of the business was due to his or her individual efforts. …

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