Employee Stock Ownership Plans (ESOPs) have become commonplace in the United States, with 6,669 plans covering 14.4 million people. ESOPs are a fantastic option for private companies that want to reward and motivate employees by providing them with equity, but how and when share prices are valued is somewhat complex. Typical stocks are valued on a public stock exchange, meaning that the valuation and how it is attained is transparent and updated daily. ESOPs work differently. The Department of Labor mandates that an ESOP value its shares at least annually, which may seem extreme, but given how these share prices are determined, regular valuations are in everyone’s best interest.
ESOPs must determine what their shares would sell for on the open market without the benefit of actually being traded on one. That means that the trustee of an ESOP typically sets the share price based on a recommendation from an independent, third-party valuation firm. There are several methodologies used for valuations, but all take historical and future projected financials into consideration. Most appraisals utilize an income approach, which relies heavily on financial data. The approach may examine historical results, dividing them by a capitalization rate to determine value. It may also forecast future cash flows, which are then discounted back to the present value. Either way, organizations and their employees benefit most when updated financial information is provided and analyzed annually, so that share prices are never severely outdated, reflecting values that are either considerably higher or lower than is appropriate.
Similarly, other market factors that may change during the course of a year could have a profound effect on share prices. Industry performance plays a role, as does the competitive landscape. When major competitors are bought or sold, or when they experience an event that either leads to exceptional performance or bankruptcy declarations, these factors affect your industry standing and therefore inform value assessments.
ESOP companies grow 2 to 3 percent faster than would be expected without an ESOP, and have lower turnover and 2.5 percent higher productivity. Furthermore, ESOPs that leverage an ownership culture throughout the organization grow 6 to 11 percent faster. In order to reap these benefits long-term, however, ESOPs need to be actively managed. This ensures that employees understand the true value of their compensation packages and can rely upon their future existence. When ESOPs are not frequently monitored, this often leads to the program’s termination.
Over time, shares are allocated and debt is repaid, meaning that repurchase liability can accumulate quickly and consume a growing share of cash flow. If this has not been anticipated, cash that might have otherwise been used to fund growth initiatives is eroded in order to satisfy the company’s repurchase obligation. When the company’s growth is stifled, causing stock prices to drop, this burden becomes too heavy to shoulder. In order to properly manage ESOP obligations and ensure this does not happen, companies must regularly study their future repurchase obligations through the lens of regularly updated future stock price projections.
Valuing ESOP stock prices annually not only fulfills the Department of Labor’s mandate to do so; it also ensures the long-term viability of the company, their program, and the ongoing high performance, productivity, and satisfaction of employees.
Some of the most valuable trademarks are also the most recognizable company names: Google, Microsoft, Walmart, Mercedes, and others. However, trademarks protect more than corporate names. They also safeguard logos, designs, product names, taglines, and more. Furthermore, trademarks are not simply for Fortune 500 companies, either. Smaller organizations rightly rely on them too and, regardless of the nature of your business, you should never underestimate the potential value a trademark holds for your brand and, by extension, your company.
It is now widely believed that trademarks are a substantial portion of intangible value for companies, and intangible assets now account for approximately 80 percent of the value of an average U.S. company. That figure is substantially larger than it was even a few years ago and continues to grow. It is hard to ignore the math. Trademarks have become so valuable because they actually generate revenue.
Trademarks help distinguish your company and its products and services from the competition, making it easier to build trust with customers and, ultimately, attract and retain them. A trademark can function like a promise, becoming synonymous with a level of quality or service customers can expect and count on. It is the reputation of a particular brand. This brand recognition sways purchasing decisions and drives revenue generation, as does the fact that when certain products and services are trademarked, the competition is shut out from offering the same and thus revenues are maximized.
There is no more effective communication tool than an image, brand name, or tagline that succinctly conveys so much information. Trademarks tell a universally understood story about your reputation, your quality, your differentiators, and other intellectual and emotional attributes. Trademarks are valued both on their income history, as well as probable future sales and profits. Essentially, as your business reputation grows, your brand and trademarks become more valuable. And even though they make you money, they require minimal investment. The United States Patent and Trademark Office charges around $275 to obtain a trademark, and they are equally affordable to maintain.
Trademarks can also make it easier to expand your business into other industries or geographies. They can be bought, sold, or licensed, facilitate merger and acquisition activity, attract financing, and enable more effective recruiting. In more ways than one, Intellectual Property (IP) has become a coveted source of revenue.
With increased digitization, however, trademarks are becoming more difficult to protect. Information is shared online at such a dizzying pace, it is easier than ever before for competitors to embrace your ideas. Without trademarks, there is no recourse for this, meaning that a competing company could easily profit from another’s ideas, in some cases more so than the originator. Although IP disputes are becoming more common, they are much easier to resolve when you can point to trademark protections.
Most of today’s industries are rife with competition and when you create a trademark, you give your company the opportunity to differentiate itself from the pack. A well-executed trademark is specific enough to help you stand out, distinctly identify your business and, hopefully, your values. Most importantly, trademarks help generate more revenue (new and recurring) and protect those profits and your market share from others that are eager to erode it.
Fire, floods, earthquakes, and tornados; theft, vandalism, and negligence. Whether it is mother nature, an untrustworthy employee, or simply an error in judgement, business losses are a reality that cannot be ignored. When business owners suffer an equipment loss (and sometimes also a loss of accompanying records), nothing compounds that stress more than worrying about how to prove the value of those losses to an insurance company. Should you ever find yourself in the throes of the unthinkable, and you did not obtain equipment appraisals ahead of time, a retrospective appraisal could be your best path forward.
Eventually, damaged equipment will need to be either repaired or replaced. Retrospective appraisals comprise a trusted approach to dealing with significantly damaged equipment and involve the careful study of remaining paperwork and equipment to determine a defensible valuation of losses. Appraisers evaluate the equipment (if possible), as well as available records such as original purchase paperwork, maintenance logs, repair receipts, and other documentation that would support the equipment’s prior condition and resultant valuation. Most appraisers would also weigh demand for the equipment and other market conditions.
Sometimes, losses due to widespread disasters cause additional complications because supply and demand are impacted. In these instances, it is not uncommon for supply to dwindle and demand to spike or, conversely, for demand to dry up. Qualified appraisers know how to maneuver these situations and assign value accordingly. Additionally, if a loss was suffered in the distant past, appraisers have the ability to pull data from historic repositories to perform their work for a specific time in history, as well.
Retrospective appraisals enable business owners to secure fair compensation for damaged equipment, whether you are pursuing matters with your insurance company or simply claiming a loss on your tax returns. Owners also seek retrospective appraisals when documenting equipment donations or for litigation.
Performing equipment appraisals after the fact is not an easy undertaking, which is why it is so important to hire a seasoned professional for the task. Independent, third-party valuation experts are without a doubt the best choice to perform this type of work. Machinery and equipment valuations can be complex operations that involve weighing multiple factors within the context of a specific methodology. Damaged or lost equipment and/or records only complicate the process, making it even more critical to seek professional assistance that will hold up to scrutiny in court, and with insurance and tax agencies.
There are several common tax scenarios that require business owners to determine a justifiable dollar value for their companies. Business valuations are critical for gift and estate tax liability purposes, and/or to engage in the sale of your business. In all of these instances, business valuations determine the taxable value of your business interest, and that is not a figure you want to get wrong.
Reporting Gift and Estate Taxes
One of the most common tax purposes to drive a valuation is for federal estate tax planning and/or gift tax reasons. In this case, the fair market value of a company is absolutely necessary to determine your tax liability. The value applied to your business has a direct correlation to the taxes you will owe, whether they be gift taxes on shares you have given away or estate property taxes. If the value determined by the IRS differs from the value you used for your tax calculations, you or your estate could be liable for additional taxes. Valuations for estate tax purposes are especially complex because they are based on a body of laws and regulations that are always in flux, changing with new court decisions or government priorities.
Occasionally, owners choose to give all or part of their interest in a business away to a charity of their choice. Donations are typically made with cash, but corporations may also choose to donate stocks, machinery, real estate, or other assets. Should you find yourself in this situation, the IRS requires a business valuation as documentation to support the deduction for the years in which the gift was given. Assuming the fair market value of the donation is properly assessed, you are generally able to deduct that amount from your taxable income, thereby lowering your taxes and supporting a charitable organization at the same time.
Sale of Business/Succession Planning
The value of your business drives the capital gains taxes that result from a sale, so you will need to determine the taxable value of your business interest as accurately as possible. If you underestimate, you will likely overpay on taxes because you will miss out on certain tax-saving strategies. Furthermore, selling a business interest for less than fair market value can cause the IRS to deem the transaction a combination sale and charge you gift tax on the difference between the stated value and the value the IRS determined. Transactions from one family member to another are especially scrutinized by the IRS, but any sale involving a disparity in the fair market value versus the stated value will cause your transaction to be flagged. Unfortunately, by the time the IRS challenges the value, years could have passed, meaning that your additional tax liability will be compounded by accrued interest and penalties.
Similarly, if you overestimate, you could invest more time and money into the process than is necessary. The IRS could also deem an above fair market sale a gift from the buyer to you and charge you the resultant gift taxes. An independent business valuation helps you attain the highest possible fair price for your business, ensuring you profit while avoiding additional taxes and penalties. Valuations are also integral for buy-sell agreements for similar reasons.
Without a valuation from an independent, qualified appraiser, any of these tax scenarios could, unfortunately, implode. While the fair market value of a business is always open to interpretation, the IRS is much less likely to challenge professional appraisals based upon sound assumptions and ample supporting evidence.
Upon close examination, most startups with valuations in excess of $1 billion, known as unicorns, turn out to be pretty horses in disguise. A recent study performed by professors at Stanford University and the University of British Columbia found that without the use of complex stock mechanics, many unicorns would lose their horns. The study shows that, on average, these companies report values about 51 percent above what they are really worth. Unicorns, so named because they were once rare enough to be considered mythical, are becoming commonplace. In the US alone, there are 135 of these venture-backed companies out there, with more on the horizon. Luckily, it is possible to separate the hype from reality.
The study, which examined 116 unicorns founded after 1994, with average valuations of $2.7 billion, found that 11 percent of companies used preferential stock to boost their valuations to more than twice what they would be worth using fair value estimates. In many cases, the disconnect lies in the contractual terms between investors and the companies. In some instances, a company gives stock preferences to a backer in exchange for a high valuation, but the shares include a provision to receive additional equity if an initial public offering is set below a target price. Investors are then able to take advantage of this provision in the instance of a mediocre IPO.
Another investor protection, called a liquidation preference, guarantees minimum payouts in the event of an exit, but can also exaggerate a company’s value by as much as 94 percent. Companies have also been doling out ratchets to shareholders, which can inflate valuations by 56 percent or more.
These provisions are now commonly offered to later stage investors who are paying a higher price for their shares, and would thus experience lower returns. Various option rights improve investors’ returns and shield them from risks that might result in losses.
The overvaluations are a product of the use of “post-money valuation.” Analysts, the media, and often the companies themselves take the price per share realized in the most recent round of funding and revalue older share prices using the higher price of the latest class of shares. So by assuming all of a company’s shares have the same price as the most recently issued shares, overvaluation occurs. Startups continue to chase these overblown valuations because of the fanfare and credibility that follows. Unfortunately, other industry players are not going out of their way to correct the problem, because everyone is essentially benefitting from it.
The benefits of overvaluation are short-lived, and it is always at the expense of early investors and employee shareholders. Plus, if the bubble bursts, employees will suffer most. But overvaluations also impact the companies, as well as the economy as a whole. Independent valuations are a great way to separate the pretty ponies from the truly mythical.
Exit planning is not something that should be undertaken in an afternoon. Ideally, it is a multi-year process. Whether you are gearing up for a sale, or preparing to pass your business along to the next generation, it is imperative to fully understand your business’ value and to do your best to maximize it before a change in ownership. A business valuation is the cornerstone of that process. Without one, you cannot boost your sale profits or arm the company’s future leadership with the insights they need to be successful.
Knowledge is power, and nothing is more critical to exit planning than understanding your position in the marketplace; the strengths and weaknesses of your daily operations and balance sheet; and the worth of your tangible and intangible assets (the latter of which comprise the bulk of most businesses’ worth and are notoriously difficult to value). A business valuation will guide you on whether the time is right to proceed with an exit or, more likely, if it makes sense to hold off until you address pressing issues that will serve as red flags and value detractors for potential buyers. Plus, business valuation experts are able to find value in places where accountants typically do not, allowing you to make a credible, independent argument for a higher sale price when the time comes.
First, consider your finances. Any potential buyer will expect to see at least three years’ worth of financial statements. Business valuations comb through your financials, normalizing your paperwork so that one-time expenses and occasional income fluctuations do not negatively impact your negotiations. Valuation experts are also able to provide you with insights on which debts should be paid down, areas of your operations where the cost overhead exceeds industry standards, business processes to streamline, and other issues that can be addressed prior to an exit.
In terms of assets, business valuations assess the worth of intangibles like brand recognition, patents, copyrights, client lists, talent, and other elements that have no book value. Valuations also help to preserve more of the value of tangible assets. The standardized depreciation tables typically used by accountants can rob companies from capitalizing on the value of depreciated assets that are still in use. Valuations include equipment appraisals that ensure you are able to list all of your relevant assets on your balance sheet accurately so that you don’t inadvertently shortchange yourself.
A business valuation also gives you a more concrete sense of where the market is headed, your competitive standing within that market, your competitive differentiators, and your firm’s future trajectory at the present time, as well as an idea of how those factors could change by making certain adjustments. Valuations remove the guesswork from exit planning.
No matter how much time and internal manpower you dedicate to the process, no company can accurately synthesize the information and factors that play into a comprehensive exit strategy as well as a third-party business valuation expert. Business valuations make a successful exit by giving you the opportunity to maximize your business, whether you are exiting in six months or six years.
Entrepreneurs and business owners do themselves a disservice by moving towards a sale too hastily. If you have decided it is time to sell your business, the last thing you should do is actually list it. At least, not if you would like to get the best return on your investment. Business owners who are serious about selling and maximizing profits should take their time, ensuring that the process is well planned, and that they are approaching their exit with the same care and thought used to build the business in the first place.
A great place to start is by seeking a business appraisal from a certified third-party specialist. A business valuation ensures you understand the worth of your tangible assets, like real estate and equipment, as well as your intangible assets, like innovation or other intellectual property. Intangibles are the hardest to pinpoint and often comprise the bulk of a business’ value, so it is very important to attain an independent assessment of these. And, perhaps most importantly, a valuation flags any issues that are detracting value from your business, giving you the opportunity to fix them beforehand. An appraisal will point out areas where your cost overhead is too high, or where you have bad debts or other issues that can be proactively addressed. By cleaning up the bad and protecting or even enhancing the good, you will set yourself up for the best case scenario at the time of sale.
Most businesses opt to do this work, then seek a second valuation. This helps them understand how the changes they made improved their company’s worth. Depending on those findings, owners either decide it is time to sell, or decide to make one more round of improvements before moving forward. Either way, a business valuation helps to maximize your sale price, and serves as a guidepost for you, your investors, and potential buyers during future negotiations.
Ideally, you should attain your first valuation and begin the planning process years before a sale. This gives you ample time to increase your earnings and cash flow, and make other recommended changes per the report findings. You will need to provide the past three years of financial statements to any prospective buyers and, ideally, the business is operating at its best during those years. Most smart entrepreneurs seek their first valuation four to five years prior to sale, giving them ample time to implement necessary changes, as well as three years of improved performance to point to during the sale process.
Selling your business is a huge decision that should not be undertaken lightly. It no doubt took years, if not decades, of meticulous planning and calculated decision-making to grow your business to what it is today. A sale should be approached with the same level of strategic decision-making. Entrepreneurs that fall prey to the temptation of hastily putting up a for-sale and walking away inevitably regret it. Selling should never be an emotional, sudden, or careless undertaking. Instead, choose to focus on better understanding your strengths and weaknesses and addressing them appropriately. Time spent achieving operational efficiencies, cost reductions, and other value enhancers will be well-rewarded down the line.
Executives involved in succession planning are well-versed in the business of maximizing a firm’s value prior to potential sales. Profitability is always the name of the game, causing leadership to double down on the usual suspects: winning more new clients and maximizing assets under management. Sadly, even though technology has proven itself as a value driver, helping firms shave costs and grow more efficiently is often overlooked as a key component of the process. Afterall, technology gaps and outdated systems hobble a company’s future outlook, especially in today’s digital economy. When a firm settles for antiquated technology, growth requires the addition of more people, an equation that simply is not scalable.
Technology not only enables a company’s growth, but a fully integrated, scalable firm using modern, cloud-based systems is more valuable, commanding a higher price upon exit. This is especially true when it comes to the adoption of integrated workflow and the automation of back-office processes. This might include well-documented workflow processes, an updated CRM system, scanned documents, and content management software that automates reporting and ensures compliance. In fact, investing in content management software alone can increase the valuation of a firm up to $3.6 million, depending on the organization’s size. Content management technologies save considerable recurring costs by enabling corporations to pay less in overhead costs, store less paper, and hire fewer administrative employees. Automation also helps with record-keeping, which is paramount for succession planning.
Companies that are able to capture data, interpret it, gain valuable business insights, and act upon them are worth much more than companies that cannot. In the current business environment, knowledge is everything, so it is only fitting that companies are assigned value based on how much knowledge they can capture and use to their advantage.
Recently, we have witnessed stronger valuations, business-friendly changes to the tax policy, and the likelihood of rising interest rates, all of which makes the present a favorable time for owners to consider opportunities to sell. But technology is not just an integral piece of the puzzle for future exits. Whether your firm is eyeing a sale, merger, going public, or is simply looking to ratchet up your strategic planning, technology increases the value of your business and helps best position you for transitions of any nature.
All businesses, regardless of end-game or circumstance, need to pinpoint their own value drivers and actively work to increase their business’ value. Ideally, this process should begin with an independent business valuation and result in a 2-5 year strategic plan to help you capture more cash flow in the short term. Such a plan should involve updating all necessary systems, processes, and operating tools, ensuring that you continue to build incremental value for your business. Poor planning can minimize a lifetime of hard work and success. Meanwhile, careful preparation and attention to key business drivers will augment your gains, helping your firm reach its most profitable and prosperous future.
In today’s knowledge economy, intellectual property (IP) truly fuels economic growth. IP includes assets such as copyrights, patents, trademarks, licenses, proprietary technology, contracts, software, databases, R&D, and more. Today, in the United States, IP is worth over $5.8 trillion each year and now consists of over 35 percent of the total economy. IP also accounts for over 74 percent of all US exports, amounting to nearly $1 trillion. Now, more than ever before, business success is driven by ideas and innovation, rather than labor or raw materials.
It is no surprise that corporate valuations have changed to reflect this shift. While it is true that at one time tangible assets like real estate, raw materials, and equipment made up 80 percent of the market value of a corporation, that ratio has completely reversed. Now, it is intangible corporate assets that account for 80 percent of the value of most US companies. This is especially true for companies operating in knowledge-intensive or innovation-heavy sectors, or companies with well-known brand names.
This phenomenon is not exclusive to the United States either. Global businesses have caused innovation to become more collaborative and unfold across borders. In fact, R&D efforts increasingly include emerging economies, and three Asian countries—Japan, China, and the Republic of Korea—are among the top five patent-filing countries.
Intellectual property is more valuable than ever, and your organization’s IP likely comprises your most valuable assets. This can be attributed to the fact that, on average, patented products and services produce 50 percent more return than unpatented ones. That is why patent disputes, sales, and acquisitions have become so prevalent—it is where the money is. Globalization and technology advancements like artificial intelligence and the Internet of Things (IoT) have added layers of complexity to the issues of IP management and enforcement, raising key questions about creation, invention, and ownership, but IP, when managed and wielded properly, also enables global collaboration in the digital world.
Furthermore, when IP is properly protected and promoted, it helps consumers make better purchasing decisions, ensuring that they better understand the safety, reliability, and effectiveness of their purchases. Not to mention the fact that IP helps generate groundbreaking solutions to global problems like health, hunger, and climate change.
While most large, public companies have recognized the importance of regularly protecting and valuing IP, many small or medium-sized enterprises (SMEs) wait too long to get serious about the process, putting them at risk for losing the assets that make up the lion’s share of their business value. Unfortunately, a simple mistake or oversight in this arena can wipe out the viability of a business overnight. Yes, getting proactive about IP in the early stages of your business can feel like an unwarranted expense and time-consuming initiative that is better saved for a later date. But the alternative is much more costly. Ask yourself this question: could your business sustain losing 80 percent of its market value tomorrow? If the answer is no, it is time to take action.
This is why it is so important for companies to seek professional assistance to properly protect and value their trade secrets and confidential business information. IP has long been used by businesses to increase their competitive advantage in the marketplace. It has always been an enabler for successfully bringing products and services to market. Now, however, in our data-driven economy, its value has crossed into a new realm of importance, as it’s widely recognized that IP drives revenue, improves balance sheets, increases stock values, and drives a company’s future success.
Congress introduced the Tax Cuts and Jobs Act (TCJA) in 2017 in modification of the Internal Revenue Code put into place in 1986. This new tax reform ushered in critical changes to the existing American tax code and, as a result, caused many taxpayers to question their current tax strategies. Their main concern: How will the Tax Cuts and Jobs Act impact my charitable giving?
The short answer: quite significantly, actually. Every new law has its own nuances, which is why it is important that taxpayers understand the ins and outs of TCJA. With a stronger understanding of the tax reform, taxpayers can use it as a guide in determining the best giving strategy for their unique situation. In other words, how they can support the same charitable causes while also getting the most out of their earnings.
The Tax Policy Center predicted that the Tax Cuts and Jobs Act would cut the number of households claiming itemized deductions in half—from around 37 million to 16 million in 2018. The reasons for such a severe drop are threefold: the TCJA lowered individual income tax rates, capped state and local tax deductions, and doubled standard deduction amounts. Because individual tax rates were lowered, it started a snowball effect that also reduced the value of other deductions. State and local deductions are now capped at $10,000 and standard deductions nearly doubled to $12,000 for individuals and $24,000 for couples filing jointly. As a result, wealthier taxpayers will likely continue claiming their itemized deductions while middle-class families will have to elect standard deductions. For households that are consistently well over the standard deductions amount, not much will change. For middle-class families, however, around two-thirds will no longer itemize their deductions—a drop from 17 percent to 5.5 percent. If a taxpayer has itemized deductions in the past but can no longer do so under the TCJA, they will no longer collect tax benefits for their donations.
For high-income earners and individuals who want to begin giving more under the new tax reform, the Tax Cuts and Jobs Act does offer two benefits. Now, taxpayers can take a deduction for 60 percent of their adjusted gross income (AGI), compared to the 50 percent limit preceding the new tax law. Additionally, there is now no limit to the total charitable deductions you can claim.
This information, of course, does not imply that individuals only give to nonprofits for the tax incentives—that could not be farther from the truth. Millions of taxpayers will still continue to financially support charities across the globe; the TCJA will impact whether or not taxpayers will itemize their contributions.
Appraisal Economics has been providing charitable donation valuation services to donors and recipients for over 30 years. These charitable valuations include assets such as: intellectual property, real estate, and equipment, among others.