Many elements must be addressed with care when a partner is disassociating, and one of the most important is valuing their interest in the business. Several approaches can be used, and each has its pluses and minuses. Let’s look at the most common methods:
- Book value – based on the company’s balance sheet and calculated as the partner’s share of net assets. This is a simple calculation that reflects historical costs but may not reflect current market conditions. It also ignores goodwill and other intangible assets. The book value may be significantly lower than the market value.
- Market value – based on what the business would be sold for on the open market including considerations of its current value and the value of comparable businesses. This approach provides a more accurate reflection of current worth and accounts for the value of intangible assets and future earning potential but is more complicated and subjective. It usually requires the help of a professional valuation expert.
- Agreed-upon formulas – based on a specific formula agreed upon by all parties. May include a multiple of earnings, a percentage of sales, or other metric. Its advantage lies in avoiding disputes and tailoring the approach to the specifics of the business, but consensus can be hard to achieve, and if the agreed-upon formula was reached at the business’ outset, it may be outdated and fail to reflect current value accurately.
- Capitalized earnings or cash flow – Estimates future earnings and applies a capitalization rate reflecting a required rate of return. This is useful for businesses with stable and predictable earnings and has the additional advantage of considering future profitability, but can be challenging to calculate.
- Appraised Value – Relies on an independent third-party appraiser who assesses various objective factors. This is helpful when consensus can’t be reached on a valuation method, but can be expensive and time-consuming.
- Buy-Sell Agreement – a legally binding contract that establishes how share values will be valued and purchased in the event of disassociation, disability, or death. Provides clarity and avoids disputes, but must be kept up to date to avoid changes in business circumstances.
Valuing a business in the face of a partner’s disassociation requires consideration of the nature of the business, the size of their interest, the assessment of goodwill and intangible assets, and economic conditions. If you need assistance in approaching this complex topic, contact our experienced professionals today.
