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How Is The Worth Of A Business Determined?


The worth of a business is generally determined as some multiplier of gross revenue or net income. The value of the inventory, equipment or any other hard assets would then be added to that value. We also would add in the accounts receivable and deduct any liabilities or accounts payable. Different industries use different multipliers for that first portion, and that’s their most difficult. Sometimes a multiplier of the gross income is easier to deal with because there is less concern from the buyer that the seller is manipulating costs and payments in order to alter the sale price of the business. Gross income or gross revenue is a little harder for the seller to manipulate for their benefit.

Are Income Tax Considerations Incorporated In Business Succession Planning?

The income tax issues that we deal with have to do with the capital gains that are received. Most businesses have a very small basis, meaning that the owners started the business with much less value than they were worth at the time of the sale. That increased value is capital gain, which can be paid out over time, temporarily allowing the taxes to be deferred. It is the interest that the seller receives on a promissory note that is taxed as ordinary income. So, you want to consider both the capital gains portion and the ordinary income when structuring the sale. We can’t avoid those taxes, but we can at least defer them until a time when the seller of the business is no longer receiving income from the business so that the tax rate will be lower.

What Is The Role Of Life Insurance In Business Succession Planning?

There are two potential roles of life insurance in business succession planning. One role is to ensure that upon the death of one business partner, the other partner will be able to continue operating the business alone and will not become partners with the heirs of the deceased partner. A buy-sell agreement is something that the two parties enter in order to ensure that upon the death of one party, the surviving party pays the deceased partner’s family for their interest in the business. This is generally funded by a life insurance policy that pays the family of the deceased for their interest in the business.

What Are Cross Purchase And Entity Purchase Agreements Related To Business Succession Planning?

Cross purchase and entity purchase agreements both relate to the life insurance policy described above, in which each partner is the owner of the policy on the other partner’s life. Alternatively, the entity or the partnership itself can be the purchaser of the life insurance. There are some tax advantages to doing cross purchase agreements. The proceeds from the insurance policy are given to the deceased partner’s family and it is tax free. If it is an entity purchase, then the beneficiaries of the insurance policy have to pay income taxes on the death benefit. However, if a partnership involves several partners, then each partner would have to buy a policy on each of the other partners. For example, if there are five people involved in a partnership, then each individual would have to buy four life insurance policies, totaling twenty policies in all. That would be very cumbersome and difficult to do. In contrast, the entity could simply purchase a life insurance policy on each of the partners, totaling five policies in all. In that case, the premiums for the policy would be tax deductible. In a cross purchase, however, the premiums would not be tax deductible. So, it just depends on the situation for complexity and tax benefits. We look to see whether or not it would be better for each of the partners to ensure the others or for the entity to ensure all of them.

Do All Estate Planning Attorneys Handle Business Succession Planning?

Unfortunately, not all estate planning attorneys handle succession planning. It’s such an important part of the planning for a family that is involved in a closely held business (which many families are). It is frequently overlooked and not discussed by the attorney when an event occurs to the owner of the business. Oversight of this nature often leads to a terrible void and a difficult mess to clean up.

Who Are The Professionals Required To Assist In A Business Succession Plan?

An attorney will develop an appropriate plan to set up the appropriate documentation. An accountant will also be needed. A business appraiser may be necessary if the parties are having a hard time agreeing on the value of the business. Additionally, an insurance agent may be needed in order to underwrite the life insurance policies or disability insurance policies that would go along with it.

Are Estate Planning And Business Succession Planning Always Intertwined?

Estate planning and business succession planning are intertwined if the person is a principal in a business entity, meaning that their estate is tied up inextricably with their business. A personal estate plan that would not address the business planning issue would be less than adequate for when the time comes. For people who are involved in closely held businesses, the business planning is as important as the personal estate planning.

For more information on Determining Worth Of A Business, a free initial consultation is your next best step. Get the information and legal answers you are seeking by calling (626) 385-6303 today.

Newell & Havens Attorney At Law

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