Purchasing a Small Corporation

Purchasing a Small Corporation

Roughly 20% of all small businesses in the U.S. are organized as corporations. Whether you are looking to buy or sell a corporation or even just shares of a corporation, there are a number of ways to determine the fair value. Even if you aren’t planning a transaction, it’s a good idea to keep track of the value of your business as a performance benchmark, and as an indicator of business strength when working with banks or outside investors. Two of the major methods for valuations of corporations are provided below. Within each of these methods, different techniques can be used to find more precise estimates. While no technique is perfect, these basic samples will give you two ways to value the company and estimate an appropriate price.

The first step of evaluating a corporation should always be to review its financial statements. If these are not publicly available, it may be necessary to enter into a confidentiality and nondisclosure agreement with the corporation you are interested in. These documents will provide detailed information regarding the revenues and expenses of a corporation. Financial statements and additional information from the seller will be necessary to compute fair values under the methods listed below.

If buying or selling shares in a small corporation is your ultimate goal, you will likely need to enter into a confidentiality agreement before reviewing financial statements and starting initial discussions with the other party. A relatively standard confidentiality agreement can reduce the risk of disclosing confidential information for both parties. Once an agreement is signed, the seller will be more comfortable disclosing details about the performance of the business that may not be fully recognizable from financial statements alone. Without a confidentiality agreement, the buyer may not have access to the full details of business performance, leading to increased risk of error in determining a price. The two methods below can be thought of as a good baseline for getting a rough estimate of the value of a company, however, financial analysts can help you determine a more accurate estimate and can explain many of the nuances in corporate valuations to help you make a well-informed decision.

Asset Method

The asset method is a very straightforward way to determine the value of a business. To determine the value of the business, you simply add up the value of the assets of the company. The balance sheet financial statement should provide all the information you need, but be sure to use the asset values after depreciation is taken into account. The asset method is easy to use and gives you a concrete number, but it doesn’t account for situations where the business may be worth more than the sum of its assets.

Earnings Method

Historical and projected earnings can be a useful estimator of the value of a business. Many large corporations are valued by analysts based on projected future cash flows. Under an earnings method valuation, you will make predictions about future revenues and expenses across a timeline and then discount those cash flows back to the present value using an appropriate interest rate based on economic conditions and the risk of the business. This method makes use of more variables and requires more subjective judgment than the asset method. A benefit of this method is that it takes into account the value of goodwill — the value of the business separate from the assets. Due to the complex nature of this method, a professional should be consulted to make sure that all assumptions and predictions are appropriate.

Valuation Adjustments

If you are looking at valuation methods to determine the price for shares rather than an entire business, majority and minority interests should likely be priced differently. If the shares in a transaction will grant majority control to the purchaser, the price of the shares should be increased to account for the additional voting power granted by those shares. In contrast, a minority interest should often be sold at a discount. This is because even if you own the shares, you may not be able to exert control over the business operations. Each share can initially be valued at the pro rata share of the total value of the company and then discounts and premiums should be applied for minority and majority interests respectively. Additionally, the classification of the corporation as either a C-corp or S-corp may affect the valuation. If the company is an S-corp, it will not be subject to the same double taxation that occurs with traditional C-corps, however an S-corp shareholder may have less protection from litigation. As with any nuance in the transaction, you should go over the details with an advisor to determine its effect on the business valuation and purchase price.

Purchasing a business is a very large commitment and should not be rushed. Transactions on this scale should always be heavily researched and conducted with the assistance of experience professionals. If you are considering purchasing or selling a small corporation or a large number of shares in a corporation, you should work with an attorney to ensure that you are adequately represented and that all the details have been taken care of. This article was sponsored by Vlodaver Law Offices, LLC, an experienced business solutions and transactions law firm in the Twin Cities. If you would like a free legal consultation, contact us.