The Importance of Business Valuation

“If I die, my children will own the business and my manager will run it. There’s no need for formal business valuation.”

The Scenario

Jane Patel’s husband died when their two children were quite young. To make money, Jane began working as a personal trainer. Soon, she created a diet and exercise regimen she named Simply Better, which focused on portion control, locally sourced organic food, and high intensity interval training. Her clients loved the results they got from her program so much that her local gym adopted it as their official diet plan. When the gym was bought out by Mega Fitness, a multi-state chain of

gyms, they also made it their official diet plan. She paid Mega Fitness to endorse the program and create ads, and before long celebrities, chefs, athletes and even physicians were endorsing Simply Better.

Over the years, Jane relied on her top manager, Ellen Balanca, to help the company grow ever more successful. Jane’s estate grew along with the company to reach roughly $30 million—$20 million being the assumed value of Simply Better, and the other $10 million in real estate and securities. Jane’s will stipulated that everything be split evenly between her children, Raj (a sculptor) and

Katy (studying to become an actress).

Tragically, Jane was killed in a small plane crash. Raj and Katy filed her will in probate and will inherit Simply Better. However, the attorneys for Mega Fitness are pressuring the children to sell the business, especially in light of the fact that Simply Better owes Mega Fitness $5 million for promotional expenses. They have proposed a buy-out for $12 million plus forgiveness of the $5 million debt essentially, $17 million. The business means a lot to Raj and Katy, but they are overwhelmed and turn to the company attorney, Jack Kirby, for guidance.

CHARACTERS AND CONCERNS

Jane Patel – Creator and owner

of Simply Better, a popular diet

and exercise plan. Jane recently

passed away with an estate

plan in place, but no business

succession plan.

Raj Patel – Jane’s son, a sculptor,

would like to own Simply Better

and does not want to sell to

Mega Fitness.

Katy Patel – Jane’s daughter,

an aspiring actress. She is also

interested in owning Simply

Better with her brother and does

not want to sell to Mega Fitness.

Ellen Balanca – The top manager

at Simply Better and a key

contributor to the company’s success.

A Planning Strategy

Jack speaks quite frankly to Raj and Katy. He knows

that Jane wanted her children to have their share of the business, but doesn’t believe they have the knowledge or experience to successfully run the company. Raj and Katy reluctantly agree—not only are they unprepared to lead the company, they are unwilling to give up their artistic aspirations. That leaves a sale—but to whom? Jane’s top manager, Ellen, is prepared and eager to run the company, but doesn’t have the money to make the purchase. While they all know that Jane would have preferred that Ellen take over, they are left with the low offer from Mega Fitness.

Jane liked to claim that the company was worth $20

million, but she never conducted a proper business

valuation, so they make that their first order of business. Two different business appraisers come in with disappointing results—$12 million and $14 million. Armed with this knowledge, they decide to accept the Mega Fitness offer of $12 million plus forgiveness of the $5 million debt.

Jane could have avoided all the stress and confusion her children went through after her death by simply putting in place a buy-sell agreement.

She could have:

• Named Ellen as her successor

• Devised a proper valuation formula for determining the sale price, ensuring that her children got a fair amount as their inheritance without the hassle of trying to run the business or sell it on their own

• Funded the buy-sell agreement with a life insurance policy on Jane’s life

• Structured the buy-sell agreement to consider and

mitigate an excess tax burden on Jane’s estate

With a properly structured and funded buy-sell

agreement in place, at Jane’s death, Ellen would have immediately received a sufficient amount to buy the company, pay off the debt to Mega Fitness, and ensure a smooth transition of ownership.

MORAL OF THE STORY

It is extremely difficult—perhaps

impossible—to have a successful

transition of ownership without a

proper plan in place. It is certainly

impossible for a potential

successor to purchase a business

without available funds. Business

valuation is key to making a buysell

agreement work. It allows

heirs to receive a fair price for

their share of the business, while

ensuring the successor owner

does not have to overpay in order

to take control of the company.

And again, life insurance provides

the perfect tool to ensure that

funds are available just when they

are needed.