Explanation of Business Valuation: The essence and necessity
Business Valuation is something you will encounter at some point in your company’s development, probably sooner than you think. For employees, the value of their participation in the company may be more relevant. It is easy to get caught up in all the jargon, but really it is rather simple and I’ll try to explain here how it works and how it can be done.
It’s actually not that hard; Business Valuation. A company (BV) is in principle worth what the market gives for it. The tax authorities (Belastingdienst) generally agree with this – until a situation arises in which staff want to buy into your company. Then the tax authorities suddenly have a very specific opinion about the value that your company should perhaps represent. In addition, as a company you try to form a good price for both the tax authorities and your staff. From the perspective of employee participation, it is important that you delve into company valuation – and the methods used for this.
Company valuation is an essential part of any form of employee participation. You want the fair and correct price to the employees, without having problems with the tax authorities or making yourself unpopular with other investors. Appreciation is therefore immediately the biggest stumbling block, as a result of which many well-intentioned participation initiatives are never carried out. This week we dive deeper into everything related to business valuation, such as: why this is so important, who does this and what the role of the tax authorities is. In this article we talk about the value of private companies – not about listed companies whose value is in principle determined by the share price. There are several reasons to delve into company value and the way it is determined. Almost all reasons stem from the necessity of the ‘tax tax base’. In other words, the value that the tax authorities want to keep in order to possibly levy tax on the transaction. In the case of employee participation, this is where it gets interesting! The tax authorities have a strong opinion about the relationship between an employer and an employee.
Suppose an employer and employee come to an agreement to transfer a share at a price below the price that the ficus assigns to this share. In that case, the tax authorities regard this as providing wages (in kind) to the employee. Both the employer and employee must then (as usual) pay wage tax.
The BV wants to have an employee participate. The shares of the BV are valued at EUR 10 each. The employee has served many years of good service and contributed to building the company. That is why this employee may buy the employer’s shares for EUR 5 each. After all, the employee has in principle already paid part of the value of the share through hard work. The tax authorities will see the difference in EUR 5 per share as a form of remuneration. The tax authorities will therefore apply payroll tax (income tax and employer tax) on the EUR 5.00. Taken by the bank, this amounts to about EUR 7,- levy per EUR 5,- paid out [!].
How does the tax authorities look at Business valuation?
It is important to know what value the tax authorities assign to the company. But does the tax authorities always know? And is the tax authorities also clear about this? The answer is: no, the tax authorities are not consistent or transparent about the company value they hold. You can make agreements with the tax authorities, but this is only possible through an intermediary and only if the tax authorities believe they can determine the value with great certainty. Pretty worthless for all kinds of start-ups, small entrepreneurs, service organizations without inventories or other hard things on the balance sheet. That is why it is smart to have your BV valued based on a sound valuation method, which shows that you are trying to act honestly instead of leaving out value in order to pay as little tax as possible.
The value of your business
Basically, the value of your company is just what the market gives for it. As an entrepreneur/owner of a company, you accept this market value or not (you sell or not). The business owner will have to take the tax authorities into account in this regard, to prevent additional assessments from following. To be clear: price does not always equal value! The price paid for a share is therefore not always equal to the value of the share (the value of the company). Wikipedia gives a nice description of price in a stock transaction. “Price is, as it were, the final element of a transaction. Both parties are apparently of the opinion that the price established at that time is a better alternative than not acting. […] Before making a decision whether to buy or not To sell, a valuation statement is necessary. The price established is observable to outsiders; the underlying valuation process is an individual mental exercise.” However, the price can influence the value that the tax authorities assign to a share. A good rule of thumb is this: if the price for the stock is emotionally on the high side,
The tax authorities have no problems with this. Not even when it comes to employee participation. If the price feels like a ‘discount’, there is a good chance that the tax authorities will check whether enough tax has been paid.
Roughly speaking, there are six methods of business valuation that can provide certainty, including in employee participation. These methods are actually all quite simple and straightforward. The difficult thing is often to collect the right numbers. In addition, they are possibly made somewhat more complicated when one tries to make logical estimates about the future. This involves three different flight paths:
- the value in use based on what has been achieved in the past (‘sum of previous profits’);
- the business value by looking at today (‘balance sheet value’ or ‘EVA’), or;
- the business value by looking to the future (‘future profit x factor’, ‘Discounted Cashflow method’ or ‘Profitability method’).
No method is right or wrong – they all give their own idea of the company value. Which of these methods you use depends a lot on: a) the goal you want to achieve; and b) what is realistic for your type of business. Here is a brief description of the valuation methodologies. In the next two blogs, we’ll take a closer look at each method.
Value based on the past
The company value can be determined by using a method that mainly looks at the past. Banks in particular like to use this valuation method to determine the amount of a credit. In that case, the enterprise value could approach the sum of the profits of the past two to a maximum of five years. Over how many years is considered, depends on the industry and the robustness of the income. For companies looking for a successor – or for companies that don’t want to give too much away and would like to apply for extra credit – this can be a successful form of business valuation. It is a relatively safe and simple form of determining business value.
Appreciate by looking at today
The value that a company represents today is often determined on the basis of the balance sheet value, or research is carried out into the added economic value (Economic Value Added, EVA). Both methods are relatively safe forms of valuing a company, but it is also known that a lot is left out of consideration with these forms. Compared to the profit that a company distributes, the equity on a balance sheet is sometimes only low. And there is usually also a return on loan capital. Both methods have the property that they look at the figures extremely often. Values such as brand awareness, brand value or other potential (but not yet collectable) value are not included in this. The future also plays a small role.
Value by looking to the future
By looking at the possible future profit, turnover or other value-increasing factors, one often arrives at higher valuations. That future value does not only depend on the numbers, but also on a certain feeling, the industry in which the company is active, the economy and the competition. There are three commonly used methods of valuing a company for the future. You can look at estimated future (profit x a factor (number of years ahead)), you can look at the expected free cash flow (Discounted Cash Flow method), and you can look at the expected return ( Profitability method).
Clearly choose one method
Ultimately, it doesn’t matter much which of the above methods is used to arrive at a business valuation. It is important to the tax authorities to be straightforward and clear in your choice for a particular method. As stated earlier, the tax authorities often do not know either, especially not with young companies. In addition, it is certainly also good for employee participation to choose one method and to stick to it for a long time. This not only creates clarity for the tax authorities, but – even better – a great deal of clarity for the employee.
In the coming blogs we will discuss each business valuation method individually. That way, everyone will soon be a star in business valuation. This is also the approach of our blogs. Information provision so that everyone can do as much as possible themselves. Because only then can we accelerate exponentially in setting up participations in our society. Long live the participations!
Share Council facilitates all forms of participation and guides the implementation. We see many projects outside our platform stumbling on this part. If you are interested in discussing this, please contact us. Participating should simply be easy, and we will help you with that!
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