How the Current Recession May Impact the Transfer of Your Business
by Bryce BowmanThe economic recession has resulted in a loss of wealth for many family-owned businesses across numerous industries. However, with valuations of publicly traded entities approaching historic lows, the current financial climate may present an opportune time to transfer the family business to the next generation.
Family business owners have long sought strategies to efficiently transfer their shares to their descendants. Historically, they have utilized limited partnerships and other legal entities to reduce the value of business interests transferred to family members. While the use of such legal entities may lower the value of transferred business interests, the value of transferred shares may also be significantly affected by the timing of the transaction. For instance, a gift transaction executed during a period of high industry growth will result in a relatively higher value for the transferred shares when compared to a similarly structured gift transaction executed during an industry downturn.
As a result of the recent slump in the U.S. economy, publicly traded companies in most industries realized significant declines in market value in the past year. As of March 2009, both the Dow Jones Industrial Average and the S&P 500 had declined about 50 percent from their respective peaks reached in 2007. While these broad market indices show a significant decline in value for the overall market, each industry has been affected differently. Therefore, it is necessary to examine each separately to determine the extent to which the economy has affected valuations in that industry.
Dealership valuation
As an example, the recession has severely upset the automotive retailing industry. Unit sales of domestically produced vehicles declined from an annual sales rate of 11 million units in March 2008 to 6.9 million units by March 2009, representing a decline of 37 percent over this 12-month period. As a result of declining sales volume, valuations of publicly traded dealerships declined precipitously in 2008.
Business appraisers typically treat the tangible book value as the minimum value of a business, since even a money-losing business may presumably sell its tangible assets for book value upon dissolution. As indicated in the associated graph, shares in publicly traded automobile retailers were valued at a median price of approximately 4.8 times tangible book value as recently as 2006. However, due to the downturn in the industry, the median share price declined to 1.1 times book value by the end of 2008.
Choosing an appraiser
While depressed industry conditions may justify a lower valuation, it is important for business owners to obtain an opinion of value from a qualified business appraiser who:
- Possesses a recognized appraisal credential such as the Accredited Senior Appraiser (ASA) designation from the American Society of Appraisers
- Thoroughly understands the client’s business model and the risk factors relevant to the business
- Is able to articulate how the industry conditions have affected the prospects for the business
In the case of the dealership industry, the appraiser should understand the multiple product offerings that comprise a dealership’s revenue and how the current industry conditions influence its products. Dealers typically offer a number of interrelated products and services, with sales of one product affecting other products and services. For instance, increases in mechanical service may generate additional parts revenue, while vehicle sales volume directly impacts revenue for a number of ancillary products and services. The appraiser should be aware of these relationships when forecasting revenue for each of the product lines and consider how the current environment may influence gross margins for each of the products.
The current economic downturn may present a good opportunity to transfer ownership interests in the family business, but each industry and every business has unique circumstances to consider. By obtaining an opinion of value from a qualified business appraiser, the owner can make an informed decision regarding the timing of estate planning transactions.