Do you need a stock appraiser?

Jul 1, 1995 12:00 PM, Shelly, Donald F., Jr.

Many times, owners of closely held printing companies have to determine the value of their firms' stock. However, is an independent appraiser always required to value the shares?

The answer is no, not necessarily. Let's look at the most common situations in which a share value is needed and highlight the situations in which formal appraisals are either advisable or required.

* General curiosity. An owner who has spent many years building a business may want to know the financial results of all these efforts.

* Employee ownership. Many corporations implement plans to make employees stockholders in the organization, including Employee Stock Ownership Plans (ESOPs), stock bonuses, direct purchases and stock options. A value must be placed on the shares when they are acquired and sold by employees.

* Personal financial statement. Banks or other creditors often request personal financial statements from stockholders, particularly when personal guarantees are required.

* Buy-sell or stockholder's agreement. This legal agreement dictates the procedure, price and share disposition terms of closely held businesses.

* Sale to a third party. The desire to know stock value may develop if an outside party shows interest or makes an offer. Alternatively, owners may be exploring selling the company and want to know how much a third party would pay and how a prospective candidate would value the firm.

* Divorce settlement. If a stockholder gets divorced, value must be placed on all assets, including shares in a closely held company.

* Estate and gift tax purposes. Parents frequently gift shares to their children to help reduce their estate size and/or make the children stockholders. If a shareholder dies, the estate must be valued, and in many cases company stock is the largest asset in the estate.

It is important to understand that the valuation's purpose determines whether or not independent appraisals will be necessary. Rarely is it justified to conduct a formal appraisal for an owner who is simply curious. In addition, most lenders only will ask for a conservative value estimate.

Buy-sell agreements typically use a formula such as book value or require shareholders to agree to a value. The agreement can specify that an appraiser be engaged, but this tactic tends to be the exception rather than the rule. Also, appraisals can be helpful in business sale situations, but are not required.

For transactions that make employees owners in the corporation, the outside appraisal requirement will vary. If an organization installs an ESOP, the law dictates an independent appraiser must value the shares. Since ESOPs can be audited by the IRS and Dept. of Labor (DOL), it is critical to have a readily justifiable value.

In other types of transactions such as stock bonuses, options and direct purchase, a third-party valuation is not required. However, since the transaction usually is between the firm and an employee, compensation issues are involved. Therefore, the value must be reasonable and not artificially low, otherwise the IRS can impute income to the employee.

In divorce situations, the simplest and least expensive solution is having both parties agree to a value for the business. If the parties refuse, one or more appraisers are hired to value the company.

An independent appraisal often is used in estate and gift tax situations, but is not a legal requirement. The IRS scrutinizes these transactions closely since parents' motivation commonly is to value the firm as low as possible to minimize potential estate taxes and/or transfer the business more quickly. Many companies hire appraisers when filing estate tax returns since the business value often is the largest asset and its value is less readily determinable. These factors make such filings subject to greater probability of being challenged by the IRS.

In gift tax situations, most individuals do not obtain appraisals when they gift shares annually to children using their $10,000 gift exclusion. They take this action because the appraisal cost relative to the gift would be very high, and even if the value were successfully challenged, the resulting taxes would not be debilitating unless the stock was grossly undervalued. For families making much larger dollar value gifts, hiring an appraiser may be worth the investment.

The nature of the transaction typically will dictate whether formal appraisals are prudent or necessary. When in doubt, it is wise to confer with legal and tax counsel before making decisions of this import. It should be time and money well spent.

DONALD F. SHELLY JR., Denver-based management consultant specializing in business continuation planning, mergers and acquisitions, employee ownership and valuation