How should founders approach valuing their business for succession planning?

In the USA, the gift and estate tax can range from 18% to 40%. Hence, many business owners look to minimize their business valuations as part of their business succession planning since it reduces the tax liability of their successors.

Another key consideration for reducing tax liabilities is the lifetime gift tax exemption limit. Currently, in 2025, this limit stands at $13.99 million. However, the provisions of the Tax Cuts and Jobs Act (TCJA), 2017 would expire by the end of 2025, and with this, the gift and estate exemption limit is expected to be halved after adjusting for inflation.

Hence, in 2025, business owners in their twilight years are trying to accelerate business succession planning to secure low valuations. For those facing this urgent timeline, this article simplifies the business valuation process in succession planning.

Ensuring accurate valuations in business succession planning

In business succession planning, an accurate valuation minimizes your tax liability and ensures tax compliance. Some of the key considerations to achieve this are as follows:

Choosing the right valuation approaches

We can divide valuation methodologies into three approaches, namely income-based, asset-based, and market-based. Each approach has its strength and provides accurate results in different scenarios and for different business models.
Let us understand these approaches in a little more detail.

Income-based approach

In the income-based approach, you would be estimating a business’ valuation as the net present value of all expected future cash flows. The accuracy of this approach increases as we move from new businesses to established concerns with long financial histories. While estimating future cash flows, we must incorporate details such as expectations regarding capital expenditure, industry trends, and macroeconomic conditions, especially inflation and gross domestic product (GDP) growth rates.

Then, we must apply an appropriate discount based on the required rate of return or inflation expectations.

Asset-based approach

Here, we simply subtract the total liabilities from the total assets to find the business valuation. Asset based approach is best applied when a company’s value is dependent on its asset portfolio, such as real estate firms, investment firms, and holding companies, as well as companies that might be liquidated soon.

Since this approach typically leads to the lowest valuation and its use is justified for early-stage businesses due to their inherent risks, early-stage company owners must use this effectively as part of their business succession planning to minimize tax liabilities.

Market-based approach

The market-based approach estimates the value of a business based on how the market is valuing similar businesses.

To apply this approach, you could find a listed company that is extremely similar to yours and adjust its valuation for all significant differences. If that isn’t feasible, you can try establishing the market valuation multiple by comparing the sales of similar companies with their valuations in funding rounds, acquisitions, or current market capitalizations. Then, you can apply this multiple to your company’s sales figures to establish its valuation.

Weighted averages approach

Often, a single perspective is not enough to perfectly capture the value of a company. Therefore, business succession planning often relies on a weighted average of all three valuation approaches, with weightage varying case by case. The income-based approach is most accurate for firms with long financial histories and should receive higher weightage in such cases.

Conversely, firms nearing liquidation are best valued using the asset-based approach. Regardless of the scenario, it is essential to incorporate the market-based approach to align valuations with external market perceptions and industry benchmarks.

Discount for lack of control (DLOC)

The discount for lack of control (DLOC) is especially applicable in business succession planning and yet it is also the most overlooked discount. As a result, most successors end up with excessive tax liabilities.

The intrinsic value of each share in a controlling stake is greater than the intrinsic value of each share in a non-controlling stake. After all, a controlling stake, by definition, allows you to mold the company as per your ambitions and financial needs.

Hence, when a business owner splits their controlling stake into non-controlling stakes when passing them onto their heirs, a discount for lack of control (DLOC) can be applied.

The applicable amount of discount for lack of control will depend on the difference between the voting powers of the original controlling stake and the resulting non-controlling stake. Typically, this discount is between 5% to 40%.

According to a study by Moore Hong Kong, which analyzed valuation reports for the trailing 12 months ending June 30, 2024, the following statistics were observed:

• 14 out of 354 circulars included the adoption of control premiums in valuation reports.
• 78.6% of valuers included figures from the ‘Control Premium Study’ by FactSet Mergerstat, LLC.
• 21.4% of valuers included figures from other sources.

The corresponding DLOC is derived from the control premium using the formula:

DLOC (%) = [1 − (1 / (1+Control Premium)] x 100

The following table shows the potentially applicable DLOC (%) based on the CP (%), as derived from the study’s analysis:

Control Premium Range for 30 June 2024 Trailing 12-Months: 11% - 34.2%	CP (%)	Discount for Lack of Control (DLOC) (%)
CP Average	23	18.7
CP Median	23.5	19.03
CP Upper Quartile	26	20.63
CP Lower Quartile	20	16.67

Valuation example for business succession planning

Let us understand the concepts that we have discussed so far through an example.

Roger Kimble is the sole owner of Kimble Motors whose ownership he wishes to distribute among his children and grandchildren in the following manner.

Name	Relation	Inherited stake
Stella Kimble	Daughter	50%
Jules Kimble	Daughter	30%
Nathan Kimble	Grandson	15%
Cillian Kimble	Grandson	5%

We will assign equal weight to all three valuation approaches since the company is equally close to generating long-term revenue and facing liquidation in the long term, while market perception remains crucial due to the possibility of an IPO.

Income-based approach

Based on its financial history, Kimble Motors is projected to operate for another five years, with annual sales growth of 14% per year, expenditure increasing at 12% per year, net working capital increasing 10% per year, and depreciation remaining constant at $1 million. We shall assume a discount rate of 6%. In this period and the forecastable period, we will assume no capital expenditure or net borrowing.

Year	Sales	Expenditure	Net income	Depreciation	Increase in net working capital	Free cash flow to equity
2020	$8,289,123.88	$7,117,802.48	$1,171,321.41	$1,000,000.00	$68,301.35	$2,103,020.06
2021	$9,449,601.23	$7,971,938.78	$1,477,662.45	$1,000,000.00	$75,131.48	$2,402,530.97
2022	$10,772,545.40	$8,928,571.43	$1,843,973.97	$1,000,000.00	$82,644.63	$2,761,329.34
2023	$12,280,701.75	$10,000,000.00	$2,280,701.75	$1,000,000.00	$90,909.09	$3,189,792.66
2024	$14,000,000.00	$11,200,000.00	$2,800,000.00	$1,000,000.00	$100,000.00	$3,700,000.00

Based on this, we can estimate Kimble Motors’ future cash flow as:

Year	Sales	Expenditure	Net income	Depreciation	Increase in net working capital	Free cash flow to equity
2025	$15,960,000.00	$12,544,000.00	$3,416,000.00	$1,000,000.00	$110,000.00	$4,306,000.00
2026	$18,194,400.00	$14,049,280.00	$4,145,120.00	$1,000,000.00	$121,000.00	$5,024,120.00
2027	$20,741,616.00	$15,735,193.60	$5,006,422.40	$1,000,000.00	$133,100.00	$5,873,322.40
2028	$23,645,442.24	$17,623,416.83	$6,022,025.41	$1,000,000.00	$146,410.00	$6,875,615.41
2029	$26,955,804.15	$19,738,226.85	$7,217,577.30	$1,000,000.00	$161,051.00	$8,056,526.30

Now, let us discount the FCFEs and take the sum to find Kimble Motors’ valuation.

Year	FCFE	Discounted FCFE at 6%
2025	$4,306,000.00	$4,062,264.15
2026	$5,024,120.00	$4,471,448.91
2027	$5,873,322.40	$4,931,354.74
2028	$6,875,615.41	$5,446,131.40
2029	$8,056,526.30	$6,020,305.12
Total		$24,931,504.33

Therefore, Kimble Motors’ valuation by the income-based method is $24,931,504.33.

Asset-based approach

Kimble Motors’ balance sheet items were as follows on the date of valuation.

Liabilities	Amount	Assets	Amount
		Patent portfolio	$8,000,000.00
Long-term loans	$16,000,000.00	Plant and machinery	$20,000,000.00
Bills payable	$900,000.00	Bills receivable	$1,500,000.00
Short-term credit	$1,400,000.00	Cash and cash equivalents	$750,000.00
Total liabilities	$18,300,000.00	Total assets	$30,250,000.00

As per this approach, Kimble Motors’ valuation = Total assets – Total liabilities
= $30,250,000.00 – $18,300,000.00
= $11,950,000.00

Market-based approach

Some similar companies that were recently funded or acquired are as follows.

Company	Sales (2024)	Valuation
Veltrix Motors	$12,000,000.00	$60,000,000.00
Stratos Auto	$20,000,000.00	$160,000,000.00
Axion Automotive	$16,000,000.00	$112,000,000.00
TorqueNova	$25,000,000.00	$125,000,000.00
Revonix Motors	$10,000,000.00	$80,000,000.00
Total	$83,000,000.00	$537,000,000.00

Based on this data, the market valuation multiple is = Total market valuation ÷ Total market sales
= $537,000,000.00 ÷ $83,000,000.00
= 6.47

Since Kimble Motors’ sales were $14 million in 2024, its valuation by this approach is = 6.47 × $14,000,000
= $90,578,313.25

Weighted average of company valuation

Now, let’s calculate the weighted average of all valuation approaches to determine the company’s overall valuation.

Approach	Valuation	Weight	Weight valuation
Income-based	$24,931,504.33	1/3	$8,310,501.44
Asset-based	$11,950,000.00	1/3	$3,983,333.33
Market-based	$90,578,313.25	1/3	$30,192,771.08
Kimble Motors' overall valuation			$42,486,605.86

Value of stakes of each heir

Now, we will estimate the value of each heir’s stake by applying the appropriate DLOC based on the table mentioned in the previous section. We shall assume that a median control premium of 23.5% is applicable in this case. So, the applicable DLOC should be 19.03%.

Heir	Stake inherited	Pre-DLOC value of stake	Applicable DLOC	Post-DLOC value of stake
Stella Kimble	50%	$21,243,302.93	19.03%	$17,200,702.38
Jules Kimble	30%	$12,745,981.76	19.03%	$10,320,421.43
Nathan Kimble	15%	$6,372,990.88	19.03%	$5,160,210.72
Cillian Kimble	5%	$2,124,330.29	19.03%	$1,720,070.24

Eqvista – Valuations that minimize taxes!

In business succession planning, valuations take a central role since they directly impact tax liabilities and at the same time, this is an area where errors are most likely to occur, potentially leading to non-compliance.

In this article, we mentioned that there are tax benefits to executing business succession plans in market downturns or when market downturns are expected. Yet, if the Internal Revenue Service (IRS) suspects that you are manufacturing an image of downturn expectations to unethically reduce tax liabilities, you would be in enormous trouble.

Hence, it is very important to make defensible choices regarding macroeconomic and industry expectations just as it is important to choose the right weights and discounts.

If you are in the middle of business succession planning and the tax implications have overwhelmed you, consider consulting with Eqvista’s valuation analysts and accredited tax experts. Our defensible valuations and sound counsel can help you avoid unsavory tax implications and most importantly, protect your legacy. Contact us to know more!