Business Valuation: Family Businesses in Singapore and Malaysia
A business can have different values under different contexts, whether it is sold to an internal party (i.e. a remaining shareholder, spouse or family member) or an external party (i.e. a potential buyer who may or may not be an employee).
For a family business in Singapore and Malaysia, as the owner can decide to keep it, bequeath it to a family member or sell it to an outsider, it should be valued under these possible scenarios to help determine the option with the best return of investment.
Hence a family business should be valued ‘internally and externally’.
The Common Standards Of Valuation Of Family Businesses Are:
● Fair Market Value
The is for the external party, and it is the agreeable price, in terms of the cash equivalents, between a hypothetical willing-and-able buyer and seller when both parties fulfill the following requirements:
- They are not under any compulsion to buy or sell;
- They have a reasonable knowledge of the relevant facts;
- They are acting at an arm’s length in an open and unrestricted market.
Hence this value is what an owner would get when he/she puts the family business up for sale in the market to a qualified buyer.
● Investment Value
This is then for the internal party. It is usually based on a particular investor’s individual investment requirements and expectations. So it tells the owner’s perceived worth of the business.
The importance of these two common standards of valuation is in their distinction: the investment value of a running business can be lower or higher than the fair market value. Such differences are usually motivated by the ‘control owners’’ desire for the best return of investments.
The Following Are The Common Variables Affecting The Perceived Value Of A Family Business:
● Related-party relationships and transactions
When running a family business, there is a likelihood of leveraging on resources - like renting a property - from a related party. Renting fees can hence be higher or lower than the fair market amount.
The same property may also enter economic risk at the time of the transaction. So it is vital to consider the buyer’s perceived value of the property and its impact on the fair market value, during the sale of the family business.
● Fringe benefits
These refer to an airplane or a vacation home, or the insurance policies of the controlling owners and other family members that were paid with the business’s revenue; and they can be manipulated by the controlling owners of the family business.
The buyer may not be able to match all those benefits and would likely give them up, thereby creating a difference between the investment and the fair market value.
● Changes in capital structure
Controlling owners of a family business can keep or change the business’s capital structure; and usually such structures would be flawed for the business, such as under-utilizing debts. This would then deflate the fair market value.
In a family business, the members still receive salary that may be more than the compensation stipulated under fair market rate and conditions. This is because owners have the flexibility to pay themselves a compensation that is higher than the fair market value.
So when using the fair market value, a buyer will only pay what the market requires for the owner’s compensation, which is usually lower.
Also, since the members are part of the management team only because of the business being owned by the family, it is likely that the new owner would not retain their employment or keep them on the same payroll.
In conclusion, the variables of a family business tend to generate a difference in the perceived value of the seller - usually the controlling owner - and the buyer. Hence both the investment and fair market value are equally relevant in the M&A of a family business.
These differences in value would also need to be accounted in the plans for exit and estate and succession. They are helpful for making decisions on what to do with the family business in the near future.
As the impact of suddenly not owning a business is significant, it is crucial for the owner and his/her family to consider all viable options using all possible contexts of business valuations in the decision-making process.
It is then a good practice to engage external experts - business and estate planning advisors - to help determine the effect of selling versus that of retaining the business ownership within the family.
Get information about your business from a business valuer.