Who Needs an Independent Valuation?

Key Takeaways:

• An independent valuation provides a baseline value and helps you understand your company’s market position and key value drivers.
• Valuations are essential for strategic planning, succession (gifting or selling), and attracting investors with equity compensation.
• They are also critical for regulatory and compliance reasons, including tax reporting (Section 409A) and financial reporting (ASC 805).

An independent valuation can provide business owners, executives, and directors with a baseline value and a set of tools to better understand the company’s position in the market, its competition, and its key value drivers. These metrics can be vital for setting goals, enhancing value, developing a succession plan, selling your company, and attracting new investors, and for other reasons we outline below. 

Going beyond the bottom line, there are 8 key value drivers that enhance your business and that a valuation can help you measure. 

Enhancing Value

For private companies without publicly-traded stock, an independent valuation is the only reliable way to get an indication of value. Instead of waiting for a major event like a sale or litigation, getting a baseline valuation can help you develop strategies, set goals, and track performance over time. 

For privately held companies, shares of stock are not publicly traded in an open market, so indications of value are not easily obtained. An independent valuation can provide this information. But why would a privately held company need one? As mentioned above, valuations are performed for a host of purposes, including selling or acquiring a business, gifting shares, divorce, death, or litigation.

While an independent valuation establishes value as required by the specific events listed above, should you wait until such an event occurs before obtaining one? The answer is that there is no need to wait to know your company’s value. A baseline value assessment can assist owners and investors alike with developing strategies and goals. A valuation can also help you better understand what is working and what isn’t.

This is a core part of building a defensible business valuation, which provides a clear strategy and timeline for a successful exit.  

An initial independent valuation might help you establish specific goals as part of your larger business strategy. Then, an annual valuation would allow you to measure and track performance against those goals, create accountability for your employees, and help you understand your position in the market.

We often advise clients to use annual valuations as a tool to create accountability and measure progress against their strategic goals.

Developing a Succession Plan

A valuation is also a key part of succession planning. Whether you intend to gift shares to family, sell the business to a third party, or establish an employee stock ownership plan (ESOP), an independent valuation provides the credible documentation needed. 

Developing a business strategy isn’t the only reason to obtain an independent valuation. You may wish to know your company’s value in order to set up succession planning, whether you’re gifting shares to family, arranging the sale of the business to another company, or by selling the company to employees through an employee stock ownership plan (ESOP).

Whether an independent valuation is required or not, it can prove to be extremely beneficial and provide you with a great deal of knowledge.

Attracting New Investors

When private equity groups or other investors provide capital, the deal often includes equity compensation like stock options. To comply with tax laws like Section 409A, you need a 'qualified appraisal' from an independent party to establish the stock's value and avoid tax penalties for your employees. 

Private equity groups (PEGs) invest billions of dollars in entrepreneurial ventures. Many of these transactions are structured so that owners and management teams receive rollover equity or noncash incentives (such as stock options) as part of their compensation packages. Equity compensation can be a useful tool in aligning the interest of the company with the interest of the former owners or employees. To the extent the company does well and the stock price appreciates, the former owners, directors, and members of management who hold shares in the new company increase their wealth through the sale of those securities.

 A step-by-step guide to financial forecasting for business valuation is a useful resource for any company looking to attract investment.  

Equity compensation is subject to certain rules, however, and valuation is a key component of those rules. For example, Section 409A of the Internal Revenue Code addresses the taxation of deferred compensation. Recipients of options could be taxed according to the extent options are “in the money” when granted. The “in the money” portion could be deemed current income and is subject to being taxed as such. This taxable portion, if any, depends on the value of the company’s underlying stock. That value is established by “qualified appraisals” issued by an independent party. In other words, employees who receive equity compensation need to know the company’s value for their own tax purposes. Although this tax consequence impacts employees, the company could be responsible for failing to withhold and pay appropriate taxes.

Similarly, if your company is required to maintain GAAP-compliant financials, you may need to comply with ASC Topic 718, Compensation – Stock Compensation, when issuing equity as compensation to employees. The standard outlined by ASC Topic 718 provides guidance on how to account for noncash or share-based payments on company financial statements. In many instances, valuations are required in order to determine the value of the award issued as compensation as of the grant date and to establish the liability on the income statement.

Navigating 409A valuations is a common challenge for companies using equity to attract and retain talent. 

Private Equity-Backed Companies

If your company is owned by a private equity group and acquires other businesses, a valuation is needed to handle the purchase price allocation under ASC 805. Additionally, fairness and solvency opinions, while not always required, add a critical layer of due diligence and credibility to transactions. 

In many instances, PEGs invest in “platform companies” and grow that platform company by acquiring similar or related companies. To comply with ASC 805, the platform company must allocate the purchase price to the various assets acquired, which are then recorded on the buyer’s financial statements. A purchase price allocation which assigns value to all the acquired tangible and intangible assets (and goodwill), is generally performed by an independent party using specific methodologies developed for this purpose.

Companies backed by PEGs may also benefit from an independent valuation for fairness or solvency opinions. While not widely applied to privately held companies, fairness opinions—which are not required—can be an important aspect of a board of directors’ due diligence when entering into a transaction. This may be especially true if the shareholder group is diverse and members represent differing interests, which may be the case for companies with complex capital structures, including preferred classes of stock. In contrast, solvency opinions are required by statute in certain situations. In both scenarios, the use of independent advisors is critical to establishing credibility.

Fortunately, not all situations requiring independent valuations are as severe as death and taxes. The receipt of stock options, a successful acquisition, and the sale of a company offer good opportunities for independent appraisals. While the reasons for obtaining independent valuations may vary—particularly among PEG-backed companies—the results are clear. Independent valuations yield the information needed to meet legal, filing, and fiduciary requirements.

For boards of directors, especially with diverse shareholder groups, relying on an independent advisor for these opinions is a crucial part of fulfilling their fiduciary duties. 

Frequently Asked Questions

Q: Why does a private company need an independent valuation?
A: Since a private company's stock isn't traded on a public market, an independent valuation is the primary way to determine its value. This is necessary for strategic planning, succession, attracting investment, and for compliance with tax and financial reporting requirements.

Q: What is a 409A valuation?
A: A 409A valuation is an appraisal of a private company's common stock by a qualified, independent party. It's required by Section 409A of the tax code to ensure that stock options granted as compensation are not 'in the money,' which would trigger immediate tax penalties for employees.

Q: How does a valuation help with succession planning?
A: An independent valuation provides a defensible and credible value for the business, which is essential for any form of succession. This includes gifting shares to family members, arranging a sale to an outside company, or transferring ownership to employees through a structure like an ESOP.

Daniel Cooper

Daniel Cooper is a Managing Director at PCE and plays a key role in the firm’s valuation practice. He specializes in ESOP valuations and estate planning, advising clients across industries on financial reporting, tax, and transaction-related valuation matters.

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