Business valuation. How complex can those two words be? On the surface it would seem that the science of business valuation involves simply applying a formula to a given set of financial data. A business worth X is always worth X regardless of how you look at it, right? Not exactly. In the litigation arena for example, the same business interest may carry different values depending on the purpose of the valuation, applicable case law, and the specific facts and circumstances of the case. Before a business appraiser can place a value on a business interest, he or she must address several key considerations described below:
Purpose of the Business Valuation
A business valuation generally falls into one of three basic groups:
- Litigation – including marital dissolutions, partnership and corporate dissolutions, bankruptcy, breach of contract, dissenting shareholder and minority oppression cases, economic damages, etc.
- Taxes – including gift and estate taxes, estate planning, family limited partnerships, ad valorem taxation, etc.
- Transactions – including acquisitions, mergers, leveraged buy-outs, initial public offerings, ESOPs, buy-sell agreements, etc.
The purpose of the business valuation can have a significant impact on the value determined by the business appraiser. Such a value derived may not be applicable for any other purpose.
Standard of Value
Related to the “purpose” of value is the “standard” of value, which addresses the “value to whom”. Standards of value include, among others:
- Fair Market Value
- Investment Value
- Fair Value
- Intrinsic/Fundamental Value
The standard of value used largely depends on the purpose of the valuation. The standard of “Fair Market Value” is often used in arenas such as estate planning and divorce cases. On the other hand, the standard of “Investment Value” is often used in M&A activity where a corporate buyer is considering an acquisition. Since a specific buyer may benefit more than the average investor by acquiring a target company – either through synergies or by absorbing a competitor – the value to that specific buyer may be greater than that of the overall market. This is also known as “Strategic Value”. In other cases, the standard of “Fair Value” may be used. This standard is often defined under state statutes (e.g. dissenting shareholder or minority oppression cases) or defined for Financial Reporting purposes (e.g. under GAAP). Still in other instances, business value may be defined as “Intrinsic” or “Fundamental Value” based on the value to a specific investor or other interested parties.
Premise of Value
The premise of value (whether the business interest is considered a “going concern” or faces the threat of liquidation) has a lot to do not only with the ultimate value derived, but the business valuation methodologies used within the business appraiser’s analysis. A “going concern” premise of value means that the business appraiser presumes that the continued assemblage of assets, resources and income-producing items will continue in use to produce income and cash flow for the business in the future. Thus, owner wealth is presumed to be maximized by the company’s continued existence for the foreseeable future.
As a going concern, the business interest may be valued based on expected future cash flows. Alternatively, if the business is presumed to be valued at liquidation value (because of the threat of either forced liquidation or orderly liquidation), the current value of the business’s net assets may carry much more weight in the business valuation conclusion than its’ potential future cash flows.
Other Business Valuation Considerations
In addition to the purpose of value, standard of value, and premise of value, there are many other considerations the business appraiser addresses that impact the ultimate business valuation determination. Other considerations include the valuation date selected, the level of value (controlling or minority interest), the tax status and tax implications of the entity, and many more. It is vitally important that the business valuation expert you select has a comprehensive understanding of the various considerations impacting the value of your business.