When we determine the value of a business because someone wants to buy, sell, finance, or for other purposes, the Standard of Value used impacts every element and the ultimate value found.
Standard of Value simply defines the agreed-upon transaction terms that form the basis for an exchange and estimating a business value. If you have ever bought or sold something, you already know the basics of what we call a Standard of Value. For example, if something is being liquidated quickly, you might have different expectations of price and terms than a market sale with no time pressure on either side. In addition, each participant in the process may see and value things differently. Using a home as an analogy, a seller may love that the home has a pool, while a prospective buyer may see that as a liability. In the end, however, the ultimate buyer and seller have to agree on what they are willing to pay for the house or there is no sale.
Standard of value, in essence, is a shorthand for the deal terms if the business valuation was a real transaction.
Like a home, each business has different attributes and assets and liabilities. Unlike a home, businesses have varying levels of complexity to run and different profitabilities. In the end, who the buyer is and who the seller is (and what they value) along with the pre-established terms of the transaction is specified by the standard of value selected for the business valuation.
Sometimes the standard of value is selected by the valuator to be the one most useful to the users, for instance using fair market value for planning a sale. Sometimes the standard of value is specified such as in many legal disputes fair value is called out in many statutes. Here are 7 common standards of value.
Fair Market Value
In a theoretical world, fair market value is as simple as what a hypothetical buyer is willing to buy for and what a hypothetical seller is willing to sell for. In reality, these are a fictitious buyer and seller not the actual ones in the transaction. When actually valuing a business, you have to take into account who makes up the pool of buyers and how they would look at it. The seller is a typical seller who is prepared to sell. Both parties are assumed to have reasonable knowledge and a willingness to transact fairly quickly. One other element of this standard of value is the transaction is paid for in cash at closing. This is probably the most commonly used standard of value.
Market Value
Market Value is much closer to a real-world scenario as it includes a reasonable marketing period prior to the transaction. This is an international standard and not frequently used in the United States. Once each party actually has knowledge of the transaction, it is the, “best price reasonably obtainable by the seller and the most advantageous price reasonably obtainable by the buyer,” according to IFRS, the international standards for Accounting Standards.
Fair Value
Fair value has multiple definitions between common use in state courts for divorce and business disputes and for use in GAAP for financial reporting. We will work with the definition used by many states for disputes.
Fair value comes into play when valuing a minority or lack of control ownership interest in a business. Because minority interest owners tend to be “along for the ride” instead of in control their interests have less value under a fair market value standard (i.e. how much would you pay for 20% of a company where the person that owns 80% says they will not pay you or distribute money to you–ever, and they legally can do that?). Under fair value the minority interest is specified to be a pro-rata share of the total value of the company. So, in our scenario above, if the company was worth $1,000,000 the 20% interest would be worth $200,000. That is fair value.
Investment Value
The opposite of fair market value is investment value. In this scenario, both parties are known and the value is determined to the specific participants. In some cases this might result in a fair market value and in others a synergistic value.
Intrinsic Value
Intrinsic value can have two different meanings, one used for divorce litigation and asset valuation and one used for business investment valuation. In Virginia divorce law, for example, intrinsic value is the subjective value that a party places on a property or asset. That subject value then needs a monetary value, which can be very complicated to determine. For investors, intrinsic value is almost the opposite of that. It is an analytical judgement of the underlying value, regardless of who the investors are (similar to fair market value). Usually this is more of a discussion point and it is rarely used as a standard of value even by investors in formal business valuations.
Synergistic Value
Sometimes, a business in itself can have multiple assets, and those assets combined are worth more together than as separate entities. Namely, the company being purchased will make more money for the buyer than the company can on its own. This is called synergistic value. This could include a biotech company who has intellectual property on a vaccine and a factory to produce that vaccine. Together, the two could be much more valuable than each separate part.
Liquidation Value
The value determined when you sell each asset of a business is called the liquidation value. This is almost the opposite of synergistic value, since each piece of the business may be worth less than the business as a whole. In an orderly liquidation, assets are sold over time so that they can get the best value. In a forced liquidation, sellers have to take a quick and usually financially worse best-offer approach in a limited time frame like an auction.
These are very brief explanations of 7 common standards of value, but all of them relate to the question: Who is the buyer and who is the seller and how much time do we have to sell? The professional judgement of a valuator helps determine a standard of value that matches the real-life transaction that is happening.
April 24, 2021 at from 11:45 AM to 1:15 PM is the next New Jersey Exit Planning Exchange meeting.
Gregory Caruso will be presenting to the New Jersey XPX Association on “Small Business Valuation in a Post Covid World”
The presentation will focus on how Covid has affected small business and business valuation in different industries and locations. Data from a variety of sources will be used to show the different effects on large companies, middle market companies, and small companies. Marketability discounts and iterative projections will be presented as ways to deal with high risk situations.
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” covers many professional judgement scenarios, explains calculations and standards in great detail and addresses other important valuation issues. You will also have web access to download sample reports, calculators and checklists. You will reach for this complete resource time and again.
“This is a book review of The Art of Business Valuation: Accurately Valuing a Small Business by Gregory R. Caruso, author. This book is a guide and desk reference published by Wiley for valuing small and micro businesses under $10 million in revenues.
The primary question answered in the book is: How do we as business valuators, business brokers, accountants, lawyers, owners, and other interested parties who prepare, review, evaluate, or use business valuations for small and very small businesses in difficult environments?
This is an environment where owners are still engaged in planning for the future. The owners are taking out loans. They are adding and eliminating partners who are often lifelong friends or family members, adding to the volatility of the mix. They are getting divorces. Some are even selling or filing for bankruptcy.
All of these common activities require an accurate business valuation; this is not just a matter of applying techniques, it requires that the person valuing the business continually ask him or herself “Does this make sense?”
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” has 400 pages covering many professional judgement, calculation, standards, and other important valuation issues along with access to sample reports, calculators, and checklists downloadable from the web. This will be the one book you will reach for if you value or rely on valuations of micro or small businesses with revenues under $10 million. The book published by Wiley is available at your preferred bookseller. To Buy from Amazon Click Here
Greg Caruso, JD, CPA, CVA, the author of “The Art of Business Valuation, Accurately Valuing a Small Business” 2020 published by Wiley is always available to prepare (or review) business valuations for all purposes and situations.
JOIN our email list to stay current on changes in small business valuation. Things like how addressing Covid is changing business valuations.
A forecast provided by management was analyzed to evaluate the usefulness and veracity for use as a base line cash flow in the business valuation. The projection showed rapid growth but unfortunately, as is common in small and micro business valuation, the forecast was not terribly useful and was not likely to be accurate enough to use in a discounted cash flow model as the income stream was too speculative. For that reason reducing the cash flow to closer to the historic average cash flow was a necessary adjustment made in valuing the company.
The Company also had a weak balance sheet. Strong balance sheets provide stability during economic downturns as general contractors can be highly cyclical. This weak balance sheet was a reason to reduce the multiplier or increase the capitalization rate reducing business value due to high risk of the projected cash flow not being met even after adjustment.
Other concerns and adjustments were reviewed in the article. The complete article is available here.
This article is the first to be published in a new column appearing every other issue called, “Size Matters, Valuation of Small and Micro Businesses”. I am honored to be asked to write this column for The Value Examiner.
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” has 400 pages covering many professional judgement, calculation, standards, and other important valuation issues along with access to sample reports, calculators, and checklists downloadable from the web. This will be the one book you will reach for if you value or rely on valuations of micro or small businesses with revenues under $10 million. The book published by Wiley is available at your preferred bookseller. To Buy from Amazon Click Here
Finally Greg Caruso, JD, CPA, CVA, the author of “The Art of Business Valuation, Accurately Valuing a Small Business” 2020 published by Wiley is always available to prepare (or review) business valuations for all purposes and situations.
JOIN our email list to stay current on changes in small business valuation. Things like how addressing Covid is changing business valuations.
“Back to Basics – COVID-19’s Impact on Micro and Small Business Valuation” is a Business Valuation Article on Small and Micro Business Valuation during a time of extreme risk due to Covid-19 appearing in Quick Read a NACVA Journal on Business Valuation.
Businesses were thrown for a loop when Covid-19 hit. It is reported that over 100,000 business have closed their doors due to fear of congregating, shut down orders, stay home orders and changes in consumer and business actions and habits.
This sea change for business certainly increased risk as measured by finance and business valuation professionals. Risk for financial analysts is the likelihood that projected cash flows will be met. How to measure the project micro and small business value during times of high risk caused by Covid-19 requires a back to basics approach.
In this article Greg Caruso proposes that business has been under unforeseen stress before. The gas crisis in the ’70’s, the Savings & Loan crisis in the 1990’s, the housing mortgage bubble in 2008, and other shocks provide historic perspective and call for a back to basics approach when valuing small and micro businesses.
More webinars on the “Valuing Small Businesses in the Shadow of COVID-19″ topic and other business valuation topics are being scheduled in the upcoming weeks. If you are interested in participating, please visit our Upcoming Events page
The Value Examiner® is an independent, professional development journal dedicated to the exploration of value and its ramifications for consultants published by NACVA (National Association of Certified Valuators and Analysts)
I am pleased to announce that I have been chosen to write a column on Small and Micro Business Valuation issues for “The Value Examiner” starting with this most recent edition.
In “Size Matters -Valuation of Small and Micro Businesses”, I will focus on matters of particular importance to businesses under $10M in revenues.
In the November/December issue, I present a case study of a recent valuation of a general contractor with a 6/30/2020 valuation date, near the peak of uncertainty from Covid-19.
The book, “The Art of Business Valuation, Accurately Valuing a Small Business” has 400 pages covering many professional judgement, calculation, standards, and other important valuation issues along with access to sample reports, calculators, and checklists downloadable from the web. This will be the one book you will reach for if you value or rely on valuations of micro or small businesses with revenues under $10 million. The book published by Wiley is available at your preferred bookseller. More information can be found at www.theartofbusinessvaluation.com
Finally Greg Caruso, JD, CPA, CVA, the author is always available to prepare (or review) business valuations for all purposes and situations.
JOIN our email list to stay current on changes in small business valuation, including how to address changing business valuations because of COVID-19.
