In a previous post, we wrote that a number of circumstances call for a business valuation: acquisitions/sales, bankruptcy proceedings, buy/sell agreements, divorce, estate or gift planning/compliance, impairment testing, raising new capital, shareholder disputes, and stock-based compensation.
We return to this point because the purpose of the exercise tends to affect the assumptions and approaches used in, as well as the conclusions determined under, a business valuation. As Shannon Pratt wrote in Valuing a Business: The Analysis and Appraisal of Closely Held Companies, “A valuation conclusion prepared for one purpose may not be the appropriate valuation conclusion for another purpose.”
So, simply because one business owner sold his company ‘for five times’ does not mean that another business owner – in the same town and in the same industry – who is in the throes of divorce will have his business valued at five times a given metric.
Again quoting Pratt: “The purpose of the valuation often determines the applicable standard of value—that is, the definition of value being sought—and almost always influences it.” There are various standards of value, including:
- Fair Market Value – The “price at which property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts.” (Internal Revenue Service Revenue Ruling 59-60)
- Fair Value – The “price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” (ASC 820-10)
- Investment Value – The “value of an asset or business to a particular owner or prospective owner for individual investment or operational objectives. Also known as value to the owner.” (International Valuation Glossary – Business Valuation, updated February 24, 2022)
- Market Value – The “estimated amount for which an asset or liability should exchange on the Valuation Date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing, and where the parties had each acted knowledgeably, prudently, and without compulsion.” (International Valuation Glossary – Business Valuation, updated February 24, 2022)
