FAQ: What is the standard of value? Part 1 of 2

Exit Insight: Getting to SoldOne of Synergetic Finance’s services is to provide company valuations to business owners. Because performing a business valuation can be complex, Synergetic Finance founder and author Joseph M. Maas explains how it works and what the standard of value means in his book, “Exit Insight: Getting to ‘Sold!’” The following is an excerpt from pages 87-90.

The Standard of Value

Determining the value of a business is a complicated task because there are different standards of value. Your valuation advisor must be knowledgeable in selecting the value standard that best suits your purpose because the conclusions of one standard will be quite different from the conclusions of another, and the material difference is likely to be substantial.

For example, when appraising the value of a business for the purpose of a third party sale, ‘investment value’ is the appropriate choice. But, if appraising a business by order of a court for litigation purposes, then the standard of value will be defined by statute. In addition, if the wrong standard is applied, the conclusions will invalidate the entire proceeding.

There are five standards of value common in valuation proceedings. This review will provide a more complete understanding of how businesses are valued, affording you a broader knowledge of how your business, or the one you wish to acquire, will be analyzed and judged.

The figure below shows four of these standards and provides only a simple representation of why one or another might be a favored choice given a particular situation.

Types of Value

5 types of value

 

 

 

 

 

 

 

Fair Market Value (FMV):

The most common definition of value used in the business valuation process is Fair Market Value. Its popularity is based on IRS Revenue Ruling 59-60, which is the basis for all Federal tax decisions, and is used by the IRS and the courts. Because of its governmental favor, valuation professionals gain valuable guidance on performing the valuation. Here is the wording of IRS Revenue Ruling 59-60, defining Fair Market Value:

“The price at which the 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, bother parties having reasonable knowledge of relevant facts.”

Another worthy definition of FMV is voiced by The International Glossary of Business Valuation Terms:

“The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”

Fair value:

Defining Fair Value is a bit more nebulous, as its definition is the cause for debate, and sometimes differs from state to state.

When engaged in a valuation project, valuators will wisely request that the attorney hired specifically to oversee the valuation provide the definition of Fair Value applicable to the statutes of the jurisdiction.”

Copyright © Joseph M. Maas for Merrell Publishing 2014-2015

In our next post, we’ll discuss three other standards of value: book value, intrinsic value and investment value.

Want more information about exit planning or business valuations? Buy a copy of “Exit Insight” for online at Merrell Publishing or Amazon. A small investment today will give you great peace of mind later!