At our company we have a tag line that says, “We value your business”. What I am going to attempt to do over the next few months is to dissect the appraisal process and attempt to explain what the driving factors in a business appraisal are and how you can apply this to your business and create business with more “value”.
This leads to the first question, or premise when looking at the concept of value. What is value? What are the different types of value? You have all heard the phrase “beauty is in the eyes of the beholder”. That is the same with the definition of value. It all depends on your point of view. Here are the different types of value.
Fair Market Value – Defined as the price expressed in terms of cash or cash equivalents, at which property would change hands between a hypothetical wiling and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is at a compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. Fair Market Value is the most well know standard of value and is the most used standard of value. It is a definition that comes from the Internal Revenue Service (IRS) Treasury Regulations 20.2031-1. Where this standard of value is widely used in a business valuation context. There are many other types of valuations and Standards of Value.
Fair Value – This is defined as 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. This definition comes from Financial Accounting Standards Board, (FASB) Accounting Standards Codification (ASC) Topic 820. This is often the standard used in judicial appraisals where fair value is the legally mandated standard that applies to specific transactions and is commonly used in matters involving dissenting shareholder oppression and litigation challenging the fairness of a particular transaction.
Book Value – This is not a standard of value. It is an accounting term to define historical cost reduced by allowances for unrealized losses, depreciation and amortization. Book value is basically the value of owner’s equity on the balance sheet, less liabilities.
Investment Value – This standard of value refers to the value of an asset, business or business interest to a specific or prospective owner. This type of value considers the prospective owner’s knowledge, abilities, expectation of risk and earnings potential, and other special factors. Investment value is also known as synergistic value. Looking at the special requirements of the purchaser. (Lawrence A. Hamermesh and Michael L. Wachter, “Rationalizing Appraisal Standards in Compulsory Buyouts”, 50 B.C.L. Rev. 1021, 2009) this standard of value would be the standard that may reflect the added value of purchasing a competitors business or the vertical integration of a supply chain.
Liquidation Value – This is a standard of value widely used and is defined by Black’s Law Dictionary as the value of a business of an asset when it is sold in liquidation, as opposed to being sold in the ordinary course of business. This standard of value is often used in the valuation of machinery and equipment and has sub-standards such as forced liquidation, orderly liquidation and value in place.
So when you look at your business and are thinking about its “value” make sure you understand the differences. These differences could cost you plenty. This usually comes into reality when a partnership has an “event” that causes them to open up the Articles of Incorporation and see what it says. Don’t be surprised by your company’s standard of value. Look at it today and make sure you understand the impact it may have tomorrow.
Matthew Cassedy a Certified Business and Machinery and Equipment appraiser. He specializes in the valuation of small to medium size businesses. He can be reached at 480-652-2977.