I’m going to be honest. We generate a heck of a lot of valuation computations in our offices and we prepare them for a wide variety of purposes. If there’s one thing we’ve learned over time it’s this: every situation is unique. Sure, each business has its own value drivers, but did you know that the purpose and context of the valuation project also impact the number?
Our clients don’t come to us unless they have an issue to tackle – sometimes it involves going to market; sometimes it involves raising capital. It could be related to gift or estate tax, divorce court, selling to employees, buying out an unfriendly shareholder, or rewarding key executives. These different types of issues require different perspectives about “value.”
What approach the appraiser of a business (or a business ownership interest) takes is dependent upon the purpose behind the valuation analysis and the subject of the valuation analysis. A preliminary step in every valuation process is identifying the purpose and scope of the valuation assignment. The appraiser is required to identify and define the standard of value, the effective date of the appraisal, and the business, business ownership interest, or security to be valued, as well as the purpose and use of the valuation (Standards Rule 9-2 Business Appraisal – Development, Uniform Standards of Professional Appraisal Practice).
A common misconception is that the “fair market value” of a share of a closely held corporation [or partnership or membership interest] is a singular figure which is valid for a variety of purposes. Initial decisions involving various premise and assumption choices are probably the most important part of the valuation process… The purpose of the appraisal and the underlying assumptions will materially impact the final results. Every valuation must begin with an answer to the question: “value of what, to whom, and for what purpose?” in order for a supportable analysis to be developed. It is crucial that the specific facts and circumstances underlying each unique transaction are clearly understood and properly reflected in the quantitative analysis. (Randall B. Whilhite, The Effect of Goodwill in Determining the Value of a Business in Divorce, Family Law Quarterly Vol. 35 No. 2 (Summer 2001) pp. 351-381, referring to Mark Maxon, Valuation of Closely Held Securities – Avoiding Common Pitfalls and Misconceptions, Deloitte & Touche Valuation Notes (June 1991))
We’ll talk more about “standard of value” and “premise of value” in future posts but for now let’s identify some of the decisions that need to be made before even beginning the number crunching. Does our client need an enterprise value number or an equity value number? Are we considering a few shares of the company, or the business as a whole? Are there limitations on the ability of the owner to exert unilateral control? Are there limitations on the transferability of the equity shares we’re looking at? Are we assuming we’re going to market in a competitive bid process, or are we valuing the business (or business interest) as is in the hands of its current owner? Answers to questions such as these can and often do impact the final number.
The moral of this story is that, unfortunately, there is no one number that will be appropriate in every scenario a business owner may need to address. But we’re prepared for this. In future posts we’ll touch on some of the considerations we watch for with every valuation matter.
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Christine Baker is an Accredited Senior Appraiser (ASA) and leads the business valuation practice at Charter Capital Partners. She has completed more than 1,000 accredited appraisals in over 20 years for a wide variety of purposes, most of which do not involve “going to market.” She has served on the AICPA Business Valuation Committee, the AICPA Forensic and Valuation Services Executive Committee, the AICPA Accredited in Business Valuation (ABV) Committee.