June 14, 2017 - contributed by Christine Baker
In recent posts we learned that no one business valuation number will be appropriate in all circumstances, and that we should understand the difference between Enterprise Value and Equity Value. In this post we’ll dive into the topic of “premise of value.” You may have never heard of this but here it is.
The International Glossary of Business Valuation Terms (yes, there is such a thing!) defines Premise of Value as follows:
Premise of Value – an assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation; for example, going concern, liquidation.
The Glossary has been adopted by the American Institute of Certified Public Accountants (AICPA), the American Society of Appraisers (ASA), the Canadian Institute of Chartered Business Valuators (CICBV), the National Association of Certified Valuation Analysts (NACVA), and The Institute of Business Appraisers (IBA). Who knew. We will happily send you a copy if you’re having trouble sleeping.
Meanwhile let’s keep talking about this Premise of Value concept. Flip open that Glossary of Terms again and you’ll find
Going Concern Value – the value of a business enterprise that is expected to continue to operate into the future. The intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.
Going concern value is refined further between “value in exchange” versus “value in use.” A great illustration is a specialized medical practice in which the sole owner is the most highly regarded (and highly compensated) specialist in the region and she makes a very respectable living operating her business. The “value in use” to her to continue operating may be relatively high… while in contrast, the value in exchange to a buyer (who very likely will not be a replica of the seller) will be much lower because of what cannot be transferred. In reality, “value in use” and “value in exchange” for this business are two very different figures.
On the flip side, a dental practice with several doctors and a large roster of patients who faithfully come in for their six-month checkups may have a value in exchange that’s nearly the same as its value in use.
We like to use the term “transferrable value” with our clients when addressing continuity planning. You may have created substantial business income over time but have you created transferrable value? Dwell upon this.
There is another premise of value defined in the Glossary of Terms: Liquidation Value.
Liquidation Value – the net amount that would be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be “orderly” or “forced.”
The idea behind liquidation value tends to speak for itself. Its use is inappropriate in many circumstances because it may not account for goodwill value that exists when all of the business assets (trained and assembled workforce, anyone?) are together in place. One caveat to mention is that liquidation value should include an allowance for intangible assets that are contractual and/or severable that may have a transferrable value of their own but often do not appear on a company’s balance sheet.
That’s a wrap for this post regarding Premise of Value. Next time we’ll delve into various “standards of value” that arise and why one might be utilized over another.
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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.