In our last post we tossed around the idea of more than one Premise of Value, such as “value in use” versus “value in exchange.” Remember that International Glossary of Business Valuation Terms we talked about? Well guess what we’re going to take a look at the Glossary again in this post. Let’s see what it says next to “Standard of Value.”
Standard of Value – the identification of the type of value being utilized in a specific engagement; for example, fair market value, fair value, investment value.
Good grief, seriously? How can there be more than one definition of business value?
Now we’re really starting to wade into the mud. In the appraisal world, the most common standard of value for many of us comes from the U.S. tax code (which frankly has nothing to do with taking a company to market). But valuation issues come up so frequently in the tax world that there is a special definition of value that must be used for tax purposes. So let us introduce to you the one and only Revenue Ruling 59-60, which defines Fair Market Value for gift and estate tax purposes as
…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.
R.R. 59-60 is another one of those documents that we would be happy to send your way if you’re in desperate need of a sleeping aid. But wait! There actually are a number of very insightful and enlightening points in this document. (Sidebar comment: R.R. 59-60 assumes the subject of a tax-related valuation project is a block of Company stock and thus ultimately is focused on Equity Value. Remember we discussed the difference between Enterprise Value and Equity Value a few posts ago.) ‘Closely held corporations are those corporations the shares of which are owned by a relatively limited number of stockholders. Often the entire issue is held by one family. The result of this situation is that little, if any, trading in the shares takes place. There is, therefore, no established market for the stock and such sales as occur at irregular intervals seldom reflect all of the elements of a representative transaction as defined by the term “fair market value.”’
This definition of Fair Market Value is refined further in federal statute and tax court case law and is relevant for everyone in the U.S. regardless of their state. Decades of memoranda and opinions from the U.S. Tax Court have firmly entrenched the concepts of lack of voting rights, lack of control, lack of marketability, the size of the block of stock and other factors that impact the Fair Market Value of the shares of a business. Discounts for this, that or the next thing are common and appropriate.
When shareholders aren’t getting along, we turn to a different standard of value. Fair Value relates to the rights of minority shareholders and what they’re entitled to receive under certain circumstances. Both statute and case law vary between states but again the focus is on Equity Value. Valuation controversies in this setting generally center around the question of whether a proposed transaction price was “fair” to the shareholder(s) who disagree with the proposed transaction.
There’s actually another use of the words Fair Value that have nothing to do with shareholder lawsuits and everything to do with audited financial statements. That’s a whole ‘nother topic for a whole ‘nother day but suffice it to say that a new valuation credential has been created especially for this purpose.
Another Standard of Value that shows up in the appraisal world is Investment Value. Sometimes called “Value to the Owner,” Investment Value is defined in the Glossary as
Investment Value – the value to a particular investor based on individual investment requirements and expectations.
Investment Value has been interpreted as “if I continue to hold on to this business, what is the value to me?” It’s also been used to describe the perspective of a potential synergistic acquirer: “what am I willing to pay for this business knowing it brings something strategic to our organization we don’t currently have?” Some go so far as to say that all transaction multiples in the M&A market reflect investment value paid by the winning bidder and the specific circumstances of both the buyer and seller, and therefore inherently cannot provide a good representation of the value of the specific business being appraised. The idea is that transaction values get “bid up” in a typical competitive sale process. Interesting concept. Jury’s still out on that one.
The Big Picture theme throughout several of our recent posts is that there is no one singular business valuation number that will be appropriate in all circumstances. This is The Reason why an opinion of value reached by a business appraiser often is not the same as the deal value reached in a third-party sale (after converting from Enterprise Value to Equity Value, if need be).
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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.