Business valuation or business appraisal is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to affect a sale of a business. In addition to estimating the selling price of a business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partner’s ownership interest for buy-sell agreements, and many other business and legal purposes such as in shareholders deadlock, divorce litigation and estate contest.
Before the value of a business can be measure, the valuation assignment must specify the reason for and circumstances surrounding the business valuation. These are formally known as the business value standard and premise of value. The standard of value is the hypothetical conditions under which the business will be valued. The premise of value relates to the assumptions, such as assuming that the business lies in the proceeds from the sale of all of its assets minus the related debt (sum of the parts or assemblage of business assets).
The main standards of value are: 1.) Fair Market Value – a value of a business enterprise determined between a willing buyer and willing seller both in full knowledge of all the relevant fact and neither compelled to conclude a transaction; 2.) Investment Value – a value the company has to a particular investor. Note that the effect of synergy is included in valuation under the investment standard of value; 3.) Intrinsic Value – the measure of business value that reflects the investor’s in-depth understanding of the company’s economic potential.
The premises of value are: 1.) Going Concern Value – value in continued use as an ongoing operating business enterprise; 2.) Assemblage of Assets – value of assets in place but not used to conduct business operations; 3.) Orderly Disposition – value of business assets in exchange, where the assets are to be disposed of individually and not used for business operations; 4.) Liquidation – value in exchange when business assets are to be disposed of in a forced liquidation.
The premise of value for fair value calculation are: 1.) In use – if the asset would provide maximum value to the market participants principally through its use in combination with other assets as a group; 2.) In exchange – if the asset would provide maximum value to the market participants principally on a stand alone basis.
Business valuation results can vary considerably depending upon the choice of both the standard and premise of value. In an actual business sale, it would be expected that the buyer and seller, each with an incentive to achieve an optimal outcome, would determine the fair market value of a business asset that would compete in the market for such an acquisition. If the synergies are specific to the company being valued, they may not be considered. Fair value also does not incorporate discounts for lack of control of marketability.
These assumptions might not, and probably do not, reflect the actual conditions of the market in which the subject business might be sold. However, these conditions are assumed because they yield a uniform standard of value, after applying generally accepted valuation techniques, which allows meaningful comparison between businesses which are similarly situated.
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