What does my business valuation really mean?

BUSINESS VALUATION STANDARDS – WHAT THEY MEAN, WHEN TO USE THEM
“If you don’t stick to your values when they’re being tested, they’re not values: they’re hobbies.”
Jon Stewart, The Daily Show

Want to know more?  Please click here for the downloadable e-book. “7 Things You Must Know Before You Order a Business Valuation” 

The Goal: To cut through the jargon and make sure you understand what your business valuation really means.   The key is to understand that different standards of value will likely produce different results (a different valuation number) and hence the reason that one valuation should not be used for multiple valuation purposes.
Key point: Value, used in the context of business valuations are referred to as valuation standards, really does have different meanings. Let’s review the primary valuation standards we work with, which are, Fair Market Value, Fair Value, and Investment Value.

1. Fair market value – this is where we spend most of our time, the granddaddy of our valuation and business sales/acquisitions engagements. This value, defined by the IRS during the days of prohibition when at that time, the owners of breweries and distilleries were being compensated for being closed by the government, is based on certain key assumptions: the seller and buyer are hypothetical (ie no specific purpose), both willing to do a deal, neither party compelled to do so, both parties are properly informed and each with the resources and rights to make it happen. Note that fair market value includes valuation discounts and premiums associated with limited marketability and minority ownership interests. It’s true, not all ownership shares are created equal!

2. Fair value – wish they called it something else, easy to confuse with fair market value. This definition is in constant motion, always on the move. Why? The definition changes with new local/jurisdictional case law rulings and decisions. So, the more we learn from real world experience, the better we understand the issues and challenges in preparing realistic valuations with greater clarity (well, not always). And, valuation discounts associated with lack of marketability and minority interests are generally excluded from fair value valuations. So fair value is really driven by jurisdictional decisions and interpretations. Ex: you will find the definition of fair value used in Florida will likely be different than the California meaning of fair value, even when it’s the same valuation issue. And if you live in Virginia, you’ll find that the term intrinsic value is used instead of fair value. Jurisdictions prevail.

3. Investment value – this value, commonly referred to as “synergistic value” looks at value through the eyes of a specific buyer, not the hypothetical buyers assumed in the fair market value standard, who is interested in acquiring a specific targeted company. Generally, the “synergistic buyer” has made certain assumptions regarding the “synergistic benefits” anticipated with the potential acquisition of a targeted business ie added customers, new markets, cost savings and has factored such benefits in the valuation.

Ok, now that you have a good understanding of what the typical “valuation standards” are, what difference does it really make? Good question.
Key point: It’s important to make sure that the proper valuation standard (above) is consistent with the purpose of having the business valuation prepared. Otherwise, you might end up valuations that are wrong. We’ve summarized this for you:

1. Fair market value:

a. Business sales and acquisitions
b. Acquisition financing
c. Estate and gift tax planning
d. Business succession planning
e. ESOPS’s (employee stock option plans, a specific type of retirement plan)
f. Calculating built-in-gains tax for C-corporations converting to S-corporations

2. Fair value

a. Owners dispute
b. Partner/shareholder ownership “earn-in” provisions
c. Dissolution (orderly, not forced)
d. Public to private ownership changes
e. Financial reporting requirements

3. Investment value – sales and acquisition between known parties

4. Other common valuation situations include:

a. Buy sell agreements – the value is whatever the parties agree to in the buy/sell agreement (hint: if you have one, is it current? And does it reflect what you really want? If you don’t have one, should you?)
b. Marital dissolutions/family law matters – we’ve seen both fair market value and fair value (intrinsic value in VA) standards commonly used.

Clients choose Harvest Business Advisors for our accurate business valuations and our consistent ability to deliver the highest price in the smoothest sale transaction possible. Harvest provides business brokerage, business valuation, and business succession planning services. We have extensive experience in the information technology and professional services, manufacturing, distribution, and contracting fields. We maintain offices in Maryland, New Jersey and Virginia. Connect with us at info@harvestbusiness.com or 443.334.8000 to discuss selling your business, ordering a business valuation or buying a business.

Fair Market Value, Fair Value, and Discounts for Business Owners when Planning or Selling a Business

In our previous post I talked about Strategic Value as a standard of value when business owners are valuing their business.  Instances where you need to know the value of your business include planning to sell or transition their business through business brokerage or a sale transfer to managers or family.

Want to know more?  Please click here for the downloadable e-book. “7 Things You Must Know Before You Order a Business Valuation” 

Fair Market Value. This value is the value a typical buyer who will not derive strategic efficiencies will pay for your business. Typically these buyers are called Financial Buyers. They are looking for what I call “working models”. Almost like a franchise they want to step into your “business model” and run it. This is the value of the business to a control owner that can make changes as desired. This value typically used for buy-sell agreements and transactions involving closely held and family business interests.  In many jurisdictions a version of this can be called Fair Value which again, is generally fair market value without discounts even when the interest is a minority interest.  This is also the value generally used on SBA loans during SBA business valuations.

Fair Market Value with Discounts.  This is the value of a minority interest in the business. The owner of this interest is either a minority owner (under 50%) or has agreed to restrictions on company control. Therefore this owner has little control over continued employment at the company (if they are an employee), distribution of profits, company policy or planning etc. Namely they are along for the ride. Because of the lack of control these interests are valued below fair market value. This is primarily used in estate and gift tax planning to lower the give or estate value. Many exiled family members from family businesses will also tell you that the lower value is very real when family harmony breaks down.

Finally, business value can be more or less than the price negotiated between parties.  Price is subject to the actual market, how well the company is positioned by its brokers, the players in the market, and other variables that cannot be fully taken into account when determining value.

Conclusion. If a business has a fair market value of $1,000,000 with 100 shares of stock issued the 100 shares to a strategic control buyer might be $1,200,000 or more. The value of 1 share to a non-control buyer (fair market buyer with discounts) might be $700 not the $1,000 fair market value. It is important to know why your business is being valued and to specify the correct level of value be used.

Gregory R. Caruso
Harvest Business Advisors
Business Brokerage, Business Valuation and Appraisal
gcaruso@harvestbusiness.com
609-664-7955

Company Valuation and Business Valuation Standards of Value for Litigation, Mergers & Business Brokerage and Other Situations

Levels of Value for Company Business Valuations and Appraisals, business owners who are thinking of selling their business or doing routine succession planning need to understand the value of their business. Often owners are surprised when they learn that company value, enterprise value, or business value found might be dramatically different depending on the situation.   The value of the business is usually determined by what it is worth to others.   From that standpoint, it makes sense that buyers in different situations might have different values. This is because different buyer types will be able to make different amounts of money (both theoretically and actually) from the business.

Want to know more?  Please click here for the downloadable e-book. “7 Things You Must Know Before You Order a Business Valuation” 

Below I discuss Strategic Control Value.

In my next Post I will discus Fair Market Value and Minority Interest Fair Market Value.  These are the main standards of value used.

Strategic Control Value. This value is the value obtained when 2+2=5. This buyer is often called a synergistic buyer. Namely the acquirer can obtain more value from the target than the target can make on their own. This can happen because of operational efficiencies or because of the ability to increase market sales with incrementally lower costs. The classic example of an operational efficiency is two delivery companies running the exact same routes. If they merge the combined entity should be able to deliver the same packages with substantially less trucks and drivers. An example of the ability to increase market sales is when a small software company is purchased by a larger one who has a sales force that is already established in the industry the software is designed for.

Studies have shown that operational efficiencies are more predictable than sales and revenue increases. For owners it is important to remember that while strategic buyers and strategic value exists in terms of day to day operations you must run your business as if you will own it forever without a strategic buy-out. If you can modify your business plan to court a strategic buyer without putting your day-to-day efficiencies and operations at risk fine but never put yourself in the position of only having one buyer or being inefficient with the hope of attracting one buyer.

In summary strategic control value is a high value that can only be met in certain times by certain buyers.  It is worth calculating when you are going to sell and strategic buyers are a real possibility.  It is not worth putting your whole company at risk for to obtain if it limits current profitability or future options.

 

Greg Caruso, JD, CPA, CVA
Harvest Business Advisors
Business Brokerage, Company Valuation, Business Appraisal
Princeton New Jersey, Baltimore Maryland, Columbia Maryland
gcaruso@harvestbusiness.com