What is business valuation
Business Valuation is the process of determining the economic value of a company, including a company division or a foreign subsidiary as a separate unit
Although the fair market value of a business is ultimately set by the supply and demand (i.e. a business is worth as much as someone is willing to pay for it), the business valuation process has many real-life consequences and must be undertaken with both good faith and diligence. Business valuations are undertaken for a variety of reasons including but not limited to evaluating mergers and acquisitions, investments in both private and public companies, debt restructurings, negotiations between partners, taxation and even divorce proceedings.
To have a credible business valuation it must be performed by a certified professional. The certifications most commonly recognized in the United States include Accredited Senior Appraiser (ASA), Accredited in Business Valuation (ABV), Certified Business Appraiser (CBA), Certified Valuation Analyst (CVA) and Chartered Financial Analyst (CFA).
Business valuation is a set of procedures designed to determine what is the fair value of a business
In order to conduct a business valuation, a finance professional must first determine the Standard of Value and the Premise of Value.
The Standard of Value is the reason and conditions under which a business is valued. One of those standards is Fair Market Value which is often used by investment funds such as hedge funds and private equity funds to value illiquid investments. It assumes a hypothetical transaction between a willing buyer and a willing seller which both have the same knowledge of the facts. Its real-life consequences are that it is used as an input in calculating a net asset value (NAV) of an investment fund and therefore determines the dollar amount of fees an investor would pay to the manager.
Another standard of value is Investment Value which is the economic value a company would have to a particular investment. It is most often used in merger and acquisition transactions and it includes any synergies the acquiring entity might derive from consolidating the target company. Intrinsic Value is the third common standard of value and reflects an investor’s opinion about a company’s economic potential. It is often used by financial professional who invest in the stock or bond market and want to determine whether an investment is undervalued or overvalued.
Premise of Value is the set of assumptions one must make in order to value a business
The most important and commonly used premise is Going Concern. The premise assumes that the business valued is as an ongoing business enterprise that has enough liquidity and capital resources to continue operations for at least the following 12 months. The opposite of going concern is Orderly Disposition which assumes the value of a company is derived from methodical sale of its assets (i.e. it considers that sum of the parts is greater than the whole). It is typically used for companies that are bankrupt or near bankrupt and whose assets need to be sold in order to satisfy the creditors.
Orderly Disposition also assumes that the valued company can continue to operate for some time in order to sell its assets in an organized manner. Liquidation is another premise of value which assumes the valued company is burning significant cash and the continuation of its operations is no longer possible. Therefore, the sale of the assets is considered forced, and on a short notice, which significantly decreases their value.
As described above, business valuations rely on different assumptions that can significantly impact the result. In order to get the most accurate outcome, the valuation professional must determine which set of assumptions best fits the situation described by the client and apply accordingly. Even with the most accurate assumptions, business valuations can be subjective based on who and for what reason is preparing the valuation. Despite that, business valuations have real-life repercussions that can affect one’s taxes, investment decisions, fees paid to investment managers, and court settlements including divorce settlements and shareholder disputes.
In order to avoid being affected adversely by an unprofessionally conducted or biased business valuation, hire only certified professionals specialized in business valuation. We can assist our clients in retaining a certified valuation professional. Contact us today!
Malescu Law P.A. – Business Lawyers