We know that two people never come up with the same valuation. What we have to remember is also that value MUST be different in different situations.
Every time we perform a valuation, we make assumptions about the scope of that valuation, and very often the basic assumption correspond to the sale of non-controlling shareholdings to the average investor – and I say this because often the implications of a takeover or potential transaction are missing. Since we are not valuing exchange listed companies here but rather SMEs, all this information should be included and the valuation process adjusted to the specific situation.
Standards of value refer to the type of value to calculate in relation to the circumstances in which the valuation take place. The standards of value vary slightly among the valuation standards of different countries, but internationally the most used concepts are:
- Fair Market Value is the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. (Source: International Glossary of Business Valuation Terms) – the International Valuation Standards also distinguish between Market Value, the price in a hypothetical transaction in which transaction costs are not taken into consideration, and Fair Value, the price for the transfer of an asset between identified parties, taking into account the advantages of participants (not to be confused with the Fair Value definition in IFRS and other accounting standards). Most valuations, also in legal settings, would apply the concept of Fair Market Value, and in some countries this corresponds to the definition of Objective Value.
- Investment value is the value to a particular investor based on individual investment requirements and expectations. (Source: International Glossary of Business Valuation Terms) – in the International Valuation Standards, Investment Value mostly refers to the advantages of holding the asset independently of the investor, and they also add Special Value, the value to a special purchaser, and Synergistic Value, the value resulting from the combination of two or more assets. The general Investment Value definition if often used when the buyer is known and in case of takeovers. In some countries this can correspond to Subjective Value.
I would recommend being aware of the valuation standards prevalent in your country or to the specific project, and sticking to the two main standards of value: Fair Market Value, that would often be appropriate for a neutral or legal valuation, or Investment Value, in which the terms and parties of the transactions are known and in which therefore some subjective and situational elements can be included in the value. In a value planning project for consulting purposes I usually calculate different values depending on different exit strategies.
Additionally in a valuation it is important to distinguish between different Premises of Value (Source: International Glossary of Business Valuation Terms):
- Net Book Value, with respect to a business enterprise, the difference between total assets (net of accumulated depreciation, depletion, and amortization) and total liabilities as they appear on the balance sheet (synonymous with Shareholder’s Equity). With respect to a specific asset, the capitalized cost less accumulated amortization or depreciation as it appears on the books of account of the business enterprise.
- Going Concern Value is 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.
- Liquidation Value is the net amount that would be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either “orderly” or “forced.”
- Replacement Cost or Value is the current cost of a similar new property having the nearest equivalent utility to the property being valued.
Most valuations take place under the Going Concern principle because value mostly depends on future cash flows. However, the Liquidation Value is also calculated in non-liquidation cases to establish a minimum value for the business, and to advise on a potential disposal. The Replacement Value is very informative for a potential transaction. The Net Book Value is often calculated in cases of insufficient information about the business’s future performance, or when performing quick valuation comparisons.
Additionally the type of valuation report and the process are highly dependent on the Valuation Scope – we can distinguish between these cases, all of which have very different requirements:
- Internal value planning
- Acquisitions or mergers
- Financing documents
- Squeeze-out of minority shareholders
- Introduction of new shareholders or profit-sharing agreements
- Heritage, tax reasons or compensation processes
- Fairness Opinion
- Group financial statements
- Purchase Price Allocation
Featured Image: “Pawn Shop Board Game”, Lina Theodorou