One of the most difficult professional engagements
is determining a valuation of a closely held
business. First there are the standards of value:
| • |
Fair value
is a term of the trade in business valuation
and the courts. It essentially is the market
value of a business divided by the percentage
interest owned in the business. |
| • |
Fair Market
Value is a term of the trade in business
valuation and the courts. It essentially
is the market value of the business interest
you own in a business, such as the shares
of stock you hold in a business. |
| • |
Minority
value is a term of the trade in business
valuation and the courts. It essentially
is the market value of the business, less
a discount for the fact you control less
than all of the business ownership. |
| • |
Swing or
Majority value is a term of the trade in
business valuation and the courts. It essentially
is the market value, plus a premium for
the fact you could influence the outcome
of control because of other blocks of stock
not having control. |
| • |
Marketability
value is the fact that closely held companies
do not readily trade on a organized stock
market, or that certain shareholder agreements
effect the marketability of stock contractually
among shareholders. |
| • |
The first important job in business
valuation is determining the appropriate
standard of value to use in the engagement. |
Essentially the cost method would be useful
in performing a valuation of a company that
holds nothing but certificates of deposits.
The underlying asset value method might be appropriate
for a real estate holding company. However,
rare is the valuation so simple and straight
forward.
The formula approach is often
used, especially by accountants, in determining
the valuation of a business as a series of expected
discounted cash flow, adjusted by judgment as
to reasonable owners salary, benefits, perks,
related party transactions, leases, rents, personal
use of auto, employee benefit plans, country
club dues, expense accounts, familial hiring,
and the myriad of other variables in most closely
held business. The formula approach then attempts
to forecast (guess) the future cash flows, based
on historical data which may or may not come
to fruition. Finally the formula approach uses
a "rate of return" assumption to recover the
cost of capital and the "inherent risk" associated
with an investment. Small changes in the "rate
of return" adjustments, can lead to wild fluctuations
in value results. Unproven forecasts can lead
to even wilder fluctuations. Finally, determining
"arm-length" salary, benefits, perks, etc. can
bog down the process and require the valuation
professional to be judgmental. For these three
reasons, the formula approach should never be
used, if another method of value is available.
(ARM 34).
The comparatives method is
the most preferred method used in valuation.
It requires obtaining relevant information about
"like kind" businesses that have sold in the
past, in similar or dissimilar locations and
economies. While the comparative method is much
more difficult to investigate, the results of
the findings are superior for use in business
valuation.
Bodtke & Stewart uses four
private transaction databases as well as contacts
in the industry to determine the appropriate
guideline company for which to establish business
valuations. It requires much more research,
much more cost, but the results are much reliable
in business valuation.
If you need information
about our business valuation practices, please
contact us.
