Business Valuation

Valuation is in the Eye of the Beholder

Standards of Value
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.

Selecting the Valuation Method

The second most critical task in determining value is selecting which of the myriad of tools used in valuation. Essentially, the four methods are:

•  Cost
Underlying Asset Values
Comparatives
Formula Method
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.
 
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  Accounting
  Auditing
  Tax
  Consulting
  Pension Services
  Litigation Support
  Business Valuation