VALUATION ISSUES AND STANDARDS

It is important to recognize and deal properly with certain subtleties and standards in the field of valuation. Issues and standards to keep in mind include:

Treatment of Debt

If the method used to determine company value uses a pre-debt-service income measure, then debt must usually be subtracted from the resulting figure.

Control Premiums

If the valuation methodology used is based on price-earnings ratios of comparable public companies and the interest being valued is the entirety of a company, a control premium may be imposed.

Discount for Lack of Marketability

This discount, also known as the liquidity discount, comes into play in situations where the business owner’s ability to readily sell his or her business is questionable. For example, publicly traded companies are highly marketable, and their shares can be quickly turned into cash. Closely held companies, however, are sometimes far more difficult to sell. Depending on the valuation, it may be necessary to subtract a discount for lack of marketability, or add a premium for the presence of marketability.

Standard of Value

When determining valuation of a company, the standard of value must be clearly defined. That is, it must be clear whether the valuation is based on book value, fair market value, liquidating versus going-concern value, investment value, or some other definition of value. Defining the standard of value is important because of adjustments that are necessary under some, but not all, of these standards.

“As-Of” Dates

Valuation methods determine the value of a company at a given point in time. Thus, businesses that undergo a valuation process are said to be worth X dollars “as of” a certain date. Values of businesses inevitably change over time, so it is critical to state the date for any valuation. In addition, the information used by the appraiser should be limited to that which would have been available at the as-of date.

Form of Organization

The legal definition of the organization under examination is an important factor in any valuation. Different legal forms of entity—corporations, S corporations, partnerships, and sole proprietorships—are all subject to different tax rules, rules which impact the value of the enterprise being appraised.

Focus of Valuation

The focus of the valuation must be clearly identified. The portion of the business enterprise being acquired, the type(s) of securities involved, the nature of the purchase (asset purchase or stock purchase), and the possible impact of the transaction on existing relationships (such as related party transfers) can all affect the value of the entity under examination.

Going through a business valuation exercise is useful for any business owner. He or she will learn a lot about the business by applying any one or several of the valuation methods discussed here. In the end, however, the true value of a business is, much like beauty, in the eye of the beholder. Or, in the case of a business owner who wishes to sell, it is the price another is willing to pay for the business.