The Standard of Value is probably the most basic assumption of a business valuation and affects the result. It allows the valuator to design the valuation report to fit the needs of the users of the appraisal or valuation.
There are different Standards of Value used by business valuators,
A note – the different valuation certification organizations sometimes use either the term “valuation/valuator” or “appraisal/appraiser.” For the average person, the terms valuation and appraisal are interchangeable. However, some like to say a “valuation” is for business interests and “appraisal” is for real estate. I use the term valuation. Though I don’t think most users of business valuations differentiate between the two and frankly, it probably doesn’t make much difference.
There are three main standards of value commonly used by business valuators/appraisers: Fair Market Value, Fair Value, and Investment Value. Then a few derivations based on those three.
Fair Market Value. This is the “willing buyer and willing seller” value, expressed as cash or cash equivalent. It assumes that both the buyer and seller are knowledgeable and are in possession of all pertinent facts, are risk averse, and possess competency in the operation of the business. This value represents an average of all financial buyers but excludes strategic buyers. Strategic buyers are those who buy a business for synergy or other advantages to their existing business. This is the standard of value used for tax purposes and in many kinds of litigation.
Fair Value. There are many definitions of Fair Value, and when you hear that term it can mean different things depending on the end use of the valuation. A common standard when you hear “Fair Value” is the same as Fair Market Value. Except the subject interest is valued as though it were a controlling interest. Meaning there is no minority interest discount. This assumption is usually present in valuations surrounding shareholder oppression litigation. The term Fair Value is often used in marital dissolution, as different courts have different standards.
Investment Value. Investment Value is the value of the subject interest to a particular, specific entity. It usually includes the business value including synergies with his own existing business operations. But could refer to an advantage unique to the buyer that is not available to anyone else.
Derivations of Standards. There are many nuances in the Stamdards of Value. One example is the legal requirement that the valuator not consider a buy/sell or partnership agreement where the agreement is determined in court or by law to unfairly penalize the non-owner spouse in the division of community property. There are other examples, but I will not go into those here. Just be aware these derivations exist.
When we do a valuation, I usually take the time to explain to the client that a valuation done for different purposes can have different results. Who is using the valuation and for what purpose determines the Standard of Value which then determines the final valuation number. So the same business can have a different valuation number (result) depending on the purpose and Standard of Value.
