Standard of Values
There are many standards of value, including fair market value, fair value, synergy value, intrinsic value, investment value, etc. One of the first decisions that must be made is the appropriate standard of value to employ. The two most common standards of value are:
Fair Market Value
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.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Approaches to Values
Traditionally, the development of a fair market value opinion is based on the consideration of one or more valuation methodologies or techniques falling under the three fundamental approaches to valuation: the asset approach, the income approach, and the market approach.
The asset approach measures the value of an asset by the cost to reconstruct or replace it with another of like utility. When applied to the valuation of equity interests in businesses, value is based on the net aggregate fair market value of the entity’s underlying assets.
The income approach measures the value of an asset by the present value of its future economic benefits. These benefits can include earnings, cost savings, tax deductions, and proceeds from its disposition. When applied to equity interests in businesses, value indications are developed by discounting expected cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risks associated with the particular investment. The discount rate selected is generally based upon rates of return available from alternative investments of similar type and quality as of the valuation date.
The market approach measures the value of an asset through an analysis of sales or offerings of comparable property. The ideal marketplace comparables are similar sized closely-held companies within the same industry, but often this information is not sufficiently available. An alternative to comparable sales of closely-held companies are public companies within the same industry. These companies are potentially subject to corresponding economic, environmental, and political factors and are considered to be reasonable investment alternatives.
Discounts and Premiums
Discount for the Lack of Marketability (DLOM)
The degree of liquidity, or marketability, associated with a particular investment or ownership interest has a direct impact on its relative value. The speed and efficiency with which an investment can be sold will enhance or detract from the value of the investment.
The value of closely held stock is not directly comparable to the value of publicly traded shares of similar common stock. This is due to the fact that shareholders of privately held companies do not have the same access to trading markets or information as do shareholders of publicly traded stocks. Therefore, the market value of closely held stock must be adjusted to reflect its lack of liquidity and ready market.
The importance of the marketability factor in business valuation has been gaining increasing recognition. Over the years, the courts have supported discounts relating to the lack of marketability of closely held investments.
Minority Interest Discount and Control Premium
Minority interest discounts reflect the fact that a shareholder who owns less than a majority interest cannot control managerial decisions, impact future earnings, control efforts for growth, or establish executive compensation. An ownership interest that gives the holder control over distributions to shareholders, sales of business assets, and other relevant management decisions has a greater unit value than an interest that does not possess such control and therefore a potential control premium must be considered.
Other Discounts and Premiums
There are a multitude of additional discounts and premiums that must also be considered depending upon the unique attributes of each valuation control and therefore a potential control premium must be considered.
Professional or Personal Goodwill
In Florida, the concept of professional or personal goodwill is defined mostly by Court cases such as Thompson v. Thompson, Young v. Young, Makowski v. Makowski, Weinstock v. Weinstock and various others. This highly debated, fact-intensive factor in business valuations must be considered, especially in litigation cases.
To find out more about how these factors effect you, please contact us to schedule an initial consultation