This has come up repeatedly so I thought it would be a good idea to clear up a common mistake. I valued a client’s non-controlling interest in their company for estate planning. After the project was completed, the client indicated they were going to use the report to help them with a potential sale of a partial or 100% interest to an investor. In my head, I was thinking, “whoa, hold on there, partner!” Here’s my paraphrased response:
“You should avoid using this report for different purposes. The standard of value in a sale to an investor might be investment value. Investment value is “…the value of an asset or business to a particular owner or prospective owner for individual investment or operational objectives.” (International Valuation Glossary – Business Valuation, p. 7). The standard of value for this report is fair market value, “…the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” (Treasury Regulation 20.2031-1). Investment value identifies a particular buyer or seller while fair market value typically assumes a hypothetical willing buyer and seller.
Investment value is when a buyer might pay a premium above fair market value (the standard of value in this report). Sometimes, that’s because they think they can grow the company faster than you or because they can eliminate expenses you are paying. The interest valued in the report is also non-controlling and non-marketable. If a buyer purchased a controlling interest in your company, the value would likely be higher than the value in the report just by eliminating the discount for lack of marketability. A particular buyer of your entire company might also expect to make other controlling changes that could increase cash flow, resulting in a value of the interest higher than fair market value. It’s critical to understand the purpose of the valuation, standard of value, and size of the interest so that you don’t compare apples and oranges.”
That was a mouthful, but I think it’s important not to shortcut my response. My client could have taken a haircut on the sale of their business if they used the estate planning report.
Valuation Reports Aren’t Interchangeable
It’s a common mistake to think you can use a business valuation report for different purposes. If any of these factors have changed, you probably need a different business valuation report than the one you have:
- Standard of value
- Valuation date
- Size of interest
- Level of value
- Jurisdiction
- Buyer/seller
There could be additional factors not listed above.
Josh Horn, CPA, CVA
Horn Valuation
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