Perhaps the most misunderstood part of valuing a business is that business valuation results may differ depending on the assumptions you make, namely:
- Who needs to know what the business is worth?
- What are the circumstances surrounding your company valuation?
Business appraisers use the formal term business value standard to address this situation. You have a choice of several business value standards that are well known:
Fair market value is used most often in valuing small businesses and professional practices.
It is an excellent fit when a business is valued for sale or purchase – after all the fair market value is established by business buyers and sellers themselves.
If you are valuing your business by comparing it to recent sales of similar businesses, the fair market value is the typical choice. The assumption here is that, by and large, business buyers and sellers act in their best interests, have taken pains to educate themselves about the market, and are not forced into a deal by circumstances.
Business fair market value and fair value may differ
Enter a deceptively similar definition of business value: fair value. Watch out – this is most often seen in legal disputes and is subject to interpretation by courts.
The assumption often made in this situation is that business owners may be involuntarily deprived of their ownership interest and need to be fairly compensated for their loss.
This is hardly the same as the business owners who freely bargain to get the fair market value for their business!
If business valuation is done for investment reasons, the investment business value definition is common. Each investor seeks to determine the expected returns and risks associated with the business of interest. Since each investor’s perception of risk and required returns is different, their business valuation results for the same business can differ considerably.
Business investment value is unique to each investor
Truly, business value defined under the investment standard is in the eyes of the beholder! This is one reason that business brokers often suggest targeting specific business buyers – those that look for synergistic benefits in a business acquisition – and are willing to pay the price.
Business value definition – a strategic choice
Giving a bit of thought to your choice of business value has strategic implications:
1. Fair market value standard is easily defensible. You can use this to justify your business asking price or offer price to buy a business.
Market-based business valuation methods are typically used to establish your business fair market value.
2. Fair value standard can be very helpful in a legal dispute such as divorce, shareholder disagreements or ownership rights infringement.
3. If you invest in a business or look to attract the right investors, investment business value should be your choice.
Income-based business valuation methods such as the Discounted Cash Flow give you an excellent way to value businesses under the investment business value standard. Each target business is valued based on its specific risk and return profile.