To get the most relevant business value, selecting the appropriate standard of value is crucial. It influences both your outcomes and ensures alignment with your goals.
What is a Standard of Value?
The standard of value is the method you choose to use to get a business valuation, which recognizes that no two businesses are exactly alike. Your choice will directly impact your valuation process and the results, so it’s important to consider it carefully and get business advice when needed.
Why Standards of Value Matter in Business Valuation
With a standard of value, you establish a framework of assumptions and methodologies as well as an interpretation of what a company is worth—whether you’re the seller or the buyer. Misalignment between this standard of value and its purpose can cause inaccuracies that potentially lead to concerning decision-making processes.
It can further impact legal outcomes and stakeholder perceptions, which must receive consideration during the process to achieve the best outcome. Business valuation services professionals help you make sure you’re using the most representative standard.
Key Standards of Value in Business Valuation
Fair Market Value
It’s defined as the price at which property would change hands between a hypothetical willing buyer and a willing seller, neither of whom is under compulsion and both having a reasonable understanding of all relevant facts related to what’s being bought/sold. We commonly use this standard for both tax and legal purposes.
However given how narrow the definition is, fair market value is not typically to the best standard to arrive at a valuation. A seller might be leaving money on the table, or a buyer could end up paying too much for the asset. For this reason, there are other standards to value a business.
Investment Value
This reflects the value of a business to a particular owner or prospective owner based on operational and investment objectives. This standard of value takes into account the benefits of synergies a buyer achieves with existing assets when buying a business.
Intrinsic Value
Intrinsic value refers to the true worth of a business, determined through a thorough analysis of all available facts by the investing party. While commonly discussed in the context of public markets—where an investor’s assessment of value may differ from the market consensus—it also applies to businesses outside of these markets. This standard assumes that a business has an inherent value, independent of external factors like market conditions or the specific intentions of a buyer.
Insurance Value
The insurance value is used to determine how much insurance a company needs to get for its assets. It considers the replacement costs and expenses related to loss of use. In the event of damage, this standard is intended to adequately protect your company and you from a substantial loss.
Liquidation Value
You would use this standard if you were considering selling off your assets individually without considering the fact that a business value is greater than the sum of its parts. Nonetheless, this standard is useful in bankruptcy or when a business plans to close operations. In these scenarios, the goal is often to get as much as possible out of what’s left through a fire sale rather than trying to maximize the sale price.
Synergistic Value
This standard is also called “strategic value”. It represents the additional value that synergy between two or more entities creates. When companies complement each other, a win-win is achieved that would not necessarily exist if only one of the entities were sold to someone else. Both loss of synergistic value and gain could impact the value of the company, division, or asset.
Collateral Value
You need to know your collateral value when you choose to pledge an asset to secure a loan. This asset value determines how much a lender is willing to give you and at what terms. They expect to recover that collateral value if you default on your loan.
Choosing the Right Standard of Value for Your Needs
This comes down to what your purpose is. It would be a mistake to take the value determined by a standard that does not meet the same purpose at face value. That could cause you to severely undervalue your business as a seller or overpay as a buyer.
For instance, fair market value makes sense for tax assessments, while investment value may be more relevant in strategic acquisitions. Aligning the standard with the valuation’s objective ensures accuracy and relevance.
Who Uses Standards of Value?
Several individuals may be involved in business valuation, each with their own goals. The best qualified to determine your business value will be someone who understands your goals and how to achieve them.
Buyers
Prospective buyers need to be able to determine the investment and synergistic value of a business. It’s not just about how much the target company is worth, but how much it’s worth to them because of strategic fit.
Tax Authorities
Government agencies are going to look at fair market value to determine your tax liabilities and to make sure you’re complying with tax, reporting, and legal obligations that may be based on this value.
Partners
Your business partners will often use a combination of fair market value and intrinsic value during buy-sell agreements or when undertaking an internal assessment to make sure transactions among partners or third parties are equitable.
Banks & Insurers
Finally, financial institutions, including insurers, will care most about your collateral value and the insurance value when assessing the risks of lending or insuring. In insurance, this determines the coverage amounts, premiums, and willingness to take on the risk.
DHJJ Can Help You Find the Right Valuation
At DHJJ, our experienced CPAs are equipped to guide you in selecting and applying the appropriate standard of value for your specific needs. We work to ensure the most accurate and meaningful valuation outcomes by determining which standard of value makes the most sense based on your objectives. To find out what a company is really worth and how to get the best value, start a conversation.
