Standards of Value
Value is not a singular, universal term when it comes to determining the value of a business. There are at least four common standards of ‘value’ you will hear referenced:
1. Fair value (special value): The price at which a property will change hands between a willing buyer and a willing seller considering the specific advantages or disadvantages each party will realize (aka synergistic buyer).
2. Investment value (going concern value): The price at which a property will change hands between a willing buyer and a willing seller considering the investment objectives of the identified buyer (aka financial buyer).
3. Liquidation value: The price at which a property will change hands between a willing buyer and a compelled seller when the property cannot be exposed to the open market for a sufficient period of time (aka orderly or forced sale).
4. Fair market value: The price at which a property will change hands between a willing buyer and a willing seller when both parties have reasonable knowledge of the facts and neither is compelled to act.
Due to its objectivity, and excluding bankruptcy scenarios, Fair Market Value (FMV) is commonly viewed as the most relevant standard of value when evaluating a business for acquisition purposes, although other standards of value may be included in the overall analysis.
Additional questions? Get in touch with your local Sunbelt office to speak with an experienced business intermediary.
“[A business valuation is] The process of determining the economic value of a business or company. Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, and divorce proceedings. Oftentimes, owners will turn to professional business valuators for an objective estimate of the business value.”
Business valuations (and appraisals) are rendered by certified and accredited professionals, affiliated with one or more nationally-recognized associations (see our Valuation Links for a list of organizations.)
Sunbelt brokers either hold these certifications or maintain relationships with business valuation firms, in order to provide this service to clients who need or desire it. Your dedicated Sunbelt business broker will advise you on the different types of valuation services available, the associated costs (if any), and provide you his/her professional opinion on the necessity of such reports.
What Determines Value?
While there are many areas that a business appraiser will evaluate, cash flow and risk are two important factors in appraising a business.
A buyer typically purchases a business for future income. Cash flow can be expressed many ways, typically either as Free Cash Flow, EBIT, EBITDA, or Seller’s Discretionary Earnings (SDE). In small business transactions, SDE or EBITDA is the most common basis for establishing a selling price.
Bottom line, the more cash flow there is, the more a buyer will be likely to pay.
All cash flow comes with a degree of risk. Risk may be present in customer concentration, reliance on vendor relationships, macroeconomic trends, competitive forces, key employees, legal exposures, and more. A formal business valuation will include an analysis of the company’s risk and quantify that risk into a percentage known as a Discount Rate or Capitalization Rate.
What About Goodwill?
Goodwill is not a random figure – it is calculated by subtracting the tangible value (fixed assets) from the final value. The residual is considered goodwill or intangible value, and it’s either there or it’s not. Business sellers often over estimate the value of goodwill, assuming that things such as technology and an established brand add “goodwill” value that should be figured into the asking price – it doesn’t unless those items improve cash flow.
Be sure to also read our Broker Opinion of Value summary to understand how that is different from a business valuation.
Brokers Professional Opinion of Value
It is important to distinguish a formal business valuation from business pricing, known as a “broker’s opinion of value” (BOV).
A BOV is a broker’s opinion of what a business may sell for, based upon their personal analysis, industry expertise, knowledge of local markets and lending, and comparable past sales. While it is not a formal business valuation, an experienced business broker should be able to deliver a BOV and articulate a realistic Most Probable Sales Price (MPSP) range.
The BOV provides a business seller with expectations on what the business may sell for, given the intended pool of potential buyers, at that given time. For some businesses, the BOV is then used to set and communicate an asking price. For large businesses, an asking price may not be advertised.
As part of the BOV, the broker should also provide insights on how different deal structuring scenarios could impact the targeted sales price and the associated tax considerations. Ideally, the broker will function as part of your overall broker team, who will collectively consider the implications of different deal structures.
Want to know more? Get in touch with your local Sunbelt office to speak with an experienced business intermediary.