Feature
Article
Business
Value Affected by Purpose of Valuation
Many
assumptions are inherent in performing a valuation. They
typically vary with the purpose of the valuation, ranging
from conservative to aggressive.Such assumptions also arise
from legal precedents, regulations and rulings, and business
or marketplace practices.
Assumptions
that are purpose-based are different from assumptions that
are specific case-based. Thus, one entity, with the same
set of facts and assumptions, can be valued at a different
amount depending on the purpose of the valuation, which
has different assumptions. However, it is important to remember
that the value derived, no matter the purpose, must be supportable
based upon the facts and circumstances of the case.
Transaction
Related
In many
cases a valuation is prepared in connection with the purchase
or sale of a n operating business. When a business is being
put up for sale, the seller places a value on the business.
The assumptions of value determined by the seller include
the value in the current owners hands as an operating concern,
with risks relating to continuity of customer relations,
stability and longevity of the earnings stream, and knowledge
of the industry.
The
buyer may evaluate the usefulness of the business as an
addition to current operations, presuming incremental value.
Conversely, the buyer may look at the business as a new
venture, estimating risk and analyzing uncertainties to
determine the future benefits the business can bring .As
the negotiations continue, in a free and open market, the
buyer and seller attempt to agree on a value and consummate
the deal. This becomes the meeting-point for the buyers
and the sellers assumptions.
The
reporting for this purpose is typically in summary form
with the appropriate schedules supporting the analysis and
conclusions. However, the users determine how they would
like the results communicated in this case.
Financing
Related
Another
purpose of a valuation is to obtain financing. The lenders
valuation presumes projected future cash flow to meet the
banks interest and principal payments, and sufficient liquidation
value of the related collateral should the deal become a
losing proposition. This differs from the assumptions of
the seller and buyer, who presume going-concern values and
evaluate earnings. They are also different from the actual
assumptions used to calculate projected future cash flow.
The
reporting for this purpose is typically in summary form
with the appropriate schedules supporting the analysis and
conclusions. However, the users determine how they would
like the results communicated in this case.
Tax
Related
Much
of the valuations performed stems from the reporting requirements
put upon taxpayers by the Internal Revenue Service. The
IRS regulations dictate the use of a fair market value standard
of value in tax cases. The term fair market value is defined
by Internal Revenue Service Revenue Ruling 59-60, 1959-1
C.B. 237, Gift Tax Regulation 25.2512-1 and Estate Tax Regulation
20.2031-1(b) as follows:
The
price at which the property would change hands between
a willing buyer and a willing seller, neither being under
a compulsion to buy or sell and both having reasonable
knowledge of relevant facts and the ability to buy or
sell. Court decisions frequently state in addition that
the hypothetical buyer and seller are assumed to be able,
as well as willing, to trade and to be well informed about
the property and concerning the market for such property.
Tax
valuations clearly presume the loss of what may have been
a key employee, and that the prospective buyer and seller
are hypothetical in nature with no motivation or specific
incentive to enter into a transaction as well as the possibility
of liquidation of the investment to pay taxes. Valuations
for tax purposes typically require a much lengthier and
more detailed report to be prepared in connection with the
matter than for other purposes.
Tax
valuations differ from the previously mentioned valuations
as they tend to be hypothetical whereas transaction and
financing related valuations deal with actual transactions.The
value of an investment included on an estate or gift tax
return would in all probability be different from the valuation
in an initial public offering registered with the Securities
and Exchange Commission. It may be the same company, but
it is unlikely to be the same value.
Tax
valuations also set their own particular standard, which
may be inappropriate for other purposes. This causes problems
when a litigator points to a previously determined tax value
and attempts to propose comparability for another issue.
The
reporting for this purpose is typically in a detailed, formal
written report as dictated by the regulation and rulings.
Ownership
Related
Valuations
between partners/shareholders also have different assumptions.
If a buy- sell agreement is designed to penalize a shareholder
for termination of ownership or employment, the valuation
method would clearly not reflect market value, even though
the agreement may refer to the buyout price as being at
market value.
For
intra-family transfers, book value is often the transfer
value, but rarely does book value correspond to value for
any other purpose.
At the
other end of the spectrum, when the buy-sell agreement is
funded with the proceeds of life insurance, the controlling
presumption in determining the market value is often the
life insurance and estate needs of the owner rather than
the value of the company.
The
reporting for this purpose is typically in summary form
with the appropriate schedules supporting the analysis and
conclusions. However, the users determine how they would
like the results communicated in this case.
Litigation
Related
Lastly,
valuations for litigation purposes create a situation where
the assumptions a valuator selects may be impacted by the
nature of the claim and the legal interpretations by counsel
for the side of the litigation being represented.
Valuators
can point to many of these examples to substantiate the
appropriateness of their opinions. In shareholder disputes,
for example, the market value multiple of a multinational,
public company may not be representative in determining
the value of an entrepreneurial business. In domestic relations
matters, the parties involved may not be contemplating a
sale, so the tax definition presuming a willing buyer and
a willing seller will not apply. In fact, the business owner/spouse
really may be an unwilling seller and, at the same time,
a particular buyer.
The
reporting for this purpose is typically based upon the specific
jurisdictional rules that exist for the type of litigation
and venue in which the matter is being tried.
Conclusion
Each
valuation purpose has its unique assumptions, and one valuation
cannot fulfill every purpose. The same investment can have
a different value to different people and for different
purposes. Valuators must know the differences related to
the different valuation purposes and apply them appropriately
in any given case.
For
more detailed information please contact:
Richard
Millman, CPA/CFF/ABV, CVA
richard.millman@hawcpa.com
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