What is your business worth? In terms of personal value, it’s most likely priceless according to you. Nevertheless, if you plan to sell your business, merge it with another company, or prepare for retirement or a career change, it’s worth knowing what the business’s true value is to a buyer.
Valuation provides a clear picture of a company’s financial health and market position. However, a firm valuation can take on different meanings depending on the standard of value used to assess it. These standards drive how to measure value and ensure an accurate price.
This blog is all about the four standards of value in business valuation. We’ll explore the primary standards of value in business valuation and their applications, highlighting each standard’s importance in making informed decisions for your business.
The Four Standards of Business Valuation
Fair Market Value
Fair market value (FMV) is the most common standard of value. It reflects the price at which a buyer and seller may transact in an open market, both having ample knowledge of the relevant facts and being under compulsion to buy or sell.
FMV is often the go-to standard in taxation and legal contexts. For example, the IRS uses FMV when evaluating estate tax and gift tax liabilities. It’s also the primary standard in partnership buy-outs and divorce settlements. To determine FMV, valuators analyze:
- historical and projected revenues,
- asset values,
- industry conditions,
- and comparable sales in the market.
FMV is a practical benchmark for assessing worth. However, it assumes hypothetical conditions rather than specific buyer-seller dynamics. FMV may not capture all the nuances of real-world transactions.
Investment Value
Investment value considers the worth of a business to a specific buyer. It incorporates the buyer’s specific objectives and situation. This standard is commonly used in mergers and acquisitions, considering the synergy between buyer and seller. For instance, if a buyer provides access to a new customer base or improves operational efficiency, a business may hold higher value to a buyer.
Investment value is important to business owners, especially those in niche markets. Keep this at the forefront of your mind when negotiating with potential buyers. Investment value provides instruction on highlighting certain elements of your business. For example, proprietary knowledge or exclusive contracts could encourage higher offers from investors.
Bonus Tip:
Here’s an easy way to differentiate FMV from investment value. FMV emphasizes a neutral outlook. Investment value highlights strategic reasons that make your business’ valuation exceptional to the right buyer.
Intrinsic Value
Intrinsic value is the perceived value of a business based on its fundamental characteristics. It disregards external market influences. Investors use this standard to assess whether a business is undervalued or overvalued.
To determine intrinsic value, analysts focus on tangible and intangible aspects of a business including:
- historical and forecasted earnings,
- growth prospects,
- capital structure and debt obligations,
- and quality of management.
Intrinsic value is for evaluations that aim to uncover long-term growth opportunities rather than current market conditions. The intrinsic value standard is employed in privately held companies where external data or comparable market prices are unavailable.
When preparing for long-term growth strategies, understanding intrinsic value is essential. This is an approach that looks ahead to the future.
Fair Value
They may sound similar, but fair value is different from fair market value. It’s a legally defined concept used in shareholder disputes or litigation. Unlike fair market value, fair value doesn’t factor in marketability discounts or reductions applied due to the lack of a liquid market for the business. Additionally, it doesn’t employ minority interest discounts or reductions based on a lack of control over business decisions. Fair value most commonly appears in legal settings and situations, such as:
- shareholder lawsuits,
- corporate mergers,
- and dissenters’ rights matters.
The absence of discounts renders fair value much higher than fair market value, or even investment value. For business owners, knowing fair value can influence negotiation outcomes and court-mandated valuations, like when they’re dealing with shareholder disputes or similar situations.
The Necessity of Understanding Standards of Value
What are your plans? Each standard offers a unique lens for assessing your company’s worth. Many businesses face financial hurdles, including less stable cash flow and limited access to capital.
Whatever valuation method you choose will provide you with a knowledgeable, strategic position in negotiations and decision-making. Hiring an experienced company to use firm valuation tools tailored to your company’s requirements will offer clearer strategic planning. Private Practice Transitions is a reliable firm that can accurately assess your company’s value.
How To Choose the Right Standard of Value
Understand Your Objective
What are your immediate and long-term plans? Do you want to sell, gain investors, or resolve legal disputes. Knowing and defining your goals help determine the right standard and course of action.
Work With Experts in the Field
It never hurts to enlist a reputable expert. Experienced brokers ensure objective and accurate assessments of your business’ value. They’ll take you through the process of determining your company’s value and outline what’s to come during negotiations.
Communicate With All Stakeholders
Make sure all relevant parties understand and agree to the standard of value used. This reduces conflict and sets realistic expectations.
Navigating the nuances of business valuation is overwhelming. Understanding the four standards of value in business valuation is a great starting point, but there’s more to know about the process of selling a practice that you cannot accomplish on your own. Hiring a knowledgeable firm can give you more insights into what fair market value, investment value, intrinsic value, or fair value can do for your business.
If you require a proper valuation of your business for selling, merging, or strategic planning purposes, choose the right approach by seeking advice from Private Practice Transitions. Our team of experts will help you unlock your company’s full potential with firm valuation services.
Make informed decisions to secure your business’s future! Contact us today with any questions, comments, or requests. We look forward to speaking and working with you.
