When it comes to determining the economic value of a firm or answering what is standard of value, business valuation standards play a key role in determining the same.
These standards provide a structured approach, ensuring consistency in methodology and reliability of valuation outputs.
In this article, we will explore the key aspects of business valuation standards, their significance, and strategies for maximizing the value of your business.
Business Valuation Standards: Meaning and Explanation
Business Valuation Standards, such as those set by organizations like the Canadian Institute of Chartered Business Valuators and the International Valuation Standards Council, serve as practice guidelines for business valuation.
These standards ensure that essential factors are considered during the valuation process. Standards like Fair Market Value (FMV), Fair Value, Investment Value, and Liquidation Value, among others, guide valuations based on specific contexts and criteria.
Business Valuation Standards: Importance
Business valuation standards provide a benchmark for consistency and reliability, fostering trust among stakeholders and promoting transparency. They serve as a shield against valuation discrepancies that can lead to financial crises. Consistent valuation criteria increase confidence among shareholders, creditors, and financial institutions. All processes must be in place for business valuation since startup funding.
Types of Valuation Standards You Should Know
Understanding various standards of value is crucial for business owners. Fair Market Value (FMV) is one the most common standards for determining the price at which a property would change hands between a willing buyer and a willing seller.
Other standards, such as Fair Value, Investment Value, and Liquidation Value, have specific contexts of application, emphasizing different aspects of a business’s worth.
For your help, here are the brief explanation of each of these valuation standards
What Is Fair Market Value (FMV)
FMV, a fundamental concept in company valuations, gauges a business’s value from the perspective of a rational investor. This standard delves into how the market perceives the company’s worth.
As per the fair market value definition, it represents the price at which an asset would change hands between a willing buyer and a capable seller in an open market, free from any constraints. While the fair market value of a business serves as a benchmark for various financial decisions and legal proceedings, it might not always reflect the actual transactional value due to various external factors, which we will see below.
The fair market value of a business is an important valuation and needs to be ascertained before an asset changes hands or your business goes up for sale.
Fair Value (FV)
Fair Value, distinct from the fair market value of a company, finds its application in accounting reporting, and in cases like shareholder disputes or marital dissolutions. Unlike FMV valuations, it does not account for reductions related to marketability and control.
This standard ensures that oppressed minority shareholders receive their fair share when selling their interest in the business. Adhering to Generally Accepted Accounting Principles (GAAP), fair value is essential for reporting asset values in accounting and helps in determining purchase prices in M&A transactions.
Investment Value (IV)
Investment Value or strategic value, assesses a company’s worth to a specific party or investor. It often exceeds the value perceived by a third-party investor due to anticipated commercial synergies.
In the context of mergers and acquisitions (M&A), or during the creation of a Special Purpose Vehicle (SPV) this standard assumes that the combined entity will be more valuable and profitable. The concept of Goodwill, the premium paid for a business above its FMV, comes into play here, emphasizing the intangible assets contributing to a business’s value.
Liquidation Value (LV)
In contrast to ongoing business concerns, Liquidation Value focuses solely on a company’s worth in the event of closure or bankruptcy. Distressed businesses, facing financial challenges, may still possess valuable intellectual property (IP) assets like patents, trademarks, and copyrights.
While these assets contribute to the Liquidation Value, the valuation process significantly differs from assessing a going concern. This standard considers quick sales and piecemeal dispositions, acknowledging the potential worth of tangible and intangible assets even in challenging circumstances.
Understanding these key business valuation standards empowers entrepreneurs and Angel Investors to make informed decisions. Whether engaging in negotiations, planning mergers, or resolving disputes, a nuanced understanding of these standards ensures a comprehensive appraisal of a company’s true worth, safeguarding the interests of all stakeholders involved.
However, if your business value is low or doesn’t reach your expected estimate, you can explore various strategies to maximize your business value.
Wait for the Best Deal: Adequate preparation time allows you to explore alternatives and contingencies, reducing the likelihood of being compelled to sell hastily. Sometimes, it’s best to wait for the best deal. If it turns out to be fair market value vs market value, go with the one that is more.
Arm Yourself with Knowledge: In-depth knowledge about your industry provides you with a competitive advantage. Addressing buyer concerns with well-researched data can strengthen your position during negotiations.
Present a Growth Plan: Presenting a growth plan outlining the potential opportunities in your business showcases its potential. A well-executed growth plan demonstrates the value the business can achieve, attracting buyers or angel investors who may be willing to invest more to buy a business.
Appeal to Strategic Buyers: Develop unique aspects of your business that cannot be replicated easily. Strong customer relationships, proprietary processes, patents, and exclusive contracts make your business more appealing to strategic buyers, increasing its value.
Sell at the Peak: Timing your sale when your industry is thriving can significantly impact your business’s value. While perfect timing might be challenging, selling during an industry upswing can fetch a higher price.
In Conclusion
Understanding business valuation standards and employing strategic approaches can significantly impact the value of your business. By adhering to industry standards, staying informed, and adopting effective negotiation strategies, you can maximize the worth of your business investment and ensure a successful sale when the time is right.
