Important business valuation standards every business should know
Business valuation is estimating the economic value of a business owner’s interest. Financial market participants use various valuation techniques to determine the fair cost of buying or selling the business. Business valuators frequently use the same valuation tools to resolve estate and gift taxation disputes, divorce litigation, allocate the purchase prices for the assets of the business, create a formula for partners’ ownership interest valuation for buy-sell agreements, and other business and legal purposes such as shareholders deadlock, divorce litigation, and estate contest. Business valuation differs from stock valuation & the various business valuation standards, which we shall cover ahead, include a code of conduct for the activity of Business valuation.
This article shall cover an understanding of key business valuation standards, what are business valuation standards, the importance of having business valuation standards & more.
Business valuation standards
Business Valuation Standards are practice guidelines for business valuation. These are the determinant factors that help understand the valuation, considering the various essential factors. Let us understand the valuation standards in detail below–
Understand valuation standards
Business valuation is governed by the Business Valuation Standards (BVS) or codes of conduct. The Valuation standards are important to be understood to connect the dots of the valuation so that its purpose get’s served. The following are the major business appraisal standards:
- CICBV (Canadian Institute of Chartered Business Valuators) Practice Guidelines. Published by the CBV Institute (Chartered Business Valuation)
- Professional Appraisal Practice Uniform Standards (USPAP). Standards 9 and 10 address business valuation and reporting requirements. The Appraisal Foundation publishes this guide.
- International Valuation Guidelines. The International Valuation Standards Council issues this publication.
- Statement of Valuation Service Standards (SSVS No 1). The American Institute of CPAs publishes this guide.
Importance of having business valuation standards
Business valuation standards provide a structure of globally accepted, identified principles and notions, definitions, and best practices in conducting and reporting valuations. They are provided and globally fostered as a benchmark to ensure consistency in methodology and reliability of valuation outputs.
The most recent catastrophe was brought on by bad practices that the Financial Stability Forum and the G20 recognized as major causes of the 2008 global financial crisis. It included severe valuation discrepancies both within and across countries. It was supposedly brought on by lax valuation standards in sub-prime lending by US banks, which resulted in a complete worldwide crisis in 2008. The banks in the US made loans for sub-prime mortgages without properly assessing the borrowers’ ability to repay the loans.
At the national, regional, and international levels, standards may serve to govern professional activities. Having consistent valuation criteria increases trust among shareholders, creditors, financial institutions, and public and private organizations and promotes transparency.
Key business valuation standards
Aside from the well-known fair market value (FMV) standard, it is only one of several business valuation standards commonly used to determine company value. Following are the four primary businessvaluation standards and the contexts in which they’re used. These are considered to be known by businesses thoroughly.
Fair market value
In company valuations, the FMV standard is used to determine value from the viewpoint of an impartial third party or the rational investor. FMV standard seeks to determine how the market perceives the company’s value in question. The FMV standard considers value from the perspective of a rational third-party investor, such as a stock buyer.
The price at which an asset would exchange hands between a ready buyer and a capable seller operating at arm’s length in an accessible and unrestrained market, without any obligation, possessing reasonable knowledge of the pertinent facts, is referred to as fair market value. This price is expressed in cash equivalents.
Reasonable market value Business valuations are used to determine the value of transactions, investment decisions, and legal proceedings, and they serve as the foundation for nearly all property tax assessments. FMV is also used in gift, estate, and income tax valuations. The FMV criteria imply value but may not necessarily reflect a real transactional (sale or buy) value because of circumstances unrelated to a rational investor.
While fair market value sometimes serves as a fallback, this value standard is generally utilized in accounting or regulatory reporting; nonetheless, the two standards are different. For example, fair value can be applied in shareholder disputes or marital dissolution cases, depending on the jurisdiction. The fair value would not include reductions for lack of marketability and control to prevent dissenting parties from being punished for the conflict’s loss of control.
Furthermore, lack of control impacts value only when a party’s interest in the business is sold to a third party. The fair value standard ensures that oppressed minority shareholders receive the full value of their interest in the business.
Following Generally Accepted Accounting Principles, fair value is used for reporting asset values in accounting (GAAP). The acquiring company uses the fair value standard to allocate purchase prices in M&A transactions.
This standard of value, also known as strategic value, refers to a company’s worth to a specific party or investor. The company’s worth is generally greater to a party like an opponent, vendor, or client than to a logical third-party investor because of the anticipation of commercial synergies. The investment value varies depending on the value of the business to the specific purchaser; for example, the business may be more valuable to one competitor than another.
Almost always, investment value is used to calculate value in a merger and acquisition (M&A) transaction. Essentially, it is a value calculation based on the assumption that the combined entity will be more valuable and profitable.
Goodwill is defined as the premium paid for the business above the fair market value of its tangible and intangible assets.
The remaining value standards are all concerned with values that are predicated on the notion that the firm will do business either alone or as a component of an acquiring company. A distressed business is less valuable than a desirable, healthy asset. As a result, liquidation value will consider the value in the context of the business being closed down.
The assumptions used to calculate liquidation value differ significantly from those used to calculate going concern value. Typically, the company will not have enough cash flows to cover its operating expenses or debt obligations and will be forced to declare bankruptcy or dissolve. However, insolvent businesses may have valuable intellectual property (IP). Customers, patents, trademarks, and copyrights are all examples of intellectual property.
The assets’ value will be determined by a quick sale and a piecemeal disposition. It is also possible that the assets will have no value because the cost of removing or transferring the assets may be greater than the actual value.
How can Eqvista help with business valuation?
It’s important to get your business valuation done by reputable and professional firms in order to have the right standards in place. Eqvista offers just that; business valuations that are compliant to valuation standards. Our team is made up of highly qualified professionals that have the education, know-how, and experience necessary to provide you with the best service. To learn more about our valuation services, reach out today!