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Business Valuation - What are "Standards of Value"?

One of the first tasks before a valuation engagement begins is knowing what Standard of Value to use. There are many different definitions of "value" and each can result in significant differences in valuation.

The following presents an overview of four standard of values frequently used:

Fair Market Value

This is a commonly used standard of value that is defined in IRS Revenue Ruling 59-60 as follows: "The amount at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy, and the later is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts."

A key concept here is that the definition above considers a hypothetical buyer and seller and not an actual buyer and seller.

Another similar definition of fair market value is presented in the book Basic Business Appraisal by Raymond Miles as follow: "Fair market value is the price, in cash or equivalent, that a buyer could reasonably be expected to pay and a seller could reasonably be expected to accept, if the property were exposed to sale on the open market for a reasonable period of time with buyer and seller being in possession of the pertinent facts, and neither being under any compulsion to act."

This standard applies to valuations used for estate and gift taxes, inheritance taxes, ad valorem taxes, Employee Stock Ownership Plans, and financial acquisitions.

Fair Value

The use of "fair value" can have different meanings within the valuation field.

For financial reporting purposes, FASB ASC 820-10-20 defines fair value as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." The accounting literature adds other unique characteristics to consider.

From a legal context, the definition of fair value is driven by case law and varies from state to state. It is a common standard to apply in state corporate dissolution and shareholder disputes.

This standard applies to valuations used for financial reporting, and in most states, stockholder disputes and corporate or partnership dissolutions.

Investment Value

This standard of value is used to determine the value to an specific buyer rather than a hypothetical buyer as would be the case with fair market value.

This standard applies to valuations used for strategic acquisitions.

Intrinsic Value

This standard of value is frequently used by financial analysts and is defined in the Shannon Pratt's book Valuing a Business as follows: "Intrinsic value (sometimes called fundamental value) differs from investment value in that it represents an analytical judgment of value based on the perceived characteristics inherent in the investment, not tempered by characteristics peculiar to any one investor, but rather tempered by how these perceived characteristics are interpreted by one analyst versus another."

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Disclaimer: The information contained in this article is for general guidance only. The information presented should not be acted upon without the advice and guidance of a professional tax, legal, or financial adviser who is familiar with all the relevant facts.

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