Business valuations are conducted with a specific purpose in mind. This purpose suggests — and sometimes dictates — the standard of value to be used in the valuation. For example, the standard used for a business liquidation is different from the one used for a gift or estate plan.
Here is a quick review of several common standards as described by the AICPA:
Fair Market Value
The most common standard, fair market value, is defined as “the price at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell, and when both have reasonable knowledge of the relevant facts.”
This standard assumes that certain synergies exist between buyer and seller. It’s typically defined as the value of a business or property to a specific buyer.
For example, an investor may have specific requirements or expectations for an acquisition, like gaining a competitive edge or expanding geographic distribution of his or her product. If the target business meets specific criteria, its value is enhanced.
This standard is generally used in cases of dissenting stockholders’ disputes. Many states define fair value with respect to dissenters’ shares as “the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects.”
Net Book Value
This is the difference between total assets and total liabilities as they appear on the balance sheet. Net book value sometimes serves as the low-end “floor” for a valuation.
Your valuation professional will work closely with you to assess your valuation needs and determine which standard applies best to the specific engagement.