‘What’s my business worth?’ is a strangely complex question. The best answer: it depends on why you ask. The value of your business may be different if the purpose of the valuation is to negotiate a sale of your business with a strong financial forecast supported by historical financial performance than if the principals are in litigation and the purpose is to negotiate an ownership settlement or if the business is required to have a valuation by a regulatory body. The purpose of a valuation defines a “standard of value“, which is the defensive technical approach and scope of the valuation. A standard of value is the definition of value used in a valuation. The standard of value is determined by the purpose of the valuation.
The price in a transaction is the negotiated amount of money for the assets, shares or rights transferred. For more info, check out our articles on Price vs. Value.
Value is an opinion. A valuation is the act or process of developing an expert opinion or conclusion of value at a date using a defined standard of value based on assumptions regarding the circumstances of the business, and reliant upon one or more valuation approaches. A chartered business valuator provides an expert opinion of the value of the business.
There is more than one standard of value. The purpose of the valuation will determine the standard used. The standard of value affects the methods, inputs and assumptions used in the valuation.
Fair Market Value is a standard of value that is most often used as it related to negotiated amount in a transaction. Fair market value, in Canada, is considered to be the highest price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, each acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or to sell and when both have reasonable knowledge of relevant facts.
Fair Value is a standard of value that is typically defined or imposed by a third party. Financial reporting standard setting bodies like the International Accounting Standards Board (IFRS) or the United States Financial Accounting Standards Board (US GAAP), typically define 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. This is often a standard that is used in court cases.
Investment Value is a standard of value considered to represent the value of an asset or business to a particular owner or prospective owner for individual investment or operational objectives. Sometimes this is called value to owner. It can represent the amount an owner would pay to avoid losing access to the investment.
Market Value is a standard of value considered to represent the estimated amount for which an asset or liability should exchange on the date of value between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing, and where the parties had each acted knowledgeably, prudently, and without compulsion.
The standard of value selected for valuation is based on the reason the valuation is requested. An opinion on the value of your business based on Fair Value used for litigation purposes may not be suitable when selling your business. Negotiating the selling price of your business based on an Investment Value opinion may put you at risk of selling too low. It all depends on the purpose.