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Definitions and Approaches to Value

Definition of Value

The standard of value depends on the purpose of the valuation.

Fair Market Value

Fair Market Value of equity is the amount at which property would change hands between a willing buyer and seller when neither is under compulsion and when both have reasonable knowledge of the relevant facts. This value most closely represents the amount that a purely financial buyer with no operating or market synergies would pay for the business.

Investment Value

Investment Value of equity is the specific value of an investment to a particular investor/buyer or class of investors/buyers based on individual requirements. This value most closely represents the amount that strategic buyers with operating and market synergies would pay for the business.

Fair Value

The legal definition of Fair Value varies from jurisdiction to jurisdiction as specified in state statutes and case law precedents. The financial reporting definition of Fair Value is defined in FASB ASC 82 as the highest and best use price that would be received to sell an asset or paid to transfer a liability in and orderly transaction between market participants - exlcuding transaction costs. In both definitions, Fair Value and Fair Market Value are similar concepts.

Approaches to Value

An appraisal considers all approaches to value and then converges on an opinion of value.

Income Approach

The income approach employs the Discounted Cash Flow (DCF) method where the net present value of forecasted future cash flows is discounted at a rate to reflect systematic and unsystematic risk.  

When quantifying Investment Value or the amount strategic buyers would pay for a business, cash flows are forecast from the potential acquirers' financial perspective. Requiring an understanding of the business' industry and the vertical markets served, the appraiser creates Performa financial models that include:

  • Future cash flows from product lines and/or licensing of its intellectual property
  • Future cash flows of the potential acquirers’ complimentary product lines
  • Potential acquirers’ operating cost structure, capital structure and distribution channels
  • Potential acquirers' incremental investment to integrate the company or product line 
  • Discount Rate that reflects market and technology risks of integrated businesses

Market Approach

The market approach employs the Guideline Public and Guideline Merger & Acquisition methods where the valuation is based on multiples of revenue, earnings, gross margin, and/or assets for comparable public companies and M & A transactions for comparable companies in the industry. Multiples are adjusted to account for differences in marketability, capital structure, size, key person(s), intellectual property, cost structure, competitive market position, technology risk, and market risk.

Asset Approach

The asset approach is generally defined as the sum of all assets and liabilities adjusted to fair market value. It is typically employed when a business is better off dead than alive and will be liquidated either orderly or forcedly.

Variables Affecting Value

Value is dependent on industry, macroeconomic, capital market, legal & tax, accounting & finance, and business operations factors.