Business Valuation 101: Fair Market Value

Fair Market Value (FMV) is the true intrinsic value of an asset, independent of any emotional, sentimental, or perception of value by vested parties (i.e. business owners). For example, a painting may have more intrinsic value to its original owner because it carries a story or is part of a sentimental memory for the owner. A potential buyer would not have the same feeling towards the painting because they have no association with the painting’s past. The fair market value of that painting is based on its commercial value versus its non-commercial value. As you can see from this example, this is particularly relevant in family law cases where businesses can be one of the most significant and valuable assets held by the family.

The same principle applies to the sale of an asset. Generally speaking, negotiations would typically rest at a price that is closely related to the FMV of that asset. The highest price the buyer is willing to pay and the lowest price the seller is willing to accept. Having a current valuation report, and ideally, a history of valuation reports provides context and a focal point for negotiations and discussion which can save time, money, and optimize the price of the asset for the parties involved.

Business Valuations are useful in a wide range of applications including:

• Matrimonial law purposes;
• Quantification of economic losses;
• Corporate litigation;
• Shareholder buyouts and disputes;
• Expropriation;
• Income tax planning purposes;
• Purchase and sale of a business;
• Financial reporting;
• Estate planning; and
• Management planning.

Components of Value

A valuation report, depending on the type, offers economic analysis, industry analysis, company operations analysis, financial analysis, conclusion, and review. There are two main perspectives when considering the value of a business:

• Tangible Asset Value is determined from the business’ balance sheet considering what is often referred to as ‘hard assets and liabilities’ to determine the Tangible Asset Value, free from any intangible assets, including goodwill.
• Intangible assets represent the brand value, customer relationships, company’s workforce, and the knowledge and know-how comprising intellectual property and goodwill.

Goodwill can be broken down into two subsets components; Commercial Goodwill, the perceived value of the various intangible assets that can be directly linked and tied to the business and Personal Goodwill which represents the value the current owner brings to the business based on their skill set, reputation, and expertise. Personal Goodwill is generally not considered to be transferable and would be represented as a diminishing or depreciating value according to the level of involvement the original owner has in the company upon transfer of ownership. It is not considered a saleable value unless otherwise demonstrated in the Commercial Goodwill.

Key Principles of Valuation

Considerations made during the valuation process include:

• Value is Future-Oriented in that valuation is generally determined by the expected benefits and cash flow an asset, such as a business, can generate in the future.
• Valuation is Specific to a Point-In-Time and is determined having considered facts known and expectations made only then. In the context of family law, this is commonly applied to the critical dates being the date of marriage and the date of separation where asset valuations must be considered at each of these different points in time.
• Commercial Value vs. Non-Commercial Value applies to the transferability of assets where the commercial value is the transferable value, and the non-commercial value is the value to the owner.
• Market-dependent valuation refers to the consideration of economic conditions (boom, bust, or recession) in which the sale or transfer of the asset is occurring in. Investment alternatives regarding rates of return and risk profiles are also factored into the valuation.

Once you have determined a business valuation is necessary, there are three types of valuation reports to choose from under the reporting standards of the CBV Institute. A Calculation Valuation Report, an Estimate Valuation Report, and a Comprehensive Valuation Report. The level of valuation report you require depends on the scope and level of analysis required for the use of the report.

The Calculation Valuation Report offers a high-level analysis. This report offers users a conclusion based on a minimal review, investigation, vetting of assumptions, and often more reliance on management representation. There is little corroboration of information, and thus this report provides a conclusion with the least amount of comfort. It does provide the user with a general sense of value and is generally suitable for certain income tax planning, management and shareholder planning purposes, or where a high-level perspective is beneficial without incurring significantly higher costs associated with the other two reports. Calculation Valuation Reports are occasionally used in certain circumstances for family law but are generally not recommended.

Estimate Valuation Reports offer a limited review and analysis to the user relative to Comprehensive Reports but more vigour than what is associated with a Calculation Report. There is more corroboration of information provided, assumptions made, when providing a conclusion such as on the value of shares, assets, or an interest in a  business, stock options and others to name a few. Estimate Valuation Reports are suitable for transactions, income tax planning, and/or for litigation purposes where the report may be used as part of expert testimony in courts such as in family law and shareholder disputes.

The Comprehensive Valuation Report offers the most robust reporting out of the three reports. Its scope requires and review and consideration of the economy at the valuation date, industry considerations and other pertinent factors, it is also the costliest of the three reports, given the level of work performed. It provides the user with the highest level of comfort with respect to conclusions of value and is often required for higher-level litigation matters, fairness opinions, or other securities law purposes. In our experience, we note that Comprehensive Valuation Reports are rarely utilized in family law matters.

The valuation of a business, whether for transactional purposes or those of a family law settlement, has many factors that must be considered and carefully evaluated. It is difficult for those within the business or close to the business to truly understand the fair market value of the business, particularly when there have been many personal contributions that are not accountable for on a balance sheet. Our Valuation team has extensive experience in providing a range of valuation reporting to suit the end user’s needs whether it is a high-level overview or a comprehensive report with a high degree of corroboration.

About SB Partners Valuation Division:

Our valuation team is led by Partner and Valuation Division President Trevor Hood, CPA, CA, CBV, CFF. He is joined by Ian Lobo, CPA, CA, CBV, CFF Principal and Vice-President Valuation Division, Rob Smith, CPA, CA, CBV – Senior Manager and Robert John Gergely, CPA, CA, CBV- Manager. The Valuation Division works with lawyers assisting clients with their desired outcomes by providing comprehensive reporting for their legal team.

Get in touch today to learn more.