Any of the above might impact the validity of a valuation inside the one-year period.
How Can a Change in Purpose Affect Value?
One aspect of value many business owners don’t consider is the impact that “purpose” has on the validity of a valuation. For instance, we are likely to arrive at vastly different conclusions if a valuation is done for a minority buyout vs. a strategic purchaser. Understanding the context of the valuation is critical – and by default, a change in context (or purpose) is likely to impact value.
Valuation and Divorce: A Case Study in Purpose
A great example of valuation purpose affecting value is when a valuation is performed in the context of a divorce. Valuations are often required when a privately held business is part of a marital estate. In order to perform a division of property the parties must know the value of the asset, and in the absence of a public market price a third party valuation is required.
If we assume for a moment that we are valuing a minority interest (50% or less, lacking elements of control and liquidity), as a valuation analyst we would ordinarily consider applying a Discount for Lack of Control and/or a Discount for Lack of Marketability. This may result in a discount from the pro rata share of the business of anywhere from 20-50%.
Example 1: In many jurisdictions, the courts have stepped in and limited the ability to apply so called discounts. In order to not “punish” an exiting spouse, the valuation is precluded from applying these discounts, instead developing a value that is higher than what we would conclude if we were performing the value for a different purpose.
Example 2: Staying with the divorce scenario, in many situations as a valuation analyst we might look at the impact of “personal goodwill’ on the overall value of a business. That is to say, how much value is attributable to an individual owner vs. the enterprise itself? This is very common in medical and professional practices, or scenarios where the “owner is the business.”
Similar to limiting discounts, states take wildly differing views on the treatment of personal goodwill in divorce matters. In many states personal goodwill is considered a marital asset, this divisible in the separation of assets. In others, personal goodwill attaches to the individual and is separated from our valuation.
Given the above scenarios, a valuation performed in the context of a divorce could have a materially different finding than a valuation performed for, say, exit planning purposes. In our examples above, not only does purpose affect the validity of a valuation, but so does jurisdiction!