Company Valuation

1.? An introduction

In its most basic form, valuation is the process of assigning a value or worth to an asset or liability. Stock analysts use a variety of economic factors, including market value, earnings projections, and other factors, to assess a company's equity worth. Because data is readily available, publicly traded corporations are generally easier to evaluate than privately held enterprises. Value assessment, which is seen as a synthesis of science and art, can be more challenging for private businesses.

The income, market, and asset-based techniques are the three methods of business valuation that are most frequently applied. The income approach calculates current value by projecting a company's cash flows into the future and discounting them at a suitable cost of capital rate. The final value can be significantly impacted by the cost of capital, or discount rate, that is utilized in the denominator. Value is ascertained by the market approach through financial ratio analysis of similar benchmark companies. Last but not least, the asset-based strategy calls for a thorough revaluation of all of a business's liabilities and assets, both tangible and intangible.

2. Getting Ready

A corporate entity's worth is determined through a complex process that requires equal attention to planning and analysis. Setting out the road map for the valuation process requires careful thought and consideration before looking over financial statements and evaluating risk factors related to the company. We will first go over some of the decision-making processes that give the valuation process direction before talking about the three methods to business valuation. The concepts and criteria that follow are only intended to be used as a general guide; the specifics and processes may differ depending on the organization certifying valuation practitioners.

?3. Standard of Value

Determining a company's value is undoubtedly the main factor in business valuation, but defining "value" is not that simple. Value can have various meanings. Thus, specific standards of value have been developed in order to value a business. Selecting the proper value standard for the given scenario is one of the first decisions to be made when planning a business appraisal.

4. Guidelines and Definitions

Because valuation professionals have access to a variety of standards of value, it is crucial that the right standard be chosen in accordance with the specifics of the engagement or project.

Fair market value is defined by IRS Revenue Ruling 59–60 as “…the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

Fair value, within the statutory standard of value context, is typically applicable in cases of dissenting stockholders’ appraisal rights. The fair value definition varies from state to state and there is no clear majority position with respect to certain elements of fair value. In states that have adopted the Model Business Corporation Act, the definition of fair value means, “the value of the corporation’s shares determined (i) immediately before the effectuation of the corporate action to which the shareholder objects, techniques…, and (ii) without discounting for lack of marketability or minority status…”

In the case of financial reporting, the Financial Accounting Standard’s Board (FASB) implemented ASC 820, Fair Value Measurements (SFAS 157), which defines 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.” The fair value definitions above are still open to intense debate.

Investment value is the value to a particular investor based on individual investment requirements and expectations.

Book value with respect io a business enterprise is the difference between total assets (net of accumulated depreciation, depletion, and amortization) and total liabilities as they appear on the balance sheet (synonymous with “shareholder’s equity”). With respect to a specific asset, book value is the capitalized cost less accumulated amortization or depreciation as it appears on the books of the business enterprise.

Intrinsic value is the value that an investor considers, on the basis of an evaluation or available facts, to be the “true” or “real” value that will become the market value when other investors reach the same conclusion.

Going concern value is the value of a business enterprise that is expected to continue to operate into the future. The intangible elements of going concern value result from factors such as having a trained work force, an operational plant, and the necessary licenses. systems, and procedures in place.

Liquidation value is the net amount that would be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either “orderly” or “forced.”

In business valuation, fair market value is the most commonly applied criteria. Concepts like going concern value and liquidation value go beyond "standard of value" and into the "premise of value."

5. Premise of Value

The choice of evaluating a business as an active entity or as one that is about to go out of business is the premise of value. Sometimes a company is evaluated under the assumption that it will continue, but it turns out that the business would be worth more if it were liquidated. This is the kind of information that ought to be included in the valuation report, which is why, while conducting an analysis on a company, you should look at every feasible option. A simple assumption about the most likely set of transactional circumstances that could apply to the subject valuation is what the premise of value is (e.g., going concern, liquidation).

6. Ownership Interest

The practitioner must be aware of the ownership interest that has to be valued in order to apply the proper data and algorithms in the valuation process effectively. "control" and "minority" are the two phrases that are frequently used to define ownership interest. A person who holds a controlling interest in a business can influence its management and policies. A controlling interest in a firm is defined as more than fifty percent of the business. An owner who holds a controlling interest typically has the ability to influence the company's debt as well as equity. A minority interest in a business is defined as ownership of less than 50% of the corporation and usually excludes the right to control the organization.

7. Valuation Date

IRS Revenue Ruling 59–60, which is the cornerstone of the valuation process, altered the way businesses are valued. Ruling 59–60 specifies, among other things, that although valuation is a forward-looking procedure, it must be grounded in the facts that were known as of the necessary valuation date. Some apply this to the later part of the regulation, assuming that only information pertinent to the valuation date need to be utilized.

8. Essential Elements

When determining a company's fair market value, a variety of pertinent aspects should be carefully taken into account. This is particularly true when assessing a closely held company whose owners own a controlling stake and whose stock quotations are scant or nonexistent. IRS Revenue Ruling 59–60 lists eight of these elements:

?1.????The type of business and the company's history since its founding.

2.???? The overall economic outlook as well as the state and future prospects of the individual industry.

3.???? The stock's book value and the company's financial standing.

4.???? The company's ability to generate revenue.

5.???? The company's ability to pay dividends.

6.???? Whether goodwill or any other intangible asset is present in the business.

7.???? The amount of stock sold as well as the size of the block that needs to be valued.

8.???? The market value of stocks of companies operating in the same or a related industry that are actively traded in a free and open market, either over the counter (OTC) or on an exchange.

?The method of valuation must be chosen after all the preparations have been made, including choosing the standard of value, addressing the ownership interest, the valuation date, and the essential elements. It is also necessary to use the proper calculating procedure for each approach.

About the Author

Roi Polanitzer, CFV, QFV, FEM, CRM, FRM, PDS, FILAVFA, is a well-known authority in Israel in the field of business valuation and has written numerous articles that articulate many of the concepts used in modern business valuation around the world. Roi Polanitzer is the owner and chief actuary of Intrinsic Value — Independent Business Appraisers, a business valuation firm headquartered in Israel. He is also the owner and chief data scientist of Prediction Consultants — Advanced Analysis and Model Development, a data science firm that specializes in machine learning projects.

Over 20 years, he has performed valuation engagements for mergers and acquisitions, employee stock ownership plans (ESOPs), fairness opinions, gift and estate taxes, incentive stock options, buy-sell agreements, corporate and partnership dissolutions, dissenting stockholder actions, damages, marital dissolutions, and many other business valuation purposes. He has testified in a wide variety of magistrates and rabbinical courts across the Israel and frequently participates in mediation proceedings between spouses.

He holds an undergraduate degree in economics from Ben-Gurion University and a graduate degree in business administration, majoring in finance, from Ben-Gurion University as well. He is a Fellow of the Israel Association of Valuators and Financial Actuaries, and certified as a Corporate Finance Valuator, a Quantitative Finance Valuator, and a Financial and Economic Modeler by the Israel Association of Valuators and Financial Actuaries.

Mr. Polanitzer professional recognitions include being designated as a Financial Risk Manager — Certified by the Global Association of Risk Professionals, a Certified Risk Manager — Chartered by the Israeli Association of Risk Managers, and a Professional Data Scientist — Certified by the Professional Data Scientists’ Israel Association.

Mr. Polanitzer developed models, functions and approximation equations in the fields of actuarial science and valuation. In addition, he served as the chairman of the committee for determining a valuation policy the Israel Tax Authority’s employees (“Polanitzer Committee”).

Mr. Polanitzer led and took a very significant part in writing the IAVFA’s statements of opinion in the fields of actuarial science and valuation. In addition, he published over 600 papers in Hebrew and over 400 papers in English in the fields of actuarial science and valuation.

He is publisher of the weekly newsletter of the Israel Association of Valuators and Financial Actuaries (primarily for the professional valuators community in Israel).

Mr. Polanitzer develops and teaches business valuation courses for the Israel Association of Valuators and Financial Actuaries, and frequently speaks on business valuation at professional association meetings. He also developed and often teaches a full-day seminar on business valuation for economists and accountants.