In a previous post, we explained the importance of understanding the purpose of a business valuation prior to beginning the exercise. It is equally important to clarify beforehand another variable: the premise of value, an assumption regarding the circumstances that may be applicable to the subject valuation.
There are two general premises of value (referencing the International Valuation Glossary – Business Valuation, updated February 24, 2022):
- Going Concern Value, which “assumes the business is an ongoing commercial enterprise with a reasonable expectation of future earning power,” and
- Liquidation Value, which is the “amount, net of relevant costs (e.g., preparation and disposal), that would be realized if the business is terminated and the assets are sold.”
Liquidation value, in turn, typically takes one of two forms: forced, in which assets are “presumed to be sold with less than a reasonable period of market exposure,” or orderly, in which assets are “presumed to be sold over a reasonable period of market exposure to maximize expected return.”
Think of the premise of value as a question: Is the business expected to continue to operate? The answer, understandably, can lead to value conclusions that are quite different.
Circumstances can serve as a guide when it comes to identifying the appropriate premise of value.
For instance, if the context is that of …
… a potential sale, then a discussion should occur between the buyer and seller around how each party views the viability of the business as an operating entity over the long term. Will the value of the business be higher if its operations continue or if its assets are sold on a piecemeal basis?
… bankruptcy proceedings, then it might make sense to prepare multiple valuations of the business assuming various future scenarios.
… a minority, non-controlling interest, then the most likely future scenario might be one in which the business continues to operate under the status quo.
So, before you undertake a business valuation, ensure that you understand not just why the valuation needs to occur, but also the premise under which it will be conducted. Consult with your CFGI valuation professional so that all parties are working from the same set of assumptions from day one.
