Investment Value
Not Just for Divorcing Couples
In a archived article, Business Valuation in Divorce is Different, we discussed why Investment Value is more appropriate in the context of family law. But, this method is not just for divorcing couples. In any situation in which the party acquiring an interest (or a greater interest) in a company will become (or continue to be) part of the management team, Investment Value is often the most appropriate method. Here’s why.
In a Fair Market valuation, the objective is to determine what a hypothetical “willing buyer” would pay a hypothetical “willing seller” in a hypothetical “free market” etc. But, that is not what is going on in a divorce or in a variety of other private company business situations. An abbreviated list would include the following.
* Sale of shares in a corporation to a new hire.
* Repurchase of shares in a corporation from a retiring, or otherwise terminating, employee.
* Sale of a partnership interest in a professional firm to a new partner.
* Repurchase of a partnership interest in a professional firm from a retiring, or otherwise terminating, partner.
* Implementing a stock option plan.
* Implementing a Stock Appreciation Rights program.
* Establishing a value, or value formula, for a buy-sell agreement.
In each of these examples, the buyer is a current (or soon-to-be) partner and/or a member of the management team and, as such, intends to benefit (or benefit to a greater extent) financially from future operations. This is strictly an insider transaction, with no hypothetical “willing buyer” in sight.
In a small professional firm, for example, a prospective outside acquirer would typically find value primarily in the people who operate it. S/he would be “buying the people” rather than the firm itself. The resulting dependence on 1-3 key individuals creates risk which, in turn, depresses value from the perspective of an outsider. For an insider, not so much.
A key insider owner should certainly be cognizant of the importance of a management structure that has breadth and depth. That’s just prudent management. But, importantly, s/he need not fear that the currently thin management structure will suddenly evaporate by virtue of a loss of motivation. In addition, there are many important financial benefits to being an inside owner, including control or influence regarding:
* Salaries
* Bonuses
* Retirement plans
* Common executive perks (such as automobile or expense allowance)
* Uncommon executive perks (such as an apartment or extensive foreign travel)
In some cases, the value to an insider may be considerably higher than to an outsider. Conversely, if the company or professional firm is in financial difficulty, the value of the inside investment could be well below Fair Market Value, because the financial risk will be borne entirely by the current owner/manager team. The common thread here is the value of stock or partnership interest to an inside investor. That is why Investment Value in such cases is the valuation method of choice.
Note: This article first appeared in Active Garage, a premier portal to powerful insights from thought leaders on topics ranging from leadership to authoring business books.
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