Your business has (correctly) more than one value at the same time!
At first, you might not think about a business having more than one value at the same point in time, but here are some examples: book value that comes right off your balance sheet, forced liquidation value that a lender would consider as collateral for a business loan, or fair market value like a business that can be traded in an open market. But there are more types of value. These are referred to as “standards” of value. A more complete list of commonly used standards of value would include:
- Fair market value
- Fair market value for IRS purposes
- Book value
- Orderly liquidation value
- Forced liquidation value
- Investment value (called “owner’s value” in some parts of the world)
You can calculate the value of a business as of any given day, using every one of the standards listed above! You might then ask, “which is the correct standard?” The answer to that question is: “it depends”.
It depends on the purpose of the valuation. For example:
- Fair market value would be appropriate if there is an open and unrestricted market for the stock—like the New York stock exchange
- Fair market value for IRS purposes—this definition is very much like fair market value, but with more hypothetical assumptions
- Book value—this is like the owner(s) equity section of a balance sheet prepared in accordance with generally accepted accounting principles
- Orderly liquidation value—this would be used if you simply wanted to stop doing the business and retire, without trying to sell it
- Forced liquidation value—much like the value a lender would use if valuing the business as collateral for a loan
- Investment value—what the owner(s) of a closely held business would expect to get if they sold the business to another person, who expects to build upon and grow the business.
To summarize, you value a business using the standard of value that is appropriate to the purpose of the valuation!