A business interest is valued under three recognized approaches: the income approach, which converts expected future cash flows into a present value; the market approach, which draws on prices paid for comparable companies or interests; and the asset approach, which values the company's assets net of its liabilities. The valuator applies the approaches that fit the company, reconciles the indications, and states the standard of value and the valuation date.
Business valuation is required in shareholder and partnership disputes, in divorce where a business interest is marital property, in buy-sell disputes, and in damages matters where a business was destroyed rather than merely interrupted. The approach chosen depends on the company's stage, its earnings history, and the availability of comparable transactions.
Valuation conclusions are sensitive to normalization adjustments, the discount rate, and the treatment of owner compensation, and two valuators can reach different conclusions from the same statements. The standard of value changes the answer: fair market value, fair value, and investment value can diverge materially for the same interest. Discounts for lack of control and marketability are the most litigated inputs and must be tied to the interest actually being valued.
The three approaches are recognized in professional standards and in the courts, and a valuation that follows the published standards and explains its choices is generally admitted. Exclusions follow valuations that apply a standard of value the governing framework does not use, that rely on projections with no support in the company's history, or that apply discounts by rote. The fair market value versus fair value comparison explains the standard-of-value question.
Usually more than one is applied and the results are reconciled. An established company with steady earnings supports the income approach; a company with active comparable transactions supports the market approach; a holding company or a business being liquidated points to the asset approach. The report explains why each was or was not used.
A change to the reported financial statements to show the company's sustainable earning power: removing one-time gains or losses, restating owner salary to what an outside manager would be paid, and separating personal expenses run through the business. Each adjustment is listed and explained.
Value is measured as of a specific date using what was known or knowable then. Events after that date are generally not considered unless the governing framework directs otherwise, so the choice of date, often set by the framework or agreed by the parties, can change the conclusion.
Request a consultation on Business Valuation Approaches or call (201) 343-0700. Plaintiff and defense counsel.