Valuation Definition – what is value?
Price v Value
Is value the same as the price? Not necessarily. As guru investor Warren Buffet succinctly puts it:
“Price is what you pay. Value is what you get”
Price and value are not necessarily the same. Mr Buffet has amassed vast billions knowing the difference.
In a business sale scenario with a desperate seller, a drawn-out sales process with just one belligerent buyer, the price offered will likely be less than what the business is worth.
On the other hand, if there is a competitive bidding process, with lots of enthusiastic ego driven buyers, eager to transact quickly with limited information, then the offered price is likely to be more that the true value of the business.
Price is a historical fact. A price based on the motivations, interests and financial capabilities of buyers and sellers at that time. The price may or may not have a relation to the value ascribed to the business.
Value is an economic concept. It is the price most likely to be achieved between buyers and sellers in accordance to a definition of value. It is hypothetical. The value will depend on the definition of value. The basis of value.
Basis of Value
What is the definition of value, the basis of value? Market Value is the most common valuation definition, but not the only definition.
Market Value is defined as:
“The estimated amount for which a business should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion”*
Some key terms from this definition include:
- “Estimate”. The value is an estimated amount. It is the most probable price
- “Date”. The valuation is date specific. The valuation date is important. The value could be different on another date. It is important the correct date is provided.
- “Willing”. The parties are neither over eager or being forced into the transaction. Both parties are motivated to transact.
- “arm’s length”. No special relationship is presumed to exist between parties. The parties are independent and unrelated.
- “knowledgeably”. Parties are presumed to be reasonably informed.
Market Value presumes a price is negotiated in an open and competitive market where all participants are acting freely.
Other definitions of Value
Fair Value: The value that is fair between two identified parties, considering the respective advantages or disadvantages that each will gain from the transaction. Fair value is often used in legal disputes; common law matters.
Special Value: Special value is unique to a buyer. The business offers advantages to the buyer that are not available to other buyers, for example.
Synergistic value: Is the element of value that is created by the merger of the businesses. The combined value of the two entities is more that their parts, perhaps do to cost savings
The key legal matter in relation to the defintion of market value, is the the High Court case Spencer v The Commonwealth of Australia. In this case the key principals of market value are recognised as
- willing but not anxious vendor and buyer
- hypothetical market
- parties aware of current market conditions
Highest and best use
It is also common to assess market value as the “highest and best use”. So the best use value maybe higher that the current value.
About the Author
Simon specialises in providing forensic accounting and valuation services. Prior to founding Lotus Amity, he was a Forensic Accounting partner with BDO Australia and led their National Forensics practice. He has worked as a forensic director for a major offshore forensic accounting practice which included assisting in multi-billion-dollar litigation in relation to the largest Bernie Madoff feeder fund. He has also held senior management positions with Deloitte and Crowe Horwath. Simon is a Chartered Accountant, CA Accredited Business Valuer and a Certified Fraud Examiner.
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