An important piece at the beginning of any valuation is establishing how value is defined. It is not enough to say, “we need a value for a business.” Similar to sports, we must set the rules by which we are going to play.
In family law matters, the question of standard of value begins with the premise of value, which falls under two categories:
According to The Merriam-Webster Dictionary, the definition of “value” is “a fair return or equivalent in goods, services, or money for something exchanged.” In business valuation for family law matters, there are three main standards of value utilized:
Fair market value is the most frequently utilized standard of value in most business valuations. It falls under the value in exchange premise of value. Fair market value is defined by the International Glossary of Business Valuation Terms as
the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.
One of the first items to note is that this definition assumes a hypothetical buyer and seller. That means we are not considering the specific seller or buyer’s individual opinions or assumptions. The next item to note is that the hypothetical buyer and seller are unrestricted, not under force (compulsion), and have reasonable knowledge. In short, both buyer and seller understand the business and circumstances of the business, industry, and economy as of the date of value, as an informed investor might before making an investment decision.
These items should be the starting point as a valuator determines the hypothetical type of buyer (e.g., C corporation, S corporation, or individual). From this point forward, the valuator uses this “perspective” when reviewing the company’s financials and making adjustments and decisions about the appropriate levels of discounts for control, marketability/liquidity, goodwill, and much more.
Fair value, as it relates to the premise of value, falls in between a value in exchange and value to the holder. This is because fair value differs from fair market value and investment value on the presumptions of a sale and willingness of the parties. Fair market value assumes a willing buyer and seller. Investment value assumes the business will not be sold. While fair value can be viewed in light of an exchange like fair market value, it does not assume a willing seller.
There is no “one-size-fits-all” definition for fair value. In business valuation, the context varies from state to state based on prior case law, e.g., dissenting shareholder cases, corporate dissolution cases, and, in some states, divorce. The Delaware case of Tri-Continental v. Battye, 31 Del. Ch. 523, 74 A.2d 71 (Del. 1950), defined fair value this way:
The basic concept of value under the appraisal statute is that the stockholder is entitled to be paid for that which has been taken from him, viz., his proportionate interest in a going concern. By value of the stockholder’s proportionate interest in the corporate enterprise is meant the true or intrinsic value of his stock which has been taken by the merger. In determining what figure represents this true or intrinsic value, the appraiser and the courts must take into consideration all factors and elements which reasonably might enter into fixing the value.
The fundamental difference between fair value and fair market value is that FMV implies a “willing seller.” In fair value cases, most courts are concerned with the concept of fairness, resulting in the valuations intended purposes to be “equitable” for the disadvantaged party. Oftentimes, the simplest way to look at fair value is to think of it as fair market value but without the use of discounts for control or marketability/liquidity.
Investment value is presumed to be a value to the holder premise. In family law cases, the standard does not presume a sale will occur. Rather, the owner will hold the investment and benefit from its future earnings.
Some courts in divorce cases have adopted the investment value standard, as there is no “willing buyer” and the owner will continue to operate the business. This standard of value should be reviewed on a case-by-case and jurisdiction-by-jurisdiction basis. In the California case Golden v. Golden, 270 Cal.App.2d 401, 75 Cal. Rptr. 735 (Cal. Ct. App. 1969), the reasoning behind the use of the standards was defined as follows:
. . . in a matrimonial matter, the practice of the sole practitioner husband will continue, with the same intangible value as it had during the marriage. Under the principles of community property law, the wife, by virtue of her position of wife, made to that value the same contribution as does a wife to any of the husband’s earnings and accumulations during marriage. She is as much entitled to be recompensed for that contribution as if it were represented by the increased value of stock in a family business.
Investment value is also called intrinsic value and is often used in mergers and acquisitions. From this view, the value allows for a specific investor’s investment criteria, assumptions, and synergies to be utilized in arriving at the indicated value.
