1.5 min read.
As a business owner, it’s crucial to understand the valuation process and the terminology used in it. Knowing these terms can help you prepare for a business sale, merger, or acquisition, or when creating a buy-sell agreement or doing estate planning. In this blog post, we’ll cover five essential valuation terms that every business owner should know.
1. Fair market value: This term refers to the price at which a hypothetical willing and able buyer and seller would agree to exchange property in an open and unrestricted market. Fair market value applies not only to physical assets but also to businesses and their assets.
2. Fair value: Fair value is a legal term defined by state law and/or legal precedent, which may be used in shareholder disputes or marital dissolution cases. It starts with fair market value, but certain adjustments are made to account for fairness to the parties involved. For example, in shareholder dispute cases, the minority shareholder may be awarded to be bought out at the fair value of his or her shares that is not subject a deduction of the discount for lack of control.
3. Going concern value: This term is often used in buy-sell agreements and divorce cases and refers to the estimated worth of a company that’s expected to continue operating in the future. It includes intangible elements such as a trained workforce, operational plant, and necessary licenses, systems, and procedures.
4. Valuation premium: This refers to the additional amount added to a company’s value estimate due to certain factors. For instance, a control premium might apply to a business interest that possesses the power to direct management and policies.
5. Valuation discount: This term refers to the reduction in a company’s value estimate based on specified circumstances. A discount for lack of marketability is an example of a discount that reflects an ownership interest’s inability to be converted to cash quickly and at minimal cost. A discount for lack of control is also commonly applied in the valuation of a minority equity interest.
By familiarizing yourself with these five essential valuation terms, you’ll be better equipped to understand the appraisal process and maintain a clear big-picture view of your company. Whether you’re preparing for a sale or creating a long-term strategic plan, understanding these terms is essential for any business owner.