How Differing Standards and Premises of Value Can Affect the Valuation of a Business

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of forensic accounting services including business valuation, fraud investigation, and fraud deterrence programs in Philadelphia and the Delaware Valley.

Can a business be simultaneously worth $10 million, $60 million, $72 million, and $100 million?  It can when different standards of value and premises of value are used by the business valuator.

Several months ago, David Anderson, of David Anderson & Associates – a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley – was asked to value a bio-technology business owned by the wife in a Pennsylvania divorce case.  In this week’s column, he is using that case to illustrate the different values he could have reached for her business.

There are three standards of value, Anderson said, that business valuators use:

Fair Market Value (FMV): This standard of value is required for Pennsylvania divorces.  The FMV is the price at which a business 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.

Among the factors that must be considered by the business valuator employing the FMV standard is a discount for lack of marketability, recognizing there is usually no market for a privately-held business.  Consequently, the seller will generally have to incur additional costs for a business broker, and the sale is likely to take an unknown period of time (during which the seller will not be able to earn a return on the eventual value paid).  In the above-mentioned divorce case, Anderson determined a fair market value of $60 million based upon a 30 percent discount for lack of marketability.

Fair Value (FV): This standard of value is required for New Jersey divorce cases and for minority shareholder oppression cases in Pennsylvania and New Jersey.  FV is essentially FMV but without any discounts.  Had Anderson valued the above-mentioned business in one of these instances, he said he would not have applied the 30 percent discount and would have determined the wife’s company to be worth $72 million.

Strategic or Investment Value (SV or IV): This value is that which would be paid by a buyer who perceived the purchase of this business would result in a synergistic benefit to the buyer.  For example, the buyer might see the purchase as filling in a gap in its product line; or adding customers who would make additional purchases of the buyer’s existing products; or eliminating a competitor, etc.

For these types of reasons, the buyer would be willing to pay more than the FMV of the company.  In the above-mentioned divorce case, three months after the date of Anderson’s valuation, a larger bio-technology company offered to pay $100 million for the wife’s company because it filled a gap in their product line.  Therefore, to this larger company, the wife’s business was worth $100 million instead of the $60 million FMV that Anderson determined.

In addition, Certified Valuation Analyst Anderson said, there are three primary premises of value for businesses.  Each of these can affect the value as determined under one of the three standards:

Book Value: This is the difference between the value of the assets and the value of the liabilities recorded on the books of a company.  It ignores the true market value of the assets shown on the books.  For example, in the above-mentioned divorce case, the value of the bio-technology patents and trademarks of the business were recorded at cost less amortization of that cost.  Their book value ignored the actual higher market value of the patents and trademarks themselves.

Additionally, the business’s technology equipment was recorded on its books at cost less depreciation.  Again, this ignored the active resale market and values the company could have realized by selling the equipment.  Book value usually results in a low valuation for a company.  In the above-mentioned case, the book value of the business was about $10 million.  Despite the low value realized by valuing a business at its book value, many buy-sell agreements, shareholder agreements and partnership agreements contain clauses basing the sales value of shares on book value.  This is primarily because the parties involved in the transaction and their legal advisers are not familiar with business valuation principles.

Going Concern Value: Most business valuations are based upon the assumption the business will continue to operate after the hypothetical sale.  Hence, the business’s value will be based upon the assumption the derived value of the business (as determined under one or more of the Income, Market and Cost methods) will be greater than the book value of the business.  In the above-mentioned divorce case, each of the values reached under the three premises of value was based upon the going concern premise of value.

Liquidation Value: This value refers to the net amount that would be expected to be realized if the business was terminated and its assets were sold on a piecemeal basis either through an orderly or forced sale.  This would clearly have resulted in a very low value for the company in the above-mentioned divorce case (likely less than $10 million) because of the very low prices the company would have realized for the quick piecemeal sale of its assets.

The above explanation provided by Anderson shows how a company can simultaneously have a value of $10 million, $60 million, $72 million, and $100 million.  It is therefore critically important, he emphasized, that the business valuator and the parties involved understand which standards and premises of value should be used in the valuation process.

If you need a business valuation professional in Philadelphia, or if you require any other services of a forensic accounting expert in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia.