The Level of Value
Why Estate Planners Need to Understand This Critical Valuation Element of a Buy-Sell Agreement
We have preached for several years here at Mercer Capital that all businesses with more than one shareholder should have a current, well-written buy-sell agreement.
Business appraisers retained pursuant to the operation of buy-sell agreements are normally bound to prepare their valuations in accordance with the kind of value described or defined within the agreements. For clients with valuation processes as part of their agreements, it is imperative for estate planners to understand the six defining valuation elements of a valuation process agreement (as outlined in the book Buy-Sell Agreements for Closely Held and Family Business Owners).
This article deals with one of those defining elements – the level of value. Keep in mind that there is no such thing as “the value” of a closely held business. Confusion over an appraiser’s basis of value, either by appraisers or by users of appraisal reports, can lead to the placing of inappropriately high or low values for a buy-sell agreement transaction. Therefore, it is essential that business appraisers and the parties using appraisals are aware of the correct basis (level) of value. Properly specifying the intended level of value provides a platform for appropriate and consistent valuation methodologies in deriving the conclusion of value.
The levels of value chart is an economic and financial model used by appraisers to describe the underlying financial behavior of individual owners and businesses in the process of buying and selling businesses and business interests. It summarizes a hierarchy of detailed facts and circumstances that characterize transactions involving particular business interests in specific situations. The model generally describes and organizes the valuation relationships that emerge from observing many thousands of individual transactions.
Understandably, business owners are often confused by or are totally unaware of the various levels of value. Business owners tend to think of value in terms of an “enterprise” basis or perhaps a “sale” basis. Valuation professionals look more at terminology like “controlling interest” basis or “minority interest.”
- Strategic control value refers to the value of an enterprise as a whole, incorporating strategic features that may motivate particular buyers and capturing the expected business and f inancial synergies that may result from its acquisition. Higher expected cash flows relative to financial buyers may enable strategic (or synergistic) purchasers to pay premiums, often called strategic control premiums, relative to financial control values. Strategic buyers may also increase the price they will pay based on the use of their own, presumably lower, cost of capital.