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Levels of Value Levels of value refer to the conceptual points at which value may be determined when considering differences between and within public and private markets regarding issues of synergy/lack of synergy, control/lack of control, and degree of marketability. The diagram below shows illustrative relationships among the various levels of value. Differences among the various levels of value depend on specific entity level and security level characteristics.
Publicly Traded and Privately Held There are two broad market categories - publicly traded and privately held. Publicly traded companies are regulated and professionally managed. Additionally, publicly traded companies typically provide significant financial disclosures and have a relatively low cost of capital. In contrast, privately held companies are less regulated and their owners are often significantly involved in managing the company. Privately held companies typically do not disclose financial information, and they typically have a relatively high cost of capital. Non-control (minority interest) owners in publicly traded companies have greater access to information and more protections than non-control owners in privately held companies. The securities of publicly traded companies can typically be bought and sold much more quickly and efficiently than the securities of privately held companies. Understanding the value implications of differences between publicly traded and privately held markets is critical in appraising a business interest. Strategic Buyers and Financial Buyers A strategic buyer is typically another firm in target's industry that has the assumed ability to leverage the target's capabilities through horizontal or vertical integration. A strategic buyer may be willing to pay a "strategic premium" in order to obtain the opportunity to achieve synergistic benefits. Robert T. Slee in Private Capital Markets provides the following description of synergy: "Synergy is the increase in performance of the combined firm over what the two firms are already expected to accomplish as independent companies." Strategic buyers set synergistic value, and this level of value is typically associated with the investment value standard. A financial buyer does not bring operational synergistic benefits. Thus, a financial buyer based valuation relies on the expected benefits inherent in the target company. Levels of value one through six in the diagram above are associated with financial buyers, and these levels of value may be associated with any standard of value, depending on the appraisal's context. If you are considering the purchase/sale of a business, you should understand the value to you, the value to a financial buyer, and any potential synergistic value to a strategic buyer. AAI can help business owners and their advisors understand these various values and how they apply to a specific circumstance. Control and Non-Control (Minority) Ownership An ownership interest in a business is often not equal to a pro rata share of that entire business due to issues regarding control/lack of control. The ability, or lack thereof, to control policy, dividends, discretionary expenses, and other phases of the company’s operations is a factor that influences the pricing decisions of both buyers and sellers. Even when control issues are not presently apparent, there is the potential for these issues to be a concern in the future. Thus, the potential for these issues to be a concern induces another element of risk. A lack of control discount for a publicly traded business interest, if one exists, is relatively small. In contrast, the increased risk is large for a non-control interest in a privately held company relative to a control ownership position. When using the fair market value standard, non-control interests in privately held companies often warrant relatively large adjustments from a control interest level of value. If a standard other than fair market value is applied, then an adjustment for lack of control may or may not be appropriate. Degree of Marketability Marketability is defined by the International Glossary of Business Valuation Terms as "The ability to quickly convert property to cash at minimal cost." For two investments identical in all other respects, the market will accord a considerable discount to the investment that cannot be converted into cash quickly, especially when there is a risk of loss in value. The IRS recognizes this issue in Revenue Ruling 77-287, which states: "Securities traded on a public market generally are worth more to investors than those that are not traded on a public market." Publicly traded securities can typically be sold with a phone call, and cash from the sale is usually received within a week. Relative to publicly traded securities, the sale of a privately held business interest involves considerable time (often up to 24 months), risk (uncertainty regarding the ultimate price), and expense (both explicit and opportunity costs). When using the fair market value standard, privately held interests often warrant relatively large adjustments from their corresponding publicly traded interest value. If a standard other than fair market value is applied, then an adjustment for lack of marketability may or may not be appropriate. Asset Analytics, Inc. | |
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