'Standards and Premises of Value'

Fair Market Value:

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 arms 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. Fair Market Value is also defined by the United States Treasury in Revenue Ruling 59-60 and is cited in various tax codes. In general, Fair Market Value is the most popular and widely used Standard of Value, commonly utilized for tax planning and reporting and financial acquisitions. Tax reporting covers a number of different transactions ranging from estate administration and gifting to income tax reporting of different types of taxable entities. Financial acquisitions (with some exceptions) are acquisitions by financial buyers or financial investors, rather than competitors or new market entrants. Real estate appraisers use the term “market value” which is generally synonymous with “fair market value” used in a business valuation assignment.

Investment Value:

The value to a particular investor based on individual investment requirements and expectations. This value is also referred to as Strategic Value, indicating that the value to a particular investor is potentially enhanced by synergies resulting from the transaction. The Investment Value Standard of Value is most often seen in strategic acquisition transactions. These acquisitions (with some exceptions) are acquisitions by competitors or new market entrants looking to capitalize on synergies or economies of scale from the acquisition or potential efficiencies beyond the operation of the existing entity. Investment value is also referred to as “value to the holder” because it is representative of value to a particular buyer or seller. Some states use this term, but may define it in various ways. It is often (but not always) different from the Fair Market Value Standard of Value.

Intrinsic Value:

The value that an investor considers, on the basis of an evaluation or available facts, to be the “true” or “real” or “fundamental” value that will become the market value when other investors reach the same conclusion. The Intrinsic Value Standard of Value is typically seen in conjunction with auctions, in some litigation and securities analysis. Publicly traded stock analysts will often issue a “buy” recommendation for a particular stock. They are saying that the intrinsic value of the stock is higher than its current selling price (market price), so buy it and reap the rewards! Classic intrinsic value is rarely seen in valuation assignments unless it is related to public sector securities. On the other hand, some states do use the term as a surrogate for valuation assignments suggesting that a marketability discount is not appropriate when it appears that one spouse is “purchasing” the property from the other.

Fair Value (for Financial Reporting):

The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale. This definition is derived from Financial Accounting Standards Board (FASB) Statement No. 157.

Fair Value (for Shareholder Oppression):

In the context of litigation, Fair Value has many definitions, as it is defined by the case law within the jurisdiction in which it is being applied. In general, Fair Value can be defined as a pro rata ownership of the business enterprise as a going concern without reference to discounts for lack of marketability or for minority position (lack of control). Model Business Corporation Act, Section 13.02 (1999). While this is not always the case, this definition does differ slightly from the definition of Fair Market Value (a similar and often confused Standard of Value) because it typically excludes valuation discounts or premiums. In this context, Fair Value has numerous definitions, as the definition is typically dependent on the statutes and case law of the jurisdiction in which it is being used.

Using the right “standard of value” in a divorce setting is crucial to an appraiser's credibility. Some appraisers are using the terms “divorce value” or “matrimonial value” as the standard, which is unsettling, because it simply presumes state law. You must educate your appraiser as to the proper premises and foundations that the appraisal opinion will reflect.

'Premises' of Value

One of the underlying assumptions of the Standards of Value is the premise associated with the Standard of Value. In valuing businesses, the common premises are either going-concern (assuming future operations) or liquidation (assuming a sale of the assets, usually piecemeal). Liquidation can imply either forced (sale with a short period of time, say 30 days) or orderly (sale within a reasonable exposure time to market, say four to six months). Two additional ideas are often considered as “Premises” of value. These are Value in Exchange and Value to the Holder. The premise associated with the Standard of Value identifies value to whom. Loosely defined, value in exchange is value under a contemplated sale and value to the holder is value to the current owner.

Each premise has a different perspective toward value.

Fair Market Value is a value representative of value in exchange, while Fair Value could be either value in exchange or value to the holder depending on the statutes and case law in a particular jurisdiction. Investment and intrinsic value are both values to the holder. The premise can often be associated with the purpose of the valuation/appraisal engagement. In considering the issue of “personal goodwill” and “enterprise goodwill” some states will include “personal goodwill” as community property because it is Value to the Holder, arguably constructed during the term of the marriage and consequently, divisible.

In addition, machinery and equipment appraisers often use a combined standard and premise, such as “fair market value in continued use” signaling that the equipment installed and ready for use is being valued. These make-ready and calibration costs are included in the appraised value. Equipment auctioneers, on the other hand, will normally provide “market value” or what an item is expected to sell for on a piece-by-piece basis. Fair market value in continued use will be a higher value; an auctioneer's “market value” will be a lower value. For most going-concern businesses with on-going operations, fair market value in continued use is the preferable standard.

'Standard and Premises' in a Marital Dissolution Context

Unlike estate, tax, shareholder oppression or financial reporting, marital dissolution does not have a consistent precedent regarding the Standard of Value and premise that is applicable throughout the U.S. Instead, each state has statutes and a variety of case law applicable to marital dissolution depending on the jurisdiction. Because of the variety of positions on value, there is no single Standard of Value that can be applied in all circumstances. In some jurisdictions, the terminology utilized may be confusing to the appraiser and present different underlying assumptions from what an appraiser commonly expects. This state-by-state treatment usually forces the matrimonial attorney to choose appraisers who are conversant and familiar with the law in the filing jurisdiction.

Conclusion

In order to determine which Standard of Value to apply, a matrimonial attorney needs to understand and communicate the specific jurisdiction's property statutes as well as how enterprise and intangible value have been treated in previous case law. Sharing this knowledge with the valuation analyst/appraiser will then help to ensure that the correct Standard and Premise of Value is chosen and properly defined for an applicable value conclusion.

Robert E. Schlegel, a member of this newsletter's Board of Editors, is a Principal with Houlihan Valuation Advisors in Indianapolis, IN. Jason Thompson, CPA/ABV, AM, CFE, is a Partner in the Business Valuation/Litigation Services Group with Greenwalt Sponsel & Co., Inc., an Indianapolis CPA firm.

Appraisers are frequently utilized to assist matrimonial courts in determining the value of property subject to equitable distribution within a marital estate. Interestingly, every appraisal should be provided with listed assumptions ' which may give rise to questions concerning the analysis pertaining to the standards and premises relied upon. Many state courts apply a “fair market value” standard, although often the interpretation and constructs of “fair market value” differ from state to state according to the prism of case law and statutory law. (One of the better treatments of varying interpretations is the book “Standards of Value ' Theory and Practice,” by Jay Fishman, Shannon Pratt, and William Morrison (2007).) One of the key assumptions in any appraisal is the presumption of a standard, or a foundation upon which to base judgments. A premise of value modifies the standard through definition of the expected use of the property being appraised. The matrimonial attorney should understand the variability that exists regarding these standards and premises, as well as review any nuances that an appraiser may use in defining value of the marital property. This is fertile ground for logic and reasoning, and can often expose the ill-prepared appraiser and undermine the conclusions presented. Alternatively, the attorney must be aware that his/her own selected appraiser may come under attack for a cavalier valuation analysis.

'Standards of Value'

According to appraisal theory, there are four common Standards of Value. The International Glossary of Business Valuation Terms (Glossary) is a commonly used source of business valuation/appraisal terminology. The Glossary defines the term Standard of Value as the identification of the type of value being used in a specific engagement; e.g., fair market value, fair value, investment value. An additional standard, “Intrinsic Value,” has a classic meaning, although some states are using this term with unique definitions. Interestingly, Fair Value has two definitions, varying by use.

Fair Market Value:

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 arms 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. Fair Market Value is also defined by the United States Treasury in Revenue Ruling 59-60 and is cited in various tax codes. In general, Fair Market Value is the most popular and widely used Standard of Value, commonly utilized for tax planning and reporting and financial acquisitions. Tax reporting covers a number of different transactions ranging from estate administration and gifting to income tax reporting of different types of taxable entities. Financial acquisitions (with some exceptions) are acquisitions by financial buyers or financial investors, rather than competitors or new market entrants. Real estate appraisers use the term “market value” which is generally synonymous with “fair market value” used in a business valuation assignment.

Investment Value:

The value to a particular investor based on individual investment requirements and expectations. This value is also referred to as Strategic Value, indicating that the value to a particular investor is potentially enhanced by synergies resulting from the transaction. The Investment Value Standard of Value is most often seen in strategic acquisition transactions. These acquisitions (with some exceptions) are acquisitions by competitors or new market entrants looking to capitalize on synergies or economies of scale from the acquisition or potential efficiencies beyond the operation of the existing entity. Investment value is also referred to as “value to the holder” because it is representative of value to a particular buyer or seller. Some states use this term, but may define it in various ways. It is often (but not always) different from the Fair Market Value Standard of Value.

Intrinsic Value:

The value that an investor considers, on the basis of an evaluation or available facts, to be the “true” or “real” or “fundamental” value that will become the market value when other investors reach the same conclusion. The Intrinsic Value Standard of Value is typically seen in conjunction with auctions, in some litigation and securities analysis. Publicly traded stock analysts will often issue a “buy” recommendation for a particular stock. They are saying that the intrinsic value of the stock is higher than its current selling price (market price), so buy it and reap the rewards! Classic intrinsic value is rarely seen in valuation assignments unless it is related to public sector securities. On the other hand, some states do use the term as a surrogate for valuation assignments suggesting that a marketability discount is not appropriate when it appears that one spouse is “purchasing” the property from the other.

Fair Value (for Financial Reporting):

The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale. This definition is derived from Financial Accounting Standards Board (FASB) Statement No. 157.

Fair Value (for Shareholder Oppression):

In the context of litigation, Fair Value has many definitions, as it is defined by the case law within the jurisdiction in which it is being applied. In general, Fair Value can be defined as a pro rata ownership of the business enterprise as a going concern without reference to discounts for lack of marketability or for minority position (lack of control). Model Business Corporation Act, Section 13.02 (1999). While this is not always the case, this definition does differ slightly from the definition of Fair Market Value (a similar and often confused Standard of Value) because it typically excludes valuation discounts or premiums. In this context, Fair Value has numerous definitions, as the definition is typically dependent on the statutes and case law of the jurisdiction in which it is being used.

Using the right “standard of value” in a divorce setting is crucial to an appraiser's credibility. Some appraisers are using the terms “divorce value” or “matrimonial value” as the standard, which is unsettling, because it simply presumes state law. You must educate your appraiser as to the proper premises and foundations that the appraisal opinion will reflect.

'Premises' of Value

One of the underlying assumptions of the Standards of Value is the premise associated with the Standard of Value. In valuing businesses, the common premises are either going-concern (assuming future operations) or liquidation (assuming a sale of the assets, usually piecemeal). Liquidation can imply either forced (sale with a short period of time, say 30 days) or orderly (sale within a reasonable exposure time to market, say four to six months). Two additional ideas are often considered as “Premises” of value. These are Value in Exchange and Value to the Holder. The premise associated with the Standard of Value identifies value to whom. Loosely defined, value in exchange is value under a contemplated sale and value to the holder is value to the current owner.

Each premise has a different perspective toward value.

Fair Market Value is a value representative of value in exchange, while Fair Value could be either value in exchange or value to the holder depending on the statutes and case law in a particular jurisdiction. Investment and intrinsic value are both values to the holder. The premise can often be associated with the purpose of the valuation/appraisal engagement. In considering the issue of “personal goodwill” and “enterprise goodwill” some states will include “personal goodwill” as community property because it is Value to the Holder, arguably constructed during the term of the marriage and consequently, divisible.

In addition, machinery and equipment appraisers often use a combined standard and premise, such as “fair market value in continued use” signaling that the equipment installed and ready for use is being valued. These make-ready and calibration costs are included in the appraised value. Equipment auctioneers, on the other hand, will normally provide “market value” or what an item is expected to sell for on a piece-by-piece basis. Fair market value in continued use will be a higher value; an auctioneer's “market value” will be a lower value. For most going-concern businesses with on-going operations, fair market value in continued use is the preferable standard.

'Standard and Premises' in a Marital Dissolution Context

Unlike estate, tax, shareholder oppression or financial reporting, marital dissolution does not have a consistent precedent regarding the Standard of Value and premise that is applicable throughout the U.S. Instead, each state has statutes and a variety of case law applicable to marital dissolution depending on the jurisdiction. Because of the variety of positions on value, there is no single Standard of Value that can be applied in all circumstances. In some jurisdictions, the terminology utilized may be confusing to the appraiser and present different underlying assumptions from what an appraiser commonly expects. This state-by-state treatment usually forces the matrimonial attorney to choose appraisers who are conversant and familiar with the law in the filing jurisdiction.

Conclusion

In order to determine which Standard of Value to apply, a matrimonial attorney needs to understand and communicate the specific jurisdiction's property statutes as well as how enterprise and intangible value have been treated in previous case law. Sharing this knowledge with the valuation analyst/appraiser will then help to ensure that the correct Standard and Premise of Value is chosen and properly defined for an applicable value conclusion.

Robert E. Schlegel, a member of this newsletter's Board of Editors, is a Principal with Houlihan Valuation Advisors in Indianapolis, IN. Jason Thompson, CPA/ABV, AM, CFE, is a Partner in the Business Valuation/Litigation Services Group with Greenwalt Sponsel & Co., Inc., an Indianapolis CPA firm.