Does the value of a given asset exist objectively? Maybe it doesn't exist? Let's imagine that we found ourselves on a desert island with a gold bar (let's assume for the sake of clarity that it is not an Amber Gold bar...); no help, plus we are hungry and thirsty. What is the value of this gold bar to us? Basically, the value is zero - what can we do with this bar? On this unfortunate desert island, we will not sell it to anyone or exchange it for drinks and food...
So what creates value? Value is created by context - conditions that objectively exist or that we arbitrarily establish to determine value, i.e. make a valuation. This context is technically called the value standard. It is impossible to make a proper valuation of an asset - either the valuation of an enterprise or a company - without determining the standard of value. Without defining a standard of value, we operate on shifting sands - it is unclear where we will end up and whether we will get there at all... A gold bar on a desert island has zero value; However, if we have successfully left this deserted island and found ourselves, for example, in London, we are much richer.
The question then is - what are the value standards used when valuing enterprises and companies? I suspect that by far the most commonly used standard is the fair value standard, sometimes also called fair market value.
Value standard for business valuation - fair value
Accounting Act of September 29, 1994 (hereinafter referred to as AA) in Art. 21 section 6 defines fair value as "the amount for which an asset could be exchanged and a liability settled under the terms of an arm's length transaction between willing and well-informed, unrelated parties." According to the definition of the National Specialized Valuation Standard of the Polish Federation of Associations of Property Appraisers "GENERAL PRINCIPLES OF ENTERPRISE VALUATION" (hereinafter referred to as KSWS OZWP), fair market value is "the value of the subject of valuation expressed in money or an appropriate equivalent, in the estimation of which it is assumed that the parties involved in the transaction a typical hypothetical buyer and a typical hypothetical seller, interested in carrying out the transaction and not acting under duress (order). It is assumed that the appraiser has adequate information about the parties to the transaction and that the buyer and seller have adequate knowledge about the subject of the valuation. The value determined based on the fair market value category is accepted by the buyer and the seller. The described transaction conditions are very similar to the definition requirements of Market Value used in the International Valuation Standards. It is common sense to assume that both definitions - KSWS and AA - are identical. Please note that both definitions are quite laconic, which may sometimes cause differences in interpretation.
Fortunately, we also have International Financial Reporting Standard 13, “Fair Value Measurement,” which defines fair value in detail and comprehensively. This standard should be treated as a more detailed definition of the definitions given in the KSWS and AA.
Generally, the fair value standard for business valuation and company valuation assumes the determination of a price between transaction parties with the following features:
- unrelated standard/typical market participants;
- interested but not under duress;
- having an appropriate and symmetrical level of information about the subject of the transaction.
The fair value standard is used when measuring value for the purpose of preparing financial statements and for the purpose of conducting transactions between related entities - in this case, from the point of view of tax risk management, it should always be used.
What about beyond the fair value standard?
Value standard for business valuation - fair value
We also have a standard of fair value, which KSWS OZWP defines as "the value of the subject of valuation expressed in money or an appropriate equivalent, when estimating it, it is assumed that the transaction involves a specific buyer, not necessarily interested in carrying out the transaction, and a specific seller, not interested in carrying out the transaction. The buyer or seller must act under duress (order). The determined value should be fair from the seller's point of view, taking into account the fact that he is unable to maintain (keep) the subject of the valuation. The above definition is not identical to the definition of fair value contained in International Accounting Standards.
The main feature that distinguishes fair value from fair value is setting a price for specific (not standard/typical) parties, at least one of whom does not have to be interested, but at the same time is obliged to carry out the transaction. An additional aspect of fair value (although not fully included in the definition above) is taking into account the economic interests, to the extent possible, of both the seller and the buyer - hence the term "fair". The fair value standard is often used in business valuations and company valuations for divorce and probate purposes. Additionally, the application of this standard may result from existing law or actual legal relations between the parties - e.g. shareholders' agreement, articles of association or company statute.
Let's imagine a company in which Mrs. Mrs. X. Assuming the lack of additional regulations between States X and Y, it should be assumed that in the hypothetical case of the breakdown of the marriage between the spouses and Mr. Please note that in this specific situation, only Mrs. and at the same time, in accordance with the provisions of the agreement between the (former) spouses, she would be obliged to acquire a 20% stake.
Enterprise valuation value standard - investment value
Another interesting standard of value in business valuation is Investment Value. KSWS OZWP defines this value as the value of the subject of valuation for a specific investor (owner), expressed in money or an appropriate equivalent, when estimating it, his or her individual requirements and expectations regarding the subject of valuation are taken into account. Fair market value, unlike investment value, is depersonalized and impartial.” The investment value of a given enterprise is defined for a specific potential buyer and takes into account synergy factors in the event of acquisition by that potential buyer. This means that the investment values of the same entity may be different for different potential buyers - the investment value of enterprise Z for entity F may differ significantly from the investment value of the same enterprise Z for entity H.
To give more life to these somewhat theoretical considerations, let's analyze the following example.
Company A has been using only 60% of its production capacity for over 5 years. The normalized annual cash flows of Company A with 60% capacity utilization amount to 25 million PLN, and the estimated normalized cash flows with hypothetical full production capacity utilization amount to 50 million PLN. Company B and Company C are potentially interested in purchasing 100% of the shares of A. Company A, Company B and Company C run the same operational activities and are competitors. Company B has an order portfolio that significantly exceeds its production capacity and if A were acquired, A would use its full production capacity. Company C has an order portfolio corresponding to its production capacity, but has access to cheaper raw material, so that, assuming the purchase of A and the current use of production capacity by A, annual cost savings after tax would amount to 15 million PLN. Which values should be used to value Company A according to the investment value standard for Company B and which according to the investment value standard for Company C?
The answers are not difficult. For Company B, the cash flow of 50 million PLN should be used to estimate its investment value of Company A, because after a hypothetical takeover, Company A would use its full production capacity. For Company C, the flow of 40 million PLN (25 + 15) should be taken into account when estimating its investment value of Company A - after the hypothetical purchase of Company A's shares, after-tax cost savings of 15 million PLN will materialize.
Often, the investment value is estimated by a potential buyer after conducting a detailed due diligence process of the target company. In this phase of the project, the potential buyer is usually able to determine in more detail possible synergy effects and take them into account in the value estimation. The investment value determines the upper negotiation possibilities from the buyer's point of view - any price negotiated below the investment value can be perceived as favorable for the buyer; at a price above the investment value, carrying out the transaction would involve a loss for the acquirer.
A separate issue is the so-called premise of value – it should not be confused with the standard of value. There are two main value assumptions: going concern value - the valuation of the enterprise or company is made assuming that the entity will continue as a going concern, and liquidation value - we carry out the valuation of the enterprise or company assuming liquidation. entity.
To sum up, in order to conduct a valuation of an enterprise or company, we must first define a standard of value defining what basic conditions we will take into account in the valuation process.
Do the above-mentioned value standards exhaust all possibilities? Unfortunately not. In addition to the theoretical standard of intrinsic value - I took the liberty of omitting its broader discussion due to great ambiguity regarding its practical application - we also have the so-called value standards for the valuation of enterprises and companies (or references to them) included in the Commercial Companies Code. I will try to present them to you in the next note.