How is a Business Interest Valued?

There are five basic methods experts utilize to determine the value of an asset:

• Fair Market Value: the price at which an asset would change hands between a willing and able buyer and a willing and able seller in an arms length transaction in an open and unrestricted market where neither the buyer nor the seller is under compulsion to buy or sell and when both have reasonable knowledge of all relevant facts;
• Investment Value: the value to a specific buyer as opposed to a hypothetical buyer; investment value considers buyer-specific attributes, such as cost savings, business synergies, etc.;
• Intrinsic value: the value of a business or an interest in a business to the specific individual whose interest is being valued.  The focus is on the “real” value to the seller as opposed to looking to the market.
• Fair Value: a highly specific method that values the owner’s prorata share of a business without consideration of discounts for minority interests or lack of marketability—generally, this is the measure of value in so-called shareholder oppression cases;
• Holder’s interest: the value to the owner; this includes the concept of personal goodwill—i.e., the value of the individual’s name and reputation. It is a very subjective standard.

What value do we use in Michigan?  Answer: It depends and there are numerous factors that you must consider.  First, not all businesses are created equal.  Thus, there is a difference between a law firm, which makes money on the name of the individual partners, and a biotechnology company, which derives revenue from patents held in the company name.  Second, the value of the interest also depends on whether the owner held the interest passively—i.e., as part of an estate plan—or actively—i.e., the individual literally built the business from scratch.  Finally, and not by way of limitation, there may be objective evidence of value, such as buy-sell agreements or stock redemption agreements that can be used as benchmarks.

Valuations are therefore expert witness driven and are usually skewed to reflect the interest of the party hiring the expert. Specifically, a business owner will likely argue for a fair market value approach because this method reflects the true value of the business if it were to be sold in the open market.  A spouse, however, wants a holder’s interest value which actually measures the value to the owner.

The upshot: If you are dabbling in this area, make sure you hire an expert who is well versed in these areas and has previous testimonial experience.  A poor valuation can be stricken or simply obliterated at trial.