What is "Value"? A common business valuation trap
In my role, I am often required to review business and company valuations prepared by other valuers. Whilst most valuations are prepared to a high standard, I continue to come across some common errors.
One of the most common mistakes made by business valuers is the application of an incorrect definition of “value”.
Concepts of “Value”
Business valuers are most commonly required to use one of the three main concepts of value (i.e. “market value”, “fair market value” and “fair value”) and whilst their definitions are similar (and in fact in some circumstance would even produce the same result), they each require the valuer to make certain assumptions. In addition, there are a number of other concepts of “value” which may be adopted including, but not limited to:
- book value;
- going-concern value;
- intrinsic value;
- liquidation, break-up or fire-sale value;
- replacement value;
- special value;
- value to the owner.
For a valuer, determining which definition to adopt will be dependent on the circumstances under which the valuation is being prepared (e.g. for income tax purposes, financial reporting purposes, shareholder disputes, takeover opinions, family law matters etc). The valuer may even be restricted on what definitions he/she must adopt (e.g. through a definition in a shareholder’s agreement, by instruction of a court or by regulatory guides issued by the Australian Securities and Investments Commission).
The consequences of adopting the incorrect concept of “value” can be significant, not only for the valuer but more importantly, for the client and other stakeholders.
Below is a summary of some recent case law which highlight the confusion around the definition of “value” and the importance of getting it right.
Toll v Prixcar (2007)
In this case, Toll held a 33% interest in a joint venture which it was required to sell due to an ACCC directive. The joint venture agreement called for the sale price to be based on “fair value” however the valuer in the case had adopted “fair market value”, incorporating a minority discount and failing to take into account special value associated with the strategic interest held by Toll. As a result, the court found that the valuer significantly undervalued Toll’s interest in the joint venture.
Syttadel Holdings v Commissioner of Taxation (2011)
This case highlights that the price paid can, and does, differ from market value in certain situations.
In this case, Syttadel Holdings had disposed of a marina for $8.9 million but had argued that the “market value” of the marina was actually $4.5 million, therefor meeting the net asset value test for passing the small business CGT concessions.
In his judgement, the judge disregarded the valuation opinions of Syttadel’s valuer (who had valued the marina at $4.5 million) on the basis that he had adopted “curious” valuation practices, adopting a market value by reference to offers made and the sum at which the vendor was prepared to sell (rather than by reference to a completed transaction) and by applying unsupported earnings yields. The judge noted that he was left with the distinct impression that Syttadel’s valuer adopted the $4.5 million valuation for unconvincing reasons, and then made assumptions necessary to rationalise the value adopted.
The Commissioner’s valuer however, based his valuation with reference to market evidence and the potential growth for the marina. As a result, the Commissioner’s valuer concluded that the marina had a market value of $5.3 million, well below the price at which the marina transacted, but crucially, higher than the net asset value test. The Tribunal agreed with the conclusions reached by the Commissioner’s valuer.
MMAL Rentals v Bruning (2004)
This case highlights the importance of understanding the premise of “value” in shareholder agreements.
In this case, Mitsubishi owned 80% of a Thrifty rental car business, with the remaining 20% being held by its managing director (Bruning). Mitsubishi held a call option to acquire the 20% which it did not own at “fair market value”. When Mitsubishi exercised its option, they valued the shares at approximately $60,000, while Bruning valued the shares at $6 million.
The court concluded that the agreement between Mitsubishi and Bruning should be varied to allow the shares to be valued according to their “fair value” rather than their “fair market value”, that it was not appropriate to apply a minority discount to Bruning’s 20% interest and that special value should be taken into account in relation to the 100% ownership that Mitsubishi would hold post sale. Consequently, the court determined that the “fair value”’ of Bruning’s shares amounted to $1.25 million.
There is no doubt that understanding the correct concept of “value” is important for any valuer to get a grasp on when undertaking a valuation.
However what is more frequently overlooked is getting this right at other stages of commercial negotiations, such as when drafting shareholders’ agreements. As highlighted in the MMAL Rentals v Bruning case, the conflicting parties held different concepts of “value” and the court subsequently altered the agreement to accommodate the circumstance of the case. I also recently came across a shareholders’ agreement which contained conflicting definitions of “value” which would only add to the confusion in the case of a dispute.
The above highlights the importance for advisors (legal and financial) to appreciate the relevance of varying definitions of “value”.
Originally posted on NickNavarra.com.au