To properly consider Business Valuation, we first need to deal – somewhat philosophically – with the notions of value and worth.

What is something worth?

Fundamentally, the worth of something is the value that someone places on it. This might seem a bit circular at first, but bear with me. We are generally dealing with two parties in a transaction: the person who has the thing, and the person who wants the thing. Let’s refer to them as the vendor and the buyer respectively, even if no transaction actually occurs.

We now have two actors who will independently determine what this thing is worth. Specifically, they will determine what this thing is worth to themselves. This highlights that the worth of something is subjective and will vary from person to person, and situation to situation. For example,

• a diamond may be worth a lot of money because it is rare and in high demand for its beauty and durability. On the other hand, a plain rock may not be worth much at all because it has little practical use or aesthetic value.
• The air we breathe is free and plentiful. In most situations, we wouldn’t pay for air. If we are in outer space, or far below the ocean surface, where air is not freely available, we might be willing to pay a large sum for just one more breath.
• You may not be willing to pay more that $10 for an old broach, until you find out it is a family heirloom with significant sentimental value to your family members.

The value you place on something is not necessarily the same as what others might attribute to that thing. This subjective nature of value drives aspects of the markets for real estate, artwork, vintage collectables (such as stamps and coins), and even intangibles like domain names.

The value of something can also change over time. A range of factors can drive the change in perceived value, such as changes in technology, shifts in consumer preferences, or fluctuations in the economy.

What this all points to is that determining the worth of something is often a complex and ever-changing process. So much sits below the surface.

The Theory of Value

Our core valuation concepts are derived from economics and finance, with a pinch of psychology.

Economists believe value can be determined by various factors, such as usefulness, scarcity, demand, and supply. Finance offers a range of methods and formulae to estimate value. Behavioural economics – taking insights from psychology and economics – adds some valuable insights into how we perceive and assign value. We often deviate from the rational, utility-maximizing assumptions of traditional economics and finance, and make imperfect decisions that are influenced by our cognitive biases and our emotions.

As a result, we have an inexact science with illusory approaches to feign valuation accuracy. We use language that suggests a specific answer, like intrinsic value and rational decision-making, but there is no universal answer to the question “what is this thing worth?” Our methods make approximations and assumptions, which we will see during the course of discussion of those methods.

In an attempt to achieve a level of consistency in the application of valuation methods, there are best-practice rules that should be applied. When I (as a valuation analyst) make an estimate of value of the thing, it should be reasonably similar to the estimate made by another, similarly informed, valuation analyst. What use is getting an external, independent valuation if there can be no consistency?

In the Context of Business Valuation

So, how does this apply to a Business Valuation?

Let’s start with a definition. Business Valuation is the process of determining the economic worth of a company or a specific part of a company through the assessment of the financial and non-financial factors that contribute to (or detract from) the value of the business. We also refer to the report generated as a Business Valuation. For our purposes, we are using the term to mean the action of assessing and ascribing value to the business.

To actually apply this definition, we need to acknowledge the following:

• The result of the process is an estimate of value.
• A Business Valuation is a statement of opinion by the valuation analyst, typically based on their professional judgement and experience.
• A different valuation analyst would likely arrive at a different conclusion of value.

Furthermore,

• Because the value of anything will change over time, we are making our conclusion of value for the business as at a specific date. This is often referred to as the Valuation Date.
• Because the value of anything is a subjective assessment, we need to clearly define for whom the business valuation is being done for. It is through their eyes we need to assess the business.
• Because the value of anything is impacted by its context, we need to consider the milieu in which the business operates – the economy, geography, and local market conditions, for example.

All of thee factors – and many others – are considerations in undertaking a Business Valuation. We rely on these core principles to direct the path a Business Valuation may take, from proposal to conclusion.