By Paul Wonch, MBA, CPA/ABV, CVA, MAFF
Several years ago when I was doing a valuation of a car dealership in Wyoming, one of the owners told me, “beauty is in the eye of the beholder.” He was referring to a small junk yard with old vehicles and parts that appeared to me couldn’t be worth much. His point, however, is well taken. Who’s to say that someone wouldn’t pay a lot for one of the old broken-down cars if it held some special meaning for that individual? You never know. What someone might pay for something based on perceived value could vary wildly from person to person.
From a valuation perspective, value has the potential to be fairly arbitrary, depending on specific individuals and circumstances. This is why those of us in the profession doing business valuations need common definitions of value. We call this the “standard of value.” One of the most common standards of value is “fair market value,” typically defined as the price at which the property would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell, and both having reasonable knowledge of relevant facts. This definition makes certain assumptions to help us determine value.
One of the key assumptions in the fair market value standard is that both parties to a transaction are “willing.” This is to say that the seller wants to sell and the buyer wants to buy. This may not be the case in a real world transaction. A seller may have circumstances that put him or her in a position where they have no choice but to sell. The fair market value standard assumes otherwise. It also assumes both parties have a reasonable knowledge of the same set of facts. Once again, this may not be true under various circumstances, but the fair market value standard assumes it is.
So while beauty may be in the eye of the beholder, the application of a standard of value helps the valuation professional determine value on a less arbitrary basis.
Paul Wonch is the founder of Wonch Valuation Advisors, a leading business valuation and financial forensics firm based in Indianapolis, Indiana.