In a valuation process buy-sell agreement the level of value must also be defined.  In my experience, the level of value can be problematic and lead to confusion if not defined in the buy-sell agreement.  There are numerous business valuation resources that define the level of value.  Generally, the recognized levels of value include:

1.       Strategic control value – this contemplates the value of an entire enterprise that a buyer views as a strategic investment.  Here the buyer is able to realize synergies by improving cash flow, use its own lower cost of capital and/or the investment is a strategic add to the acquirer’s operations/portfolio.  Often control premiums are applied to reach this level of value.

2.       Financial control value – this contemplates the value of an entire enterprise from the perspective of a financial buyer.  Here there may be synergies, but they are typically associated with a view towards improving the acquisition target’s cash flow – not necessarily a strategic acquisition improving the acquirer’s overall operations/portfolio mix.  This level of value is sometimes considered a minority marketable level of value with an added financial control premium.

3.       Minority, marketable value – this contemplates the value of a minority interest that is freely traded in an active market.  Minority interest refers to a lack of control in the company operations.  The only element of control available is the ability to retain the shares or sell them in the market.  This level of value is often viewed as the share price of publicly traded stock. 

4.       Minority, non-marketable value – this contemplates the value of a minority interest (non-controlling) that is not freely traded on an active market.  This is often the situation in closely-held companies where the owner does not have a controlling interest and there is no marketplace for the respective ownership interest.  Here you will see discounts for lack of marketability applied to the minority (non-controlling) value.

The levels of value above should yield values in that order – the strategic control value is considered the highest value and the minority, non-marketable value is considered the lower value.  Intuitively, a strategic buyer that will benefit from a 100% controlling synergistic acquisition will pay more than a buyer purchasing a 30% interest in a closely-held private company that has no market for the ownership interest. 

If there are multiple appraisers involved in the valuation process buy-sell agreement, then the results will be markedly different if the level of value is not applied consistently.  It is key to define the appropriate level of value to be used by the appraiser(s) in a valuation process buy-sell agreement.     

Aside from “fair market value” there are some other standards of value that exist.  For example: fair value, intrinsic value, strategic value and investment value. “Fair value” is likely the standard of value that leads to the most confusion in a buy-sell agreement setting and the other standards appear infrequently.  I often see “fair market value” get confused or used interchangeably with “fair value.”  However, these are two very different standards from a valuation perspective and can lead to different results in a valuation process buy-sell agreement. 

“Fair value” can actually have two distinct meanings.  First, “fair value” can be a statutory standard used in dissenting shareholder cases, shareholder oppression cases and divorce proceedings.  As a statutory standard, the company value in most cases is determined without applying discounts for lack of control or lack of marketability.  Second, “fair value” is also an accounting term used in financial reporting.  ASC 820 defines “fair value” for financial reporting that is commonly used in purchase price allocations and when valuing intangible assets. 

The takeaway here: be wary if the valuation process buy-sell agreement uses “fair value” as the standard of value. This is especially true if there are multiple appraisers involved in the process. A best practice is to fully define the standard of value to be applied in the buy-sell agreement. I often recommend quoting the business valuation standards in the agreement so there is no ambiguity.