What Does Valuation Mean?
A valuation is the process of determining the fair market value of a company in a notional context, meaning that the valuation is a) time specific, b) there is no negotiation, and c) there is no exposure to the open market. Valuations are highly subjective calculations that aim to determine the fair market value of a company. There are many common situations when valuations are required, including business reorganizations, expropriations, employee share or stock option plans (ESOPs), mergers and acquisitions (M&A), and shareholder disputes.
Divestopedia Explains Valuation
There are several business valuation methods that can be used, depending on the situation. However, all valuations have the following principles:
- Value is time specific - a valuation cannot be restated using hindsight or new information;
- Value is prospective rather than historic - valuations are primarily done by calculating the present value of future benefits;
- The market, general economic conditions, and types of purchasers available dictate the rate of return used to calculate the present value;
- There are two components to value: a) commercial, which is tied to an asset and is transferable, and b) non commercial, which is tied to personal attributes and is not transferable;
- Value is influenced by liquidity - there is a direct relationship between liquidity and value. The higher the liquidity of a company, the higher its value should be; and
- The value of the minority interest is always lower than the value of the majority interest - this is because the minority interest cannot influence operations and strategy. As well, the minority interest cannot dictate the quantum and timing of the return. This lack of influence results in a minority discount.