Page 17 - Bankruptcy and Reorganization Services

Chapter 4

Purpose of the Valuation and Standard of Value

Overview

Two important concepts in business valuation revolve around "why" and "how" a valuation is per-
formed. The first concept is the idea that the rationale or purpose for the valuation can have an impact on
the conclusion of value. The second concept is that the process of arriving at a conclusion of value is a
dynamic one which must be anticipated by all practitioners who work in this area. The building blocks
of business valuation that embrace these concepts are encapsulated in two principals that help define the
direction of each engagement: (1) the standard of value and (2) the premise of value. Because each en-
gagement is unique, it is imperative for the practitioner to fully understand and properly document the
intended purpose of each valuation. By following the framework established by VS section 100, practi-
tioners will have a solid foundation for achieving these goals. fn 1

The balance of this practice aid is devoted to selected key valuation situations and issues that are unique
to bankruptcy proceedings and distressed companies. Before turning to these issues, however, a brief
overview of basic business valuation concepts is presented in order to provide a point of reference for
readers. Immediately following this paragraph are several bankruptcy terms that are more fully dis-
cussed in later chapters. The next several chapters include a discussion of the purpose and standards of
value, premises of value, valuation approaches and methods, the valuation synthesis and conclusions,
the cost of capital, discounts and premiums, and debt determination in the context of financial distress
and bankruptcy. A brief chapter that discusses financial tools and techniques that can be used when per-
forming valuations in a bankruptcy context is then presented. Next, attention is turned to a discussion
and examples of special bankruptcy situations which often require valuations. The topics covered in-
clude adequate protection, claims determination, asset recovery, plan confirmation, and the best interest
of creditors test. This is followed by a discussion of solvency studies performed in the context of recov-
ery actions. The penultimate chapter contains a discussion focused on reorganization value and plan
confirmation valuation issues.

Standard of Value

Traditional business valuations are usually performed under one of the following basic standards (or def-
initions) of value: fair market value, fair value, and investment value.

Fair market value as it relates to business valuations has its roots in the tax code and case law. The defi-
nition established by the tax regulations in Treasury Regulation Section 20.2031-1(b) is as follows:

fn 1 See paragraphs .11–.46 of VS section 100.

All VS sections can be found in AICPA Professional Standards.

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