The specialty of business valuation is evolving, and one recent development is the emergence of investment value as the appropriate standard of value in some divorce cases, rather than fair market value. This trend is important to monitor to ensure your valuation expert estimates the correct standard of value. If not, a court may disregard his or her conclusion.
Investment Value Definition
The most common standard of value, fair market value, estimates the value that the universe of hypothetical buyers and sellers would agree on for an interest in the subject company. It is customarily defined by IRS Revenue Ruling 59-60, but it also may be appropriate for valuations prepared for purposes other than federal taxes.
On the other hand, investment value captures “the value to a particular investor based on individual investment requirements and expectations,” according to the International Glossary of Business Valuation Terms. (This publication is a joint effort of the most prominent business valuation organizations.)
Investment value reflects a particular investor’s subjective goals regarding expected returns, desired tax attributes, acceptable risk and potential synergies with other businesses. This type of investor could be a potential equity or debt holder, or an existing or prospective operator-owner, traditionally in a merger and acquisition or strategic decision-marking context.
To determine business value to distribute assets equitably between the parties in a divorce, some jurisdictions have begun to use investment value, which is known as the “value to the holder.”
Investment Value in Divorce
According to the business valuation textbook, Standards of Value: Theory and Applications:
“Value to the holder considers the business or business interest in the hands of its owner, regardless of whether he or she intends to sell the business. It further assumes that the entitled spouse will continue to enjoy the benefits generated by a business that was created or appreciated during the marriage.”
In a divorce context, the use of investment value, rather than fair market value, is an important distinction to make, because affects a valuator’s assumptions and methodology. For example, an appraiser might consider the actual tax burden of a pass-through entity, rather than the taxes the company would incur if it operated as a C corporation when estimating investment value for a divorce.
When an appraiser applies the investment value standard, valuation discounts for lack of control and marketability are usually less relevant, especially if one spouse controls the business. That’s because the goal is to measure the full value of the interest to the husband and wife, not the universe of all buyers and sellers who might discount private business interests. As a Virginia court opined in Patel v. Patel (2013 VA App. LEXIS 110):
“Courts valuing marital property for the purpose of making a monetary award must determine…that value which represents the property’s intrinsic worth to the parties.”
Investment value remains a controversial topic among business valuation professionals and may contradict with how some jurisdictions treat personal goodwill. Courts in some states have interpreted the law to mean that investment value eliminates some (or all) personal goodwill from the value of the interest. Others contend that you cannot summarily exclude personal goodwill if the intention is to measure the full value of the interest to the husband and wife.
Evolution of Investment Value
There’s more than one way to define the term “value.” Investment value is an alternative to fair market value, and it started as way to help debt and equity investors estimate value in business combinations and strategic decision-making. Now divorce courts are also embracing investment value when splitting up marital assets. But the overriding goal remains the same: To measure the full value to a particular investor, which are the owner-operating or investor in a sale, or the husband and wife in a marital dissolution case.