An essential key to useful and persuasive valuations
Today's post is by Dennis Webb, ASA, MAI, FRICS of Primus Valuations. Dennis is a business valuer and real estate appraiser, former syndicator, and engineer. His 30-year multidisciplinary practice includes the business of holding and operating real estate, allocating value to special-use real estate, and business valuation. His focus is on technology to address “hard-to-value” asset valuation that has long proved vexing for appraisers, advisors, the courts, and property owners alike.
Intangible assets are a fundamental part of business valuation. We can identify them, understand and describe their role in the enterprise, and apply specific processes to value them. Most of that is straightforward. But another intangible class potentially influences every transaction, for interests in operating businesses, real estate, personal property, and other assets.
The intangible component of value I am referring to is personal to the parties.
“It is the difference between fair market value and investment value, and can be a huge proportion of the transaction. It is a limitation that can render the valuer’s analysis worthless when its intended use is a buyout of any ownership interest, and sometimes for the entire asset or business. It can also destroy the usefulness of a comparable transaction. Intangibles are easy to ignore, but we do so at our professional peril.”
Every sale conveys a personal benefit. Every one. Real estate appraisers look for extraordinary “conditions of sale,” which are examined and price indications adjusted. Business valuers recognise intangible synergy in M&A transactions when it is apparent. Unless they wash out in large transaction populations, interpreting market evidence requires the valuer to be on the lookout for intangible benefits (or detriments). The example I use in this article is different because it occurs when the valuation is to be used to support a buyout between two parties. The usual fair market value standard is only marginally useful, typically pinpointing one end of the range of value. It's the only thing it can do because it postulates hypothetical buyers and sellers who are not real people. They are composites, stripped of all personal attributes; useful but fictional characters. Now actual people are involved, and we are called upon to go further.
Internal buyout standards of value
Take real estate-holding partnerships. Once the valuer's assignment involves actual people, say for increasingly common internal buyouts, the fair market value standard is only useful if none of the parties cares about anything except future returns, risk, and how long they will be in the deal (whether they are acquiring those things or trading such a position for cash). As I have noted, this is an extreme situation and lies at the maximum end of the discount spectrum. This end is typically discounted from net asset value (a concept which is simplified here for the sake of example). The other end is no discount. The in-between is represented by intangible value attributed to the buyer and/or seller and is usually where the deal will be struck. Fair market value gives way to some form of fair or equitable value. A valuer who can quantify the effects of any intangibles and come up with one or more fair value conclusions will be genuinely useful to the parties trying to make the deal.
When Intangible Value is Important for Real Estate Owners
“Intangible value must have been present when a shared real estate ownership arrangement is entered into, since fractional ownership is usually created when the parties expect to realise substantial benefits.”
Many of these benefits—pooling resources for purchasing and improving property, sharing the use of a property that would otherwise be prohibitively expensive, or maybe just being in business together because of mutual trust—are intangible. Presumably, these effects are uniformly positive. After all, would you go into a deal if you disagreed with your partners' objectives? How about someone with whom you had strong disagreements?
Of course, you wouldn't.
It would be unusual for the original good feelings to persist unimpaired over the years through personal and economic changes and generational changes. The new car has been “driven off the lot” and isn't going back. It is definitely “used” at that point. Of course, if the valuation is for litigation, good feelings (and intangible value) will likely be absent anyway.
Years later, a family's real estate business may be harmonious, or it may not. The family members in charge of management may be highly regarded, but this not always the case. (Of course, intergenerational transfers involve parties who have most likely had their position thrust upon them.) The level of trust and confidence in the future could be very high or very low. In any such case, these intangible elements could strongly affect fair/equitable value in either direction.
Getting to Agreement on Buyout Pricing
When it comes time to get all the partners to agree on a buyout process and its pricing mechanism, these issues could easily be at the forefront of matters that must be resolved. If things are not going well, then there are many ways that ongoing problems could be reflected in value. If, on the other hand, trust and confidence levels remain high, then the partners might be more comfortable with reducing the yield (or discount) required for exit pricing.
Even if not entirely supported by the facts, it may be necessary to reduce the discount to get all parties to agree on any buyout process or formula. The partners can do anything they collectively wish to do. A good understanding of their special circumstances and their trust and confidence may be required to get to agreed-upon pricing and a workable buyout plan. The process needs to be seen as equitable by all.
The list of possible intangible and investment benefits and detriments is long. Fortunately, the valuer can usually interview the parties to a buyout transaction and determine what needs to be considered. Since there are two parties, the valuer may be unable to come up with a point-value conclusion, and a range of values may be more appropriate. But at least the issues associated with the position and views of each of the parties will have been “placed on the table” by the valuation report. They will at least have a more objective basis for arriving at a transaction price that is seen as fair to all.
The valuation process and such special conditions concerning risks associated with minority ownership and buyouts are discussed in detail in Valuing Fractional Interests 2.0, the only comprehensive, multidisciplinary work on valuing shared real estate ownership.
Why Family Business Buyouts Need More Than Just Numbers
The business of a family partnership can be quite personal. The specific degree of internal trust and confidence can be crucial in crafting workable buyout provisions that will benefit future generations. Determining price is a key element of any buyout; lawsuits over exit pricing are hardly uncommon. Conceptual buy-in is achieved when all parties believe they are being treated fairly, and market-level discounts can challenge that perception on both sides. Equitable/fair value should be fair to all, but the process of finding it may require the parties to consider intangible circumstances that a market-value analysis deliberately ignores.