“I seem to have stirred up a hornet’s nest with the discussion of fair market value,” admits Mike Pellegrino, referring to the continuing BVWire debate. “In my view [and as Dexter Draff pointed out last week] what folks are in effect valuing when they perform M&A is not necessarily fair market value of a company but investment value.” Motivations are different, as are timing requirements. Investor knowledge may be different, too. “All of these factors dictate why the closing price for a transaction is something other than intrinsic value.
“We as a profession are generally asked to opine as to the fair market value of a company, NOT the investment value,” Pellegrino adds. Yet the general profession “intermixes the two constantly, and (I speculate) generates investment values more often than not.” For example, many practitioners use public and private transactions data to generate comparable values to establish subject company FMV. “However (as Draff pointed out), many of those transactions use an investment value standard to arrive at a price for the acquisition target that accounts for synergies, necessity for a deal, etc. The accounting profession has struggled for years with how to address the premium or discount,“ Pellegrino says, “lumping the balance into goodwill as it had no other place to put it.”
The bottom line, in his opinion: “BV professionals commit what amounts to measurable error—and perhaps gross error, over time—by mixing and misapplying value standards.” Pellegrino recently applied his theory in “Valuing Early-Stage Companies,” Valuation Strategies, May/June 2007 (reprinted at his website). He is currently working on extending his initial research to the broader BV community, for publication in the Business Valuation Update™, and welcomes “new thoughts and ideas.” Email the editor. (We also assume that Mr. Pellegrino would welcome the correct spelling of his name, which we misspelled in prior editions. We regret the error, and have corrected it in online versions of the BVWire.)