Does the valuation method parties pursue, and that a Court uses, matter to the ultimate valuation of a firm? This recent paper studying data from Finnish appraisal of private terms over a 16 year period suggests that the choice of methodology does matter.
For readers of this blog, or those who know of appraisal predominantly through the Delaware-dominated and – more relevant here – public company dominated area, this conclusion may seem obvious. Of course valuation methodology matters to valuation! Important to recognize is that appraisal is not solely (or even mostly) a concern for shareholders in large, publicly traded companies with likely liquid public markets for their securities. Instead, appraisal is often the remedy of the minority shareholder in a private firm; the oppressed shareholder or the person being squeezed out of an enterprise. Unlike with some large public company transactions, the “merger price” in such instances is almost definitively not set by an arm’s length transaction, and the ‘merger’ itself often involves the irreducible conflict of management being on both sides of the transaction.
These cases are further complicated by the fact that because no public market exists for the individual shares of the business (and setting aside whether a market may exist for the business as a whole), and thus the valuation question is far more tabula rasa (blank slate) for an appraiser of a private company. The Finland evidence suggests that in such instances, the choice of valuation method is a significant determinant on how the valuation comes out.
More generally, this is evidence against the “rationality” perspective and for the “measurement” perspective – per the authors “The ‘rationality’ perspective believes that the choice of a valuation method does not affect the outcome. That is, the valuation estimate incorporates all the available information pertaining to the valuation, and the chosen valuation method is rationally adjusted if needed. Conversely, the ‘measurement’ perspective argues that the chosen method determines which information and adjustments are incorporated into the valuation estimate. In other words, the limitations and biases inherent in valuation methods manifest themselves in valuation estimates.”