2.15 Disposition costs in valuators’ reports
An informed and prudent buyer is unlikely to pay as much for the shares of a company as they would for the underlying tangible and intangible business assets owned by the company. Aside from any concerns about hidden liabilities, the buyer will realise that there would be a cost to liquidating the assets; this potential (or “latent”) cost effectively reduces the value of the shares.
Once the value of the company’s net business assets (after accounting for goodwill, redundant assets and long-term liabilities) has been established, the most direct way to calculate the value of the shares is to deduct notional disposition costs that would be incurred by the company if it converted all its business assets to cash. The largest disposition cost is likely to be corporate tax, principally tax on gains (if any) in goodwill. Possible tax planning to limit such taxes can usually be ignored as this type of tax planning normally assumes that beneficial ownership does not change (whereas the concept of fair market value assumes that the business does change ownership, at least notionally).
Other disposition costs, such as realtor’s fees, should also be brought to account if they are material.
Latent taxes on tangible capital assets are usually accounted for in the tax shield calculation so no further calculation is needed.
Disposition costs potentially payable by a company selling its assets diminish the value of its shares.
It should be noted that these costs refer only to the disposition costs incurred within the company. The net amount remaining represents the gross amount payable to shareholders as a liquidation dividend and therefore represents the value of the shares. Taxes payable by shareholders on receipt of their dividend is their cost (i.e. it is outside of the company) and does not affect the gross value of the shares.
Contact MVI to discuss how potential / latent / contingent disposition costs might reduce the value of your company’s shares.