Shareholder value represents the return of an investment in a company to the shareholder. It is a more complicated calculation than at first glance, since shareholder value does not merely consider the shareholder's total investment in the company and reduce that for distribution or dividend payments paid to date. Determining the fair market value of the company as a whole is the first step to calculating shareholder value. The fair market value of the company may need to be discounted to arrive at the ultimate value to the shareholder.
Determine whether any adjustments need to be made to the company's balance sheet or profit and loss statement. Common adjustments include depreciation, reclassification of personal expenses and representing debt at the proper outstanding amount.
Determine the fair market value of the company. Fair market value, as defined by the Internal Revenue Service Revenue Ruling 59-60, is the amount at which property would change hands between a willing buyer and a willing seller, each having reasonable knowledge of the relevant facts and neither being under any compulsion to buy or sell. This concept of value is also supported by numerous court decisions. Fair market value can be determined using one of the three main valuation approaches: income approach; market approach; cost approach.
Consider all three valuation approaches and employ the approach most relevant to the company being valued. The income approach is used when the earnings of the company are stable. The market approach is used when sufficient relevant market information is available to determine the value based on recent transactions of similar companies. The cost approach is primarily used when the company has many assets, such as a real estate holding company. If more than one valuation approach is used, reconcile the values. Valuation professionals commonly use an average or weighted average of the values in calculations.
Determine whether discounts or premiums need to be applied to the resulting value. If the shareholder value being determined is for a minority shareholder, i.e. less than 50% ownership interest, a discount for lack of control as well as a discount for lack of marketability may be appropriate. If the shareholder value being determined is for a controlling owner, i.e. ownership of 85% of the company, a control premium may be appropriate. The value determined after the application of discounts and premiums is the fair market value of the company.
Verify the total number of shares that are issued and outstanding as of the date the calculation is performed. Determine what portion of those shares is held by the shareholder whose value you are calculating. Multiply the fair market value of the company by the shareholder's ownership percent to calculate the shareholder's value in the company.
When determining shareholder value for estate planning, gift tax purposes or litigious matters, consider hiring an accredited business valuation specialist to perform the calculations.
Things You'll Need
Company balance sheet
Company profit and loss statement