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Matschke, Manfred Jürgen; Brösel, Gerrit; Matschke, Xenia:
Fundamentals of functional business valuation
URN: urn:nbn:de:gbv:ilm1-2014210014
Published OpenAccess: September 2014
Original published in:
Journal of business valuation and economic loss analysis. - Berlin : De Gruyter
(ISSN 1932-9156). - 5 (2010) 1, Article 7, S. 1-39.
DOI: 10.2202/1932-9156.1097
URL: http://dx.doi.org/10.2202/1932-9156.1097
[Visited: 2014-08-28]
Volume 5, Issue 1 2010 Article 7
Journal of Business Valuation and
Economic Loss Analysis
Fundamentals of Functional Business
Valuation
Manfred Jürgen Matschke, Ernst-Moritz-Arndt-Universität
Gerrit Brösel, Technische Universität Ilmenau
Xenia Matschke, Universität Trier
Recommended Citation:
Matschke, Manfred Jürgen; Brösel, Gerrit; and Matschke, Xenia (2010) "Fundamentals of
Functional Business Valuation," Journal of Business Valuation and Economic Loss Analysis:
Vol. 5: Iss. 1, Article 7.
DOI: 10.2202/1932-9156.1097
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Fundamentals of Functional Business
Valuation
Manfred Jürgen Matschke, Gerrit Brösel, and Xenia Matschke
Abstract
After a brief overview of different company valuation theories, this paper presents the main
functions (decision, arbitration, and argument or negotiation function) of company valuation
according to the functional (i.e., purpose-oriented) theory. The main body of the paper focuses on
the decision function and shows how the decision value can be derived as a subjective limit value
that different economic agents assign to the company. Finally, the differences between the
functional and the market value oriented theory of company valuation are discussed.
KEYWORDS: decision function, decision value, functional business valuation, subjective limit
value
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INTRODUCTION
In this article, we introduce the reader to the concept of functional business
valuation, a business valuation concept which stresses the importance of taking
into account for whom the valuation is conducted and for which purpose. We
discuss the valuation of a business as a whole entity or bigger self-contained parts
thereof to which economic results can be assigned, in particular payments. These
economic results can be influenced by owner or manager activities and are thus
person- and plan-dependent. We do not discuss the valuation of single non-
influential, not self-contained goods and of the goodwill in connection with
accounting.
The functional business valuation concept can be applied to the purchase
and sale of a business as well as to merger and split situations. In these situations,
conflicts between different parties, such as between the buyer and the seller or
between the partners in a merger or split, are prevalent in the sense that everybody
seeks to seize a maximum share of the transaction gain. At the same time, also
common interests are present with regard to finding a transaction that is
acceptable to all parties involved. Application possibilities for functional business
valuation are abound. According to the German Chamber of Commerce (IHK), in
April 2008 there existed 1,845,474 registered businesses, of which only 17,450
were stock companies, of which only 1,178 were publicly traded at a German
stock exchange (Institut der deutschen Wirtschaft, 2009, p 66).
This means that for most sale/purchase or merger/split transactions, it is
not possible to employ “market prices” for valuation purposes because such prices
simply do not exist. But even if market prices for firm shares (for publicly traded
companies) exist, the knowledge of such a market price is not sufficient in order
to decide whether a transaction is beneficial for all parties involved. To determine
whether the transaction is sensible for a party, this party has to know its decision
value, the limit value to which the suggested transaction price can be accepted.
For example, at the stock exchange, buyers and sellers typically set limit prices
which can be interpreted as decision values: If the actual market price falls below
a buyer’s limit price, the buyer will buy, if it rises above a seller’s limit price, the
seller will sell. A transaction between a buyer and a seller takes place if the actual
market price lies between the respective limit prices. Using the market price as
decision value is even more out of place when bigger share parcels are traded. In
this case, a negotiation solution is the typical outcome. During these negotiations,
the “price” per share is not necessarily the sole or most important object of
negotiations. In functional business valuation, this is reflected in allowing for a
multi-dimensional decision value – as opposed to just a one-dimensional decision
value (limit price), reflecting the fact that a typical agreement contains much more
information than just a price. A multidimensional decision value would indeed be
1
Matschke et al.: Fundamentals of Functional Business Valuation
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a very complex “market price” since it does not only include a price, but also
other, oftentimes non-monetary components. Such a complex contract does not
form at the stock exchange, but is the outcome of negotiations or – in special
cases – arbitration. Summarizing, the functional business valuation concept lays
the theoretical foundation for understanding conflict-related agreement processes
in imperfect and incomplete markets by defining the relevant conflict situation
and discussing the adequate determination of decision, arbitration, and
argumentation values with stress on the determination of the decision value.
The global economic crisis has ruthlessly exposed the shortcomings of
the currently applied methods of business valuation. After all, these methods
mostly rely on concepts of capital market theory that are based on the assumption
of a perfect market and perfect competition in an idealized model world. In many
cases, reasonable economic decisions, e.g., concerning the acquisition or sale of a
business, cannot be based on these models. Such decisions rather require models
that explicitly consider the existence of imperfect markets as well as the precise
goals, plans, and expectations of the person for whom the valuation is to be
conducted.
The literature on business valuation is often confined to enumerating
different values and consequently focuses on the question which of the numerous
business values might be the “right” one. Functional business valuation denies the
existence of an objective or “right” business value. The basis of a client-oriented
valuation must be the ideas of the client for what reason he wants a value to be
calculated. Business valuation is seen as an economic process to make all partners
of the deal content, i.e., a way of most effectively investing scarce capital.
Such a subject
-
oriented concept of functional business valuation has been
available in Germany for over thirty years. This paper provides an introduction to
this valuation concept for an English-speaking audience. After an overview of the
functional concept and the main functions of business valuation in the second
section (“Overview”), the decision function and the associated decision value are
described in the third section (“Decision Value”). The fourth section (“Distin-
guishing between Functional and Market Value-Oriented Business Valuation”)
demonstrates the advantages of functional business valuation compared to market-
oriented business valuation, followed by the conclusion.
OVERVIEW
1. DEFINITION OF TERMINOLOGY
Clear and unambiguous definitions are the foundation of every science. For this
reason, we start by defining the core terms “valuation”, “valuation subject”,
“valuation object”, and “value”.
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Journal of Business Valuation and Economic Loss Analysis, Vol. 5 [2010], Iss. 1, Art. 7
DOI: 10.2202/1932-9156.1097
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