Valuation of a Debtor’s estate is likely one of the most important analyses a Debtor will undergo. Ascribing value to the estate helps determine the possible payout available to satisfy creditors’ claims. The need for valuation arises in multiple stages of the bankruptcy case, which a Debtor’s financial advisors and professionals are tasked with completing. Because the Bankruptcy Code does not prescribe a method for valuating assets, judges tend to accept one of several valuation methods available to Debtors. These methods, which are briefly discussed in this article, include the income-based approach, market approach, and asset approach.

The Income-Based Valuation Approach

The income approach is based on the theory that when purchasing an asset, a buyer does not pay more than the present value of the earning potential that can be generated by the asset, and when selling an asset, a seller does not sell for less than the present value of the earnings expected to be generated. The income approach is based on a businesses’ cash flows and is evaluated using the discounted cash flow method (“DCF”). A DCF analysis determines the value of a business based on projections of how much revenue the company can generate in the future. This is one of the more commonly used valuation approaches.

The Market-Based Valuation Approach

The market approach is based on the principle of substitution, meaning a sophisticated investor will not pay more for a property than it costs to acquire a substitute or comparable property. The main methods within the market approach are the guideline publicly traded company method and the mergers and acquisitions method. When selecting comparable companies, a valuator’s knowledge of the industry is crucial because the comparables must be in the same industry, be of similar size, and share similar growth prospects. The valuator analyzes financial statements noting differences for which adjustments must be made.

The Asset-Based Valuation Approach

Finally, the asset approach to valuation involves revaluing the debtor’s balance sheet from book value to fair market value by valuing each item on the balance sheet separately at its fair market value and identifying and valuing assets that are not generally recognized on a balance sheet, such as intellectual property. The asset approach is most useful for asset-intensive businesses like investment holding and real estate companies. It is also useful in liquidation cases, where the company will not continue to operate.

As previously mentioned, the need for valuation comes up throughout the life of a bankruptcy case. Perhaps the most obvious scenario in which valuation presents itself is in determining whether a debtor’s plan of reorganization is reasonable or feasible. Feasibility depends on the valuation of the debtor’s reorganized business and its likelihood to succeed in the current business landscape. Valuation also comes into play in connection with a creditor’s right to adequate protection, though the analysis is limited to the extent of the creditor’s interest. The Bankruptcy Code states that the value of a creditor’s interest should be determined in light of the purpose of the valuation and the proposed disposition of the property’s use. Valuation analyses are also used in connection with avoidance actions, when a debtor’s solvency is at issue on the eve of bankruptcy due to preferential payments or fraudulent transfers. Finally, valuation is used during the 363-sale process to identify and estimate sale proceeds.