Premises of Value
Fair market value vs. orderly and forced liquidation value
The same machine can carry three very different values. The premise of value sets the assumed conditions of sale. Here is how the common premises differ and when lenders use each one.
Short answer
The premises in one table
| Premise | Sale conditions | Installation | Exposure time |
|---|---|---|---|
| Fair market value in continued use | Willing buyer and seller; equipment stays in the operating business | Included, depreciated | Normal market |
| Fair market value installed | Market value as installed, without testing whether earnings support it | Included, depreciated | Normal market |
| Orderly liquidation value | Seller compelled to sell; as-is, where-is; buyer removes | Excluded | Reasonable period, often several months |
| Forced liquidation value | Seller compelled; properly advertised public auction; immediacy | Excluded | Short |
| Salvage value | Worth only for parts or reuse elsewhere | Excluded | Varies |
| Scrap value | Material content only | Excluded | Varies |
Summarized in our own words from the definitions published by the American Society of Appraisers. Each report quotes the full definition used and cites its source.
Continued use
Fair market value in continued use
This premise assumes the equipment stays where it is, installed and working, as part of a going business. It includes the depreciated cost of getting the machine into production: freight, foundations, rigging, electrical and piping work, and start-up.
When the appraisal does not test whether the business earns enough to support that value, the premise is stated as continued use with assumed earnings. A report that relies on a cost approach alone supports only that version.
Liquidation
Orderly liquidation value
Orderly liquidation value is the gross amount the equipment would likely bring when the owner must sell, but has a reasonable period to find buyers. Equipment is sold as-is, where-is, and the buyer pays to remove it. The report should state the assumed liquidation period.
This is the premise most asset-based lenders rely on for borrowing bases and collateral coverage.
Liquidation
Forced liquidation value
Forced liquidation value assumes the equipment is sold quickly at a properly advertised public auction. Exposure time is the main difference from orderly liquidation. Lenders use it as the downside case.
Choosing
Which premise to request
- Asset-based line or term loan secured by equipment: orderly liquidation value, often with forced liquidation value.
- Acquisition or SBA change-of-ownership loan: fair market value in continued use, often with orderly liquidation value.
- Workout, default or restructuring: forced liquidation value, and sometimes liquidation value in place.
- Insurance: a cost-based premise such as replacement cost new. This is not a substitute for a lending premise.
The client sets the intended use, and the premise is agreed in writing before work starts. If a requested premise does not fit the use, we will say so.
Questions
Premise of value questions
Is orderly liquidation value higher than forced liquidation value?
Usually. Orderly liquidation allows a reasonable period to market the equipment to the right buyers. Forced liquidation assumes an immediate auction. The extra exposure time is the main difference between them.
Is an auction a premise of value?
No. An auction is a method of sale. A well-attended, well-advertised auction can produce prices at orderly liquidation value or even fair market value. The premise is defined by the assumed conditions of sale, not by the venue.
Are liquidation values net of sale costs?
Orderly and forced liquidation values are normally stated gross, before commissions, removal and other sale costs. The report should say so. A lender can deduct expected costs to reach a net recovery figure.
Why is fair market value in continued use higher than liquidation value?
Continued use includes the cost of freight, foundations, wiring, piping and installation that makes the equipment productive in place. A liquidation buyer must remove the equipment and pay those costs again, so those costs drop out of liquidation premises.
Have an assignment?
Send the asset list or company name and the intended use. You will get scope, fee and timing back by email.