What distinguishes Level 3 valuations from Level 1 and Level 2 valuations in Exit's financial assessments?
Exit Franchise · 2025 FDDAnswer from 2025 FDD Document
The Company categorizes the fair value of its financial assets and liabilities according to the hierarchy established by the Financial Accounting Standards Board, which prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described as follows:
Level 1: Applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities. Level 1 assets represent quoted prices in active markets and, therefore, do not require significant management judgment.
Level 2: Applies to assets or liabilities for which there are inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly, for the asset or liability such as: quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or similar assets or liabilities in less active markets; or other inputs that can be derived principally from, or corroborated by, observable market data.
Level 3: Valuations based on inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Source: Item 23 — RECEIPT (FDD pages 42–235)
What This Means (2025 FDD)
According to Exit's 2025 Franchise Disclosure Document, the company uses a three-level hierarchy to categorize the inputs used in determining the fair value of its assets and liabilities. These levels are based on the reliability and observability of the inputs. Level 1 valuations rely on quoted prices in active markets for identical assets or liabilities, representing the most straightforward and reliable method. Level 2 valuations use inputs other than quoted prices from Level 1 but are still observable, either directly or indirectly, such as quoted prices for similar assets or liabilities in active or less active markets. These inputs can be corroborated by market data.
Level 3 valuations, in contrast, are based on unobservable inputs. These inputs are supported by little to no market activity and are significant to the fair value of the assets or liabilities being assessed. In these situations, Exit develops inputs using the best information available, which requires significant judgment and estimation from management. This approach is used when market-based data is not available or reliable.
For a prospective Exit franchisee, understanding these valuation levels is important because it provides insight into how Exit assesses the value of its assets and liabilities. The reliance on Level 3 valuations, which require significant judgment, may indicate a higher degree of uncertainty or subjectivity in the company's financial assessments compared to valuations based on more readily available market data (Levels 1 and 2). Franchisees may want to inquire about the specific assets or liabilities that are valued using Level 3 inputs and the rationale behind the chosen valuation methods to better understand the potential risks and uncertainties involved.