November 29 , 2018

Fair Market Value vs Fair Value

The value of your business can differ under different circumstances. The terms “fair value” and “fair market value” are standards of value that can have very different meanings to a business valuation expert. In addition, they may be legally defined for shareholder litigation and divorce purposes but mean something entirely different in an acquisition or disposition of a business.

 Fair Market Value

IRS Revenue Ruling 59-60 defines Fair Market Value as “The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.

” Certain suitors of acquisition targets may plan to combine a target w/ their company. When doing so, they can realize certain revenue and/or costs synergies that increase value when combined. Examples include eliminating duplicate administrative departments or realizing more revenue by better distribution into new markets. These suitors may also feel they can operate a business better that current owners.

Under Rev. Rul. 59-60, a valuation expert considers eight factors when estimating fair market value:

  1. Nature and history of the business,
  2. Economic outlook for the general economy and industry,
  3. The company’s book value and financial condition,
  4. The company’s earnings capacity,
  5. The company’s dividend-paying capacity,
  6. Goodwill and other intangible value,
  7. Previous sales and the size of the block of stock, and
  8. Market prices of comparable stocks.

Fair Market Value also may incorporate discounts to reflect a business interest’s lack of control or lack of marketability (discussed in a previous post).

Fair value

To obtain Fair Value from Fair Market Value a business valuation expert will make certain adjustments in the interest of fairness to the parties of a dispute (generally unwilling buyers and/or sellers).

The fair value standard can prevent controlling shareholders from taking advantage of minority shareholders by forcing them to accept a discounted price against their will. The same principles apply with a divorce. A spouse who is a minority or equal shareholder in a business – and maybe passive owner - is generally not a willing participant in the businesses sale or buyout in divorce proceeding (see discussion below).

State law determines how fair value is defined and those definitions can differ from state to state. In many states, fair value is defined as a shareholder’s proportionate share of the fair market value of the company as a whole, without regard to any discounts for lack of control or marketability. On flip side, Fair Value also generally doesn’t include any strategic or synergistic premiums that might otherwise increase the company’s fair market value.

Divorce cases

In a divorce context, it’s important that the attorney review all applicable statutory and case law that governs valuation and provide that input. The rules can vary in divorce or family law from state to state. For example valuation:

  • Can be based on fair market value only but adjustments still may be required (see note below).
  • Can apply fair value standards similar to those in dissenting shareholder cases
  • Can use the term “value,” or don’t address valuation at all so it’s critical for the attorney to examine the courts’ interpretation of the term.

Note on Fair Market Value: more than half of states exclude the value of a spouse’s personal goodwill from the marital estate.

As you can see, whenever it’s necessary to determine the “value” of a business or business interest, it’s critical to learn about valuation standards and work with a business valuation expert (and you legal representation) who understand the law and subtle nuances from a valuation perspective. Call me at direct 770-380-2406 to discuss your particular circumstance.