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Standards of Value Standard of value refers to the type of value being sought. Typical standards of value include fair market value, fair value (legal context), fair value (financial reporting context), investment value, intrinsic value, and value as specified by contractual agreement (e.g., buy-sell agreement). Fair market value is the standard typically used for tax issues and employee stock ownership plans. Fair value (legal context) is the standard typically used for stockholder disputes and corporate/partnership dissolution. Fair value (financial reporting context) is appropriate for the preparation of financial statements. Investment value is appropriate for making a purchase/sale decision. The parties to a buy-sell agreement can typically write the agreement however they want. However, it is very important for all parties to the agreement to understand the value implications of the wording in the agreement. AAI can help business owners and their advisors understand the various standards of value and how they apply to a specific circumstance. Fair Market Value Fair market value is the standard typically used for tax issues and employee stock ownership plans. Fair market value is defined by the International Glossary of Business Valuation Terms as: "The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts." The Internal Revenue Service defines fair market value as: "The price at which a 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." It is implicit in the definition of fair market value that that the sale is consummated as of a specific date and the title passes from seller to buyer under the following conditions:
Consider how the assumptions that underlie the fair market value standard compare to a negotiated transaction. Negotiated transactions are strongly influenced by specific buyers and specific sellers who may differ regarding each of the following:
Thus, negotiated transactions are based on the buyer's and seller’s assessments of their own and the other party’s investment value. Negotiated prices occur at fair market value only by coincidence. Fair market value, which emphasizes average buyers and sellers that are equally well informed, is derived from multiple negotiated investment value based decisions. Fair Value (legal context) "Fair value is the standard of value used to determine the cash price dissenting and oppressed shareholders will received in exchange for their shares of stock. Currently, this much debated standard of value is widely understood to mean the proportionate value of the company as a whole. Today, this understanding is essentially correct in many jurisdictions, as courts increasingly have interpreted fair value to be a pro rata share of the entity-level value rather than the value of the individual minority shares themselves. While the general trend in many states is not to allow or limit the use of minority and marketability discounts by statute or case law, some states still allow the discounts either by precedent, a court's discretion, or special circumstances." - Fishman, Pratt, Morrison Fair Value (financial reporting context) The Financial Accounting Standards Board (FASB) defines fair value as: "The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." The FASB often provides amplifying guidance on valuing assets/liabilities for financial reporting purposes. Investment Value The International Glossary of Business Valuation Terms defines investment value as: "The value to a particular investor based on individual investment requirements and expectations." Because investment value is based on the requirements/perspective of a particular individual, the investment value standard is most applicable to an individually specific purchase/sale analysis. Intrinsic Value The International Glossary of Business Valuation Terms defines intrinsic value as: "The value that an investor considers, on the basis of an evaluation or available facts, to be the 'true' or 'real' value that will become the market value when other investors reach the same conclusion." Contractual Agreement Value A contractual agreement may specify a formula or a standard to be used to determine value. If a standard is specified, the agreement may amplify the application of the standard. AAI recommends that buy-sell agreements be reviewed by a valuation professional when the agreement is being drafted and exercised. Asset Analytics, Inc. | |
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