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Business Valuations - Standards of Value
There are Three Standards of Value Used to Value a Business
Fair Market Value
In the United States the most widely recognized and accepted Standard of Value is termed Fair Market Value (FMV) and it is defined 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. (-IGBVT)" It is the standard used in all Federal tax matters, whether it is gift taxes,
estate taxes, income taxes or inheritance taxes. The IRS has defined FMV in
In the 1990s, Arthur Andersen & Co. provided a tongue-in-cheek definition of FMV:
"Fair Market Value is the amount, price, highest price, most probable price, cash or cash– equivalent price at which property would change hands or
the ownership might be justified by a prudent investor or at which a willing buyer and seller would exchange, would agree to exchange, have agreed
to exchange, should agree to exchange or may reasonably be expected to exchange, possibly with equity to both and both fully aware or having
knowledge or at least acting knowledgeably of the relevant facts, possibly even acting prudently and for self–interest and with neither being
under compulsion, abnormal pressure, undue duress or any particular compulsion.
Fair Value & Divorce Value
Fair Value can have several meanings, depending on the purpose of the valuation. In most states, Fair Value is the statutory Standard
of Value applicable in cases of dissenting stockholders' valuation rights. In these states, if a corporation merges, sells out, or takes
certain other major actions, and the owner of a minority interest believes that he is being forced to receive less than adequate
consideration for his stock, he has the right to have his shares appraised and to receive fair value in cash. It is also used for
divorce cases sometimes with some modifications.
In states that have adopted the Uniform Business Corporation Act, the definition of Fair Value is as follows:
"Fair value," with respect to a dissenter's shares, means the value of the shares immediately before the effectuation of the corporate action to which the
dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable."
Even in states that have adopted this definition, there is no clearly recognized consensus about the interpretation of Fair Value in this context, but
published precedents established in various state courts certainly have not equated it to Fair Market Value. The State of Utah has also adopted this
definition of Fair Value with the exception that Utah Code Ann. Section 16–10a–1201(4) 1995 eliminates the words "unless exclusion would be inequitable"
from the end of the definition. Within the valuation profession the strictest definition of Fair Value of a minority interest is a pro rata share of a
controlling interest valuation on a non-marketable basis.
The authors of Ibbotson Associates SBBI Valuation Edition 2005 Yearbook define Fair Value as "...the amount that will compensate an owner involuntarily
deprived of property. Commonly, there is a willing buyer but not a willing seller, and the buyer may be more knowledgeable than the seller. Fair Value
is a legal term left to judicial interpretation. Many consider Fair Value to be Fair Market Value without discounts."
Fair Value is also the standard of value used by the Financial Accounting Standards Board (FASB) in its pronouncements pertaining to business valuation.
In June of 2004 the FASB released its Exposure Draft Fair Value Measurements which attempts, for the first time, to "define Fair Value and establish a
framework for applying the Fair Value measurement objective in GAAP." Although FASB uses the term "Fair Value" just as it is used in various state
statutes, it should be clearly understood that this is a completely different definition of value. Although FASB's definition of Fair Value should be
considered a work in progress, as of June 2006 FASB's revised definition of Fair Value was as follows:
"Fair Value is the price that would be received for an asset or paid to transfer a liability in a transaction between marketplace participants at the
measurement date." Fair value may also relate to value in divorce. Many states have specific definitions of Fair Value with regard to marital dissolution.
Note: The differences in the various definitions used for Fair Value are, at present, irreconcilable. That is why you will not find this term in the
International Glossary of Business Valuation Terms (IGBVT).
As you can see, the definition is complicated.
Strategic or Investment Value is the value to a particular investor based on individual investment requirements and expectations. In the U.S. and U.K., it is equal to "Market Value" for the investor who has the capacity to put the property to good use: in its "Highest, Best and Most Valuable Use". For other investors with limited capacity or vision, Investment Value is lower because they cannot put the property to use in a way that is maximally productive. Nevertheless, this is the standard used by both potential investors and sellers to determine a selling price.