Monday, February 9, 2015 at 10:39AM Fair Market Value and Fair Value
Many of us have heard the terms fair market value and fair value. These terms are used often in the valuation of entities. Understanding the differences is critical.
When we hear the term “fair market value” we envision a price for an asset that is fair to all parties involved. The Internal Revenue Service 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 the relevant facts.” Under the fair market value standard of value, shareholder discounts may be applied if the subject being valued lacks control over the entity or if there is a lack of marketability. The fair market value standard is commonly used in federal and estate tax matters and sometimes in judicial matters.
Fair value is used for financial reporting matters and judicial purposes. For financial reporting matters (such as purchase price allocations and goodwill impairment testing), the Financial Accounting Standards Board defines fair value as “the price that would be received to sell and asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This is understood to be an exit price.
For judicial purposes--such as divorce, shareholder dissent and oppression--there is no clear consensus on a definition. Interpretations vary state to state. However, many view fair value to be fair market value without discounts for such things as control and marketability considerations. To state it another way, the value of the shares on a pro-rata basis.
Valuation in Value Matters 