There are many different types of business valuations, and it can be hard to know which type is needed in any given scenario. As a business owner, you may not know all of the complexities involved with a valuation, when one is required and what type of value is being assessed.
There are three main types of value that can be assessed: fair market value, fair value and market value.
- Fair market value: Fair market value (FMV) 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 arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of relevant facts.”
- Fair value: In financial reporting, fair value (FV) is defined 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 a measurement date.” Note: A different definition of fair value is often utilized in shareholder dispute situations.
- Market value: Market value (MV) is determined by the factors of supply and demand, and is not determined by the fundamental value of an asset.
The Internal Revenue Service generally considers FMV as its standard of value for reporting purposes. Valuations required for estate, gifting, 409A, and ESOP compliance purposes must follow FMV standards. Similarly, shareholder buyouts, valuations for marital dissolution and planning purposes also generally follow FMV standards.
United States generally accepted accounting principles (GAAP) uses FV as its standard of value. Valuations required for financial reporting purposes, such as ASC 718 (stock-based compensation), ASC 350 (goodwill impairment) and ASC 805 (business combinations), will require a FV valuation.
MV, on the other hand, is simply the price that an asset or business receives in the marketplace. This is most commonly seen with mergers and acquisitions and is the actual price agreed to between buyers and sellers. This can reflect any number of dynamics, including potential synergies, strategic intent, the impact of negotiations and competitive dynamics, and deal structure.
It’s important to know the appropriate type or standard of value when considering a valuation. RKL’s valuation team can help your organization determine what type of valuation you need. Reach out to your RKL advisor or connect with us using the form at the bottom of this page.
