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Fair Market Value
The most common standard of value
Hodges & Hart regularly reviews buy-sell agreements with an emphasis on valuation of an owner’s interest in a closely held business. In many cases, the applicable sections simply state the use of fair market value without further reference or definition.
The term fair market value (FMV) is the most common standard of value. In valuation a standard of value is a definition of the value being sought. This single item is perhaps the most overlooked aspect of drafting a buy-sell agreement, yet it is laden with the greatest dangers for the parties involved.
For many situations, the standard of value is legally mandated, whether by law or by binding legal documents or contracts. In the absence of any compelling reason to use another standard of value, fair market value is generally recommended as the standard of value for buy-sell agreements. It is well-known, well-defined and familiar to business appraisers.
This standard of value applies to virtually all federal and estate tax valuation matters, including charitable gifts, estate tax issues, ad valorem taxes (a tax based on the value of an asset), and other tax-related issues. Fair market value is also the applicable standard of value in many bankruptcy cases involving valuation issues.
Fair Market Value is defined as: “The price at which 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. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as being willing to trade and to be well informed about the property and concerning the market for such property.” [1] Revenue Ruling 59-60: 1959-1, Cumulative Bulletin 237.
An important question to consider is: the fair market value of what? The statutory and case law of fair market value place significant attention on the business interest being valued. It tends to link the concept of value to the attributes of specific business interests.
FMV is a standard of value that can be applicable to any level of value, ranging from the value of an entire enterprise or to a small, minority interest. In the context of buy-sell agreements, it is necessary to specify the “what”, or, the particular kind of value the parties to an agreement desire.
Fair market value is the standard of value specified in may buy-sell agreements. It is important that business owners, attorneys and other advisors have a working knowledge of this standard.
At Hodges & Hart, LLC, Brian Tanz holds two (2) separate valuation credentials:
- Certified Business Appraiser (CBA) ~ The Institute of Business Appraisers (IBA)
- Accredited Valuation Analyst (AVA) ~ The National Association of Certified Valuation Analysts (NACVA)
The IBA and NACVA are professional organization dedicated to supporting business valuation and finance professionals in the field of valuation, litigation support and related disciplines.
Please contact Hodges & Hart should you be interested in having us review a buy-sell agreement or would like to discuss the concept of fair market value.
This article is authored by Brian Tanz, AVA, CBA & Director.
Sources:
- Z. Christopher Mercer, ASA, CFA, Buy-Sell Agreements, copyright 2007 Mercer Capital
- James R. Hitchner, CPA/ABV, ASA, Financial Valuation Applications and Models, copyright 2003, by John Wiley & Sons, Inc.
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