4. Fair Value, Fair Value and Fair Market Value

Understanding Standards of Value.

When you obtain a valuation, you're getting it for a certain purpose (or purposes). Understanding that purpose allows us as your service provider to define the appropriate Standard of Value by which our work will be guided, and judged. Sometimes various standards of value can conflict with one another, ar at the very least create unanticipated complexity. One of our clients is experiencing a three-way collision between standards of value, and to stay compliant it’s rather cumbersome, to say the least.

The first time we met Rich, we hit it off. Here’s a guy that understands finance, has a background in accounting, and sees eye-to-eye with us on many of the nuances of valuation. Rich took us down his own little rabbit hole of valuation madness, which is a three-way collision between three standards of value, each dubbed Fair Value, Fair Value, and Fair Market Value (no joke).

What’s that? Two definitions of Fair Value? Yes, my friends, it’s the case. We have Fair Value as defined by the Principles of Corporate Governance; and Fair Value for Financial Reporting defined by SFAS 157.

Fair Value1 defines how we may appraise the company’s stock for shareholder buyback purposes. It often applies to cases of dissent, oppression and dissolution, and specific interpretations of this standard differ by state. This standard has ancestry dating back to the early nineteenth century, evolved through time, and was redefined separately by two institutions in 1992 and 1999. According to the Principles of Corporate Governance from the American Law Institute, Fair Value in this context is defined as:

“…the value of the eligible holder’s proportionate interest in the corporation, without any discount for minority status or… lack of marketability… using customary valuation concepts and techniques.”

In contrast, Fair Value2 was defined by the FASB and has had increasing relevance since the advent of SFAS 123R (as well as SFAS 141, 142, and other statements), and has been refined in the newly minted SFAS 157. Fair Value for Financial Reporting pertains to all financial accounting. Basically, any aspect of GAAP that requires a valuation must adhere to this standard, which is defined in SFAS 157 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.”

Fair Value2 allows discounts for lack of control (DLOC) and marketability (DLOM), where the DLOM may be calculated using a protective put methodology.

Fair Market Value, as you may know, relates to the IRS standard of value. This is a well-tried standard that’s been around the block a number of times. A good analyst will have worked through the case law and will understand the nuances of Fair Market Value. FMV allows for both DLOCs and DLOMs, and is often defined as follows:

“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.”

Back to our friend Rich. His company is doing very well. That’s good, but complicated. Unfortunately it triggers the need for a new appraisal on a fairly regular basis, and at least once a quarter we have a new valuation to run for his company taking into account the achievement of milestones, historical performance data, forward-looking projections, and other relevant data. Each new appraisal requires us to set up our tool bench for a three-way compliant valuation, a delicate job.