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Valuation Essentials - What is the Value Definition?

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The following is an excerpt from The Executive's Guide to Business Valuation by valuation expert and M&A i-banker Justin Kuczmarski, MBA, CPA, CVA, CIRA, ABV. To view this free, 300-page guidebook, please click the blue link above to download.

Fair Market Value

The “mother of all definitions”, fair market value is by far the most commonly used value definition/standard. This universality is driven by how fair market value is mandatory in all business appraisals for federal tax purposes. FMV’s compulsory use in private business valuation for tax compliance, in addition to the established familiarity courts have with the FMV definition, have established fair market value as the default value standard.

IRS Revenue Ruling 59-60 characterizes the arm’s length definition of fair market value as follows:

The amount at which the property would change hands between a willing buyer and 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.

Some valuators have characterized fair market value as the most likely cash or cash equivalent price. Others have been more skeptical of FMV. In the process, detractors have noted how fair market value lacks a firm basis in reality by focusing on hypothetical buyers and hypothetical sellers. What is the correct interpretation of fair market value?

The unfortunate answer is that both interpretations are accurate: fair market value may not be perfect in its hypothetical willing buyer and seller concept, but it is nevertheless assumed the most probable indicator. Hence, FMV is presumed the arm’s length price a willing buyer and willing seller would agree to. The caveat: FMV is the price a willing buyer and willing seller would adhere to assuming not only a hypothetical transaction but also factors such as no “compulsion to sell” and “both parties having reasonable knowledge of the relevant facts”.

In meeting with existing clients or perspectives, it is wise to refer to fair market value as the “right off the street” arm’s-length value. This expression helps paint the picture of FMV as void of synergies and cost savings inherent to a particular buyer. The latter is referred to as investment value in appraisal jargon. Investment value is a different value standard than FMV.








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