Fair Market Value, Fair Value, and Discounts for Business Owners when Planning or Selling a Business
In our previous post I talked about Strategic Value as a standard of value when business owners are valuing their business. Instances where you need to know the value of your business include planning to sell or transition their business through business brokerage or a sale transfer to managers or family.
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Fair Market Value. This value is the value a typical buyer who will not derive strategic efficiencies will pay for your business. Typically these buyers are called Financial Buyers. They are looking for what I call “working models”. Almost like a franchise they want to step into your “business model” and run it. This is the value of the business to a control owner that can make changes as desired. This value typically used for buy-sell agreements and transactions involving closely held and family business interests. In many jurisdictions a version of this can be called Fair Value which again, is generally fair market value without discounts even when the interest is a minority interest. This is also the value generally used on SBA loans during SBA business valuations.
Fair Market Value with Discounts. This is the value of a minority interest in the business. The owner of this interest is either a minority owner (under 50%) or has agreed to restrictions on company control. Therefore this owner has little control over continued employment at the company (if they are an employee), distribution of profits, company policy or planning etc. Namely they are along for the ride. Because of the lack of control these interests are valued below fair market value. This is primarily used in estate and gift tax planning to lower the give or estate value. Many exiled family members from family businesses will also tell you that the lower value is very real when family harmony breaks down.
Finally, business value can be more or less than the price negotiated between parties. Price is subject to the actual market, how well the company is positioned by its brokers, the players in the market, and other variables that cannot be fully taken into account when determining value.
Conclusion. If a business has a fair market value of $1,000,000 with 100 shares of stock issued the 100 shares to a strategic control buyer might be $1,200,000 or more. The value of 1 share to a non-control buyer (fair market buyer with discounts) might be $700 not the $1,000 fair market value. It is important to know why your business is being valued and to specify the correct level of value be used.Gregory R. Caruso Harvest Business Advisors Business Brokerage, Business Valuation and Appraisal firstname.lastname@example.org 609-664-7955