Fair Market Value
Defining Fair Market Value
Fair Market Value is the price a specific property, asset, or business would be purchased for in a sale. A company’s fair market value should be an accurate appraisal of its worth.
Calculating Fair Market Value is subject to the following conditions:
- Prospective buyers and sellers must be knowledgeable about the asset.
- Buyers and sellers must not be coerced or strong-armed into selling or purchasing.
- All parties must provide a reasonable time frame for the transaction to be completed.
In other words, FMV is an estimate of the amount of money an industry-educated, interested, unpressured buyer would pay to an industry-educated, interested, unpressured seller.
How to Determine the Fair Market Value of Your Company
If you are considering selling your business in the future or are just trying to strategically plan for the long-term, determining the fair market value of your company is a crucial step. The difference between the fair market value and the purchase price can often be considerable; consequently, many sellers hire professional appraisers for business valuation. This cost can range from a few thousand dollars to $50,000; however, it is highly recommended to hire a third party as most owners inaccurately estimate the value of their business, which can lead to disappointed expectations regarding the company’s value or a low sale that leaves hard-earned money on the table.
(Are you in the process of selling your company? The first thing to do is to identify “destroyers” that can impact your company’s value. Click here to download your free “Top 10 Destroyers of Value“.)
There are many ways to calculate the Fair Market Value of your business; some of the factors that affect a business’s FMV are the business type, the economic conditions at the desired time of sale, the book value, recent income, dividends, goodwill, and recent prices paid for comparable businesses. During an assessment of your company, an appraiser will look for the following items along with many others:
- Future Earnings: An appraiser will forecast future earnings over multiple years, factoring in the discount cash flow and discount residual value by comparing your company to similar ones. The discount rate reflects the diminishing value of money year after year. They will also determine the “capitalization of earnings rate,” which indicates the cost of capital and the company’s risk.
- Asset Assessment: They will evaluate the Fair Market Value of all the tangible assets of the company, such as inventory or equipment, as well as the intangible assets, such as brand, reputation, and location.
- Comparable Sales Figures: They will analyze recent sales of commensurate companies.
- A Partial Purchase Discount: If the buyer is purchasing a minority share of the company, less than 50%, a discount will typically be applied since the other party would still control the business.
Appraisers and valuation experts typically use more than one approach when evaluating the FMV of a company. So grab your business tax returns and general ledger to get started identifying the value of your business today!