Partnership Disputes: Fair Market Value vs. Fair Value Matters
By: ELI C. NEAL, CPA, ABV, CFF
We value minority ownership interests in privately held companies often; it’s one of the most common types of business valuations we perform. However, not every minority interest valuation is the same. It’s important for clients and their attorneys to understand the nuances.
Different valuation purposes can lead to different values, even if the interest being appraised is exactly the same. The difference stems from the Standard of Value that’s used. For this blog post, we’ll focus on the difference between two Standards of Value: Fair Market Value and Fair Value.
We’ll ignore the valuation textbook definitions (you can find them here) and focus on plain English:
Fair Market Value
Fair Market Value is the price that a hypothetical buyer would pay for a minority ownership interest. Fair Market Value considers that an owner of a minority interest doesn’t have control to make management decisions or change dividend amounts. If the business starts sinking, a minority owner is going down with the ship.
Fair Market Value also considers that it will probably be very hard to sell the minority interest. There’s not much of a market for most privately held minority interests, because buyers are often wary of not having control and likely concerned about their own future difficulty of selling.
The first consideration is called a Discount for Lack of Control and the second consideration is a Discount for Lack of Marketability. Both discounts decrease value, to recognize and account for the relative lack of attractiveness of minority interests.
Fair Value
Fair Value, on the other hand, is all about “fairness.” Fair Value is defined by state statute or case law for shareholder and partner legal matters. Rather than calculating the price a hypothetical buyer would pay for the minority interest, Fair Value focuses on what the company is worth as a whole, and then arrives at a pro rata amount for the individual interest.
From a practical standpoint, the major difference is often that Discounts for Lack of Control and Discounts for Lack of Marketability are applied when determining Fair Market Value and are not applied when determining Fair Value.
Which standard is used when?
Every situation is different, but Fair Market Value is generally used for the following assignments:
Estate tax reporting
Share gifting
Merger or sale to another entity
New shareholder or partner joining the ownership group
Marital dissolution
On the other hand, Fair Value is often used in a dispute context. Whether there are allegations of shareholder oppression or a forced buy-out, Fair Value is intended to allow the separating owner to receive pro rata value, so they are not penalized by the circumstances.
Law firm Beresford Booth has a few great articles outlining the considerations of minority shareholders:
If you need a minority interest valued, give 4 Corners a call at 425.800.4896 or schedule a video call here; we’ll listen to your situation and help you scope your project. We’d love to help you.