An Arbitrator’s Guide to the Business Valuation Fair Market Value Standard

The selection of the appropriate standard of value is generally established by the circumstances and the expected use of the valuation. The most well-known standard of value established when valuing an entity is fair market value defined as:

A standard of value considered to represent 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, each 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 relevant facts.  

Fair market value is a hypothetical standard as opposed to an actual transaction, and can be divided into five main sections:

1.     The price determined that the property would change hands and implies cash or cash equivalent transaction.

2.     The hypothetical willing buyer who is seeking an investment for the buyer’s money that will provide an adequate return while taking into consideration the potential risk and reward of each particular investment opportunity. Thus, it is assumed that the buyer has other investment opportunities to choose from and will invest in an asset that provides a rate of return commensurate with the risk the buyer is willing to absorb.

3.     The hypothetical willing seller wants to obtain the highest desirable price. Thus, aside from the consideration of the buyer’s requirements, attention must also be given to what price the seller would accept.

4.     The position that neither the buyer nor seller is under any compulsion to complete the transaction, which may differ from an actual transaction where a variety of factors may necessitate the transaction to close.

5.     Both parties have reasonable knowledge of the relevant facts. This knowledge would include information that is known by parties to the transaction, as well as information that would have been known or knowable at that time.

A determination of the appropriate standard of value must be made for every business valuation to ensure that it reflects the relevant standard for the purpose and use of the engagement.