Deciding on a valuation, whether it’s a business, real estate or intellectual property, can be a challenge. You know that there’s an inherent and objective value in the marketplace, but other — less tangibles — can weigh in on the determination of value. Understanding the difference between fair market value and fair value will both help you get a fair price for your agency and help the process of finding a buyer and sealing the deal that much more seamless.
Let’s explore the difference between the two.
Fair Market Value
Fair market value is the price at which a buyer who wants to buy and seller who wants to sell would make a deal if the there are no factors compelling the purchase or sale, respectively. In the case of fair market value, it’s assumed that both parties are well-informed and able to make an objective decision.
Fair market value is the most widely used in the financial accounting world to determine the value of a business and is also accepted by the IRS as a representation of the value of your business. Fair market value is what you could expect on an unrestricted market.
It doesn’t consider any strategic value in buying or selling at a given price or by a given time. For example, whether or not the buyer can realize greater ROI in the company than its current owner wouldn’t be a factor. The buyer’s desire to buy because of the company’s ability to complement the buyer’s own company’s lines of business wouldn’t be considered. The seller’s need to sell because of market trends, litigation, liabilities, death or retirement of a majority shareholder would not be disregarded in fair market value. Any of these would represent a compulsion to buy or sell beyond the fair market value.
Fair market value would include the following as laid out in IRS Revenue Ruling 59-60:
- Type of business
- History of the business
- Financial statements to review liabilities, liquidity, revenues, etc.
- Earnings potential
- Goodwill and other intangible assets
Fair value is the price at which you you can sell an asset (or transfer a liability) in an orderly fashion. It does take into consideration the risk, strategies, advantages and disadvantages of both the buyer and the seller.
By contrast, we could say that fair market value is a value created in a vacuum with no external strategic consideration while fair value considers not only the value of the company itself, but also the value to one or both parties of buying or selling by a given date. Fair market value is the more objective price while fair value is a price that makes the most sense given the current situation and between a certain buyer and a certain seller.
Fair value has been ascending in popularity over the past two plus decades because it attempts to take valuation out of the theoretical and into the real world. It is accepted within GAAP (generally accepted accounting principles). As with anything in the world of accounting documentation of these intangibles and how you factor them into the fair value is key. Fair value is not a haphazardly obtained number.
How Fair Value Is Used
Fair value is often used when shareholders disagree about the value of the company. These disagreements arise from varying perceptions about the strategic value of selling the business by a certain time and for a certain price. In these cases, shareholders would first review the more objective fair market value and then add to or subtract from that valuation to account for strategic variables. With consideration for majority and minority share — and perhaps with external counsel advice on hand — these shareholders would agree upon a fair value.
If they already have a buyer, then they would take this value to the negotiating table. If they’ve not yet placed the company on the market, then they would make the company available in the marketplace at this price.
Determining the Value of Your Company
For more information on obtaining an insurance agency valuation, check out our easy to follow yet thorough agency valuation video. If you need assistance determining the value and successfully selling your insurance agency, please give us a call: (321) 255-1309. We look forward to learning more about your company and helping you sell your company at a value that makes sense for you.