What is Fair Market Value (FMV)? How much does my company worth?
What does my company worth? Many investors and business owners make the mistake by jumping right into the numbers and the multiples. The truth is, valuation is based on the availability, completeness, and the relevancy of the financial and operating information about the subject company. For example a startup with little financial data and industry data would heavily rely on the owner’s financial projections, hence the valuation would be highly subjective. In that case, financial partners or authorities would consider the valuation as “lack of context” or “insignificant”, meaning the valuation is unreliable. So, what makes a valuation reliable?
Before we go further into the valuation principles and methodologies, we need to understand the term “value”. Most buy, sell, investment transactions focus on profitability of an opportunity and would consider the value as fair market value. However, shareholder transactions or taxations for taxable capital gains and litigations often call for “notional market valuations”, where value is determined without market exposure. The concept of “fair market value” is the cornerstone of business valuation theory.
Fair Market Value
International Glossary of Business Valuation Terms defines “fair market value” as:
The highest 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, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts
Fair market value, therefore, is used often by CRA or financial buyers to determine the intrinsic value of the opportunity. So before you try to determine the value of your company, it would be worthwhile to better understand the purpose of the valuation. If the purpose of the valuation is to determine the price for an investment or a company, a valuator might use discounted cash flow method, adjusted book value approach, or cash flow capitalizations to determine the value.
How much does my company worth?
Since the purpose of a valuation is to determine the value for a rational person, the valuation metrics and methods could vary from one company to another. A going concern company with a long operating history might be better represented by market value. On the other hand, a company ceases to be going concern might be better represented by its liquidity value or adjusted book value.
The valuation dynamics
To truly understand the value of an opportunity, a sophisticated financial participants (buyer, seller, or other stakeholders) would then understand the business’s value under different circumstances. What is the value of the company under a normal market? Or selling in a strong market? What if the business is in a sunset industry? Or in a booming industry? What is the tax benefits or liabilities I can expect from the purchase? A reliable valuation would not ignore some pertinent facts and overweight favorable facts about the company. A reliable and certified valuation provides not only a potential price but also the dynamics of the values for the purpose of the valuation.
Who should value my company?
For public company valuations, the CFA Institute provides the gold standard for financial analysis and equity valuations; CFA Charterholders are employed all over the world in banks and investment management companies of different sizes.. For private companies, CBV Institute provides complete standards and guidelines for valuation reports in Canada. The Institute is engaged in a worldwide consultation process toward adoption of International Valuation Standards (IVS), led by the International Valuation Standards Council (IVSC). CBV Institute is both a member and sponsor of the IVSC and is represented by CBVs on several IVSC boards.
We have another article “Who Should Prepare Your Valuation Report” here.