Fair market value is the most commonly applied standard when determining the value of a going concern or a holding company. This standard defines the value as the price a willing buyer would pay to a willing seller, with both parties having reasonable knowledge of all relevant facts and acting without pressure or compulsion.
A key consideration, often overlooked, is how fair market value applies in intercompany transactions, particularly when minority interests are involved. For example, in cases where a 25% interest is being sold to a partner who already owns 50%, it might seem intuitive to assume the buyer will have majority control post-transaction. However, under the fair market value standard, appraisers must assume a hypothetical buyer who is unrelated to the transaction. That means the 25% interest must be valued independently and without assumptions about future control—often resulting in the application of a minority interest discount.
This frequently raises questions: why should a minority discount apply if the buyer is already in a controlling position? The answer lies in how the standard is defined and applied.
Advisors should ensure that shareholder agreements, membership agreements, and employee equity agreements clearly define how value will be determined to avoid confusion and potential disputes. For instance, specifying that fair market value should be calculated without discounts for lack of control or marketability can provide clarity in internal transactions.
When advising clients on structuring these agreements, aligning the definition of value with the client’s goals and the likely context of future ownership changes is critical. Addressing this proactively can prevent complications down the road.
For further guidance on fair market value or any valuation-related matters, our team is here to help.