Standards Can Vary Widely

A standard of value defines the type of valuation performed. A premise of value, on the other hand, speaks to the assumptions surrounding the actual or hypothetical circumstances related to the specific valuation performed. It's important to make and understand the distinction.

There are three basic standards of value — fair market value, investment value, and intrinsic value. (In some situations such as shareholder actions and divorce cases, "fair value" may be introduced as a fourth "standard.")

1. Fair market value is the standard that most people are familiar with, and the legal standard used in most valuations. It relates closely to real estate appraisals performed by comparing a property to comparable properties sold recently. However, by definition, fair market value is hypothetical, and may or may not be achieved if the business is transferred.

The Official Definition The definition of fair market value adopted by the professional appraisal community has as its foundation IRS Revenue Ruling 59-60, and is published by the American Society of Appraisers as: "The amount at which property would change hands between a willing seller and a willing buyer when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts." Keep in mind: The "amount" is always assumed to be cash without terms. Adjustments must be made for the value if terms are involved.

2. Investment value, conversely, represents the value to one particular interested buyer or investor. It is generally higher than fair market value. Reason:  The buyer supposedly has specific reasons for acquiring the property that motivate him to pay a premium over fair market value.

3. Intrinsic value involves fundamental financial analysis of the inherent characteristics of the business. The most familiar example of intrinsic value is that developed by securities analysts: If their analysis of a security reveals, for example, a value in excess of the current market price, they issue a "buy" or "accumulate "recommendation. If the value is less, they issue a "sell" recommendation. Intrinsic value may affect the business appraisal when — and if — it's found in case law on point to the appraisal being performed.

One More Option

Finally, there is fair value. Technically, this is not a standard of value utilized in "ordinary" professional appraisals. It is a legally created standard that applies in certain situations defined by various state statutes. The attorney and appraiser must be certain that it's applicable in the matter at hand before applying it.

There is no definition of value for "fair value." Rather, fair value defines a point in time with respect to when the value should be determined. Generally, the concept applies in dissenting or oppressed shareholder actions and divorce actions.

In states that have adopted the Uniform Business Corporation Act, fair value, regarding a disenter's shares, is defined as:   "The value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable." (Oregon Revised Statutes, Section 60.551 (4))

Even in states that apply this statute, there's no clear consensus about the interpretation of "fair value" in this context. However, the courts have generally not equated it to fair market value and the differences are normally found in the applicability of allowable discounts. It is the responsibility of the court to define the value and typically the emphasis is on "fair." The facts and circumstances ordinarily provide the parameters.