Does the "Fair Market Value" of Your Business Really Matter?

Scott A Mitchem CPA, CVA, CFEI get calls all the time from people asking me to prepare a business valuation for them.  My first question is “Are you involved in a legal action or did somebody die?”  Most of the time the answer is usually “No, I am considering selling my business or admitting a partner." Often I hear from a buyer that they are looking at purchasing a business and they wanted to see if the price offered is fair.  I assert that a proper business valuation not only costs too much if done in conformity with the AICPA's or the Uniform Standards of Appraisal Practice standards, but the resulting estimate of Fair Market Value is really not relevant to the buyer or seller.

What the business owner really needs to know is what is my business worth to me.  He or she needs to know that number if considering selling the business or admitting a partner or crafting a buy/sell agreement in case of a partner's death or withdrawal. If you want to buy a business you really have two questions to answer.  First how much money can I make with this business after considering the cost to purchase and second,  how much would it cost me and how long would it take to build a business like this one myself.

The Internal Revenue Service in its federal estate tax rules defines Fair Market Value as "The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts."  The American Institute of Certified Public Accountants defines it as "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, 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."

How are these definitions relevant to you? The fair market value of your business is only relevant if you are being forced to buy your business say from a your spouse in a divorce or your partner to break up a business.  It could also be relevant in figuring out what your children might owe on your estate if you leave them the business.

Why isn't fair market value relevant if you want to sell your business?  The problem with Fair Market Value is alluded to in the differences between the IRS definition and the AICPA's definition.  The key is the hypothetical willing buyer and willing seller.  In the real world we never encounter the hypothetical willing buyer and willing seller.  If you want to buy or sell a business you are a real buyer or a real seller.

What I like to offer buyers and sellers is consultation where I can help them determine what the subject business is worth to them not some impossible hypothetical person.  I can do as much or as little research as it takes to make them  comfortable with their decision.  Then I can help them with the purchase allocation so that sellers can recognize as much capital gains and buyers as much depreciation and amortization as is "fair" on the transaction.

If you don't have a negotiated value that is fair to the business and fair to your partners widow,  if you don't have a prenuptial agreement and you need to divide your property in a divorce, if you need to gift away stock to your children and substantiate the value for the IRS, then come see me and we will talk "Fair Market Value."  Otherwise,  let us help you figure out what the business is worth to you and your partners and plan accordingly.

Scott A Mitchem CPA, CVA, CFE
Price Kong & Company
ScottMitchem@pkcpa.com
(602) 776-6313