Valuation Process Buy-Sell Agreements
Aside from “fair market value” there are some other standards of value that exist. For example: fair value, intrinsic value, strategic value and investment value. “Fair value” is likely the standard of value that leads to the most confusion in a buy-sell agreement setting and the other standards appear infrequently. I often see “fair market value” get confused or used interchangeably with “fair value.” However, these are two very different standards from a valuation perspective and can lead to different results in a valuation process buy-sell agreement.
“Fair value” can actually have two distinct meanings. First, “fair value” can be a statutory standard used in dissenting shareholder cases, shareholder oppression cases and divorce proceedings. As a statutory standard, the company value in most cases is determined without applying discounts for lack of control or lack of marketability. Second, “fair value” is also an accounting term used in financial reporting. ASC 820 defines “fair value” for financial reporting that is commonly used in purchase price allocations and when valuing intangible assets.
The takeaway here: be wary if the valuation process buy-sell agreement uses “fair value” as the standard of value. This is especially true if there are multiple appraisers involved in the process. A best practice is to fully define the standard of value to be applied in the buy-sell agreement. I often recommend quoting the business valuation standards in the agreement so there is no ambiguity.