How to Find Fair Market Value or FMV
Fair market value represents an asset’s price under certain sets of conditions.
When it comes to public corporations, the fair market value of stock is public and in most cases, is regulated by the market. In private corporations, the fair market value of shares is the generally accepted present value of a private company’s stock’s single share. Generally, third party appraisers are responsible to determine the fair market value of this stock. It shows the potential worth of the stock market in the open market.
Fair Market Value or FMV for Company Stock
At its core, the FMV or fair market value, is an asset’s potential price in the open market. Fair market value represents an asset’s price under certain sets of conditions. Let us take a closer look at what the fair market value of stock is in greater detail.
What is Fair Market Value or FMV for Company Stock?
As mentioned earlier, the fair market value constitutes an assets price under certain conditions which are:
- The prospective sellers and buyers have basic knowledge regarding the asset
- They behave for their best interest
- There isn’t any undue pressure for trading
- People get a reasonable amount of time for completing transactions
Keeping these conditions in mind, the fair market value of an asset should highlight an authentic assessment or valuation of its worth. Real estate and tax law use this term quite regularly. It is a major reason why it is so distinct from terms like appraised value or market value, which are quite similar. This is because FMV takes into consideration the economic principles pertaining to open and free market activity.
Why is Fair Market Value Important?
Fair market value of shares comes in handy for a variety of reasons. For instance, they are critical for assessing an individual’s property taxes. Depending on the amount of time someone owned the property, the difference between the property’s fair market value and purchase price can be substantial. In many cases, pro appraisers utilize guidelines, standards, along with local and national regulations for determining a house’s FMV.
Fair market value’s importance is also prevalent in the insurance landscape. For example, if someone makes an insurance claim because of a car crash, the company providing coverage to the owner’s car generally covers up the damages based on the vehicle’s fair market value.
Other reasons why FMV proves its importance
- It ensures fair and transparent transactions between buyers and sellers. By requiring both parties to act in their own interests, have full knowledge of the asset, and be free from coercion, fair market value promotes equitable deals.
- It is widely used in legal and regulatory settings: Tax authorities use fair market value to determine the appropriate tax liabilities on assets, property, and transactions. Insurance companies depend on FMV to calculate claims and compensation amounts for insured assets like vehicles. Fair market value is employed in divorce settlements to divide assets equitably.
- It provides an accurate representation of an asset’s true worth by considering factors like growth potential, replacement cost, and market conditions, rather than just historical cost. This gives a more realistic picture of a company’s financial position.
- Fair market value accounting allows businesses to practice asset reduction by declaring if an asset’s value was overstated, helping them weather financial difficulties.
- It enables companies to take advantage of capital gains by selling appreciated assets at their fair market value.
Example of Fair Market Value
Let us say that a company called EcoGro, focused on developing software products that integrate into everyday life, enhancing productivity, efficiency, and overall user experience.
Here is a look at the cap table of the company:
| Equity | Shares | Price | Capital | Ownership |
|---|---|---|---|---|
| Common | 8,000,000 | $0.00 | $80 | 100% |
| Before 409a Valuation | After 409a Valuation | ||
|---|---|---|---|
| Price Per Share (Board Determined) | $0.00 | Fair Market Value (FMV) (409A Valuation) | $0.20 |
To issue stock options to its employees and comply with IRS regulations, EcoGro needs a 409A valuation. Here’s how the process typically works:
Calculate the total assets less the total liabilities of the company to evaluate the cost of the company.
| Before Valuation ($) | After Valuation ($) | |
|---|---|---|
| Total Assets | 1,295,609 | 1,373,489 |
| Total Liabilities | 145,457 | 145,457 |
| Revaluation of Intangible Asset | - | 77,880 |
| Total Stockholders' Equity (Total Assets – Total Liabilities) | 1,150,152 | 1,228,032 |
Thus, from a balance sheet perspective, the Company is worth $1,228,032 and has 8,000,000 shares outstanding, the value per share would be
Price Per Share = $1,228,032/8,000,000 = $0.15
Projections and estimates to know what the company will be worth in the future. The earnings are determined by calculating the net present value of the expected future cash flows or future earnings of the company and dividing them by the capitalization rate.
| Year | Net Cash Flow ($) | 21.15% PV Factors | Present Value of Cash Flow ($) |
|---|---|---|---|
| 2024 | 153,783 | 0.84740447 | 130,317 |
| 2025 | 174,610 | 0.69946716 | 122,134 |
| 2026 | 165,324 | 0.5773563 | 95,451 |
| 2027 | 178,329 | 0.47656319 | 84,985 |
| 2028 | 195,419 | 0.39336623 | 76,871 |
| Terminal Value | 1,185,050 | 0.39336623 | 466,159 |
| 975,916 | |||
| Add: Cash and Equivalence | 739,913 | ||
| Less: Debt | -80,000 | ||
| 1,635,829 | |||
| Rounded | 1,636,000 |
The terminal value is calculated as shown below:
| Net Cash Flow in the Final Year | 195,419 |
| Terminal Cash Flow | 203,236 |
| Discount Rate - Growth (21.15% - 4%) | 17.15% |
| Capitalizing @17.5% | 1,185,050 |
The Company value is $1,636,000 and has 8,000,000 shares outstanding, the value per share would be
Price Per Share = $1,636,000/8,000,000 = $0.20
- The valuation can also be done by comparing the company with other similar companies in the market.
- If no recent transaction exists for the company, the backsolve technique is used to determine the value of the company’s common stock.
- The new FMV of the common stock is determined to be $0.20 per share.
So according to IRS Section 409A, the company would need to set the FMV of the common stock at $0.20 per share to be used for stock option exercise pricing.
The FMV is calculated using 409A valuation performed by a professional expert like Eqvista.
Fair Market Value vs. Market Value
Many people wonder what the main differences are between fair market value vs book value. Well, the points mentioned below will help you understand what makes both of them so different from each other.
- Book value represents the company’s net asset value.
- An asset’s book value is present in the balance sheet with amortized cost, historical cost, or even fair value. The market value is a reflection of the asset’s fair value.
- Book values are the asset’s accounting value and don’t carry too much relevance whenever an organization is planning to give away that asset. In contrast, the valuation that market value shows is more accurate during the selling or buying of an asset.
- With the help of book value, you can find out an asset’s actual acquisition cost. Market value, however, keeps you updated regarding market trends happening currently.
- Investors are able to calculate an asset’s book value whenever a corporation offers its earnings reports on a quarterly basis. On the other hand, market value changes all the time.
- Book value equals the firm equity’s overall value. On the other hand, market value gives you an indication about an asset or firm’s current market value.
- You can use book value to find out an asset’s (owned by a company) actual worth. Market value offers us the asset’s or firm’s projected value.
Determining Fair Market Value of Private Company Stock
To determine FMV of a private company’s stock, the most common and accepted approach is to conduct a 409A valuation. Conducting an independent 409A valuation is the standard and IRS-accepted method for determining the FMV of a private company’s stock.
409A Valuations
- IRS Section 409A requires private companies to conduct independent third-party valuations (409A valuations) to establish the FMV of their common stock. This prevents companies from undervaluing stock for tax benefits.
- 409A valuations consider factors such as the company’s assets, future cash flows, comparable public companies in the same industry, and recent transactions involving the company’s stock.
- 409A valuations must be performed at least annually and after any material events that could impact valuation, such as funding rounds, acquisitions, or layoffs.
Board Rule for FMV
- In the absence of a 409A valuation, the company’s board must use the “Board Rule” to determine FMV through a reasonable valuation method considering: Company’s tangible and intangible assets
- Anticipated future cash flows
- Market value of comparable companies
- Recent transactions involving the company’s stock
- Other relevant factors like control premiums or lack of marketability
Maintaining FMV
- To maintain a valid FMV, companies cannot make a public offering within 180 days of the valuation.
- The valuation should be documented, ideally by an experienced professional, to support its reasonableness if challenged.
How do you determine the Fair Market of Stocks?
Strike prices should be greater or equal to the fair market value under 409A valuations. When you are valuing your organization, a 409A valuation provider generally looks at a variety of factors, which include:
- The overall worth of your assets
- The current worth of the future cash flows
- The amount of a common stock’s worth in similar organizations
- Your company’s equity in similar industries or businesses
Common Valuation Methods (Income/Asset/Market)
There are three main types of valuation methods used by professionals, namely: the income value approach, market value approach, and asset based approach. All of these processes are highly effective in their own ways.
Income Value Approach
In this type of approach, an organization is evaluated mainly for its future earnings potential. While there are plenty of examples to showcase why this method is effective, Capitalizing future earnings would be the best one. This method examines a corporation’s past earnings to project the financial potential for the future.
This approach could come in handy if a strategic investor comes aboard (for instance, Shark tank investors).
Market Value Approach
The market value approach is also quite popular among valuators. This approach represents what buyers could be planning to pay for a company or a portion of it when the seller and buyer have good understanding about the business and don’t have any pressure to sell or buy.
This method allows you to find out a fair value within your market. You can then divide this among the shares for finding out their exact value.
Asset Based Approach
In an asset based approach an organization’s liabilities and assets are added up, which shows the company’s overall value. A valuation like this generally comes useful when someone decides to sell their entire business.
Eqvista 409a Valuation Services
Eqvista is a leading provider of 409A valuation services for startups and private companies.Eqvista aims to provide high-quality and defensible 409A valuation services to protect companies from adverse tax liabilities and penalties.
Eqvista offers several key benefits for companies seeking 409A valuation services:
Expertise and Certifications
- Eqvista has a team of 15 NACVA certified valuation analysts with extensive experience across various sectors and industries.
- They are nationally recognized experts in offering defensible 409A valuations for companies of all sizes and stages.
409A Valuation Process
- Eqvista’s team uses proven methodologies and a specialized approach to accurately value companies and provide audit-ready 409A valuation reports.
- Their process is designed to provide safe harbor status as per IRC regulations, protecting companies from IRS penalties.
Pricing and Packages
- Eqvista offers affordable and transparent pricing for 409A valuations, starting at $990 per year.
- Provide unlimited 409A valuations for 12 months with different pricing tiers based on the company’s funding stage (e.g., Startup: $990/year, Seed: $1,290/year, Series A: $1,990/year, Series B: $2,490/year).
- Custom pricing is available for companies that don’t fit into the standard tiers.
Additional Services
- In addition to 409A valuations, Eqvista offers a range of valuation services, including investment (VC) valuations, software valuations, startup valuations, portfolio valuations, HMRC valuations, and valuations for LLC to corporation conversions.
- Eqvista also provides tax consulting services, assisting with complex tax considerations, equity structuring, and filing services like 83(B), Form 3921, Rule 701, and QSBSs.
With their team of certified experts, specialized approach, and affordable pricing, Eqvista aims to provide high-quality and defensible 409A valuation services to protect companies from adverse tax liabilities and penalties.
FAQs
Here are some frequently asked questions about FMV (Fair Market Value):
Why do I need to complete an FMV form?
As a qualified custodian, financial institutions are required to obtain the fair market value annually for each investment held by account owners. The FMV information is submitted to the IRS.
What assets require an FMV form?
An FMV form is required for alternative assets that the custodian cannot obtain a valuation for, such as real estate, private equity, private lending, digital assets held in trusts, and assets held within single-member LLCs or trusts owned by an IRA.
How do I find the value of my asset for the FMV form?
The value can be found on value update statements, bank statements, or by contacting the company the asset was purchased from. For digital assets held in trusts, itemize the assets held within the trust.
Can someone else complete the FMV form for me?
Yes, a qualified third-party valuator can complete the FMV form for you.
What supporting documentation is needed for the FMV form?
If the last reported value has increased or decreased by more than 20%, supporting documents like bank statements, value update statements, or letters from the asset company are required.
Where do I submit the completed FMV form?
The FMV form can be completed and submitted online by the deadline to avoid late fees. The specific online submission process may vary by institution.
Interested to know the Fair Market Value of your Company?
The fair market value is basically the price buyers are ready to offer to any willing seller even if they are unrelated. Particular circumstances exist for determining FMV, which is guided by section 409a for private companies. That is why it’s important to gauge a professional valuation provider like Eqvista to find the fair market value of your company.
We provide complete valuations of private companies in any industry, starting at $990 for startups. Contact us today to know more about our 409a valuation services!
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