FMV of Thinly Traded Stock: Everything you need to know!

With a 409A valuation, private firms must first assess their common stock’s “fair market value” (FMV). The recognized current worth of one share of a private company’s common stock is known as fair market value. It shows how much the stock would be worth if it were traded on the open market. Thinly traded securities are those that trade in little volume and have a high level of volatility. Over-the-counter exchanges are where many thinly traded public corporations trade. Low volume and wide bid-ask spreads are indicators of thinly traded securities. When opposed to liquid investments, thinly traded investments carry a higher amount of risk.

FMV and thinly traded stock

The fair market value and thinly traded stock are correlated yet different. The recognized current worth of one share of a private company’s common stock is known as fair market value. It shows how much the stock would be worth if it were traded on the open market. This is not to be confused with “post-money valuation”, which is the market value of the complete business. These securities are ones that are difficult to sell or exchange for cash without causing a major price shift.

Understanding Thinly Traded Stock

Thinly traded stocks are those that can’t be sold or exchanged for cash without causing a big price shift. They are traded in small volumes and have a limited number of buyers and sellers. As a result, when a transaction happens, the price of such securities may fluctuate dramatically. Illiquid securities are commonly referred to as such. These are those that trade at a lesser volume and have a higher level of volatility. Thinly traded corporations frequently trade on over-the-counter markets.

How to determine if security is thinly traded?

Wide bid-ask spreads and low volume are indicators of thinly traded equities. These securities, on average, carry a slightly higher risk than liquid assets. Outside of the national stock markets, sparsely traded stocks are common. As a result, when there aren’t enough ready sellers and buyers, the gap between the asking price and the bidding price widens.

• Dollar volume – This measure informs investors of the amount of US dollars transacted on a given day. When compared to securities with larger dollar volumes, securities with low dollar volumes may be deemed thinly traded.
• Bid-ask spread – The difference between the bid and ask price is usually a good indicator of how liquid a market is. The bid-ask spread on thinly traded securities is greater than on liquid securities.

Understanding FMV for Thinly Traded Stock

Thinly traded securities can’t be easily sold or exchanged for cash without causing a large price shift. Marketable securities are traded on stock exchanges or in money markets and can be bought and sold. These are extremely liquid, making purchasing and trading them a breeze. Because of their infrequency and tiny trading volumes, thinly-traded assets have difficult access to market pricing. Due to market conditions, non-traded securities are frequently unavailable for purchase.

How Does the Valuation of a Thinly Traded Stock Work?

Because thinly traded securities are traded in small amounts, they are illiquid securities. Thinly traded assets are not easily sold or swapped, and when buyers express interest in buying them, the price changes dramatically. They are not commonly found on national stock exchanges; instead, they are usually found on the over-the-counter market, which is where securities are exchanged outside of the stock exchange. Traders of lightly traded securities wind up selling their holdings for far less than the stock’s value. Illiquidity is one of the most significant risks associated with sparsely traded assets. Risks associated with thinly traded securities are typically higher than those associated with other securities and liquid assets. It is critical to be able to distinguish thinly traded securities from regular securities. 

Important provisions of valuing securities (thinly traded stock)

The Investment Company Act of 1940 requires registered investment firms funds to evaluate portfolio securities for which market quotations are readily available using market values. When market quotations are unavailable, funds must evaluate portfolio securities and any other assets using their fair value, which is established in good faith by the fund’s board of directors. There are a few things to think about before registering them, which are as follows:

• Section 2(a)(41)(B) – When market quotations are readily available, the value of securities held by registered investment corporations (“funds”) is the market value. When market quotations are unavailable, a fund must value its portfolio securities and other assets using fair values assessed in good faith by the fund’s boards of directors. Uses other than accessible market quotations to value securities issued by regulated firms (as defined in section 2(a)(9).
• Section 22(c) – Section 22(c) empowers the commission to make rules governing open-end funds’ redeemable securities.
• Section 22(e) – According to this clause, open-end funds may not suspend the right to redeem, and they may not defer payment of redemption proceeds for more than seven days after receiving a redemption request.
• Section 23(b) – Closed-end funds that issue common stock are generally prohibited from selling the shares at a lower price than the securities’ current net asset value covered by Section 23(b).
• Revenue Ruling 59-60 Section 3 – For inheritance tax and gift tax purposes, all other available financial data, as well as any relevant factors impacting the fair market value, must be considered when assessing the shares of closely held firms or corporations whose market quotations are not available. There is no standard formula that can be used to the many distinct valuation situations that may arise in the valuation of such shares. However, the overall strategy, procedures, and elements that must be considered when valuing such securities are detailed. The goal of this Revenue Ruling is to lay out and evaluate the strategy, techniques, and variables to consider when valuing shares of tightly held firms’ capital stock for estate and gift tax purposes.

How to determine the price of thinly traded stock?

Wide bid-ask spreads and low volume are indicators of thinly traded equities. These securities, on average, carry a slightly higher risk than liquid assets. Thinly traded securities, as previously indicated, are frequently found outside of national stock markets. As a result, when there aren’t enough ready sellers and buyers, the gap between the asking price and the bidding price widens. If a seller sells a security at a lower bid price and a buyer buys it at a high ask price, the security’s price can change dramatically. Because a smaller number of players can quickly influence market pricing, there is a liquidity risk with sparsely traded securities, making them riskier than liquid assets.

Blockage Discount & Premiums

The blockage discount, also known as the blockage factor, is the discounted price or value given to equities by the market when a block of shares is sold. Discounts or premiums may be given to the calculated value of interest or operational business to reflect the lack of liquidity and ownership rights or constraints, depending on the type of interest or subject entity, degree of value, and assumptions used in developing cash flows. Each of these options should be studied to determine the most likely technique for liquidating the block. The approach or techniques chosen should be the most cost-effective disposal option and the method that generates the maximum profit for the block’s owner.

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Choose Eqvista for valuing FMV of thinly traded stock

Knowing the fair market value of your other investments, such as stocks and bonds, can be extremely beneficial when it comes to managing your finances. When considering an investment, you should be aware of the product’s value as well as the market’s asking price. While there isn’t a specific formula for calculating FMV, you can get a ballpark estimate using comparative market analysis and/or appraised value. Sometimes it becomes hard to find the correct fair market value of the thinly traded stock. We at Eqvista can make this process easier for you. Our experts provide the best valuation of your stocks. To book a free consultation with us, contact us and one of the experts will get in touch with you.