In the classic English nursery rhyme, the first little piggy “went to market” and the next little piggy “stayed home.”
If this children’s fingerplay were about the value of your company, I suppose the third little piggy would have gotten an appraisal of Fair Market Value, and surely cried something other than “Wee! Wee! Wee!” all the way home.
(Incidentally, does anybody know what emotions caused the last little piggy’s cry? Was he or she happy, like a kid yelling “Whee-e-e-e-e!” going down a sliding board? Or sad? Or scared? I never was sure about this… but I digress.)
Fair Market Value (FMV) is what a willing buyer will pay to a willing seller when each is fully informed and under no pressure to act. This valuation standard comes from IRS Revenue Ruling 59-60, which sets standards that are used by business appraisers in valuing private corporations for estate tax and gift tax purposes, ESOPs, divorce cases and other situations where the result may be challenged and the appraiser required to defend his or her work.
In contrast, Market Value (MV) is the price at which an asset trades in an open and competitive market. In other words, the real world. When the first little piggy goes to market and seeks actual buyout proposals for his business, he or she is going to find out the MV.
In theory, the piggy who went to market and the piggy who gets an appraisal of FMV should get very similar results. FMV should be an estimate of MV.
In practice, the results may vary widely. MV may be much higher than FMV because a buyer will pay extra to remove a competitor, expand into a new territory, acquire key executive talent, add new products to an existing distribution system, acquire new distribution channels for their existing products, consolidate overhead expenses, achive other synergistic or strategic objectives, or satisfy a gigantic ego. In other cases, MV may be much lower than FMV because of negative industry trends or glaring risks such as overreliance on the business owner or a majority of revenue coming from a single customer.
Predicting MV is extremely inexact. But much can be learned by analyzing actual acquisitions of private companies, carefully and honestly examining your own business, and probing the strategic objectives of potential buyers.
— David Bass
PLEASE COMMENT ON MY BLOG. I APPRECIATE YOUR THOUGHTS.