Let's consider the notion that the Fair Market Value of an interest in a company or its assets is the second highest price.
In the U.S., Fair Market Value (FMV) 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" (Treasury Regulations 20.2031.1).
I think it useful to breakdown a few components of this standard of value. Let's take a look at four of them:
1. PRICE. The standard requires a single point estimate expressed in terms of money. The construct does not allow for the flexibility to consider ranges, nor non-cash considerations. Price under FMV represents value in a real or hypothetical exchange having minimized synergistic considerations, where the exchange is premised by a liquidation or going concern context.
2. WILLING BUYER. The theoretical meeting of the hypothetical buyer and seller under the FMV standard needs to occur in a 'marketplace' that considers the extent of influence of synergistic buyers. While the construct seeks to maintain contact with the hypothetical nature of the buyer, courts have considered case specific circumstances where the only possible buyers are synergistic, not financial.
3. WILLING SELLER. The construct requires that a seller is a hypothetical willing seller selling in a hypothetical market. When deciding to sell, real world considerations taken by the seller include liquidity, alternative uses, future cash flows, and risk.
4. NO COMPULSION TO BUY NOR SELL. While the theoretical notion here is that there is no compulsion in any hypothetical negotiation, courts have allowed case-specific consideration that parties involved in any transaction in the real world naturally make decisions based on their involvement in a bankruptcy, or a need for immediate liquidity for example.
So, the next time you have an occasion to contemplate a valuation under a FMV standard (think 409A valuation) consider the implications of the standard's definition, and the notion of the second highest price.