What Does Fair Market Value Mean?
Fair market value refers to the highest price, expressed in terms of cash equivalents, at which property would change hands between a willing and able buyer and a willing and able seller acting at arm's length in an open and unrestricted market. Fair market value also assumes that both parties are freely willing to buy or sell, and that both have reasonable knowledge of the relevant facts.
A professional valuation of a company only provides the fair market value in a notional or hypothetical setting. The actual price obtained when the business is sold may be very different.
Divestopedia Explains Fair Market Value
Fair market value as defined above can be vastly different than the actual price obtained in the open market, in the real world of deal making. This difference may occur for the following reasons:
- An open and unrestricted market assumes that all potential buyers have been approached and are included in the sales process. In reality, this usually is not the case.
- Business sales are rarely consummated such that all of the purchase price is in cash. Many deals include non-cash considerations, such as vendor take backs, earnouts or shares.
- In many instances, sellers may be compelled to exit their business due to health issues, a need for retirement funds, or just boredom, which makes them highly motivated to sell and potentially unlikely to chase the highest price available.
- In the open market, the negotiating strengths of the buyer or seller might not be equal, which can lead to one party having an advantage relative to the terms obtained in the deal.