Business Fair Market Value
A business Fair market value (FMV) or market value is commonly used in business valuations and is defined by the ATO as: “the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm’s length.” If you have asked yourself; What is the value of my business? according to what? the market? my competitor? why do we define “fair market value” and what is it used for? We encourage you to read this article for answering all of your questions.
“Fair” – meaning – when the buyer has all the important information to make an informed decision when negotiating the price.
“Market” – meaning – a hypothetical buyer across the entire market. i.e., NOT a specific party that has a specific reason to pay extra for it. E.g., a car collector paying double the price for a car because it completes their collection.
So why do we need this concept of “Standard of Value” called “Business Fair Market Value”?
Knowing the fair market value of your business can be used for several different purposes. You might find yourself in a position where you wish to sell your business since you are retiring, but you want to make an informed decision of what the current market (hypothetical buyer) value of your business is.
This could apply as well to certain share schemes where employees are offered shares, so what is the ‘fair market value of these shares? This would have tax implications and the ATO needs to know what the fair market value is.
On the other hand, there may be one 50% shareholder buying out the other, or you’re planning to hand the company to one of your family members, where there could be capital gains or gift tax implications, so how much capital did they actually gain?
You might say that your business is worth $1 million, but in the ATO’s eyes, it could be worth $2 million, because this is what a buyer in the market would pay without a family discount.
Furthermore, you may have sold it to someone with strategic interests and the price inflated past FMV; consequently, valuing your business under/over fair market value means potentially paying incorrect taxes which can have consequences.
Alternatively, you could be planning your exit of the business and would like to know the current value if you ‘went to market’. A valuation would help to set your objectives and know how to increase your business’ value in order to achieve your price goals at sale.
You can then start looking for a specific buyer with synergistic interests and achieve a sale over FMV, e.g., a retail seller buying the wholesaler business.
How you arrive at the “business fair market value” for your business is a complex and detailed process that is beyond the scope of this article. As there are a myriad of data points, variables, and assumptions that go into the process, it is important to consult a professional valuer.
Often with small to medium-size businesses, the business is the largest or one of the largest assets within the owners’ portfolio. For this reason, not having a professional valuation can leave your company grossly under / overvalued, potentially causing implications with the ATO, having your business remain advertised for sale for years without an offer, or you might end up buying your business partners shares for a significant amount over the value you should have paid.