What is fair market value (FMV) and why is it important? (2023)

To introduce the concept of fair market value (FMV) and why it is important for private companies, we consider two hypothetical employment scenarios.

In Scenario 1, apublic companyHe offered you a job. Your job offer includes a stock grant with options to purchase 1,000 shares of common stock on a specified date and price. Before you accept his offer, you want to know what 1,000 shares of this company's common stock are really worth. Where can you find this information? Well, if it's not already stated somewhere in your stock contract, just look up the company's symbol online and see how much it's trading today. Light!

Scenario 2 is similar, but this time you receive a job offer from aPrivate To pursue🇧🇷 This company also offers a stock grant with options to purchase 1,000 shares of the company. But you can't just Google a company's stock symbol and find out how much a company's stock is worth. In the absence of an open market with buyers and sellers willing to value stocks, you need some other agreed upon mechanism to help you understand stock value. This is where fair market value (FMV) comes into play.

In this guide, we discuss the basics of fair market value and how it applies to private equity. Keep in mind that there are other types of market values ​​used in industries like real estate and insurance; We'll mention them briefly, but this guide will focus primarily on the fair market value of stocks.

• What is Fair Market Value (FMV)?
• How a 409A rating determines a stock's fair market value
• What is the difference between market value and fair market value?
• Other uses of fair market value
• What is the fair market value of my company's stock?

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What is Fair Market Value (FMV)?

GenerallyThe fair market value of an asset is the selling price of that asset in an arm's length transaction,that is, a transaction in which both parties are informed, independent and acting in their own best interests.

More specifically, for our approach,The fair market value of a private company's stock indicates how much a share of that stock would be worth in the open market🇧🇷 The shares of a private company are, by definition,notThey are listed on public markets, so the pricing mechanism on these markets can be inaccurate. In that case, the fair market value of that share must be determined otherwise.

Fortunately, there is a mechanism that can determine the fair market value of a private company's stock. It's called a 409A rating.

How a 409A rating determines a stock's fair market value

ONE409A ratingIt is an independent and unbiased assessment of what a private company's common stock is worth.

The 409A assessment takes its name from Section 409A of the Internal Revenue Code. That should give you a clue as to why it's important for a private business to complete a 409A assessment - namely, because the IRS wants to ensure that businesses assess themselves as accurately as possible.

But knowing the fair market value of your company's stock involves more than just having a good relationship with the IRS.

Any private company wishing to issue shares to its employees must have aPreisassociated with these actions. After all, it's hard to put together an attractive stock package when you can't tell a potential employee what your company's stock is worth.

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Overview of the 409A Assessment Process

Market value may not be easy to determine. In other words, you can't just read a Pulley guide (no matter how useful and informative it is!) and crunch some numbers to please the IRS.

The evaluation process generally requires consideration of both quantitative and qualitative factors, including but not limited to:

• of your companycoverage table
• Your company's past, present and future cash flows
• Your company's past financial statements and future financial forecasts
• A comparative market analysis of similar companies (i.e. companies in a similar industry or at a similar growth stage)
• All intangible assets (i.e. copyrights, trade secrets and other company assets that are difficult to value)
  

For this reason, many new businesses seek help from a 409A appraisal company. Such a company will generally hire a professional valuer (or team of valuers) to review the relevant facts and estimate the business value of the company. Once this value is broken down across all stock types in the company's capitalization table, the company should be able to determine the fair market value of an individual common stock.

Other factors such as B. A discount to reflect the fact that the shares are illiquid and cannot be sold on the open market can also affect the FMV.

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What is the difference between market value and fair market value?

Although they have two words in common, fair market value is not the same as market value.

Market value, also known as open market valuation or OMV, is the price at which an asset can be sold in an open market. The market value of a public company's stock is fairly easy to determine on a public stock exchange. But market value can also refer to how much a company hasuntilcan be bought or sold, in which case it is calculated by multiplying the current share price by the number of shares outstanding.

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Other uses of fair market value

When researching fair market value information, you may find the same term used in different contexts in different industries. To avoid confusion and provide a more comprehensive overview of FMV, we've briefly summarized some other common uses below.

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Market value in the real estate market

If you've ever bought or sold a home, you may have heard the term "fair market value" associated with real estate.

To determine a property's fair market value in the current market, a realtor can compare recent sales prices of similar properties in the area and factor other factors, such as property taxes, into a rough estimate. Many homes also have an appraised value calculated by a professional appraiser and this value may differ slightly from the FMV.

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Fair market value in the insurance industry

Insurers may also use fair market value to assess the value of items in insurance claims. Since many valuables (a used car, stolen jewelry, etc.) do not have a commonly agreed upon price, the FMV can be used to determine how much the insurer will pay.

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Fair market value for other tax purposes

The IRS may require a fair market value estimate for gifts above a certain size. For example, if someone gives a relative a rare painting for $1, the IRS can use the FMV to calculate the actual FMV of that painting for gift tax purposes.

Fair market value can also help determine the amount of tax deduction associated with a charitable donation.

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What is the fair market value of my company's stock?

Whether you're the founder of a private company or a prospective employee trying to value a block of stock, fair market value is something you should understand.

As a founder, you need to work with your team to complete a 409A assessment if you haven't already. And as a potential employee, you need to make sure you understand the value of every block of inventory that comes your way.

Competitive stock packages are typically structured so that stock options are awarded to the employee as a tax-free event:Incentive stock options or ISO, are an example of this. This requires the company to conduct its 409A assessment in order to qualify for IRS Safe Harbor. You can read more about this in our guide to 409A ratings, but the bottom line is that FMV isn't just an interesting number; This can have a big impact on taxes and the overall valuation of a block of shares.

Want to learn more about FMV and how to get an accurate 409A score once and for all? Schedule an appointment with the experts at Pulley to see how we can help you with an auditable 409A values ​​and limits worksheet, all in one.