Articles

In Canada, fair market value is defined as the highest price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

This might surprise you, but fair market value is often different from the price paid in a particular transaction.

So, what is fair market value?

•       Fair market value is the highest price and, therefore, considers the amount that would be paid by buyers who believe that they can enjoy post-acquisition economies of scale, synergies, or strategic advantages by combining the asset being valued with assets already owned by the buyer (referred to as special interest purchasers).

•       It is expressed in terms of cash equivalents, which means that there is no risk that the value received by the vendor might be less than the stated consideration, in contrast to amounts to be received pursuant to an earn-out agreement or in the form of shares or a note bearing a low rate of interest.

•       The hypothetical buyer and seller are willing and able.  Whether or not this is the case for the owner whose asset is being valued is not relevant to determining fair market value.

•       The hypothetical parties to the transaction are acting at arms length with the result that the hypothetical negotiations between them are assumed to be between parties with opposing interests.

•       The market is open so no potential purchasers are excluded.

•       The market is unrestricted.  Any restrictions that might prevent the sale of the asset (for example, restrictions on share transfers in a shareholders’ agreement) are momentarily lifted.  However, the hypothetical buyer is assumed to discount the price because that buyer would be subject to those restrictions after acquiring the asset.

•       Neither hypothetical party is under compulsion.  Therefore, there would not be a transaction unless both the vendor and the purchaser were satisfied with the price.

•       Both parties have reasonable knowledge of the relevant facts.  It is assumed that both the vendor and the purchaser know all of the facts that are important for determining the value of the asset.

Having reviewed the definition of fair market value, it is easy to see why it might differ from the price that would be obtained in an actual transaction.  In the real world the two parties to a transaction rarely have equal financial strength, negotiating ability and knowledge.  One party often has a greater need to transact than the other.  In addition, the consideration may not be all cash and cash equivalents.  Earn-outs, vendor-take-backs and shares that can not immediately be sold are common forms of payment.

Fair market value is determined in a notional market as the need to determine the fair market value of an asset or liability generally arises only when there has been no arms length transaction to indicate value.  For income tax purposes, transactions between non-arms length parties (for example, in reorganizations) must occur at fair market value in order to avoid adverse income tax consequences.  Fair market value is also used in establishing loss claims in commercial litigation and may be used in expropriations and shareholder agreements.

There are many difficulties in determining fair market value.  As the market cannot be tested by advertising the asset for sale, special interest purchasers may not be identifiable or it may not be possible to quantify with reasonable certainty the premium that identifiable special interest purchasers would pay for the benefits that they would anticipate realizing.  As a result, it is not uncommon for a valuator to assume that there are no special interest purchasers for an asset being valued.

So, is the fair market value of an asset what you want or need to know?  The answer depends on what you are going to do with the value information.  In some circumstances, the use of fair market value is dictated by legislation or agreement.  If you are involved in such a transaction, fair market value is what you need to know.  As discussed earlier, when a business is up for sale, fair market value is not generally equal to either the asking price or the price offered by a potential purchaser.  However, obtaining a sense of what the fair market value of the business is provides a good starting point when developing an acquisition or disposal strategy.

Wolrige Mahon LLP has professionals trained to determine fair market value and professionals with experience in buying and selling businesses.  If you would like assistance in either of these areas, please contact us.