You Say Potato - I Say Potahtoe - Valuation Terms Differ
As plan sponsors ready themselves for new valuation rules, it's critical to understand that "FASB Speak" is not always the same language as that used by traditional business appraisers. Consider the term "fair value."
According to FAS 157, "The definition of fair value retains the exchange price notion in earlier definitions of fair value. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. Therefore, the definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price)." Click here to read a summary of Statement 157.
In contrast, the Model Business Corporation Act 3rd edition (copyrighted 2003 by the American Bar Foundation), defines "fair value" to mean "the value of the corporation’s shares determined:
(i) immediately before the effectuation of the corporate action to which the shareholder objects;
(ii) using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal; and (iii) without discounting for lack of marketability or minority." Dr. Shannon Pratt (in his book entitled The Lawyer's Business Valuation Handbook) describes "fair value" as a statutory standard of value applied in dissenting shareholder cases but influenced by the actual state venue. He goes on to say that "fair value" is seldom mistaken for "fair market value" in appraisal land.
According to the International Glossary of Business Valuation Terms (2001), fair market value is "the 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." Click here to access the full glossary.
What's the moral of the story? When people banty about valuation terms, ask exactly what they mean.
