Fair market value vs. investment value

"What is the business worth?" is an incomplete question. Worth to whom, under what assumptions? The answer is called the standard of value, and it changes the number — sometimes by a lot. A valuation that never names its standard is answering a question it never asked.

Fair market value: the hypothetical deal

Fair market value is the price at which a business would change hands between a hypothetical willing buyer and willing seller, neither under compulsion, both reasonably informed. The phrasing comes from U.S. tax authority and it governs estate and gift tax work, most buy-sell agreements, and by convention much of everything else. Note what the definition excludes: no particular buyer. No synergies, no strategic motives, nobody's cheap capital. The buyer is a financial abstraction, and the value reflects what the business earns on its own.

Because the buyer is hypothetical, fair market value leans on evidence of what typical buyers pay — which is whymarket comparables and broad transaction statistics matter to it. Reported small-business sales averaging around 2.58 times SDE, with a median price of $340,000, are evidence about that hypothetical buyer's behavior.

Investment value: the particular buyer

Investment value is worth to a specific buyer with specific circumstances. A competitor who can close the back office and keep the revenue is buying different cash flows than a stranger would inherit. So is a distributor acquiring a supplier, or an owner of the building next door. Their synergies are real, and the business is genuinely worth more to them than to the market at large.

This is why "my competitor paid four times earnings for a shop like mine" proves less than sellers hope. That price contained the buyer's synergies, and a valuation for any other purpose cannot borrow them. The spread between fair market value and a strategic buyer's investment value is not an error in either number. It is the negotiating room, and knowing both figures is exactly how a seller prices an asking figure above the appraised one without pricing out of the market.

Fair value: the legal standard

A third standard, fair value, appears in shareholder disputes and dissenters' rights cases, where its meaning is set by state statute and case law rather than economics. In many jurisdictions it means a pro-rata share of the whole company with no discount for holding a minority stake — precisely because applying one would let a majority squeeze out minority holders at a reduced price. Financial reporting uses the same words for a different concept again. If a lawyer is involved, ask which definition controls before running a single number.

Why it decides the discounts

The standard of value determines whether marketability and control discounts apply at all. Fair market value of a minority interest typically takes both; fair value in many states takes neither. The same 30 percent stake can carry two defensible values, and the difference is the standard, not the math. Seevaluation discounts: DLOM and DLOC.

Name the standard, then value the business

Every engagement should state its standard of value and its valuation date on page one, because both are premises, not conclusions. The methods come after: fair market value work leans on market evidence and normalized earnings, while investment value work models the actual buyer's costs and capital. ExitSight reports state the standard, the premise of value, and the effective date up front, where a reviewer looks first.