Fair Value and Market Value
Shareholder agreements often include dispute clauses detailing the steps to be taken if the parties fall out or one party wants to exit the company.
Often these clauses will provide for one party to purchase the other parties shares at either a ‘Fair Value’ a ‘Market Vale’ or a ‘Fair Market Value’.
These phrases are treated almost interchangeably outside of the valuation sphere however they can lead to dramatically different valuation results for parcels of shares, especially in the case of valuing a minority shareholding.
So what is the difference?
Market Value or Fair Market Value is frequently defined 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.’
Fair value is defined as;
‘The estimated price for the transfer of an asset between knowledgeable and willing parties that reflects the interests of those parties’
The difference between the valuation methods is that under Fair Value every shareholder is expected to be treated equally whereas this is not the case under Market Value or Fair Market Value.
This is important when dealing with shareholder agreements that include a minority party, because under a Market Value approach or a Fair Market Value approach the control premium/minority discount is considered when valuing a parcel of shares, whereas under a Fair Value approach minority discounts are not considered and the value of the shares is split on a pro rata basis.
In the 2018 KPMG Valuation Practices Survey it is noted that control premium/minority discount can be above 30% therefore the ultimate effect on the value of the minority shareholding can be substantial.
Broadly speaking a majority shareholder would prefer a Market Value or Fair Market Value valuation method as this would allow for the purchase of the minority shares at a discount, whereas a minority shareholder would prefer a Fair Value valuation method as this would result in no discounts being applied to their shareholding on exit.