Executive Summary
“Standard of value” is not just a valuation buzzword—it is often the hinge that determines which assumptions are allowed and which ones are off-limits in a dispute, transaction, or negotiated resolution.
Fair market value (FMV) and investment value (IV) answer different questions. FMV estimates what a hypothetical, willing buyer and willing seller would agree to in an open and unrestricted market, with neither under compulsion and both having reasonable knowledge of relevant facts. Investment value estimates what the business is worth to a specific buyer (or a defined class of buyers) given that buyer’s unique expectations—often including synergies and buyer‑specific risk/return requirements.
For attorneys, mixing these standards can create avoidable credibility problems: an expert may “bake in” strategic synergies while testifying to FMV, or apply discounts inconsistent with the asserted standard. The sections below provide a practical framework, an illustrative numeric example, a comparison table, and a checklist for building or challenging a valuation position.
When This Issue Arises
The FMV vs. IV distinction commonly matters in:
- Shareholder/partner disputes and buyouts (including dissenting shareholder matters and closely held company deadlocks)
- M&A negotiations and transaction planning (especially when a strategic buyer claims unique synergies)
- Divorce and other ownership division disputes where the standard of value is controlled by statute, case law, or a court order
- Estate and gift matters where FMV is commonly referenced
- Damage calculations where a “but‑for” value must be measured under a defined standard
Accepted Methods and Frameworks
1) Start by locking the standard of value. Before any model is built, confirm whether the engagement (or the forum) calls for FMV, IV, “fair value” (a term that can mean different things in different contexts), or another defined standard.
2) Use accepted valuation approaches. The three generally recognized approaches are the income approach (e.g., discounted cash flow), the market approach (e.g., guideline public company and transaction multiples), and the asset approach (often relevant for holding companies or asset‑intensive businesses). The selected approach should be consistent with the standard of value and the facts.
3) Make buyer‑specific assumptions explicit. Under IV, synergies, strategic growth initiatives, special financing, or other buyer‑specific benefits may be appropriate. Under FMV, those benefits are typically excluded unless they would be available to the broader marketplace of hypothetical buyers.
Illustrative numeric example (simplified):
- Assume a business produces $1.0M of sustainable annual cash flow.
- FMV case (hypothetical buyer): discount rate 15%, long‑term growth 3%. A simple capitalization proxy is $1.0M ÷ (15% − 3%) = $8.33M. If an additional 20% combined discount is applied for lack of marketability and other FMV‑consistent risk considerations, the indicated value is ~$6.66M (≈ $6.7M).
- IV case (specific strategic buyer): buyer expects $0.2M of synergy benefits (cash flow becomes $1.2M) and uses a lower required return (10.6%) based on its own cost of capital. $1.2M ÷ (10.6% − 3%) = $15.79M. If a 30% haircut is applied for integration/execution risk, the indicated value is ~$11.05M (≈ $11M+).
- Takeaway: the same company can produce materially different values depending on whether the assumptions are “market‑participant” (FMV) or buyer‑specific (IV).
Documents and Data Checklist
To evaluate (or challenge) the asserted standard of value and the inputs behind it, attorneys typically gather:
- Governing documents and deal terms: shareholder/operating agreements, buy‑sell provisions, term sheets, letters of intent, redemption mechanics, valuation clauses, and dispute‑resolution provisions
- Historical financials: annual and interim financial statements, general ledger exports, and relevant supporting schedules
- Tax returns: business and, when relevant to normalization, key owner returns or schedules
- Forecasts and assumptions: budgets, management projections, backlog/pipeline reports, pricing assumptions, and key KPI definitions
- Customer/vendor/contract data: major contracts, concentration analysis, pricing terms, churn, and any non‑recurring items that may require normalization
- Capital structure and debt: loan agreements, covenant calculations, maturity schedules, and any planned refinancing assumptions
- Synergy and integration assumptions (IV cases): documented synergy models, planned cost savings, cross‑sell initiatives, integration costs, and timing/realization evidence
- Market data: guideline company selections, transaction comps, market multiples, and support for chosen discount rates and growth rates
Practical organization note: consolidate the above into a single folder with clear date ranges and a short index. Better organization typically reduces follow‑up requests and improves the credibility of the inputs used.
Common Pitfalls and Rebuttal Strategies
- Pitfall: Stating FMV while using strategic synergies. Rebuttal: Identify which cash‑flow line items reflect buyer‑specific benefits, then test whether those benefits would be available to a typical market participant.
- Pitfall: Switching standards mid‑analysis (FMV in one section, IV in another). Rebuttal: Require a single, explicit standard of value and reconcile every material assumption to that standard.
- Pitfall: Unsupported discount rates or growth rates. Rebuttal: Ask for the build‑up/WACC support, the data source, and sensitivity tables showing how value changes with reasonable ranges.
- Pitfall: Double‑counting risk (e.g., higher discount rate plus separate “risk discount”). Rebuttal: Trace each risk adjustment to a specific factor and confirm it is not already captured elsewhere.
- Pitfall: Applying discounts/premiums inconsistently with the engagement context. Rebuttal: Tie each discount/premium to the controlling interest level being valued and the controlling definition used by the forum or agreement.
Comparison Table: FMV vs. Investment Value
Note: The example values are illustrative only and are not a substitute for a case‑specific valuation analysis.
Frequently Asked Questions
Q1. What is a “standard of value”?
- It is the definition of value that controls which assumptions are permitted (e.g., hypothetical market participants vs. a specific buyer).
Q2. Is investment value usually higher than fair market value?
- Often, but not always. Investment value can be higher when credible synergies or buyer‑specific advantages exist, but it can also be lower if the specific buyer faces unique risks or higher required returns.
Q3. How does “fair value” fit into this discussion?
- “Fair value” is context‑dependent. In accounting, it generally refers to a market‑participant‑based measurement. In some shareholder dispute statutes, “fair value” can exclude certain discounts. The controlling definition must be confirmed in the relevant context.
Q4. What should counsel ask for to test whether an expert improperly used synergies?
- Ask for a bridge from baseline cash flows to the synergy‑adjusted case, evidence that the synergies are achievable, and whether those benefits would exist for hypothetical buyers (FMV) or only for a specific buyer (IV).
Q5. What documents matter most early on?
- Deal terms or governing documents (if any), historical financial statements, tax returns, and management projections. Without these, it is hard to validate the standard of value or the reasonableness of key inputs.
Q6. How can an attorney use FMV vs. IV to challenge an opposing valuation?
- Focus on internal consistency: identify every buyer‑specific assumption, confirm the stated standard of value, and use sensitivity analyses to show how the conclusion changes when the assumptions are aligned with the controlling standard.
Sources
- IRS Publication 561 (Determining the Value of Donated Property): https://www.irs.gov/pub/irs-pdf/p561.pdf
- International Glossary of Business Valuation Terms (NACVA PDF): https://edu.nacva.com/preread/2011BVTC/20110803InternationalGlossaryofBVTerms.pdf
- International Valuation Standards (effective 31 January 2025) PDF: https://saicawebprstorage.blob.core.windows.net/uploads/resources/IVS-effective-31-January-2025.pdf
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Disclaimer: This article is for informational purposes only and does not constitute legal advice.
