What s Fair About Fair Market Value

What's Fair About Fair Market Value?


By Laura Markee, CFA, ASA, Markee Valuations
September 2020 Bar Bulletin
September 1, 2020
questionsanswered.net

Imagine a situation in which your customers are divorcing, and the partner is a successful psychologist. For the sake of the example, presume even more that her practice is so successful that she earns over $500,000 each year in her practice, much higher than the market standard of $250,000 for solo practitioner psychologists with her level of education.


In a divorce in Washington State, attorneys ought to be mindful of when and how Washington's "reasonable value" requirement may enter play in identifying the value of an independently held company. In particular scenarios, reasonable market price (FMV) and reasonable worth analyses will result in considerably different conclusions and attorneys who are uninformed of the application of fair worth may encourage their clients to accept a value for their company interest far below what might be granted.


Definition of Value


In business appraisal, appraisers are most frequently engaged to determine worth under the reasonable market price standard. Fair market value (FMV) is defined by the American Society of Appraisers as:


"The price, revealed in regards to money equivalents, at which residential or commercial property would change hands between a theoretical willing and able purchaser and a hypothetical ready and able seller, acting at arm's length in an open and unrestricted market, when neither is under obsession to purchase or sell and when both have reasonable understanding of the appropriate truths."


Although FMV is the standard of value in a marital dissolution context in numerous states, in Washington, the reasonable value standard is utilized. Unlike FMV, there is no frequently accepted definition for reasonable value. In the AICPA's published SSVS,1 it is noted that, "for state legal matters only, some states have laws that utilize the term fair value in shareholder and partner matters. For state legal matters only, for that reason, the term may be defined by statute or case law in the particular jurisdiction."


In dissenter's rights actions in Washington State, courts determine the "fair value" of the shareholder's interest, rather than the "fair market value."2 In Washington, for the purpose of a shareholder oppression suit, it is agreed that "reasonable worth" does not consist of a discount for minority status.3


"Fair worth" is not synonymous with "fair market price."4 While FMV relates to identifying reasonable worth, the scenarios of a specific case are important to determining fair worth.


If the parties are getting separated and they own one hundred percent of a profitable enterprise, the application of reasonable value versus FMV will most often not enter play since the FMV of an one hundred percent ownership interest in a profitable business is frequently equal to reasonable value.


However, in certain cases, identification and recognition of the fair worth standard is crucial to reaching the correct value conclusion for the customer.


Example # 1: The Professional Practice


Let's return to the example of a partner's thriving psychology practice. Fair market worth (FMV) and fair worth analyses will lead to substantially various conclusions in this case.


In determining FMV, a lot of would concur that the "property method" to appraisal ought to be used, which assigns value to the concrete possessions minus liabilities. In this engagement, concrete possessions would consist of cash, balance due, and likely computer systems, desks, and furnishings, internet of liabilities. However, the worth would not consist of any intangible value, or "goodwill," for the basic reality that her patients and files are personal. It would break HIPAA5 and her ethical requirements to reveal this details; therefore, there is no open and unlimited market for selling it to a 3rd party. The presence of her above-benchmark level of payment develops that there is goodwill value, but under the FMV standard, there is no market for selling this goodwill.


In contrast, utilizing fair worth in the State of Washington, the court would likely designate value to the practice in the hands of its existing owners.6 A common approach for valuing expert goodwill is to establish market level compensation (replacement payment) and to the level that the owner/operator makes more than market level settlement, the distinction is capitalized to get to a worth conclusion.


The first step in this type of analysis is to develop the presence of goodwill. Goodwill is specified in the International Glossary of Business Valuation Terms as: "The intangible property that occurs as an outcome of name, reputation, client commitment, area, and comparable factors not independently determined."


The needs to develop that the owner of the professional practice is creating earnings at a level above his or her market level payment consistently with expectation that such earnings level is reasonably anticipated to continue in the future. Without the facility of professional goodwill, the value of the expert practice is the very same under the FMV and the fair worth requirement, using the asset approach (tangible properties minus liabilities).


Attorneys who are uninformed that worth can be designated to a non-saleable practice could potentially harm their customer by the extra legal costs associated with discussing the issue amongst evaluation specialists and possibly taking an unsupportable position all the method to trial.


Example # 2: The Minority Interest


As discussed, in a common reasonable value task, factor to consider is provided to the worth of a minority investor's ownership interest due to unreasonable or oppressive acts devoted by the bulk investor or investors. In this context, the concept of reasonable worth is that the minority investor has already been mistreated and is looking for remedy from the court. It would be "unreasonable" to further decrease the worth of this oppressed investor's shares for discount rates for lack of control and lack of marketability, having already suffered at the hands of the majority investor.


In a marital dissolution in Washington, picture performing an appraisal of a one-third interest in a moving company where the other 2 owners are unrelated organization partners. The determination of FMV of this one-third interest would need to consist of discounts for lack of control and lack of marketability, as it is typically accepted that the marketplace sees the value of a minority interest as less than the professional rata worth of the entire. If this one-third interest was not marked down, it would not represent the real worth to the marital estate. So, in this case, FMV and fair value would be the exact same.


Now consider that the subject one-third interest was slated to convert to a 52 percent interest in six months. Further, think of that the hubby and his company partners had signed sale arrangements 10 years previously that detailed that on this particular future date, the subject interest was going to convert to a bulk interest. In this situation, the value conclusion from a reasonable worth analysis will diverge from that of FMV.


The subject interest would nearly surely be incumbered by limitations on transfer, avoiding transfer to a 3rd party. Such limitations would safeguard the owners from having an unapproved celebration as a 3rd owner. With these restrictions on transfer, the FMV analysis would require to include the application of the discounts for absence of control and lack of marketability as is usually applied to minority interests.


However, the reasonable worth analysis would consider this future conversion to a bulk interest. The one-third interest, in the hands of the existing celebrations, will transform to a bulk interest in a reasonably short duration of time and for that reason, discounts for absence of control/marketability would not be applied.


In this case, the worst-case scenario would be that the better half employed a lawyer and an organization appraiser from out of state, both of whom were unaware of how to use fair value. The result would be that the lawyer would have advised the customer to accept the FMV decision of business interest, a quantity far listed below fair worth. It is more frequently the case that lawyers who do not have a grasp of the fair value concept will require to become educated on this concern, ultimately harming the client by the increased billings associated to investigating and comprehending its application.


Conclusion


In certain situations, fair worth, as utilized in marital dissolution cases in Washington, can diverge considerably from FMV. In order to best serve their customers, it is important that attorneys engage business valuation experts who are familiar with the suitable methodologies and factors to consider used by the courts in Washington.


Laura Markee, CFA, ASA is the owner of Markee Valuations LLC (markeevaluations.com). Over the previous twenty years, Ms. Markee has actually finished over 2,000 appraisals and has actually testified as an expert more than 35 times. Her firm of four full-time staff members carries out service evaluations for a variety of factors, consisting of marital dissolution, investor conflicts, gift and estate tax reporting, sale, and bank financing.


Laura can be gotten in touch with at 360 601 0713 or laura@markeevaluations.com.


1 Statement on Standards for Valuation Services: Valuation of an organization, company ownership Interest, Security, or intangible Asset (2007 )


2 Matthew G. Norton Co. v. Smyth, 112 Wn. App. 865, 873,51 P. 3d 159 (2002 ).


3 Robblee v. Robblee, 68 Wn. App. 69, 78-80, 81 P. 2d 1289 (1992 ).


4 Columbia Management Co. v. Wyss, 94 Or App 195, 202, 765 P2d 207 (1989 ), rev den 307 Or 571, 771 P2d 1021 (1989 ).


5 Health Insurance Portability and Accountability Act


6 Matter of Marriage of Fleege, 91 Wash. 2d 324, 588 P. 2d 1136 (1979 ).


This info is not planned nor ought to it be interpreted as legal or tax recommendations. You might wish to speak with other expert consultants relating to how this information relates to your personal circumstances.