Page 18 - Bankruptcy and Reorganization Services

The price at which the property would change hands between a willing buyer and a willing seller
when the former is not under any compulsion to buy and the latter is not under any compulsion
to sell, both parties having reasonable knowledge of relevant facts. fn 2

Fair market value is also defined by the International Glossary of Business Valuation Terms as

[T]he price, expressed in terms of cash equivalents, at which property would change hands be-
tween a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at
arm’s 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.

Most interpretations of fair market value acknowledge that the willing buyer and willing seller are hypo-
thetical persons who are dealing at arm’s length, rather than any particular buyer and seller. Further, the
definition implies that the parties have the ability and the willingness to buy or to sell. Finally, there is
also general agreement that fair market value incorporates prevailing economic and market conditions as
of the valuation date. fn 3

Fair value is described in VS section 100 as having two commonly used, but distinctly different, defini-
tions:

(1) For financial reporting purposes only, the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the measurement date.
Source: FASB Accounting Standards Codification glossary.

(2) For state legal matters only, some states have laws that use the term fair value in shareholder and
partner matters. For state legal matters only, therefore, the term may be defined by statute or case
law in the particular jurisdiction.

One common definition of fair value in the context of state legal matters is the pro rata share of the fair
market value of a business on a marketable controlling basis. In other words, fractional interests are not
discounted under this interpretation.

Investment value is defined in the International Glossary of Business Valuation Terms as "the value to a
particular investor based on individual investment requirements and expectations."

One challenging aspect of business valuation in bankruptcy engagements is that the legal terminology
describing the applicable standard of value is not clearly defined in the Bankruptcy Code or the applica-
ble state statutes. As a result, practitioners should consider relevant case law and work closely with ex-
perienced bankruptcy attorneys in determining its precise meanings.

Other standards of value commonly encountered in bankruptcy engagements, and the sources of those
standards of value, include the following:

fn 2 Also defined in IRC Section 25.2512-1 and Revenue Ruling 59-60.

fn 3 For additional commentary regarding fair market value, see Shannon P. Pratt and Alina V. Niculita, Valuing a Business: The
Analysis and Appraisal of Closely Held Companies, 5th ed. (New York: McGraw-Hill, 2008), 41–43.

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