The issue of valuing a business in a divorce case can be expensive and emotionally draining on the contestants. This is even more so when each side has adopted positions that are beyond reason. It often seems that the departing spouse (the one that will not stay with and run the business) has reasons why the business is deemed so valuable and the retaining spouse often advances reasons why the business is not worth very much. The definition of “fair market value” gets rather clouded by the emotions of the parties involved in a divorce action. Hence, this article will briefly highlight some of the intricacies of the term fair market value.
Fair market value is actually a standard of value. (Other standards of value are fair value, investment value and intrinsic value.) A Glossary of Terms was jointly developed by representatives of the American Institute of CPAs, the American Society of Appraisers, the Canadian Institute of Business Appraisers, the Institute of Business Appraisers, and the National Association of Certified Valuation Analysts. According to that Glossary of Terms, the definition of the term fair market value is as follows.
The price, expressed in terms of cash equivalents, at which a property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy nor to sell, and when both have reasonable knowledge of the relevant facts.
The concept of fair market value is, therefore, a concept of price range, with the fair market value falling somewhere within a range of prices. The low end of the range is the lowest price that a willing seller, who is seeking the highest price, would accept and still enter into the transaction. The high end of the range is the maximum price that a willing buyer, who is seeking the lowest price, will pay and still consummate the deal.
True fair market value can only be determined by the ultimate sale of a subject property on the open market. However, in divorce cases, an actual sale of the business interests is not contemplated and will not occur. Therefore, in analyzing the business and calculating values, the positions of the hypothetical seller and the hypothetical buyer must be considered.
In divorce cases, while each party might seem to have arguments with merit, it is extremely important to understand the requirements of the Fair Market Value standard, as stated above. That is, regardless of the emotional arguments that might be espoused by each contestant in a divorce case, a business valuator must consider what a real seller or real buyer might do or consider in a real transaction or sale of the subject business. Therefore, a seasoned business valuator must stick close to the basic requirements imposed by the standard of fair market value.
According to Dr. Shannon Pratt, “the real world leans much more toward the buyer’s perspective than the seller’s. So do the divorce courts. Fair market value is based largely on what is there now, as opposed to what might be there sometime after a lot of changes are made to the business. Would-be sellers are misled when they think they should be paid now for what the business may be worth after the buyer brings his own magic show to the party.” A seasoned business valuator should be able to bring reason into divorce business valuation situations. That sense of reason can often assist the parties in settling property division issues rather than depending upon the courts to do so. In the event that a trier of fact must become involved, the business valuator can provide great assistance in determining if the valuation requirements, as set forth in the standard of value, have been met.
David Singal is a CPA, CVA, and director of the business valuation department at Graber & Associates. He has performed valuations for Estate & Gift Tax, Marital Dissolution, IRS Offer in Compromise, and Litigation purposes.