Fair value (FV)

What is fair value (FV)?

Fair value (FV) is the estimated price at which an asset could be sold, or a liability could be settled, in an open transaction between willing parties in the market, as of a specific date. FV is commonly used to determine the fair value price for shares of a company’s stock and other financial assets. 

Fair value vs. carry value

Fair value (FV) is a more dynamic measure influenced by market conditions. Carry value, on the other hand, is the historical cost of an asset adjusted for depreciation or amortization. While carry value is based on the original purchase price and is recorded on the balance sheet, fair value can differ significantly, especially if the market value of the asset has changed since it was acquired.

Fair value vs. market value

Fair value (FV) and market value are often used interchangeably, but they have distinct meanings. Market value specifically refers to the current price at which an asset is traded in the market. While market value is an observable price in an active market, fair value may incorporate additional considerations, especially when market data is not readily available or when valuing assets in less liquid markets.

How does fair value work for private companies?

Fair value falls under International Financial Reporting Standard 13 (IFRS 13) and is used for fair value measurement outside of the U.S.

The FV represents what a single share of stock would be worth on the open market. To determine the FV of most public company stock, you can go online and quickly see the price of shares. This value is influenced by financial and economic factors such as the company’s earnings, comparative market analysis, and other market conditions.

However, publicly accessible FV isn’t possible with private companies. Private companies can determine their common stock’s fair value with a 409A valuation or an IFRS 13 valuation report through a third party provider. 

This type of valuation is not the same as a post-money valuation, which is the market value for the entire company usually negotiated with investors when raising funds.

Why fair value matters

Fair value influences so much within a company, most crucially, taxes, tax authorities, and financial reporting for audit purposes.

When establishing FV, third-party appraisers are obligated to come up with a number that is, in fact, fair. While you and your shareholders may see certain benefits from a lower FV, your auditors or tax authorities may reject valuations it finds “grossly unreasonable.”

How to calculate FV

The FV evaluation method depends on the accounting methodologies that your country of operations adopts.

FVs by independent appraisers are the widely accepted way to determine the current fair value of a private company’s common stock. FV influences the price employees, contractors, and other common stock option recipients must pay to exercise their stock options (also known as the strike price). The strike price is typically greater than or equal to the FV stated in the valuation report

What factors can affect the FV?

IFRS 13 introduces a fair value hierarchy that categorizes inputs to valuation technique into three levels:

• Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.

• Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.

• Level 3: Unobservable inputs for the asset or liability, typically used when relevant observable inputs are not available.In most cases Level 3 inputs are required to determine FV. 

As such, when valuing your company, FV providers look at a few different factors:

• How much your tangible assets are worth - Level 3 input

• The present value of your future cash flows - Level 3 input

• The trading multiples of similar (comparable) companies - Level 2 input

• How much equity your company has in other similar businesses or industries - Level 3 input

Companies need a new FV every year, or each time a material event (such as a new funding round, acquisition, or merger) occurs.

Using the factors listed above, the resulting FV is used to set the purchase price for stock options (exercise price).

Can a IFRS 13 report be used for 409A?

While IFRS 13 and 409A serve different regulatory purposes and have different requirements, there are circumstances where an IFRS 13 valuation can be useful for 409A valuation. 

Methodological overlap:

• Both standards often employ similar valuation methodologies (e.g., discounted cash flow analysis, comparable company analysis, and market approaches).

• A robust IFRS 13 valuation might incorporate comprehensive market data and inputs that could also be relevant for a 409A valuation.

Documentation and support:

• An IFRS 13 valuation typically includes detailed documentation and rationale for the chosen valuation methods and assumptions.

• This documentation can support the "reasonable" and "in good faith" standard required by 409A, particularly if it aligns with IRS guidelines.

Consistency:

• Using a single valuation framework can ensure consistency across financial reporting and tax compliance, reducing the risk of discrepancies.