Background. You know that in January 2009, after an on-air argument between Paul Sr. and Paul Jr., Senior fired Junior. To avoid a breach of agreement with the Discovery channel, owner of The Learning Channel, Teutul son and father signed a letter of agreement by which: “Junior shall extend to Senior, upon Senior’s request, an option to purchase all of his shares in Orange County Choppers Holdings, Inc. for fair market value as determined by a procedure to be agreed to by the parties as soon as practicable.”
In November 09, Paul Senior tried to exercise this option, but Junior refused under the argument that the language of the January 2009 letter lacked essential terms concerning the appraisal process and was merely an unenforceable “agreement to agree.” The legal battle continues with Paul Senior asking Junior to turn over all his shares of OCC for an amount of $0.00. You asked ZERO dollar? How come can it be the value of Orange County Choppers? Richard Gray, a friend of a friend, CPA/ABV, CVA, ASA at Alpern Rosenthal an accounting firm in West Palm Beach, Florida explains for you what is fair value of a business. An interesting read, especially to all those of you owning a business.
What Is Fair Value?
In performing a valuation of a business the starting point is identifying and defining the standard of value that will apply based on the facts and circumstances surrounding the engagement. Common standards of value include fair market value, investment value, intrinsic value and fair value.
Fair value is used for a number of purposes. It can be the legal standard of value in dissenting shareholder cases in some states. It is the core standard of value used in the preparation of a fairness opinion. It is also the standard of value used for the valuation of assets for financial reporting purposes.
Dissenting shareholder / oppression cases
Fair value is commonly used in dissenting shareholder litigation. As a judicially mandated concept, it is subject to court interpretation and varies from state to state. Although the standard of fair value has not been not clearly defined in the past, more recently it has been established as the value of shares on a pro rata enterprise basis. However, this can be more than simply, “fair market value without the discounts”.
The definition of fair value differs from fair market value. A fair market value valuation is the price at which a business would change hands between a willing buyer and willing seller both knowledgeable about the relevant facts. In dissenting shareholder cases, fair value is generally defined as the value of the shares as of the day immediately preceding the corporate action leading to the dissent. Fair value is intended to estimate a fair and reasonable amount. It is not intended to represent a market transaction price. Some states allow discounts in computing fair value while others do not.
In determining fair value for a dissenting shareholder action, it is important to analyze the specific facts and circumstances of the situation and understand the appropriate statutes and case law of the jurisdiction.
A fairness opinion is a formal review that assesses whether a transaction is fair to shareholders from a financial point of view. It is often used in a corporate merger or acquisition to support the suitability of the acquisition price. Fairness opinions are designed to protect the interests of minority shareholders. The key to the fairness opinion is a valuation of the business. As noted, fair value is often the standard of value used in fairness opinions.
As the reporting on financial statements under generally accepted accounting principles moves away from historical cost accounting and toward fair value, the fair value measurement principles in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures have created yet another definition. The FASB ASC 820 incorporates SFAS No. 157 and 159 and states that fair value is ”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.”
Fair value is the standard of value required under the FASB ASC pronouncement for both financial and non-financial assets. With respect to the measurement of fair value, fair value should be based on the assumptions that market participants would use when pricing the asset. Market participants are buyers and sellers in the market who are independent, knowledgeable and able and willing to transact in the market.
To summarize, the definition of the fair value standard is highly dependent on the purpose of the valuation and the facts and circumstances of the particular valuation engagement. Due to this complexity, it is important to consult with an engage a qualified valuation professional. Richard Gray, CPA/ABV, CVA, ASA firstname.lastname@example.org