Fair market value of a business: what it means and how it differs
Short answer
Fair market value is, in the words of the Treasury estate tax regulation, "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." It assumes a hypothetical buyer, not a particular one. That's different from investment value (worth to a specific buyer, including their synergies) and fair value (an accounting or state-law standard).
Standards of value compared
| Standard | Whose view | Synergies? | Typical use |
|---|---|---|---|
| Fair market value | Hypothetical willing buyer and seller | No buyer-specific synergies | Tax, SBA lending, 409A, ESOP |
| Investment value | A specific buyer | Yes, theirs | Deciding what you'd pay |
| Fair value (accounting) | Market participants, exit price | Market-participant synergies only | Financial reporting, ASC 805 |
| Fair value (state law) | Defined by statute and courts | Varies | Dissenting shareholder, oppression cases |
Where fair market value comes from
The willing buyer and willing seller wording is a Treasury estate tax regulation, but it has become the common language of small business valuation, including for lending. The IRS's long-standing Revenue Ruling 59-60 on valuing closely held stock lists factors still used today: the nature and history of the business, the economic and industry outlook, book value and financial condition, earning capacity, dividend-paying capacity, goodwill or other intangible value, prior sales of the stock, and the market price of comparable public companies. A good SBA valuation report touches each of them, even if briefly, because together they describe what an informed hypothetical buyer would weigh.
A report that ignores one of those factors without saying why, for example a valuation that never discusses the industry outlook for a business in a shrinking market, is weaker evidence of fair market value than one that addresses each and explains how much weight it got.
Why it matters for lenders
A buyer who already owns a competitor may justify a higher price from cost savings. But the lender's guaranty depends on value any reasonable buyer would pay, because that's what the business would fetch if it had to be sold. SBA's rule follows: the valuation must support the Business Purchase Price, or the difference must come from equity. See M&A valuation and synergies.
The hypothetical buyer, in practice
"Willing buyer and willing seller, neither under compulsion, both with reasonable knowledge" sounds abstract, but it drives concrete choices in a report:
- No forced sale: the value isn't what a desperate seller would accept or a fire-sale auction would bring.
- No special buyer: a competitor's cost savings, or a family member's sentimental premium, are left out.
- Reasonable knowledge: the value reflects what diligence would reveal, including problems the seller would rather not mention.
- Normal financing: the value doesn't assume unusually generous seller terms.
Fair market value across OKtoLend's work
| Engagement | Standard used | Source of the rule |
|---|---|---|
| SBA acquisition valuation | Typically fair market value (SBA doesn't specify) | SOP 50 10 8.1 requires a conclusion of value supporting the price |
| 409A | Fair market value of the underlying stock on the grant date | Treas. Reg. 1.409A-1(b)(5) |
| Purchase price allocation (tax) | Fair market value of each asset class; residual to goodwill | Section 1060; Form 8594 instructions |
| Purchase price allocation (book) | Fair value under ASC 805 | Accounting standards |
| ESOP | Adequate consideration: fair market value determined in good faith by the trustee | ERISA |
Note the Form 8594 instructions' own definition: fair market value is the gross value unreduced by mortgages, liens, pledges or other liabilities, which is why an asset allocation can exceed the equity a buyer actually pays for.
For buyers, the practical takeaway is that a price justified only by your own plans is investment value. Finance the fair market value; pay for your plans with your own money.
Lenders, meanwhile, should read any valuation's standard-of-value statement first; if it says investment value, it's answering a different question from the one the loan file needs answered.
Related: valuation discounts and fair market value under 409A.
Discounts for lack of control and marketability
Valuation discounts adjust value for the rights an interest lacks. A discount for lack of control (DLOC) reflects that a minority owner can't set pay, dividends or strategy. A discount for lack of marketability (DLOM) reflects that a private interest can't be sold quickly for cash. They matter for minority stakes, gifts, estates and 409A. Most SBA acquisitions buy 100% control, so a control discount generally doesn't apply.
Illustration, not a real deal. A 30% interest in a company worth $2,000,000 on a 100% control basis.
| Pro rata value (30% x $2,000,000) | $600,000 |
| Less DLOC 20% ($600,000 x 0.20) | -$120,000 |
| Minority marketable value | $480,000 |
| Less DLOM 25% ($480,000 x 0.25) | -$120,000 |
| Value of the 30% interest | $360,000 |
Where each applies
| Situation | DLOC | DLOM |
|---|---|---|
| SBA purchase of 100% of a business | Generally no | Usually reflected in the discount rate, if at all |
| Gift or estate of a minority stake | Often | Often |
| 409A common stock | Sometimes | Commonly |
| Buy-sell agreement | Per the agreement | Per the agreement |
How appraisers support a discount
Discounts are where valuations most often get challenged, because a few percentage points move value a lot. A supported discount rests on evidence about the specific interest rather than a rule of thumb:
- For lack of control: what the interest can and can't do under the operating agreement or bylaws; whether the controlling owner takes above-market pay or blocks distributions; voting rights and board seats.
- For lack of marketability: transfer restrictions, rights of first refusal, the expected holding period, the company's distribution history, and the size of the pool of likely buyers.
Appraisers draw on empirical studies of restricted stock and pre-IPO transactions, and on option-based models, then adjust for the facts. A report that applies "the usual 30%" without tying it to the interest's actual rights is easy to attack.
Discounts and SBA deals
SBA acquisition loans usually finance a buyer purchasing the whole business, so the valuation is on a controlling basis. Discounts become relevant when the transaction is a partial change of ownership or an owner buyout of a minority partner. In a partner buyout, for example, the remaining owner is buying out a minority stake. Whether that stake should be valued with a minority discount, or pro rata as part of a 100% value, often depends on the buy-sell agreement, which may specify the method. The valuation should state its basis and why, and the lender should check it matches the agreement. See SBA partner buyout loans.
Illustration, not a real deal. Two equal partners own a $1,600,000 business. One buys the other out with an SBA loan. If the buy-sell agreement says the price is a pro rata share of total value, the stake is worth $800,000. If it says fair market value of the interest, an appraiser might apply a 15% discount for lack of control and 20% for marketability: $800,000 x 0.85 x 0.80 = $544,000. The $256,000 difference is why the agreement, not the appraiser's preference, should decide the basis.
Tax and 409A uses
Gifts and estates of minority interests in family businesses are where discounts get the most IRS attention; the IRS business valuation guidelines list control and marketability among the factors its own appraisers consider. In 409A work, the regulation lists control premiums and discounts for lack of marketability among relevant factors, and common stock valuations usually include a marketability discount.
Questions to ask about any discount
- What rights does this specific interest have under the governing documents?
- What evidence supports the percentage, and how was it adjusted for this company?
- Has the same effect been counted twice, for example in both a higher discount rate and a separate marketability discount?
- Does the agreement governing the transaction specify how the interest must be valued?
Double counting is the quiet error: if the discount rate already includes a premium for illiquidity, adding a full marketability discount on top penalizes the same risk twice.
See also private company valuation for how level of value fits into the wider analysis.
Not tax or legal advice; discounts for tax filings deserve a qualified appraiser and an adviser.
Common questions
Which standard does an SBA valuation use?
SBA doesn't define one in the SOP; appraisers commonly use fair market value, which excludes buyer-specific synergies.
Is the purchase price the fair market value?
Not necessarily. A particular buyer may pay more for synergies. If the price exceeds the valuation on an SBA deal, the excess must be covered by equity.
Where is Revenue Ruling 59-60 relevant?
It's the long-standing IRS ruling on valuing closely held stock for tax purposes, listing factors appraisers still consider.
Do discounts apply under fair market value?
They can, for minority or non-marketable interests, because a hypothetical buyer would pay less for an interest without control or liquidity.
Is an asking price evidence of fair market value?
Not much. An asking price is a seller's opening position. Completed sales of comparable businesses, with verified terms, are much better evidence.
Related guides
Sources
This guide explains rules and practice in plain English. It isn't legal, tax or credit advice, and SBA and IRS rules change. Check the current SOP, regulations and your lender's requirements before you rely on anything here. Examples with made-up businesses are illustrations, not real deals.