There are two main ways to determine a company’s value – fair market value and strategic value. Both strategic and fair market value determine a company’s value, just based on different factors and criteria. Both strategies require willing buyers and sellers, but the methods have different meanings beyond that.
You might wonder why there would be two ways to value a company, but it all comes down to what you’re trying to measure. One determines the company’s overall value regardless of the intended buyer, while the other is based on a specific buyer or group of buyers and their criteria. In other words- what they hope to benefit from buying the company.
Fair Market Value And Strategic Value Differences
When evaluating fair market value vs. strategic value, you must understand the varying factors that determine it.
Fair Market Value
Fair market value or FMV is the overall price a company would sell for with a willing buyer and willing seller. There aren’t any other specifics taken into account. It’s just a generalization of a company’s worth as-is.
In both cases, the transaction is willing, not forced, and both understand the transaction’s facts. The fair market value FMV, though, does not consider any values a particular investor would gain by buying the business.
Fair market value is often used for tax purposes and sometimes even litigation situations such as divorce. Some business owners also use fair market value as a baseline to see what it may be worth when contemplating selling their business, as the strategic value, also known as investment value, is often a better option since it considers the value a particular buyer may gain.
Fair Market Valuation Example
In the fair market valuation process, there are a lot of assumptions as opposed to specific scenarios. The fair market value definition states that the sale is conducted by both a willing buyer and seller, but other assumptions include:
- The sale is an arm’s length transaction, meaning the two parties doing business are not affiliated with one another and are acting in self-interest.
- Both the buyer and seller are rational investors.
- Both buyers and sellers look at the economic and financial factors in the transaction.
- The buyer is not a strategic buyer but instead focuses on the potential return.
In strategic value, the value has the potential to be much higher as it’s based on a specific buyer and the benefits they could earn from it. As a result, sellers can often get more for their business when using the strategic value standard.
It’s based on the combined value of what the business is worth as is- a single, independent entity and the value buyers stand to achieve by absorbing the business and combining it with their current company.
Other assumptions and considerations made with this method include:
- Cash flow
- Expected return
- Financing capabilities of the buyer
- Business benefits
- Intangible benefits
Strategic Valuation Example
Absorbing another company has its advantages, and while the synergies for every company differ when acquiring a new company, here are some things to consider:
- Lower cost of sales
- Lower cost of labor
- Lower rent
- Higher revenues
These are just a few examples of how a company could benefit from buying another in terms of investment value.
Fair Market Value vs. Strategic Value: Similarities
- Valuators assess the assets objectively. Both are considered when buying and selling.
- Both strategies assume that informed and educated buyers with reasonable knowledge are involved in the transaction.
- Fair market value and strategic value both achieve desired results for buyers and sellers.
Fair Market Value vs. Strategic Value: Differences
- Fair market value considers hypothetical buyers and sellers, but strategic value uses a specific buyer.
- Strategic value can be much higher than fair market value because fair market value uses generalizations versus specific buyers.
- Strategic value strongly considers any synergies that could affect the benefits a buyer could gain.
Frequently Asked Questions
What Is Synergy?
Synergy is defined as “the interaction or cooperation of two or more organizations, substances, or other agents to produce a combined effect greater than the sum of their separate effects.”
When discussing strategic value, synergy is an added bonus for buyers as it often enables them to lower costs, bring in more profits, and streamline processes. But, of course, it’s important to keep in mind that no two mergers’ results are identical.
What Does Extrinsic and Intrinsic Value Mean?
Intrinsic value is the value an asset has on its own. It’s based on an objective calculation and isn’t the asset’s current market value. Extrinsic value is the difference between an asset’s market value and its intrinsic value.
How Do I Increase the FMV of My Assets?
You can’t increase the fair market value of your assets. It’s based on the going rate in the market. When you sell an asset, the best thing you can do is to time it right. See what the market value is at the time before selling, trying to get as much as you can for your asset.
It’s always best to get educated and neutral opinions of business appraisers and their valuation methodologies to determine a company’s value, whether fair market or strategic value. While strategic value is usually a higher value, it’s not always the best way to value an asset based on the circumstances.