Selling common stock is a vital way for private companies to scale. Fair market value (FMV) is a metric that helps founders and other company leaders sell their shares.
Shares of your company can be used for various purposes: in exchange for capital in equity financing, as a recruiting tool for new employees, and as an incentive for loyal team members. But how do these parties know what their shares are worth?
If you’re running a publicly traded company, it’s easy to find share value via the company’s ticker on the stock exchange. Private companies naturally don’t have the same luxury. Fair market value assigns value to your shares so that everyone — investors, employees, advisors — can operate with a mutual understanding of their shares’ worth.
How do you calculate FMV? Why is it important for growing companies? Where can you go to value your shares?
Read on to answer all of your questions on fair market value:
What is fair market value (FMV)?
The fair market value of a private company’s stock is the predicted value of one share of your company if your stock was available on the open market.
Private companies, by definition, don’t sell their shares on the stock market. Fair market value assigns worth to the shares of private companies so that everyone can operate on a level playing field. It’s often helpful to think of FMV as the private company’s version of the number next to a stock ticker.
In a more general sense, fair market value can refer to the sale price of an asset during a transaction — as long as those two parties are aware of the terms and acting in mutual best interests. But if you see FMV in relation to a private company’s stock, the definition above is a better fit.
Why is fair market value important for my company?
Determining fair market value is an essential step towards:
- Understanding the value of your company
- Securing equity financing from an investor or VC
- Giving current and prospective employees insight into their equity compensation plans
Public companies are constantly reminded of their shares’ value through activity in the stock market. Private companies need their own form of transparent valuation.
Investors will need to see FMV in order to structure the terms of their equity financing deals (i.e how much capital they’ll offer, how many shares they’ll request). Employees and candidates, on the other hand, must know the fair market value of their shares to understand the total value of their compensation packages.
Similar terms and how they’re different
Fair market value is often confused with a few similar terms. Here’s how to distinguish between them:
Market value often refers to open-market valuation (OMV), which is the price at which an asset can be sold on the open marketplace. This differs from FMV because it can apply to assets already available on the open market, such as publicly traded stocks. Sometimes, market value refers to the total value of a company (i.e all the shares combined).
Unlike FMV, fair value takes into consideration more than just the predicted value of shares on an open market—it also accounts for certain adjustments in fairness to both the company and its prospective investors. Fair value considers both fair market value and additional factors, such as the interest rate and the grant’s expected volatility.
Par value is the lowest amount for which a share of stock can be sold by your company, according to applicable state law. This value is listed in your Certificate of Incorporation.
How to calculate fair market value with a 409A Valuation
Now that you know why fair market value is important — and how it’s different from similar terms — how do you actually calculate it?
The answer: generate a 409A valuation report.
The name 409A comes from Section 409A of the Internal Revenue Code, which requires your company’s board to employ a “reasonable valuation method” to establish the fair market value of your shares.
A common method of meeting IRC 409A requirements is generating a 409A valuation report, in which the company pays for an external valuation expert to prepare and sign a detailed report, and the board approves a resolution to adopt the FMV established within it.
External evaluators will consider the value of company assets, company income, and comparable companies. Founders and company leaders should expect to have their capitalization table, term sheets, articles of incorporation, financial projections, and any past 409A reports readily available as inputs into the valuation process.
How can I find the fair market value of my company’s stock?
Preparing for equity financing? Establishing fair market value begins with a 409A valuation you can trust.
Fidelity provides fast, accurate and competitively-priced 409A valuations for growing companies. We work with independent 409A evaluators to provide reports. Our automated equity financing software helps reduce the time needed to require all the required documentation.
Other 409A valuation providers use automated “plug-in-play” models for fast delivery of reports. This is risky and often leads to overvalued shares or non-compliant report additions that can deter future investors. Fidelity is different; our team of experts is here to support you and avoid costly mistakes.
Generating fair market value is an exciting step for your company. Make sure you do it right to set yourself up for future success.
Looking for a fast, accurate, and competitively priced 409A valuation to establish fair market value? Reach out to the Fidelity team for a simple and quick 409A process with expert support.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.