Definition and Calculation of Fair Market Value (FMV)

Fair Market Value (FMV) is the estimated price at which a share of a company would be bought or sold in an open market.

For publicly traded stocks, FMV is easy to determine because you can look up the stock price online. This price reflects real-time market conditions, including the company’s financial performance, economic trends, and investor sentiment.

However, private companies must determine FMV through a formal valuation process like 409A valuation.

Note: A 409A valuation determines the FMV of a company’s common stock, which is typically lower than the company’s post-money valuation. This is because venture valuations reflect the price investors pay for preferred stock, which comes with rights and privileges like liquidation preferences and participation rights.

What is Fair Market Value (FMV) for stocks?

For companies issuing stock-based compensation, FMV is used to set the exercise (strike) price for stock options and determine the value of restricted stock units (RSUs) at the time of grant and vesting.

While FMV is used for setting prices in stock-based compensation, the expense associated with these compensation methods is based on the fair value of the options. Fair value, which differs from FMV, accounts for factors like time, volatility, and interest rates. This is typically determined using models such as the black-scholes model or other option pricing methods.

How to calculate Fair Market Value (FMV)?

For companies that need to determine FMV for stock-based compensation, a 409A valuation (or an equivalent valuation process in different jurisdictions) is used. 

This is an independent appraisal that determines the FMV of common stock using different valuation approaches:

• Market approach – compares the company to similar businesses.
• Income approach – projects future earnings and discounts them to present value using discounted cash flow method.
• Asset approach – calculates the value of the company’s assets.

Since a 409A valuation determines the FMV of common stock, it must account for the fact that preferred stockholders have higher claims on the company's value than common stockholders. To do this, valuation experts often use the Option Pricing Model (OPM) as part of the 409A valuation process.

These models help split the company’s total value fairly between preferred and common stock based on their rights and privileges.

Difference between Fair Market Value (FMV) and Fair Value (FV)

On a 409A valuation, you’ll see two key terms: Fair Market Value (FMV) and Fair Value (FV).

FMV is the price at which an employee exercises the stock options while FV is used for financial reporting.

Imagine a company values its common stock at $10 per share in its 409A valuation. This is the FMV. When employees receive stock options, the company must also calculate FV for accounting. Using black-scholes, it might determine that the FV of those options is $15 per share, due to additional factors like stock price fluctuations. While FMV affects how much employees pay to exercise options, FV affects how much the company reports as an expense on its financial statements.

‍FAQs

1. What is Fair Market Value (FMV)?

For stocks, FMV represents the price at which a share could be sold in an open market. Public companies determine FMV based on their stock’s market price. Private companies, however, must conduct formal valuations, such as a 409A valuation, to establish FMV.

2. How is Fair Market Value (FMV) different from market price?

FMV is an estimate of what an asset would sell for in an open market, while market price is the actual price at which it is bought or sold. 

3. What are the most common methods to calculate FMV?

FMV is typically determined using three main approaches:

• Market approach – Values the company by comparing it to similar businesses.
• Income approach – Estimates value based on the company’s expected future earnings, often using discounted cash flow analysis.‍
• Asset approach – Determines value by assessing the company’s net assets, considering their cost and depreciation.