A share of a company is a unit of ownership of the company, thus giving the shareholder rights over the company holdings, business profits and a say in decision-making. To raise capital for expansion, growth, or the performance of a business, companies issue shares, giving investors ownership and the likelihood of returns in the form of dividends or capital appreciation. Shares are commonly categorised into equity shares and preference shares, with each carrying different rights and benefits. Public companies list their shares on stock exchanges, unlike private companies, which transfer shares by mutual agreement. Shares are the core of business finance and the main concern of investors involved in companies.
What is Fair Market Value of a Share?
The Fair Market Value (FMV) of a share is the price at which a share of a company would be exchanged between a buyer-seller party in an open and free market where the two parties have fair knowledge of the pertinent facts and are not obligated to enter into the contracts.
FMV is an indicator of the “true value” of a share, irrespective of emotional or other effects. It is different from book value or price at the issuance and is rather an estimate based on commonly accepted valuation techniques like Discounted Cash Flow (DCF), Comparable Company Analysis, or Net Asset Value (NAV).
FMV serves a crucial function in taxation (for example, stock transfer income tax, Employee Stock Ownership Plans or ESOPs), mergers and acquisitions, investment decisions, and compliance with regulatory requirements. As private businesses do not have a listing on a stock exchange, then FMV has to be established by experts in valuation who make use of financial projections, asset appreciations, revenue-generating capability, and existing market conditions. FMV thus provides that share values are fair, clear, and accurate.
Calculation of FMV of a Company Share
1. Decisions at the Top Level: What Valuation Approach to Choose?
There are three main categories of techniques; select the one that best fits the type of business and the reason for the valuation:
- The market (relative) approach is applicable to publicly listed companies or works with good comparables. Typical metrics are P/E, EV/EBITDA, and EV/Sales. Use peer multiples to your company’s measurement to get inferred Enterprise Value (EV), and then deduct net debt from equity value to get per-share value.
- The income approach is appropriate for companies that have stable cash flows. Discounted Cash Flow (DCF) is the most commonly used approach, which discounts future cash flows to their current value. The Dividend Discount Model is also an approach used to generate income.
- The Asset (Cost) approach is used where asset values are the dominant drivers of value, e.g., in investment and property businesses or in liquidation scenarios. As an approach to estimating equity value, value assets at fair market value (replacement) and deduct liabilities.
If the firm is early-stage/startup and has variable cash flows, practitioners can also use:
- Option-pricing and back-solving are popular techniques to allocate pre-money among multiple share classes or for 409A in the US.
- Scenario-probability or scenario-based returns. (The choice depends on the data available and the goal.)
In India, valuation professionals follow ICAI/IBBI guidelines and standards.
2. DCF is the Most Instructive Income Strategy
Use DCF when you can sensibly forecast cash flows.
Inputs needed:
- Projected financial flows (Free Cash Flow to Firm or Equity).
- Discount rate (WACC when applying FCFF and cost of equity when applying FCFE).
- Terminal value assumptions (e.g., growth or exit multiple).
- Net debt to adjust EV to equity.
- Outstanding shares (to calculate per-share value).
3. Comparable Company Analysis Method (Practical Process)
- Select 4-12 listed peer companies of similar industry, size, growth, profit margins, and geographical location.
- Determine the multiples of the peer companies (EV/EBITDA, EV/Revenue, and P/E). Apply the median or trimmed mean for accuracy.
- Apply the derived multiple to your company’s normalized values (such as EBITDA, revenue, or EPS) to derive the implied enterprise value or equity value.
- Make adjustments for differences in growth rates, margins, and liquidity, and convert the implied equity value to a per-share basis.
Advantages: It is quick and market fact-based.
Disadvantages: Access to suitable comparables needs to be available and it involves the necessity of adjustments for differences like illiquidity and control.
4. Asset-Based Valuation Method (Net Asset Value/NAV)
- Redefine the balance sheet items to their fair market value (such as land, intangible assets, and working capital), then deduct liabilities to get the value of equity.
- It is appropriate for companies that have substantial assets or liquidation cases, but not appropriate for companies with high-growth intangible assets.
5. Adjustment and Discount Considerations
- Unlisted shares tend to carry a material discount due to lack of marketability (DLOM), supported by empirical observations.
- Tradable minority shares usually trade at a discount relative to control interests.
- Model item-specifically the features of share classes (e.g., convertible securities, liquidation preferences, and anti-dilution protection) to accurately capture their impact on per-share fair market value (FMV) using waterfall analysis.
- Choose a particular date of valuation (FMV relies on a particular date) and take into account the taxes and transaction costs.
ICAI/IBBI professional valuation guidance puts a strong focus on transparency in changes and heavy documentation.
Limitations in FMV Determination
FMV is not a definite value, but an estimated range based on assumptions, methods, and market conditions.
1. Subjectivity of Valuation Approaches
Varying methods (DCF, comparables, net asset-based) may give differing results for the same entity. An explosive startup with high DCF can have a lower FMV based on the net assets. The “fair” value will often be a function of the approach used, along with the specific application.
2. Uncertainty of Forecasting
DCF is heavily reliant on projections for growth, margins, costs, and revenue. Small variations in assumptions can have a big impact on FMV. Predictions made for longer terms (5-10 years) are uncertain because they are subject to fluctuating market conditions, competitive rates, governing laws and technology. The valuation is no stronger than the projections behind it.
3. Choice of Discount Rate/Multiples
The discount rate (WACC or cost of equity) in DCF is judgment-based. In comparison, the peer group and selected multiple (P/E, EV/EBITDA) can notably affect the result. A 1 to 2 percent variation in discount rate or a different peer group may lead to a value change of 20-30%.
4. Marketability and Liquidity Concerns
FMV presumes a free and liquid market. But private company shares are not liquid since it has no existing active trading market.•Discounts for lack of marketability (DLOM) are used by valuers, but their magnitude is very subjective. No perfect formula exists, and many experts can justify very different discounts.
5. Minority versus Control Rights
FMV varies for a controlling right against a minority fraction share. Applying control premiums or minority discounts introduces subjectivity. Buyers and sellers may disagree about the inclusion of control rights in valuation.
6. Market Conditions Outside
Market trend, market outlook, macroeconomic indicators like interest rates, inflation, and the demand-supply impact the fair market value (FMV). The FMV of the same firm may be very different between a bull market and a recession. Valuation can change depending upon market timing, even if the underlying fundamentals haven’t changed much.
7. Brand Value and Intangible Assets
Intangibles like brand name, goodwill, customer loyalty, patents, and confidential knowledge are difficult to measure. Several methods and approaches to valuing intangibles (e.g., royalty relief, cost approach) provide varying results. Such variability makes FMV less accurate for businesses that rely extensively on intangibles.
8. Information Asymmetry
FMV presumes buyers and sellers have “reasonable knowledge.” But one of them may be privy to other data (e.g., insider information). Inadequate or slanted financial disclosures, especially in private enterprises, may misstate the fair market value (FMV).
9. Regulatory and Legal Variations
Jurisdictions like India’s Income Tax Act, FEMA, and Companies Act may have different standards and techniques for ascertaining fair market value (FMV). It leads to several “FMVs” based on taxation, ESOP, or cross-border transactions.
10. Dynamic Business Models
Startups and budding companies often experience frequent changes in their business models by switching from one product to another. FMV analyses based on assumptions which become outdated in no time.
11. Behavioural and Negotiation Factors
Bargaining power, urgency (where there is distressed selling), and strategic factors (synergies, expansion plans) can affect fair market value (FMV). The buyers may pay a premium above FMV (a “strategic premium”), and sellers may agree on a price below FMV (because of an emergency need for funds). The transaction price can differ from the theoretical fair market value.
Conclusion
Fair Market Value (FMV) of a share is the most appropriate means of determining the actual value of ownership in a corporation. It encompasses the performance of finance, market forces, and valuation methods to provide a practical number accepted by both buyers and sellers. While there exist certain assumptions and constraints underlying FMV, it promotes compliance, transparency, and well-informed decision-making and hence becomes a key tool in taxation, investments, corporate transactions, and the regulatory regime that underpins stock valuations.
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