The fair market value (FMV) is the current value of one share of a corporation’s common stock on the open market. Common stock simply refers to the security that represents ownership in a corporation which grants owners a claim to that company’s ongoing and future profits, which can also be bought or sold by stock traders.
Using a third-party appraiser to conduct a 409A valuation is the most common way to determine the FMV of a company’s stock. A 409A valuation is typically valid for one year as long as no material events occur that would alter the determination of an investment’s FMV.
The Board Rule and General Valuation Guidelines
In the absence of a third-party 409 valuation, the Board must use a reasonable valuation method that assesses all available information and relevant material to determine the FMV. According to the 409’s so-called Board Rule, the following factors must be considered:
- The value of the corporation’s tangible and intangible assets.
- The current value of anticipated future income and other potential avenues of cash-flow.
- The market value of stock or equity of other similar entities engaged in a substantially comparable trade or nearly interchangeable business—assuming such information is available and determined by objective and nondiscretionary means.
- The collection of recent transactions involving the sale or transfer of stock or equity interests.
- Any other factors that are deemed relevant, such as control premiums or discounts for the lack of marketability and whether the valuation method is used for other purposes that could have a measurable economic impact on the corporation, its stockholders, or its creditors.
When to Calculate a New FMV
It is also going to be important to consider any statements the company has made in regard to its value, including documents such as franchise taxes. In the event the FMV is determined using the Board Rule and the corporation receives financing at a higher valuation, then the Board will need to reevaluate the FMV.
Any other significant milestones for a company will also necessitate a new assessment of the FMV. For instance, signing a major contract, completing a substantial project, developing a new product, or issuing a patent would all necessitate a recalculation of the FMV.
How to Maintain a Current FMV
In order for the valuation to be recognized as reasonable, the corporation must be able to prove that it does not anticipate that the corporation will undergo any major change within 90 days following the valuation. Once the valuation is granted, corporations must also refrain from making a public offering of securities for 180 days to maintain the status of the current valuation according to the guidelines established in the Illiquid Start-up Corporation Stock Safe Harbor.
The Board Rule factors are not required to be written out in a report, but doing so will help prove the company’s intentions in case changes do arise that were unplanned for or in the event that a valuation is challenged for any reason. Hiring a professional to handle this report with at least five years of experience in business valuations or appraisals, financial accounting, investment banking, private equity, secured lending, or any other position with comparable experience in a relevant line of business will also support the validity of the valuation and will ensure that it is considered reasonable. If relying on the Illiquid Startup Inside Valuation option, the person compiling this report does not necessarily need to be independent from the company as long as the business has been operating for fewer than 10 years.