Equitable Value vs. Fair Market Value: Key Differences
An asset's value isn't just its market price. Learn how context and the goal of fairness can result in a different valuation for specific parties.
In the financial and legal worlds, the concept of “value” changes based on context. While many are familiar with market price, a different standard known as equitable value is applied in specific legal proceedings, focusing on fairness between the parties in a dispute. Understanding this concept is important because it directly impacts the division of assets in sensitive situations. The determination of equitable value considers the unique circumstances and relationships between the individuals involved.
Understanding Equitable Value vs Fair Market Value
Fair Market Value (FMV) is the price at which property would change hands between a willing buyer and a seller, where neither is under compulsion to act and both have reasonable knowledge of relevant facts. It represents an objective, arm’s-length transaction in an open market. This standard is the basis for many financial and tax-related valuations, from real estate appraisals to stock market transactions, and assumes a broad market of potential participants.
Equitable value, in contrast, is a legal concept defined by fairness between specific parties in a legal dispute. It acknowledges the unique history and interests of those involved. For instance, a used car’s value is its FMV, determined by what similar cars sell for. However, a custom machine operated by two business partners for years requires a more nuanced approach than what a random third party would pay for it.
Equitable value is determined by a court or through negotiation, taking into account the advantages or disadvantages each party will gain. Unlike FMV, which disregards any special value an asset might have to a particular buyer, equitable value considers these specific interests. The goal is to achieve a just distribution of assets between the parties involved, not to find a theoretical market price.
Contexts for Applying Equitable Value
The application of equitable value is confined to legal arenas where fairness in asset division is the primary objective. One of the most common contexts is marital dissolution. During a divorce, the division of property is governed by either “equitable distribution,” which seeks a fair division, or “community property,” which divides assets equally. This process often involves valuing a closely held business where one or both spouses have an ownership interest.
Beyond divorce, equitable value is applied in business-related disputes like shareholder oppression lawsuits. This is where a minority shareholder alleges that controlling shareholders have acted in a way that is unfairly prejudicial to their interests. In such cases, a court may order the buyout of the minority shareholder’s interest at its “fair value,” a term used interchangeably with equitable value in this context, to provide a just price.
Other business disputes where equitable value is relevant include dissenting shareholder actions and the dissolution of partnerships. When a shareholder dissents from a major corporate action like a merger, they may have a right to have their shares purchased at a fair value. Similarly, when a partnership dissolves, the valuation considers the unique contributions and interests of each partner to ensure a just outcome.
Valuation Approaches and Adjustments
Determining equitable value requires specific adjustments to standard valuation formulas to reflect a dispute’s unique circumstances. Professionals start with three standard approaches: the Asset Approach, the Income Approach, and the Market Approach. The distinction lies in how these are modified to achieve a fair outcome. The Asset Approach values a business based on its net assets, the Income Approach on future earning capacity, and the Market Approach compares it to similar sold businesses.
A significant area of adjustment is the treatment of goodwill, which represents the intangible value of a business, such as its reputation. In legal disputes like divorces, goodwill is separated into two components: personal and enterprise. Personal goodwill is tied to an individual’s skills and is generally not a divisible asset. Enterprise goodwill, however, is an asset of the business itself and is subject to distribution.
Another aspect of equitable valuation is the application of valuation discounts. In a Fair Market Value calculation, discounts for lack of control (DLOC) and lack of marketability (DLOM) are often applied to reflect the reduced value of a non-controlling interest. In an equitable value context, these discounts may be disregarded or applied differently. For example, applying a DLOC in a shareholder oppression case could unfairly penalize the minority shareholder, so courts often prohibit it to ensure a fair buyout price. A DLOM might also be ignored if the valuation is for a division between existing owners, as the goal is fair distribution, not a hypothetical market sale.
The Role of a Valuation Professional
Determining equitable value requires the expertise of a credentialed valuation professional. These experts, holding designations like Certified Valuation Analyst (CVA) or Accredited in Business Valuation (ABV), play an impartial role in legal disputes. They provide an objective and defensible opinion of value to assist the court and parties in reaching a fair resolution.
A valuation professional’s work begins with a thorough investigation and gathering of financial data, including a review of financial statements and tax returns. They select the most appropriate valuation methods based on the specifics of the case. This involves applying standard valuation approaches and making the specific adjustments, such as the allocation of goodwill or application of discounts, that are unique to an equitable value analysis.
The culmination of this process is a comprehensive valuation report that outlines the expert’s methodology, assumptions, and conclusions. This report serves as evidence in legal proceedings, and the professional may be called upon to provide expert testimony to defend their findings. Their role is to provide an independent analysis that helps ensure the final distribution of assets achieves an equitable outcome.