What is Fair Market Value (FMV)? A Beginner’s Guide

To introduce the concept of fair market value (FMV) and explain why it matters to private companies, let’s look at two hypothetical employment scenarios.

In Scenario 1, a public company offers you stock options. You can easily value them by looking up the stock price.

Scenario 2 is similar, but this time you receive a job offer from a private company, also offering equity. But there's no ticker symbol to look up. Without an open market to set the price, you need fair market value (FMV): the price at which stock would trade between a willing buyer and seller, neither under pressure to transact. 

This guide walks through how FMV works at private companies and what it means for your equity compensation.

What is fair market value (FMV)?

Fair market value (FMV) is the price at which an asset would sell between a willing buyer and a willing seller when both are informed, and neither is forced to act. This is called an arm's-length transaction: both parties are independent and acting in their own self-interest.

More specifically to our focus, the fair market value of a private company's stock is the value of one share of that stock on the open market. A private company's stock isn't traded on public markets, so there's no market price to look up. The fair market value has to be determined another way.

Fortunately, there is a mechanism that can determine the fair market value of a private company's stock. That mechanism is a 409A valuation.

How a 409A valuation determines a stock's fair market value

A 409A valuation is an independent, unbiased appraisal of how much a private company's common stock is worth, and gets its name from Section 409A of the Internal Revenue Code. Its objective is to give the company a defensible value that holds up with the IRS.

But knowing the fair market value of your company's stock is about more than simply complying with the IRS. Any private company that wants to issue shares to its employees must have a price attached to those shares, so it can tell current and prospective employees what a share of the company's stock is worth.

Overview of the 409A valuation process

Fair market value may not be an easy thing to determine. The valuation process typically requires an accounting of quantitative and qualitative factors, including but not limited to:

• Your company's cap table
• Your company's past, present, and future cash flows
• Your company's past financial statements and forward-looking financial projections
• A comparative market analysis of similar companies (e.g., companies in a similar industry or at a similar stage of growth)
• Any intangible assets (e.g., copyrights, trade secrets, and other hard-to-evaluate company assets)

For this reason, many startups enlist the help of a 409A valuation firm. Such a firm will typically employ a professional appraiser, or a team of appraisers, to review the relevant facts and estimate the enterprise value of the company. 

Once that value is divided up between all the types of equity in the company's cap table, the firm should be able to determine the fair market value of a single share of common stock.

Other factors, such as a discount to account for the fact that the shares are illiquid and can't be sold on the open market, may also affect the FMV.

How is fair market value calculated?

There is no single formula for fair market value. Appraisers rely on three standard valuation methods, and the right one depends on the asset and the information available:

1. The market approach 

This approach looks at what comparable assets have actually sold for. For a company, that means a market analysis of similar businesses, matched on industry, stage, and size, along with recent funding rounds or acquisitions. It answers a straightforward question: what are buyers paying for something like this?

2. The income approach 

This approach estimates value from the cash an asset is expected to generate. An appraiser projects future cash flows and discounts them back to a present-day figure, on the logic that an asset is worth what it can earn over time. This method fits companies with revenue steady enough to forecast.

3. The cost approach

This approach asks what it would take to rebuild the asset from scratch, starting from its replacement cost and subtracting depreciation for age or wear. It suits asset-heavy or physical holdings. 

For an operating startup, it usually understates value, because it captures the balance sheet but not the team, growth, or intellectual property that make the company worth more than the sum of its assets, so it plays a limited role in valuing startup equity.

For a private company's stock, these methods do not stand alone. They feed into the 409A valuation covered earlier, which weighs the approaches together, applies a discount because the shares cannot be sold on the open market, and arrives at a single defensible share price.

FMV vs. market value vs. fair value: What's the difference?

Fair market value gets used alongside two similar-sounding terms: market value and fair value. They are not interchangeable, and for equity, the differences decide which number you use and where.

FMV vs. market value

Market value is the price at which an asset can be sold in an open marketplace. The market value of a public company's stock is easy enough to find on a public stock exchange. 

Market value can also refer to how much a company itself can be bought or sold for, in which case it's calculated by multiplying the current share price by the number of outstanding shares.

FMV vs. fair value

Fair value is an accounting term, and it belongs to financial reporting rather than tax. Under ASC 718, the accounting rule for expensing stock compensation, a company measures the grant-date fair value of an equity award and records it as an expense on its income statement. That makes fair value a different measurement from FMV, not just a different number. 

A 409A valuation establishes your common stock's FMV, and that figure sets the strike price employees pay to exercise their options, which is a tax matter governed by Section 409A. ASC 718 fair value measures the option itself: what the grant is worth as compensation. 

The share's FMV is only one input into that calculation, which a pricing model derives alongside factors like how volatile the stock is and how long the option lasts.

In short, the 409A sets the strike price for tax, and ASC 718 measures the option's fair value for reporting. The two live in different regimes, and treating them as interchangeable, or dropping one figure where the other belongs, is the kind of mismatch auditors flag. 

Other uses for fair market value

When searching for information on fair market value, you may come across the same term used in different contexts across several different industries:

Fair market value in the real estate market

If you've ever bought or sold a home, you may have heard the term "fair market value" used within the context of real estate.

To determine the fair market value of a property in the current market, a real estate agent may compare the recent selling prices of similar properties in the area and include other factors, such as property taxes, in a roughly estimated value. Many homes also have an appraised value calculated by a professional appraiser, which may be slightly different from FMV.

Fair market value in the insurance industry

Insurance companies may also use fair market value to appraise the value of items in insurance claims. Since many valuables, like a used car for example, don't have a universally agreed-on price, FMV can be used to help determine how much the insurance company pays out.

Fair market value in mergers and acquisitions

In a merger or acquisition, fair market value helps establish what a business and its assets are worth to a buyer. Both sides lean on FMV to price the deal and allocate value across the assets changing hands, which also shapes how the transaction is taxed.

Fair market value for other tax purposes

The IRS may also require a fair market value appraisal for gifts of a certain size. For example, if someone gifts a rare painting to a relative for $1, the IRS may value the painting at its FMV for gift tax purposes.

Fair market value can also help to determine the size of the tax deduction associated with a charitable donation.

Common misconceptions about FMV

Fair market value gets tangled up with a few adjacent concepts, including:

Myth: Setting an FMV triggers taxes. Establishing FMV is not itself a taxable event. Tax consequences arise from transactions, like exercising or selling, measured against it.

Myth: FMV is the same as what you paid. Purchase price is what changed hands in a specific deal, which may reflect a bargain, a rush, or a relationship between the parties. FMV is what an asset would fetch between a willing buyer and seller with neither under pressure. The two can differ, sometimes widely.

Myth: FMV is the same as book value. Book value is an accounting figure: what an asset is carried at on the balance sheet, typically its cost minus depreciation. It looks backward at recorded numbers, while FMV looks at what the asset is worth in the market today. For most companies, the two are not the same.

Myth: FMV is your post-money valuation. A post-money valuation reflects the price investors pay for preferred stock, which carries liquidation preferences and other rights that make it more valuable than common stock. 

FMV is the value of your common stock, established by a 409A valuation. The common share price is normally well below the preferred price, which is why the two figures should not match.

What is the fair market value of my company's stock?

Whether you're the founder of a private company or a prospective employee trying to assess the value of an equity package, fair market value is something you'll want to understand.

As a founder, you'll need to work with your team to complete a 409A valuation if you haven't done so already. And as a prospective employee, you'll need to make sure you understand the value of any equity package that's presented to you.

Competitive equity packages are typically structured so options are granted with a strike price equal to FMV, which means the grant itself is not a taxable event. Setting that strike defensibly requires a 409A valuation that qualifies for IRS safe harbor.

You can read more about this in our guide on 409A valuations, but the bottom line is that FMV isn't just an interesting number; it can have real consequences for taxes and the overall value of an equity package.

Want to learn more about FMV and how to get an accurate 409A valuation? Schedule time with Pulley's experts to learn how we can help you with an audit-ready 409A valuation and cap table, all in one.

Get an audit-ready 409A valuation with Pulley

Once you know what FMV means, the next step is establishing it for your own stock, which for a private company runs through a 409A valuation.

Pulley's 409A valuations are handled by an in-house team and built to be audit-ready, and they connect directly to your cap table, so your FMV and your equity records stay in one place. Pricing is transparent and scales with your stage, so you know what you're paying as you grow.

Talk to our team to get started.

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Frequently asked questions about fair market value

What does FMV mean?

Fair market value is the price an asset would sell for between a willing buyer and a willing seller, when both are informed and neither is forced to act (also known as an arm's-length transaction). 

For a private company's stock, there is no public market to set that price, so the fair market value of each share is established another way, through a 409A valuation.

How is fair market value determined for a private company?

For a private company, fair market value is determined through a 409A valuation, an independent appraisal of what the common stock is worth. 

An appraiser weighs factors like the cap table, past and projected cash flows, financial statements, and a market analysis of comparable companies. Then they apply a discount because the shares cannot be sold on the open market, and arrive at a defensible price for a single share of common stock.

What is the difference between fair market value and fair value?

Fair market value is a tax concept, while fair value is an accounting one. FMV, set by a 409A valuation, establishes the strike price employees pay to exercise options, governed by Section 409A. 

Fair value under ASC 718 measures what an equity award is worth as compensation for financial reporting, with the share's FMV as just one input. They serve different purposes, and treating them as interchangeable can create reporting problems.

Who determines the fair market value of company stock?

For private company stock, fair market value is determined by an independent, qualified appraiser, usually through a 409A valuation firm. 

Many startups enlist a firm that employs professional appraisers to review the company's financials and estimate its value, then divide that across the cap table to reach a per-share price. Using an independent appraiser also allows a valuation to qualify for IRS safe harbor.

How often does a company need to update its FMV?

A company generally needs a current fair market value at all times, which in practice means updating its 409A valuation at least once every 12 months and again whenever a material event occurs. 

A material event is something that could change the company's value, most commonly a new funding round. Keeping the valuation current is what preserves safe harbor and lets the company grant options at an accurate, defensible price.