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Defining Fair Market Value

✈ June 21, 2017, Avicor Aviation Inc.

Fair market value is a term often used when discussing the worth of something for sale. Those of us in the aviation world hear the term used with respect to aircraft all the time. When it comes to aircraft, "fair market value" can become skewed when a buyer falls in love with an aircraft or gets it into his or her mind that a particular model is what they want or need. Values can slide up or down based on a lot of factors and the market is often defined by the available number of a particular make and model for sale. While factors such as the number of hours on an airframe, TBOs on engines and various upgrades help to clarify the value of an aircraft, the fair market value of an aviation business is not as straightforward.

Defining FMV

Fair market value, or "FMV" as it is often referred to does have a clear definition. The definition is provided by the IRS in Revenue Ruling 59-60 and it states the following:

"The price at which property would exchange hands between a willing buyer and willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as being willing, to trade and to be well informed about the property and concerning the market for such property."

While the IRS definition is broad in its coverage, the word "property" can accurately be replaced with "business" for clarity.

What Does This Mean?

So what, exactly, does this definition mean when it comes to the value of a business? Let's break down the definition to find out.

There are four key components to the definition of fair market value. These are:

  1. Both the buyer and the seller in the the transaction are willing, interested in and able to make the transaction happen. This means that neither the buyer or seller is in a position where they must buy or sell the business, respectively, but they do have an interest in seeing the deal to fruition and the buyer has the financial capabilities to make it happen.
  2. The potential buyer is rational and is not making the decision to buy because of "falling in love" with the business, or because it will add value to something he or she already owns. The decision to buy is motivated by being a prudent and reasonable decision. It also means that the purchase decision is a financial decision in that the buyer will contribute capital and managerial competence equivalent to that of current management, whether personally or by hiring someone.
  3. The business is being bought to continue operating as a going concern and not for liquidation purposes, unless the value of all of the assets is more than the value of business as a going concern.
  4. As defined, the hypothetical sale will be a cash transaction between the buyer and seller.

FMV and Aviation Businesses

With respect to aviation businesses, fair market value has a lot of application. It is often the value used by bankers in determining the value of a business with respect to loans and lines of credit. It is the definition that is applicable if the valuation is for an estate (because the IRS requires it), may be ideal for buying out or adding a partner, or necessary in a divorce situation.

But you may be thinking that in buying or selling an aviation business, fair market value as the IRS defines it does not necessarily apply. Very often, especially with smaller aviation businesses, there are several other factors that come into play. For example, there is that passion for aviation that many of us share! How many aviation businesses have been started or bought because the owner just wants to be around aviation? We all know the percentage is quite large and that can also affect the actual value of a transaction. Similarly, when an owner is ready to retire or has other reasons for moving on, those reasons may also affect the actual transaction. And many aviation businesses are traded to build a network, take for example all of the acquisitions in the FBO industry in the past decade. And many transactions are not 100% in cash. Clearly in those situations, fair market value may not be the value applied.

As it is defined, fair market value is often just a starting point, especially when it comes to aviation businesses.

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