Market value, fair value and special value: which standard applies?

The short answer, explained

The three terms describe different questions. Market value asks what a hypothetical buyer and seller would agree. Fair value is a defined term in accounting and a term of art in takeover expert reports, and the two meanings differ. Special value is the extra amount a particular buyer could pay because of advantages only it would gain.

Which one applies depends first on the law or document that calls for the valuation. Tax law, accounting standards and takeover rules each supply their own meaning. A private agreement supplies only what its drafter writes. This page is a reference for choosing and defining the standard. For how the choice affects a particular parcel of shares, see whether a minority shareholding is worth its percentage.

Market value

For tax purposes, the Income Tax Assessment Act 1997 says in section 960-400 that "market value" is often used in the Act with its ordinary meaning, although some provisions modify it. The ATO's guide to market valuation for tax purposes explains that the ordinary meaning comes from the High Court's decision in Spencer v Commonwealth [1907] HCA 82: a notional sale between a willing but not anxious seller and buyer, after voluntary bargaining, both fully informed about the asset and the market.

Two features of market value matter most in drafting:

• The buyer is hypothetical. The ATO guide states that market value does not reflect attributes of an asset that are of value to a specific owner or purchaser and not available to other buyers. A competitor's synergies, or a co-shareholder's gain from moving to full ownership, are left out.
• The asset is valued as it is. If the asset is a 30% parcel of shares, a market value is the value of that parcel, with whatever rights it carries. Whether that differs from 30% of the whole company is a question of evidence, not an automatic discount.

Fair value

The phrase has at least two established meanings and no universal one.

In financial reporting, AASB 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The standard describes this as a market-based measurement, not an entity-specific one, and it allows a premium or discount only where it is consistent with the unit of account being measured.

In takeover and other control transaction expert reports, ASIC's RG 111 (RG 111.11) records the convention that an offer is "fair" if its value equals or exceeds the value of the securities, assessed between knowledgeable, willing but not anxious parties and assuming 100% ownership of the target. RG 111 states that a minority or portfolio discount should not be applied in that comparison, and that special value to a particular bidder is left out of the "fair" test, although it may be considered under "reasonable". Related party transactions have a separate test in RG 111.57: the transaction is "fair" if the value of the financial benefit given is equal to or less than the value of what the entity receives.

In a shareholders agreement or constitution, "fair value" means whatever the clause says. Drafters sometimes use it to signal a pro rata share of the whole company without a minority discount, but unless the clause says so, that is an argument rather than a rule.

Special value

Special value is the amount above market value that a particular buyer could pay, because of something only that buyer gains: cost savings from combining two businesses, removing a competitor, or a co-owner moving to full ownership. It is real to that buyer, and a seller negotiating with that buyer may capture part of it. It is not market value, because the hypothetical buyer does not have the same advantage. Advantages that a number of likely buyers would share, rather than one buyer alone, can be reflected in market value.

Agreements between co-owners raise special value directly. The remaining shareholders are often the only natural buyers of an exiting holder's shares, and their gain from consolidating ownership is a form of special value. A clause that intends the price to reflect it, or to exclude it, should say which.

Comparison by purpose

Worked example: one company, three answers

This example is hypothetical. The figures are round numbers chosen to show how the standard changes the question being asked.

A company's shares, valued as a whole on a market value basis, are worth $3,000,000. One competitor could save costs by merging the company into its own operations and would be prepared to pay up to $3,600,000 for all the shares. A shareholder holds 30% and wants to sell to the other shareholders under the agreement.

Check: $3,600,000 less $3,000,000 is $600,000, and 30% of $3,000,000 is $900,000.

Under the first wording the price is $900,000. Under the second, the valuer values the 30% parcel itself, and a figure such as $750,000 becomes arguable. Neither brings in the competitor's $600,000 of special value unless the clause expressly says so. Whether any difference arises for a real holding depends on its rights and the evidence, as explained in whether a minority shareholding is worth its percentage.

Defining the standard in a document

A definition that is unlikely to be disputed usually states:

• the standard (for example market value, with a short definition in words rather than a label alone);
• the interest valued, and whether it is valued as a proportion of the whole company or as the parcel itself (see business, shares or units: what is being valued);
• whether any discount for a minority interest or lack of marketability applies, and whether any premium for control applies;
• whether special value to the remaining holders or any other person is included or excluded;
• the valuation date, and whether events after it may be considered.

For property, APAVAL publishes a separate explanation of what market value means for property. This page deals with businesses and shares.

Limitations

• This is a reference on valuation concepts, not legal advice on the drafting or interpretation of any document. The meaning of a clause depends on its words and context, and is a matter for the parties' lawyers.
• Specific tax provisions can modify market value or fix the time at which it is measured. Check the provision in question.
• RG 111 describes ASIC's view for regulated transactions. It does not govern private agreements.
• Courts and tribunals decide disputed valuations on the evidence before them; nothing here predicts an outcome.

Next steps

• Identify the law or document that calls for the valuation and read its words on value first.
• In a new agreement, define the standard and the treatment of discounts, premiums and special value in plain words.
• When instructing a valuer, quote the exact definition and ask the valuer to state the basis adopted in the report.
• For buyouts under an existing agreement, see preparing for a shareholder or partner buyout.

General educational information, not financial, tax or legal advice. Worked examples are hypothetical and do not value a real business. A valuation depends on its purpose, the evidence and the agreed scope.