The Fair Commission Model of Goodwill: A New Business Appraisal Approach

Mike Sack Elmaleh

Fair Market Versus Investment and Synergistic Values


 In this article I critically explore the distinction between fair market and investment value, also called synergistic value. Many authors cite these distinctions, but I will focus on the analysis and example found in Stanley J. Feldman’s Principles of Private Firm Valuation. 1

 In my opinion Feldman’s explanations and example do not support an economic justification for distinguishing between fair market and investment values in appraisals of controlling equity interests in closely held firms. Furthermore, the placement of buyers with greater investment resources in a separate category of value introduces needless confusion into the valuation process. For these reasons, the idea that fair market value is distinguishable from investment value is not supportable.

Feldman on Fair, Investment and Synergistic Market Values        

Feldman begins with the standard definition of fair market value and then notes:

“Other valuation standards include liquidation value and investment value.”(page 1)

Feldman emphasizes the importance of buyers and sellers being informed. Being informed entails a certain minimum competence on the part of prospective buyers:

“…the reasonably informed criterion also means that participants and/or their agents       can accurately process disclosed information and rationally act on it… FMV requires that participants are reasonably informed about the risks and opportunities of the property in question and are also knowledgeable about the factors that shape the market in which the entity is expected to transact.” (page 4)

Feldman then introduces the distinction between strategic or investment value and fair market value:

“Strategic or investment value emerges when an acquirer desires to use the assets of the acquired firm in a specific way and this use gives rise to cash flows in addition to those that can be expected from the firm being operated  in its going concern state.” (page 6)

Here is the example he gives of a strategic investor:

“A local insurance agent would like to sell her agency. An informed potential buyer who desires to run the agency much like the seller is willing to pay $1,000 for the agency. The seller believes this price is consistent with the firm’s FMV. A nationally recognized financial services firm has decided to purchase local agencies all over the country as part of a roll up strategy designed to reduce the costs of managing local as well as to sell additional insurance products to the client bases of purchased agencies. The nationally recognized financial service firm is a strategic buyer. This buyer is always willing to pay more than a buyer who desires to run the business like the seller. The reason a strategic buyer will pay a premium over FMV is that the buyer expects the combined businesses to generate more cash flow than they could produce as two stand alone businesses. The price established by the strategic buyer is not the firm’s FMV because the exchange value is not based on the business as it is currently configured.” (Page 6)

Reasonably Informed Buyers Are Qualified Buyers 

 Feldman is absolutely correct in stressing that the FMV standard requires that market participants are reasonably informed about the specific nature of the market in which a target firm operates.  A major implication of this requirement is that potential equity purchasers have sufficient relevant expertise to operate the acquired company.

This implication follows from the fact that the only parties likely to have the required knowledge are parties that have had previous experience and expertise in these markets. Parties with such expertise and experience are qualified buyers.

A very large percentage of control equity transfers are financed by a third party, the seller, or some combination of the two. In order to insure that equity acquisition loans are repaid, the lender must be assured that the borrower/equity acquirer has sufficient experience and expertise to properly manage the acquired firm. This simple contingency usually insures that control equity buyers are qualified and reasonably informed.

Relevant Qualifications for Investment are a Synergistic Continuum

There is, of course, a certain minimum level of qualifications needed to acquire a controlling interest in a closely held firm. These qualifications involve minimum levels of expertise, experience, cash, and/or access to credit.  However, it is a virtual certainty that for any given target the pool of potentially qualified investors will not possess precisely the same combination of these resources. Some potential buyers will possess more expertise than others. Some will have greater access to cash and credit for acquisition purposes, some less.  However all these qualified investors are synergistic. They all believe that their skills and cash resources when combined with the resources of the target will yield greater cash flows than would be realized without the acquisition. If they did not have this belief, they would not bid on the firm.

All Potential Investors Contemplate Some Changes in Operational Configuration

Each potential bidder will evaluate the future cash flows from an equity investment in light of the target firm’s current and historical earnings, when combined with the resources the bidder brings to the investment. Contrary to Feldman’s reasoning, potential investors almost always contemplate at least some form of change in the nature of operations to enhance earnings beyond those currently realized. Some of the changes may be minor, while others more significant. Some of the changes will be implemented immediately, others phased in over time. Operational changes might involve new technology, new product lines, relocations, personnel hires and fires, pricing, and purchasing. The degree of changes contemplated will, of course, depend on the capabilities of the potential investors, as well as the investor’s perception of which changes have the best chance of enhancing cash flow.

Will the Potential Investor with the Greatest Resources Always Outbid Those with Lesser Resources?

Feldman assumes that potential investors with the greatest combination of resources will always outbid those with fewer resources and, therefore, they should be considered a separate category of value. From a strictly empirical point of view, this assumption is not universally true. The following hypothetical examples illustrate cases where the larger, better endowed investor may not outbid investors with fewer resources.

Example: A Small Accounting Practice

Consider a small sole practitioner accounting practice. Assume billing rates charged are in line with other small practices in the area. Further assume, as is fairly common, that billing rates are lower than those charged by larger regional and national firms. Because of this rate differential, a larger firm will not likely outbid a smaller local firm for this practice. A larger firm would be rightfully concerned about client retention if they tried to increase rates to higher levels. The larger firm might only be interested in acquiring those clients they think will accept higher rates. Therefore, a smaller sole practitioner or a qualified accountant desiring to become self employed may want the entire client base and thus outbid the better endowed regional firm for the practice.   

Example: A Local Hamburger Joint

 Consider a small hamburger joint with a loyal local following. The non-owner chef of many years is willing to buy the restaurant. Because he is well known to the regulars, he is confident that customers will be retained. On the other hand, a large regional hamburger chain may bid absolutely nothing for this business despite being in the same line of business while offering similar basic fare at comparable prices. This is because, operationally, they find it more efficient and profitable to simply build new restaurants rather than acquire existing ones.

Does a Separate Category of Value Reflecting Greater Potential Synergies Make Economic Sense?

Even if we suppose that the most well endowed potential investor will outbid lesser endowed investors, does this really merit a separate category of value? Whenever any tangible or intangible good comes on the market and there is more than one bidder, the price will generally be set by the highest bidder. The price the winning bidder is willing to pay will be determined by the expected utility of the investment, constrained by available investor resources. Not all bidders will have the same expectations about the derived utility, nor will all bidders have the same resources. Nonetheless, there will be a winning bid and it is inevitably the high bid. The high bid is the fair market price, period.

Why Confuse Users of Appraisal Reports?

Users of appraisal reports want to know the likely high bid for the subject equity interest. They want to know this value, because they assume that when a seller receives two or more competing bids the highest one will be accepted. Placing a special value designation for bidders who may provide the high bid because they expect to derive greater utility due to greater synergies simply adds confusion to the appraisal process. How can there be any credibility in an appraisal report that indicates the fair market value for an equity interest is $1,000, despite the existence of another qualified buyer willing to pay $2,000 for it? When we explain that we must exclude this high bidder simply because that buyer has more resources and expects to realize more utility from the investment than other bidders, the credibility of the profession is compromised.    


Feldman and others base their claim that investment value differs from fair market value on three false assumptions. First, they assume that only certain well endowed investors are capable of increasing cash flow through the use of synergy. In fact, virtually all potential investors must have a minimum combination of resources, including expertise, cash, and access to credit, that they hope to exploit synergistically. Second, they assume that only the most well endowed potential investor will attempt to change the nature of the target firm’s operations to increase cash flow. In the real world, almost all acquirers of a controlling equity interest contemplate some change in operating characteristics. Third, they assume that the largest and best endowed investor will always outbid the smaller less endowed investor. This too is a false assumption.

The idea that the highest bidder is operating in a different market is confusing to appraisal users and, in the end, lacks economic sense. Users of appraisals need to know what a subject company will sell for. Assuming the sale is arms length and the seller is rational, this will be the high bid. All bidders will have a certain mix of resources that they seek to exploit synergistically. The high bidder may or may not be the investor with the greatest endowment of resources. All these considerations are ultimately irrelevant to appraisal users. The high bid is precisely the price appraisal users want to know, and this price is indeed the fair market value. From the standpoint of real world economics, the distinction between fair market value and investment or synergistic value is dubious.


  1. Stanley J. Feldman, Principles of Private Firm Valuation, John Wiley & Sons, Inc., 2005. Other authors of authoritative texts make similar distinctions. See James R. Hitchner’s Financial Valuation, John Wiley and Sons, Inc., 2006, page 5. Also Shannon P. Pratt, Robert F. Reilly and Robert P. Schweihs Valuing a Business, McGraw Hill, 2000 pps. 30-31. The latter authors trace the fair market versus investment value distinction back to real estate appraisal practice. Of the above authors cited I find the Feldman presentation the most detailed and have therefore limited my attention to his arguments.

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