Fair Value vs Fair Market Value: Why the Distinction Matters

Two terms appear side by side on almost every private-company valuation report: fair value (FV) and fair market value (FMV). Practitioners sometimes treat them as interchangeable shorthand. They are not. Each term carries a distinct regulatory authority, a distinct governing framework, and distinct consequences when applied incorrectly. This post sets out the precise definitions, traces each standard to its source, and explains the practical situations where the distinction matters most.

Definitions: Starting from the Source

Fair Value Under ASC 820 and IFRS 13

Under U.S. GAAP, the authoritative definition of fair value appears in ASC 820 (Accounting Standards Codification 820). The standard 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. That price is an exit price, not an entry price, and it reflects conditions in the principal (or most advantageous) market for the asset or liability at the measurement date.

IFRS 13, the international counterpart, uses the same core definition. According to RSM's comparison of U.S. GAAP and IFRS, both standards state: "Fair value is 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 two frameworks are substantially converged on this point, though differences in application exist.

Fair Market Value Under IRS Standards

Fair market value (FMV) is the standard of value for income tax purposes. The IRS defines it as the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts. IRS Publication 551 states the definition similarly: FMV is the price at which property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts.

For private companies, FMV is the operative standard under IRC Section 409A (the federal tax code section governing deferred compensation and equity compensation). A 409A valuation produces an FMV conclusion that sets the exercise price of stock options. The IRS may reject valuations it finds "grossly unreasonable," which is why independent appraisals are the primary accepted method for establishing FMV.

A Side-by-Side Comparison

The table below summarizes the key attributes of each standard. The differences are not merely semantic; they reflect distinct regulatory purposes and distinct bodies of interpretive guidance.

Where the Two Standards Overlap

Both FV and FMV share a common conceptual core: they seek a price that reflects an arm's-length transaction between informed, willing parties. Neither standard contemplates a forced sale or liquidation. Both require the appraiser to consider market conditions as of a specific measurement date. Both are used in private-company valuations, and both can draw on the same underlying valuation methodologies, such as the income approach or the market approach.

This overlap is why the two terms are so frequently conflated. A 409A report and an ASC 820 analysis of the same company's common stock may reach similar conclusions and may even share inputs. The convergence is real. The distinction, however, lies in the regulatory authority each standard serves and in the specific adjustments and assumptions each framework requires.

Where the Two Standards Diverge

Regulatory Authority and Consequences

The most consequential difference is the regulatory body each standard answers to. An FV conclusion under ASC 820 is reviewed by auditors and, ultimately, by the SEC for public companies or by financial statement users for private ones. An FMV conclusion under IRC Section 409A is reviewed by the IRS. The consequences of error differ accordingly: a deficient ASC 820 disclosure creates audit findings and potential restatement risk; a deficient 409A FMV determination can trigger adverse tax consequences for option holders, including accelerated income recognition and penalty taxes.

The Role of Marketability and Control Adjustments

Both frameworks may incorporate a Discount for Lack of Marketability (DLOM) when valuing minority interests in private companies, but the rationale and application differ. Under ASC 820, adjustments must reflect what a market participant would assume in a hypothetical exit transaction at the measurement date. Under 409A, the DLOM and other adjustments are calibrated to arrive at the FMV of common stock relative to preferred stock, often using an Option Pricing Model (OPM) or Probability-Weighted Expected Return Method (PWERM). The inputs and assumptions may overlap, but the governing logic is distinct.

GAAP vs. IFRS: A Note on Geography

For companies reporting under IFRS rather than U.S. GAAP, the relevant fair value standard is IFRS 13, not ASC 820. The definitions are substantially the same, but the interpretive guidance and disclosure requirements differ in certain respects. The FMV standard under IRC Section 409A applies specifically to U.S. tax obligations; companies outside the U.S. granting equity compensation are subject to their own jurisdictions' tax rules, not 409A.

Practical Implications for CPA Firms and Founders

For a CPA firm advising a private company, the distinction between FV and FMV surfaces in at least three recurring situations.

• Equity compensation grants: The exercise price of stock options must equal or exceed the FMV of the underlying common stock as of the grant date, established by a qualified independent appraisal under IRC Section 409A. This is an IRS income tax requirement, not a GAAP requirement.
• Financial statement disclosures: Any asset or liability measured at fair value in a GAAP financial statement must follow ASC 820. This includes investments in private companies, contingent consideration in a business combination, and certain financial instruments. The FV conclusion must reflect the exit-price framework and the three-level input hierarchy.
• Purchase price allocation: When a company acquires another entity, the acquired assets and liabilities are measured at FV under ASC 820 as of the acquisition date. The FMV standard does not govern this measurement, even though the two values may be close in practice.

For founders, the practical takeaway is straightforward: the 409A valuation a company obtains before granting stock options is an FMV analysis for IRS purposes. It is not the same document as an ASC 820 fair value measurement, even if the same valuation firm produces both. The two reports may share data and methodology, but they serve different masters.

The ASC 820 Fair Value Hierarchy

One structural feature of ASC 820 that has no direct counterpart in the FMV framework is the three-level input hierarchy. ASC 820 classifies the inputs used in fair value measurements by their observability, from Level 1 (quoted prices in active markets) to Level 3 (unobservable inputs requiring significant judgment). This hierarchy governs both the measurement itself and the disclosure requirements in the financial statements.

Private company common stock, the same asset that a 409A valuation addresses, almost always falls into Level 3 under ASC 820 because there is no active market and the inputs rely on entity-specific assumptions. This means ASC 820 measurements of private company equity require the most documentation and the most judgment, and they attract the most scrutiny from auditors. For a deeper treatment of the hierarchy and its disclosure requirements, see the ASC 820 valuation guide on this site.

A Note on the 409A Valuation Process

Under IRC Section 409A, a company must obtain a new FMV determination at least annually, and also upon any material event such as a new funding round, acquisition, or merger. The resulting FMV is used to set the exercise price for stock options. An independent appraisal by a qualified appraiser is the primary IRS-accepted method for establishing this FMV.

The 409A process and the ASC 820 process can be coordinated, and in practice many valuation firms produce reports that address both standards simultaneously. The key discipline is maintaining clarity about which conclusion serves which purpose. The FMV conclusion governs the option exercise price; the FV conclusion governs the financial statement disclosure. For a full explanation of the 409A process and when a new valuation is required, see what is a 409A valuation.

Summary: Which Standard Applies When

The framework provides a clear organizing principle: if the output will appear in a GAAP or IFRS financial statement, ASC 820 or IFRS 13 governs. If the output will be used to satisfy an IRS requirement, the FMV standard applies. Any company that operates in both contexts, which describes most private companies granting equity compensation and preparing audited financials, needs both analyses conducted with precision and documented separately.