Early Stage Valuation

CHAPTER 2Fair Value Standard

The fair value standard is the standard of value that is used in business valuation for financial reporting under generally accepted accounting principles (GAAP) globally. It is also commonly used in the valuation of investments to make asset allocation decisions, evaluate investment manager performance, and assess manager compensation. It is used in the valuation of business and intangible assets in M&A transactions and in other types of business combinations. It drives the work of securities analysts and creates a global benchmark to compare company performance results. In an economy where prices are determined by the competitive action of market forces, the fair value standard points to the importance of looking at the “exit” price in an orderly transaction between market participants as a reference for valuation. The fair value standard is inspired by the idea that “fairness” can find an expression in the pricing mechanism of a market economy. At the inception of the 2008 economic crisis, it was described as “a cornerstone to building the infrastructure needed for a more broadly effective risk management system.”¹

In this chapter, we present the fair value standard as it applies to early stage enterprise (ESE) valuation. We highlight some points in the history of the fair value concept, illustrate the key features of the current fair value standard in financial reporting, distinguish it from other valuation standards, and identify resources ...