Credit Guaranties: Fair Value and Fair Market Value

Abstract

Thomas Jefferson was driven to virtual bankruptcy by the financial failure of a close friend, whose debt Jefferson had guaranteed. 1 Two hundred years later credit guaranties are commonplace in the financial structure of small, closely held businesses. Today, as in Jefferson’s time, questions regarding the financial implications of credit guaranties remain. Do credit guaranties carry a cost? Do they have value? Should they be considered in the valuation process? This paper addresses those and other financial issues related to credit guaranties. Overview Credit guaranties involving small businesses are common, and we believe they are a material financial concern often overlooked in the valuation process. Consider a dissenting shareholder case in which the shareholder’s remedy is a fair value appraisal. Assume that the majority shareholder has personally guaranteed all debt of the company, while the minority shareholder has guaranteed none. Should the appraisal process consider the financial impact of the guaranty to the company and the majority shareholder? Similarly, in a fair market value appraisal wherein all company debt is guaranteed by the majority shareholder, should the value of such guaranty be a line item allocation to the guarantor prior to establishing the enterprise value? A credit guaranty is considered a relevant factor based on the following fair value and fair market value definitions and should be considered in the appraisal process under either stan