Fair Market Value versus Distressed Value

By Clay Shultz, ASA Senior Valuation Analyst

Are you looking for a real life example of the difference between fair market value and distressed value? Look no further than the History Channel’s Pawn Stars. If you’ve never seen an episode, here’s a brief description: The setting is a Las Vegas pawn shop, which specializes in antiques, memorabilia, and other historical collectibles. Episodes feature everyday people trying to sell (or pawn) their interesting items – ranging from old currency to antique firearms – to the shop’s proprietors. Generally, the shop’s staff members know a little about the items in question. But, more often than not, they rely on an expert to offer an opinion as to what the item is worth. Once the expert has given an estimate of value, negotiations begin. A typical scenario goes like this:

  • The expert estimates that the item could sell for $4,000 to $5,000 at auction.
  • The seller hears $5,000 and makes that the asking price.
  • The pawn shop employee counters with a very low number, citing that the shop can only hope to resell the item for the estimated value of $4,000 to $5,000 given by the expert. Meanwhile, the store has overhead costs in addition to the carrying cost of its inventory.
  • After some back-and-forth, the seller realizes that in order to achieve the auction value of $4,000 to $5,000, he or she will likely incur an auction fee, which could substantially lower the proceeds from sale.
  • Finally, the seller comprehends that the offer from the shop is for cash in hand today, as compared to having to wait for the opportunity to sell the item at auction. In the final analysis, the seller usually sells the item to the shop for a price substantially lower than anticipated.

So what’s going on here? Regardless of the particular fair market value definition used, it is generally understood that the buyer and the seller are free from any compulsion to act and the asset is offered in the open market for a reasonable period of time. On Pawn Stars, it is true that neither party is compelled to act. Nonetheless, the seller goes to the shop with the intention of receiving cash today, which makes it a compulsive sale. Additionally, we have only one buyer and one seller and no market exposure. Likewise, it is important to keep in mind that fair market value describes the price at which property would change hands, not the net proceeds to the seller. In real world situations, like Pawn Stars, sellers frequently appear much more concerned with getting cash in hand than maximizing their net proceeds. As a result, the item is generally sold well below the expert’s estimated fair market value.