Note 3. Fair Value Measurements

The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:

Level 1 - Quoted prices for identical assets or liabilities in active markets.

Level 2 - Inputs other than quoted prices within Level 1 that are observable either directly or indirectly, including quoted prices in markets that are not active, quoted prices in active markets for similar assets or liabilities, and observable inputs other than quoted prices such as interest rates or yield curves.

Level 3 - Unobservable inputs reflecting management’s view about the assumptions that market participants would use in pricing the asset or liability.

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

The carrying values of the Company’s accounts receivable, unbilled revenue, prepaid expenses and other current assets, other assets, accounts payable, transaction costs, accrued expenses and other current liabilities and cumulative mandatorily redeemable common and preferred stock liability approximate their fair values based on the instrument’s relative short-term nature.

As of September 30, 2026, the Company’s outstanding borrowings consist of (i) the convertible notes payable issued on August 2, 2026, with a net carrying amount of approximately $ 1,245 thousand and (ii) a related party note payable to Dolma Impact Fund I (“Dolma”) of $300 thousand, which is payable on demand. The Dolma balance was reclassified from a convertible note to a related party note payable on demand during the year ended December 31, 2025. These instruments are carried at amortized cost and are not measured at fair value on a recurring basis. They are therefore not included in the fair value hierarchy table. Refer to Note 6, Debt, for further information on the convertible notes. As of December 31, 2025, the estimated fair values of these instruments approximated their carrying values due to their relatively short maturities.

Financial Instruments Recorded at Fair Value

The following tables present the Company’s fair value hierarchy for its financial liabilities that are measured at fair value on a recurring basis and indicate the level within the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value (in thousands):

Schedule of Financial Instruments Recorded at Fair Value on a Recurring Basis

Warrant Liabilities

The following table shows the change in the fair value of the warrant liability (in thousands):

   Schedule of Change in Fair Value of Warrant Liability

Fusemachines Inc. and Subsidiaries Notes to the Condensed Consolidated Interim Financial Statements

Forward Purchase Derivative Liability

The forward purchase derivative liability was recognized at Closing on October 22, 2025. The fair value as of September 30, 2026 was $708 thousand. The following table presents a reconciliation of the Forward Purchase Derivative Liability (in thousands):

Schedule of Reconciliation of Forward Purchase Derivative Liability

The fair value of the forward purchase derivative liability was estimated using a Monte Carlo simulation approach. The key assumptions used in valuation as of September 30, 2026: a risk-free rate of 4.21%, a valuation term of 2.06 years, and annualized volatility of 65.0%, whereas key assumptions used in valuation as of December 31, 2025: a risk-free rate of 3.53%, a valuation term of 2.81 years, and annualized volatility of 65.0%. The Company’s common share price was simulated with daily time steps for a range of various possible scenarios. The breadth of all possible scenarios was captured in an estimate of volatility, based on comparable companies’ historical equity volatilities, considering differences in their capital structure. The simulated prices were compared against the settlement adjustment features of the Forward Purchase Agreements. Under each simulated scenario of future stock price, the Company calculated the value of the forward purchase derivative liability arrangement. The average value across this range of possible scenarios, discounted to present using the risk-free rate, was used as the fair value of the forward purchase derivative liability.

Convertible notes payable

The following table shows the change in the fair value of the Convertible Notes measured at Fair Value (in thousands):

Schedule of Change in Fair Value of the Convertible Notes at Fair Value

Common Stock Warrant Liability

The Company estimates the fair value of the common stock warrant liability (refer to “Note 6 – Debt “) using an option pricing model and assumptions that are based on the individual characteristics of the warrants on the valuation date, as well as assumptions for fair value of the underlying common stock expected volatility, expected life, dividends, and risk-free interest rate.

The warrant liability is classified as Level 3 as there were no quotable prices for identical assets or quoted prices for similar. The warrant liabilities are measured using a Black-Scholes Model. The fair value of the warrant liability as of September 30, 2026 was determined using the following assumptions: a dividend yield of 0.0%, a risk-free rate of 4.94%, a stock price of $0.52, a term of 6.90 years, and annualized volatility of 65.0%. The fair value of the warrant liability as of December 31, 2025 was determined using the following assumptions: a dividend yield of 0.0%, a risk-free rate of 3.99%, a stock price of $1.65, a term of 7.65 years, and annualized volatility of 62.0%.

Fusemachines Inc. and Subsidiaries Notes to the Condensed Consolidated Interim Financial Statements

Related Party Convertible Note payable at Fair Value and Convertible Notes at Fair Value

The Company accounts for certain short-term debt (also refer to “Note 6 - Debt “) under the fair value option. At the issuance date of the Convertible Notes at Fair Value, the Company determined that the fair value approximated the principal amount.

In connection with the consummation of the business combination on October 22, 2025, which was accounted for as a reverse recapitalization, each convertible note of Legacy Fusemachines Inc., including both related party and other convertible notes, that was issued and outstanding immediately prior to the closing was converted into an aggregate of 8,048,770 shares of Legacy Fusemachines Inc. common stock in accordance with the respective convertible note agreements. Immediately following such conversion, all such shares of Legacy Fusemachines common stock were exchanged for shares of Fusemachines Inc. common stock based on the Exchange Ratio specified in the Merger Agreement. As a result of the foregoing, no convertible notes or related party notes payable remained outstanding as of September 30, 2026 other than related party note payable to Dolma $ 300 thousand.