Bogdanski says BV cases took ‘back seat’ in Tax Court this year
The big news, says Prof. Jack Bogdanski (Lewis & Clark Law School) in his seventh annual symposium on developments in federal tax valuation, is that there were hardly any business entity valuation cases. Unlike last year, when cases involving family limited partnerships (FLPs) were aplenty, this year the Internal Revenue Service seems to have poured its resources into challenging taxpayer claims for charitable contribution deductions related to conservation and facade easements. The latter, in particular, have become a mass-marketing tax shelter tool in areas such as New York City and have triggered a vigorous response from the IRS. Litigation typically focuses on whether the appraisal is qualified, whether the expert testimony was admissible under Daubert, and finally—assuming the case is still alive—what the value of the restriction is.
Notable case: This year's notable business valuation case centering on the discount for lack of marketability (DLOM) was Estate of Koons v. Commissioner, 2013 Tax Ct. Memo LEXIS 98 (available at BVLaw). At issue was the fair market value for estate tax inclusion purposes of a 50.5% interest in an FLP that held more than $320 million in cash and only two operating businesses, worth less than $30 million. Just before the decedent's death, his four children had signed off on the LLC's offer to redeem their shares of the company for cash. The transactions closed a few months later.
This fact was critical for purposes of determining the DLOM. While the petitioners' expert argued for a 31.7% rate, the IRS's expert claimed a 7.5% DLOM was appropriate considering the almost certain redemptions would make the decedent’s interest a controlling one, increasing it to approximately 70%. As Prof. Bogdanski explained, this meant that a willing buyer would "get its hands on large amounts of available cash." The court adopted the IRS expert's DLOM and valuation. The takeaway is that experts look at assets inside the company when determining discounts, Prof. Bogdanski noted.
Selling a valuation gig to the small-biz owner
An article at Forbes.com answers the most frequent question valuation analysts get from small-business owners: “Why should I bother valuing my business?” Of course, business valuation pros know the answer to this, but the article gives a good rundown of the reasons, which can give you some ammunition for marketing material to promote your practice and convince small business owners that they need a valuation.
- Someone else will value the business anyway. For bank loans, the bank will value the business, so the owner will want to demonstrate a higher valuation. Also, the IRS may value it upon a sale or estate transfer.
- A potential buyer shows up. The business owner needs a firm grip on value in case a potential buyer makes a lowball offer.
- Retirement needs. For many small business owners, their business is the main asset in their retirement plan. You can’t plan retirement income without knowing the value of the plan’s main asset.
- Estate planning. Business owners who have various assets and want to leave equal amounts to heirs need to monitor the value of the family business to make sure none of the heirs get shortchanged.
- Key person planning. A business valuation can serve as a baseline value when designing growth incentives to reward key persons in the business.
- Court challenges. Business valuation issues do end up in court, so a business owner needs all information available to fend off legal challenges.
BVWire adds that once you’ve successfully answered the question of why a valuation is needed, you can take it to the next level—convincing the owner to have the business valued every year. For one thing, this allows owners and shareholders to see if the management is increasing value each year. True, this will cost more (although an annual update can be charged at a lower rate), but the benefits will act as an offset.
Don't overstate the meaning of the Delaware Chancery's decision to use merger price
Should we read any greater importance into a recent Chancery decision to rely on the merger price—not the DCF analyses—to establish the fair value of stock at issue? "No," says Jim Alerding (Alerding Consulting). "The purpose of the case was to decide if the petitioners received a fair price for their stock in the merger. Given that purpose, the court’s decision to use the merger price made sense since there was too much uncertainty in both of the expert reports," resulting from the unpredictable income stream of the target's main asset.
He noted that the court faced what it called a “gulf” in proposed values. Therefore, "the logical answer for the court was to say that the ultimate buyer had the right number (i.e. value) based on the information at hand." Alerding is quick to add that the court's approach here "should not be taken as some sort of precedent for valuations as a whole. The solution fit the circumstances of the case, but probably won't fit many others."
FASB endorses PCC alternatives for goodwill and interest rate swaps
The Financial Accounting Standards Board has voted to endorse the first two accounting standards previously approved by the Private Company Council (PCC). The final standards will provide private companies with: (1) an alternative accounting model for goodwill; and (2) a simplified hedge accounting approach for qualifying interest rate swaps. The goodwill alternative, Accounting for Goodwill Subsequent to a Business Combination, allows a private company to amortize goodwill over a period of 10 years, or less under certain circumstances, and to apply a simplified impairment model to goodwill.
Also, the FASB voted to add a project to its technical agenda to consider alternatives to the existing goodwill impairment model for public companies and not-for-profit entities. These alternatives include an amortization model, a simplified impairment model without amortization, or a direct write-off of goodwill.
Four factors that affect multiples for CPA firm valuation
An article in the Journal of Accountancy makes some good observations about the valuation of CPA firms. First, it points out that the value of an accounting firm’s shares differs for an external sale as opposed to an internal transfer. Sales to inside ownership usually use a lower multiple than sales to outside parties. That’s because most retiring partners don’t expect their partners to pay as much as a stranger.
The multiple of billings used to determine the sale price is determined by four main factors: (1) amount of cash, if any, paid upfront; (2) length of the retention period; (3) the deal structure’s profitability for the buyer; and (4) length of the payment period.
How some firms drive value their way
An article in a recent Harvard Business Review points out that industries typically disaggregate as interfaces between various stages of the value chain become open and standardized. This allows value to migrate up or down the value chain—and away from established players. But the authors argue that it doesn't have to be that way. They point to automobile manufacturers as an example of being able to keep a fairly constant share of their industry’s total market capitalization despite competitive pressures and phenomena such as outsourcing. They do it by: (1) controlling the assets least likely to be commoditized; (2) serving as “guarantor of quality” to the end customer; (3) staying in close touch with changing customer needs; and (4) balancing the imperatives of growth and strategic control of the value chain. Clearly, factors such as these need to be taken into account when assessing the value of any firm.
New book on DLOM by former IRS manager
In a past issue of Business Valuation Update, former IRS territory manager Michael Gregory (Michael Gregory Consulting LLC) gave his perspective on how the IRS is approaching discounts for lack of marketability (DLOM) appraisals today. Now, Gregory has written a book, Discount for Lack of Marketability and the IRS, which provides the single most authoritative and up-to-date introduction available on the topic of DLOM and the IRS. Gregory championed the DLOM Job Aid published by the IRS in August 2011, and this book helps readers understand DLOM and choose the approach to it that works best for them. It provides comments from leading DLOM modelers on their models, recommendations about sources for current DLOM data, and reviews of relevant federal court cases.
Exciting CPE events coming up
Market-Derived Patent Data: What Data Is Important and How Does It Impact Value? (December 19): Michael Pellegrino (Pellegrino & Associates) shows how economic events for patents, trademarks, and other intangible assets can be put to use as market-based benchmarks and comparables.
The 2014 Online Symposium on Fair Value Measurement is BVR’s latest in-depth webinar series. Throughout 2014, the monthly webinars that make up the Symposium will critically examine best practices, professional guidance, and judicial decisions that determine the practices of measuring fair value.
The first installment of the Fair Value Symposium, Overview of Fair Value Accounting (ASC topics 820, 805, 350 and 360) (January 14), features series curator Mark Zyla (Acuitas Inc.) on the state of fair value measurement. From the history of FASB guidance to the future of fair value measurement, Zyla’s critical look at fair value practices is not to be missed.
After taking a break for Christmas and New Year's, BVWire will be back on Wednesday, January 8. Have a safe, joyful, and prosperous holiday season!
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