Description
Book SynopsisBusiness Valuation Discounts and Premiums
SECOND EDITION
Discounts and premiums do not just affect the value of a company; they play a crucial role in influencing a host of other factors and conditions that can make or break a deal. When it comes to business valuations, it''s the business appraiser''s responsibility to be intimately knowledgeable with every aspect of discounts and premiums: the different types, the situations when they may or may not apply, and how to quantify them.
In this newly updated edition of Business Valuation: Discounts and Premiums, Shannon Pratt?one of the nation''s most recognized and respected business valuation consultants?brings together the latest collective wisdom and knowledge about all major business discounts and premiums.
Addressing the three basic approaches to conducting a valuation?the income approach, the market approach, and the asset approach?Shannon Pratt deftly and logically details the different discounts
Table of Contents
List of Exhibits xv
About the Author xix
About the Contributing Authors xxi
Foreword xxv
Preface xxvii
Acknowledgments xxix
1 Overview of Business Valuation Discounts and Premiums and the Bases to Which They Are Applied 1
Discounts and Premiums Are Big-Money Issues 2
‘‘Entity Level’’ versus ‘‘Shareholder Level’’ Discounts and Premiums 3
How the Valuation Approaches Used Affect the Level of Value 8
Use of Public Company Data to Quantify Discounts and Premiums 9
How the Standard of Value Affects Discounts and Premiums 10
American Society of Appraisers Business Valuation Standard VII:Valuation Discounts and Premiums 12
Summary 13
2 Minority Discounts and Control Premiums 15
Relevant Definitions 16
Basic Minority/Control Value Relationship 16
Prerogatives of Control 17
Factors Affecting Degree of Control 18
How the Valuation Methodology Affects the Minority Discount or Control Premium 25
Do Publicly Traded Minority Stock Prices Reflect Control Value? 29
Treatment of Control Premiums in the Delaware Courts 35
How the Purpose of the Valuation Affects Minority Discounts or Control Premiums 37
Summary 38
3 Empirical Data Regarding Minority Discounts and Control Premiums 41
Premiums Paid in Acquisitions 41
Identifying Industries with Higher or Lower Control Premiums 62
Caveats Regarding Use of Control Premium Data 63
Are Control Premiums Too High? 65
Percentage Discounts from Net Asset Value 66
Summary 66
4 Minority Discounts and Control Premiums in the Courts 68
Gift, Estate, and Income Tax Cases 70
Discounts for Lack of Control in Employee Stock Ownership Plan Cases 74
Dissenting Shareholder Cases 75
Shareholder Oppression Cases 80
Marital Dissolution Cases 80
Bankruptcy Case 82
Summary 82
5 Discounts for Lack of Marketability for Minority Interests: Concept and Evidence 86
Public Market Benchmark for Marketability 86
Empirical Evidence to Quantify Discounts for Lack of Marketability 87
Restricted Stock Studies 88
Pre–Initial Public Offering Discount for Lack of Marketability Studies 90
Courts’ Aversion to ‘‘Benchmarking’’ 91
Regulatory and Court Recognition of Empirical Marketability Discount Studies 92
Summary 92
6 Synopsis of Restricted Stock Studies 95
Securities and Exchange Commission Institutional Investor Study 96
Gelman Study 100
Trout Study 100
Moroney Study 101
Maher Study 101
Standard Research Consultants Study 101
Silber Study 101
FMV Opinions Study 103
Management Planning Study 104
Johnson Study 110
Columbia Financial Advisors Study 110
LiquiStat Database 111
Summary 111
7 LiquiStat Database (Restricted Stocks, Options, Warrants, and Convertible Securities) 113
Restricted Stock as a Basis 114
Biases Beyond Illiquidity in Traditional Restricted Stock Studies 114
How LiquiStat Is Different 115
Options and Warrants in LiquiStat 116
Convertible Securities in LiquiStat 117
Summary 117
8 Blockage Discounts 118
Blockage Is Distinct from Restricted Stock 119
Factors to Analyze in Quantifying Blockage Discounts 119
Must Consider Ways of Selling Stock 122
‘‘Price Pressure’’ and ‘‘Market Exposure’’ 122
Block Buyer Could Ameliorate Blockage Discount 122
Blockage Discounts Recognized in Estate and Gift Tax Regulations 123
Blockage Discounts in U.S. Tax Court 123
Financial Accounting Standards That May Affect Blockage Discounts 126
Blockage Discounts Used to Estimate Illiquidity Discounts 126
Summary 126
9 John Emory Pre–Initial Public Offering Discount for Lack of Marketability Studies—Complete Underlying Data 128
Study #1: Adjusted Study, January 1980–June 1981 129
Study #2: Adjusted Study, January 1985–June 1986 129
Study #3: Adjusted Study, August 1987–January 1989 130
Study #4: Adjusted Study, February 1989–July 1990 130
Study #5: Adjusted Study, August 1990–January 1992 130
Study #6: Adjusted Study, February 1992–July 1993 130
Study #7: Adjusted Study, January 1994–June 1995 131
Study #8: Adjusted Study, November 1995–April 1997 131
Study #9: Adjusted Study, Dot-Com Companies, May 1997–March 2000 131
Study #10: Adjusted Expanded Study, May 1997–December 2000 133
Summary 133
10 Valuation Advisors Discount for Lack of Marketability Study 182
Description of Study 182
Results of Study 184
Summary 185
11 Factors Affecting Discounts for Lack of Marketability for Minority Interests 186
Size of Distributions 187
Prospects for Liquidity 191
Pool of Potential Buyers 193
Risk Factors 194
Summary 198
12 Discounts for Lack of Marketability for Controlling Interests 200
Discounts for Lack of Marketability for Controlling Interests: A Controversial Concept 202
‘‘Control, Marketable’’ Is an Oxymoron 202
Bases from Which Controlling Interest Discounts for Lack of Marketability May Be Deducted 202
Factors Affecting Controlling Interest Discounts for Lack of Marketability 204
Public versus Private Company Acquisition Multiples 207
Court Treatment of Controlling Interest Discounts for Lack of Marketability 210
Summary 211
13 The Quantitative Marketability Discount Model: A Shareholder Level DCF Model 213
Introduction 213
The Structure of the Shareholder Level DCF Model 214
AVisual Representation of the Shareholder Level DCF Model 217
Factors Contributing to Marketability Discounts 218
Summary 223
14 Marketability Discounts in the Courts—Minority Interests 225
Gift and Estate Tax Cases 227
Employee Stock Ownership Plan Case 231
Dissenting Shareholder Cases 232
Minority Oppression Cases 234
Marital Dissolution Cases 234
Summary 238
15 Marketability Discounts in the Courts—Controlling Interests 241
Gift and Estate Tax Cases 241
Marital Dissolution Cases 243
Summary 244
16 Voting versus Nonvoting Stock 245
Voting versus Nonvoting Stock Scenarios 245
Empirical Studies Show Little Differential for Small Minority Interests 246
Transactions Involving Premiums for Control Blocks 251
Court Cases Involving Voting versus Nonvoting Stock 251
Summary 258
17 Key Person Discounts and Premiums 260
Empirical Evidence Supports Key Person Discount 261
Internal Revenue Service Recognizes Key Person Discount 263
Factors to Consider in Analyzing the Key Person Discount 264
Quantifying the Magnitude of the Key Person Discount 265
U.S. Tax Court Cases Involving Key Person Discounts 266
Key Person Discounts in Marital Dissolutions 270
Key Person Discounts in Other Types of Cases 272
Summary 274
18 Discounts for Trapped-In Capital Gains Taxes 276
Rationale for Trapped-In Capital Gains Tax Discount 277
‘‘General Utilities Doctrine’’ 277
Tax Court Recognizes Trapped-In Capital Gains 278
Internal Revenue Service Acquiesces to Trapped-In Capital Gains Discount 279
Subsequent Tax Cases Regularly Recognize Trapped-In Capital Gains Tax Discount 280
Trapped-In Capital Gains in Dissenting Stockholder Actions 282
Trapped-In Capital Gains in Bankruptcy Court 283
Trapped-In Capital Gains Taxes in Marital Dissolutions 283
Treatment of Capital Gains Tax Liability 286
Treatment of Capital Gains Tax Liability in S Corporations 288
Summary 288
19 Nonhomogeneous Assets (‘‘Portfolio’’) Discounts 291
Portfolio Discount Principle 291
Empirical Evidence Supporting Portfolio Discounts 292
How to Value Companies with Disparate Portfolios 294
Quantifying the Portfolio Discount 295
Portfolio Discounts in the Courts 295
Summary 298
20 Discounts for Environmental, Litigation, and Other Contingent Liabilities 300
Concept of the Contingent Liability Discount 300
Financial Accounting Standard #5 May Provide Guidance in Quantifying Contingent Liabilities 301
Treatment of Contingencies in the U.S. Tax Court 301
Treatment of Contingencies in Marital Dissolution 304
Summary 304
21 Discount Adjustments for Limited Partnership Interests and Other Asset Management Entities 305
Introduction 307
Partnership Features 307
Other State Law and Regulatory Issues 308
Compliance with Federal Income Tax Regulations 308
Compliance with Federal Transfer Tax Regulations 309
Analysis of Ownership and Classes of Interests 309
Analysis of Underlying Adjusted Net Asset Value 310
Analysis of Income Capacity Value 310
Valuation of Noncontrolling Entity Interests 311
Discounts for Lack of Control and Marketability 313
Court Cases Regarding Limited Partnership Values 315
Summary 321
22 Adjusting Values for Differences in Size 323
Income Approach 323
Market Approach 325
Criticisms of the Size Premium 329
Court Cases Involving the Size Premium 329
Summary 334
Sources of Additional Data 334
23 Discounts and Premiums in ESOP Valuations 337
ESOP Definition, Types, and Benefits 337
‘‘Adequate Consideration’’ for ESOP Valuation Purposes 338
Control Premiums in ESOP Valuations 339
Discounts for Lack of Marketability in ESOP Valuations 339
ESOP Court Cases 340
Summary 344
24 Discounts and Premiums in Divorce Disputes 345
Control Premiums in Divorce 345
Discounts for Lack of Marketability in Divorce 345
Discounts for Lack of Voting Rights in Divorce 346
Key Person Discounts in Divorce 346
The Effective Discount for Personal Goodwill in Divorce 346
Active versus Passive Appreciation 347
Summary 347
25 Discounts and Premiums in Corporate and Partnership Dissolution and Oppression Cases 349
Dissolution for Shareholder (Partner) Oppression 349
Discounts 351
California Oppression Cases 357
Delaware’s Approach 359
Summary 360
26 Discounts and Premiums in Fair Value for Financial Reporting 362
Introduction 362
Fair Value of Reporting Units 363
Fair Value of Share-Based Compensation 369
Summary 371
Additional Reading 371
27 Premium and Discount Issues in Undivided Interest Valuations 372
Description and Characteristics of Undivided Interests 373
Appraisal of Assets in Fee-Simple Interest 376
Factors Affecting the Value of an Undivided Interest 379
Valuation Adjustments for Undivided Interests 381
Court Decisions Related to Undivided Interest Discounts 389
Summary 395
28 Common Errors in Applying Discounts and Premiums 397
Using Synergistic Acquisition Premiums to Quantify Premiums for Control 398
Assuming That the Discounted Cash Flow Valuation Method Always Produces a Minority Value 398
Assuming That the Guideline Public Company Method Always Produces a Minority Value 398
Valuing Underlying Assets Rather Than Stock or Partnership Interests 399
Using Minority Interest Marketability Discount Data to Quantify Marketability Discounts for Controlling Interests 399
Using Only Restricted Stock Studies (and Not Pre–Initial Public Offering Studies) as Benchmark for Discounts for Lack of Marketability 399
Inadequate Analysis of Relevant Factors 400
Indiscriminate Use of Average Discounts or Premiums 400
Applying (or Omitting) a Premium or Discount Inappropriately for the Legal Context 400
Applying Discounts or Premiums to the Entire Capital Structure Rather than Only to Equity 401
Quantifying Discounts or Premiums Based on Past Court Cases 401
Using an Asset Appraiser to Quantify Discounts or Premiums for Stock or Partnership Interests 401
Summary 401
Appendix A Bibliography 403
Books 403
Articles 404
Periodicals 407
Appendix B Data Resources 410
Control Premiums/Minority Discounts 410
Discounts for Lack of Marketability 410
Discounts from Net Asset Value for Limited Partnership Interests 412
Discounts from Net Asset Value for REITs and REOCs 413
Discounts from Net Asset Value for Closed-End Investment Funds 413
Discount and Capitalization Rates 414
Appendix C How Much Can Marketability Affect Security Values? 416
I. The Framework 417
II. The Upper Bound 418
III. A Comparison 420
IV. Conclusion 422
References 422
Appendix D Internal Revenue Service Revenue Ruling 77-287 424
Section 1. Purpose 424
Sec. 2. Nature of the Problem 424
Sec. 3. Background and Definitions 424
Sec. 4. Securities Industry Practice in Valuing Restricted Securities 425
Sec. 5. Facts and Circumstances Material to Valuation of Restricted Securities 427
Sec. 6. Weighing Facts and Circumstances Material to Restricted Stock Valuation 428
Sec. 7. Effect on Other Documents 429
Appendix E Securities and Exchange Commission Rules 144 and 144A 430
History 442
Appendix F Table of Cases 448
Index 455
