Remember the Oldsmobile commercial: “This is not your father’s Oldsmobile”? The same can be said of business appraisal. Many, if not most, of the core valuation concepts and processes have undergone material changes over the past 20 years. This is not your father’s Business Valuation anymore.
Do your expert’s reports look like they did 29 years ago? If so, you should be concerned. Here are some of the biggest changes in business valuation that impact the quality, accuracy, and supportability of the expert’s conclusion of value:
Discounts for Lack of Marketability (DLOMs) – Valuing a privately held company usually and automatically concluded with the application of a 35 percent discount for lack of marketability. After all, it’s hard to sell a privately held business quickly. So after an extensive analysis and several complex computations, the concluded value would be whacked by 35 percent. Why 35 percent? First, because some early (1960s era) market studies indicated discounts of that amount. Second, because the IRS generally accepted that amount way back then.
Not today, though. Knowledgeable business appraisers will access databases of empirical market data to compare liquid market prices with less liquid market transaction values, or apply some highly sophisticated analysis to derive a subject company-specific discount for lack of control specific to non-control interests, and that amount may be materially higher than 35 percent or materially less. The empirical evidence stands on its own.
Using Publicly Traded Stock Prices – Twenty five years ago it was universally accepted that valuing a privately held business by applying multiples derived from similar public companies derived a non-control level of value. After all, publicly traded stock are minority interests. However, that thinking has changed. Assuming a public company with widely distributed ownership and no insider control of the board, the board of directors act as a control interest for the benefit of all the shareholders – so my 100 shares of XYZ public company is not non-control. The issue of control is captured in the level of returns to which the market multiple is applied.
What does this mean to the business appraiser who hasn’t kept up? He or she may be materially misstating the value of the business.
Discount Rates – Determining the rate of return had been a pretty intuitive process. Hold up your thumb and size up the business risk qualitatively and pick a number between 15 percent and 25 percent. And while those rates may still bookend a reasonable range of returns for a mature and stable privately held company, business appraisers now have a wealth of detailed market data to help them zero in on a required rate of return that captures the risks specific to the company being appraised.
Tax Affecting – Finally, the advent of pass through tax entities that started in the late 1980s, including as S-Corps and LLCs have opened up a can of worms as to how to treat the taxation of profits in a valuation when all the market data is from publicly traded corporations that are not pass through tax entities and pay taxes (political hyperbole aside). Business appraisers wanted to tax impact profits, arguing that an S-Corp is fundamentally not worth more than the same company without an S-Corp status. The IRS wanted no tax affecting at all, arguing that the shareholders pay the taxes, not the corporation and cherry-picked some cases to prove their point.
Today appraisers look at sophisticated models that attempt to measure the incremental value of the pass through tax entity over a taxable entity, focusing on the benefit of tax free distributions, the tax free build up in basis, and potentially differing tax rates. The issue is clearly no longer black and white.
Make sure you and/or your clients are getting supportable appraisals. The professionals at Advent Valuation Advisors hold the business valuations’ highest levels of training and credentialing. They write and speak on BV, and teach BV to budding appraisers. Call us today.