Business Valuation and Taxes : Procedure, Law, and Perspective

by David Laro (Georgetown University); Shannon P. Pratt (Willamette Management Associates, Portland, Oregon)

• ISBN13: 9780471694373
• ISBN10: 0471694371
• Format: Hardcover
• Copyright: 2005-04-01
• Publisher: Wiley

Summary

Disputes over valuation issues fill the court's dockets and for good reason, fair market valuations are required frequently by the law. The authors believe that approximately 243 sections of the Code and several thousand references in the Regulations explicitly require fair market value determination. Consequently, taxpayers file an estimated 15 million tax returns each year reporting an event involving a valuation related issue. It is no mystery, therefore, why valuation cases are ubiquitous. Today, valuation is an important and highly sophisticated process. Valuators need legitimate guidance to perform their work. The objective of this book is to provide knowledge, and guidance to those who do the valuations as well as those who are affected by them. This unprecedented text provides: Clear guidance and perspective on business valuation from two of the nation' s top authorities, Hon. David Laro and Dr Shannon Pratt. Insightful perspective and discussion on critical issues, procedures and law pertaining to business valuation. An overview of business valuation procedures Law and techniques of Fair Market Value Opinion from the Hon. David Laro and Dr. Shannon Pratt who express their unique and critical views. The business valuer with everything from the basics to the sophisticated. From definitions to valuing complex business interests, what you need to know about business valuation. Everything from empirical market evidence to credible expert business

Author Biography

DAVID LARO was appointed by President Bush to the United States Tax Court, confirmed by the Senate, and vested as a federal judge in November 1992. He formerly practiced law in Flint and Ann Arbor, Michigan, specializing in tax law for twenty-four years. Judge Laro was chairman and CEO of a publicly traded international company and cofounded Republic Bancorp, a Michigan bank holding company. He is an adjunct professor of law at Georgetown University Law Center, a visiting professor at the University of San Diego Law School, and a lecturer at Stanford Law School. He is a frequent guest speaker and has written numerous articles on taxation.

Shannon P. Pratt, CFA, FASA, MCBA, CM&AA, is the Chairman and CEO of Shannon Pratt Valuations, Inc. a premier business valuation firm located in Portland Oregon, and is the founder and Editor Emeritus of Business Valuation Resources, LLC. Over a distinguished career of close to four decades, he has performed valuation engagements for M&A, ESOPs, gift and estate taxation, marital dissolution, shareholder oppression and dissent, and numerous other purposes. He has conducted numerous fairness and solvency opinions, has testified in a wide variety of federal and state courts across the country, and frequently participates in arbitration and mediation proceedings. Dr. Pratt is one of the most successful and respected authors in his field. He is the author or coauthor of several industry standards, including Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Valuing Small Businesses and Professional Practices, The Market Approach to Valuing Businesses, Standards of Value, Business Valuation and Taxes, The Lawyer's Business Valuation Handbook, and Cost of Capital

Table of Contents

Forewords	xvii
Preface	xxiii
Acknowledgments	xxvii
Standards of Business Valuation	1	(16)
Summary	1	(1)
Introduction	2	(1)
Sources for Defining Value	3	(4)
Definitions of Value	7	(8)
Premise of Value	15	(1)
Conclusion	16	(1)
Subsequent Events	17	(7)
Summary	17	(1)
Key Question	17	(1)
Valuation Date	17	(2)
Subsequent Events---Exceptions	19	(4)
Conclusion	23	(1)
Business Valuation Experts	24	(24)
Summary	24	(1)
Introduction	25	(1)
Proving Business Value	25	(1)
The Expert Appraiser	26	(1)
Types of Experts	26	(1)
Various Roles of Experts	27	(1)
Business Valuation Litigation Witnesses	28	(1)
Admissibility of Evidence Underlying Expert Opinions	29	(1)
Limitations to Admissibility	30	(1)
Reliability of the Expert	31	(2)
Minimum Thresholds for the Business Valuation Expert	33	(1)
Sarbanes-Oxley Act of 2002	34	(1)
Attorney Assistance to the Expert	35	(2)
Qualified Appraiser	37	(1)
Concerns about Expert Testimony	38	(2)
Court-Appointed Expert	40	(1)
Conclusion	41	(1)
Appendix: Expert Credentials and Qualifications	42	(6)
Sources of Law and Choice of Courts	48	(7)
Summary	48	(1)
Structure of the American Legal System	48	(1)
Tax Law	49	(2)
Tax Litigation	51	(4)
Burden of Proof in Valuation Controversies	55	(8)
Summary	55	(2)
Burden of Proof	57	(1)
Who Bears the Burden of Proof	58	(1)
Burden of Proof: Exceptions to the General Rule	59	(4)
Penalties and Sanctions	63	(7)
Summary	63	(1)
Introduction	63	(1)
What You Need to Know	64	(1)
Valuation Penalties	65	(2)
General Penalties	67	(1)
Discretionary Sanctions	68	(2)
Valuation and Choice of Entity	70	(9)
Summary	70	(1)
Introduction	71	(1)
Corporations	72	(1)
Limited Liability Companies	73	(1)
General Partnerships	73	(1)
Limited Partnerships	74	(1)
Sole Proprietorships	75	(1)
Valuation Considerations	75	(2)
Choice of Jurisdiction	77	(1)
Conclusion	77	(2)
Valuation of S Corporations and Other Pass-Through Tax Entities: Minority and Controlling Interests	79	(58)
Introduction	79	(2)
Case Law Background	81	(2)
S Corporation Minority Interest Appraisals	83	(44)
Comparison of Minority Interest Theories---A Summary of the Issues	127	(3)
S Corporation Controlling Interest Appraisals	130	(1)
Summary	131	(1)
S Corporation Valuation Issues---Partial Bibliography	131	(6)
Valuation of International Transactions	137	(16)
Summary	137	(1)
Introduction	138	(1)
Transfer Pricing	139	(8)
Customs Valuation	147	(5)
Conclusion	152	(1)
Adjustments to Financial Statements	153	(6)
Summary	153	(1)
Separating Nonoperating Items from Operating Items	154	(1)
Addressing Excess Assets and Asset Deficiencies	155	(1)
Handling Contingent Assets and Liabilities	155	(1)
Adjusting Cash-Basis Statements to Accrual-Basis Statements	156	(1)
Normalizing Adjustments	156	(1)
Controlling Adjustments	157	(1)
Conclusion	158	(1)
Comparative Financial Statement Analysis	159	(9)
Summary	159	(2)
Comparable Ratio Analysis	161	(5)
Common Size Statements	166	(1)
Tying the Financial Statement Analysis to the Value Conclusion	167	(1)
Conclusion	167	(1)
Economic and Industry Analysis	168	(10)
Summary	168	(1)
Objective of Economic and Industry Analysis	168	(1)
National Economic Analysis	169	(1)
Regional and Local Economic Analysis	170	(1)
Industry Analysis	170	(2)
Conclusion	172	(1)
Partial Bibliography of Sources for Economic and Industry Analysis	172	(6)
Site Visits and Interviews	178	(3)
Summary	178	(1)
Site Visits	178	(1)
Management Interviews	178	(1)
Interviews with Persons Outside the Company	179	(1)
Conclusion	180	(1)
The Income Approach	181	(28)
Summary of Approaches, Methods and Procedures	181	(1)
Introduction to the Income Approach	182	(1)
Net Cash Flow: The Preferred Measure of Economic Benefit in the Income Approach	182	(2)
Discounting versus Capitalizing	184	(1)
Relationship between Discount Rate and Capitalization Rate	184	(6)
Projected Amounts of Expected Returns	190	(1)
Developing Discount and Capitalization Rates for Equity Returns	190	(4)
Weighted Average Cost of Capital (WACC)	194	(1)
The Midyear Convention	195	(1)
The Income Approach in the Courts	196	(4)
Conclusion	200	(1)
Appendix: An Illustration of the Income Approach to Valuation	201	(8)
The Market Approach	209	(51)
Summary	209	(1)
The Market Approach	210	(1)
Revenue Ruling 59-60 Emphasizes Market Approach	210	(1)
The Guideline Publicly Traded Company and the Guideline Transaction (Merger and Acquisition) Method	211	(2)
How Many Guideline Companies?	213	(4)
Selection of Guideline Companies	217	(2)
Documenting the Search for Guideline Companies	219	(1)
Choosing Multiples Based on Objective Empirical Evidence	219	(1)
What Prices to Use in the Numerators of the Market Valuation Multiples	220	(1)
Choosing the Level of the Valuation Multiple	220	(2)
Selecting Which Valuation Multiples to Use	222	(2)
Assigning Weights to Various Market Multiples	224	(1)
Sample Market Valuation Approach Tables	224	(1)
Other Methods Classified under the Market Approach	224	(5)
Conclusion	229	(1)
Appendix: An Illustration of the Market Approach to Valuation	230	(30)
The Asset-Based Approach	260	(6)
Summary	260	(1)
The Adjusted Net Asset Value Method	260	(1)
Excess Earnings Method (The Formula Approach)	261	(4)
Conclusion	265	(1)
Entity-Level Discounts	266	(16)
Summary	266	(1)
Trapped-In Capital Gains Discount	267	(4)
Key Person Discount	271	(5)
Portfolio (Nonhomogeneous Assets) Discount	276	(3)
Discount for Contingent Liabilities	279	(2)
Conclusion	281	(1)
Discounts for Lack of Marketability	282	(29)
Summary: General Introduction to Shareholder-Level Discounts and Premiums	283	(1)
Definition of Marketability	283	(1)
Benchmark for Marketability Is Cash in Three Days	284	(1)
Investors Cherish Liquidity, Abhor Illiquidity	285	(1)
Degrees of Marketability or Lack Thereof	285	(1)
Empirical Evidence to Quantify Discounts for Lack of Marketability: The Restricted Stock Studies	286	(5)
Empirical Evidence to Quantify Discounts for Lack of Marketability: Pre-IPO Studies	291	(3)
Criticisms of the Pre-IPO Studies	294	(1)
Factors Affecting the Magnitude of Discounts for Lack of Marketability	295	(4)
Use of the Databases for Quantifying Discounts for Lack of Marketability	299	(3)
Discounts for Lack of Marketability in the Courts	302	(7)
Conclusion	309	(1)
Partial Bibliography of Sources for Discounts for Lack of Marketability	310	(1)
Other Shareholder-Level Discounts	311	(13)
Summary	311	(1)
Minority Discounts/Control Premiums	311	(6)
Voting versus Nonvoting Shares	317	(1)
Blockage	318	(3)
Discounts for Undivided Fractional Interests in Property	321	(2)
Conclusion	323	(1)
Weighting of Approaches	324	(4)
Summary	324	(1)
Theory and Practice	324	(1)
Mathematical versus Subjective Weighting	325	(1)
Examples of Weighting of Approaches	326	(1)
Conclusion	327	(1)
Valuation of Options	328	(12)
Summary	328	(1)
Introduction and Background	329	(1)
General Principles of Option Valuation	330	(4)
Specific Rules for Valuing Options	334	(5)
Conclusion	339	(1)
IRS Positions	340	(43)
Summary	340	(1)
Introduction	341	(1)
Rev. Rul. 59-60	342	(8)
Rev. Rul. 65-192	350	(4)
Rev. Rul. 65-193	354	(1)
Rev. Proc. 66-49	354	(4)
Rev. Rul. 68-609	358	(1)
Rev. Proc. 77-12	359	(2)
Rev. Rul. 77-287	361	(6)
Rev. Rul. 83-120	367	(4)
Rev. Rul. 85-75	371	(1)
Rev. Rul. 93-12	372	(2)
Tax Advice Memorandum 1994-36-005	374	(4)
Rev. Proc. 2003-51	378	(4)
Conclusion	382	(1)
Business Appraisal Reports	383	(17)
Summary	384	(1)
Business Valuation Report-Writing Standards	384	(8)
Elements of the Business Valuation Report	392	(5)
Organization of the Report	397	(1)
Qualities of a Good Appraisal Report	397	(2)
Conclusion	399	(1)
Questions to Ask Business Valuation Experts	400	(7)
Summary	400	(1)
Qualifications	400	(2)
Financial Statement Adjustments and Analysis	402	(1)
Economic and Industry Data	402	(1)
Site Visits and Interviews	402	(1)
General Questions about Methodology	402	(1)
Discount and Capitalization Rates in the Income Approach	402	(2)
Projections Used in the Income Approach	404	(1)
Market Approach	404	(1)
Asset-Based Approach	405	(1)
Entity-Level Discounts	405	(1)
Minority Interest Discounts/Control Premiums	405	(1)
Discounts for Lack of Marketability	405	(1)
Voting/Nonvoting Stock	406	(1)
Questions about Contradictory Prior Testimony	406	(1)
Appendix A IRS Business Valuation Guidelines	407	(5)
Appendix B International Glossary of Business Valuation Terms	412	(7)
Appendix C Bibliography	419	(7)
Appendix D Table of Cases	426	(5)
Index	431