Business Valuation Discounts and Premiums

by Shannon P. Pratt (Willamette Management Associates, Portland, Oregon)

• ISBN13: 9780471394488
• ISBN10: 0471394483
• Format: Hardcover
• Copyright: 2001-10-01
• Publisher: Wiley

Summary

Business Valuation Discounts and Premiums There is often more money in dispute in determining the discounts and premiums in a business valuation than in arriving at the pre-discount valuation itself. Discounts and premiums affect not only the value of the company but also play a crucial role in determining the risk involved, control issues, marketability, contingent liability, and a host of other factors that can make or break a deal. It is essential that every appraiser know when discounts and premiums apply and how to quantify them. Shannon Pratt's Business Valuation Discounts and Premiums compiles all the key information you need to successfully and accurately determine discounts and premiums in business valuations. It explores the three areas of discounts and premiums-income valuation, market valuation, and the asset approach-explaining how different discounts or premiums may be applicable, depending on the basic valuation approach used, and how each approach can affect the outcome. Filled with many never-before-published studies, the comprehensive coverage includes: * Strategic acquisitions * Extensive empirical data * Pre-IPO marketability discount studies * Merger and acquisition negotiations, empirical evidence from completed transactions, and positions taken by courts in litigation * Strategic acquisitions on premiums * Studies on minority discounts, available for the first time Written by a recognized authority on business valuation, this book will help you master the complex issues and exploit the numerous uses for premiums and discounts to their utmost. www.wiley.com

Author Biography

SHANNON P. PRATT is a founder and Managing Director of Willamette Management Associates, one of the oldest and largest independent valuation consulting, economic analysis, and financial advisory services firms, with offices in cities across the United States.

Table of Contents

List of Exhibits	xvii
Foreword	xxi
Preface	xxiii
Acknowledgments	xxvii
Overview of Business Valuation Discounts and Premiums and the Bases to Which They Are Applied	1	(16)
Discounts and Premiums Reflect Relative Risk and Relative Growth	2	(1)
Discounts and Premiums Are Big-Money Issues	2	(1)
``Entity-Level'' versus ``Shareholder-Level'' Discounts and Premiums	3	(8)
How the Valuation Approaches Used Affect the Level of Value	11	(1)
Use of Public Company Data to Quantify Discounts and Premiums	12	(1)
How the Standard of Value Affects Discounts and Premiums	13	(2)
Summary	15	(2)
Minority Discounts and Control Premiums	17	(28)
Relevant Definitions	18	(1)
Basic Minority/Control Value Relationship	19	(1)
Prerogatives of Control	20	(1)
Factors Affecting Degree of Control	21	(8)
How the Valuation Methodology Affects the Minority Discount or Control Premium	29	(4)
Do Publicly Traded Minority Stock Prices Reflect Control Value?	33	(7)
How the Purpose of the Valuation Affects Minority Discounts or Control Premiums	40	(3)
Summary	43	(2)
Empirical Data Regarding Minority Discounts and Control Premiums	45	(19)
Premiums Paid in Acquisitions	45	(11)
Identifying Industries with Higher or Lower Control Premiums	56	(3)
Caveats Regarding Use of Control Premium Data	59	(2)
Percentage Discounts from Net Asset Value	61	(1)
Summary	62	(2)
Minority Discounts and Control Premiums in the Courts	64	(14)
Gift, Estate, and Income Tax Cases	66	(2)
Discounts for Lack of Control in Employee Stock Ownership Plan Cases	68	(1)
Dissenting Shareholder Cases	69	(3)
Shareholder Oppression Cases	72	(2)
Marital Dissolution Cases	74	(1)
Bankruptcy Case	75	(1)
Summary	75	(3)
Discounts for Lack of Marketability for Minority Interests: Concept and Evidence	78	(12)
Public Market Benchmark for Marketability	78	(2)
Empirical Evidence to Quantify Discounts for Lack of Marketability	80	(1)
Restricted Stock Studies	80	(3)
Pre--Initial Public Offering Discount for Lack of Marketability Studies	83	(4)
Regulatory and Court Recognition of Empirical Marketability Discount Studies	87	(1)
Summary	88	(2)
Synopsis of Restricted Stock Studies	90	(21)
Securities and Exchange Commission Institutional Investor Study	91	(7)
Gelman Study	98	(1)
Trout Study	98	(1)
Moroney Study	99	(1)
Maher Study	99	(1)
Standard Research Consultants Study	99	(2)
Silber Study	101	(1)
FMV Opinions Study	101	(1)
Management Planning Study	102	(3)
Johnson Study	105	(3)
Columbia Financial Advisors Study	108	(1)
Summary	109	(2)
John Emory Pre--Initial Public Offering Discount for Lack of Marketability Studies---Complete Underlying Data	111	(41)
January 1980--June 1981	112	(1)
January 1985--June 1986	113	(1)
August 1987--January 1989	113	(1)
February 1989--July 1990	113	(1)
August 1990--January 1992	113	(11)
February 1992--July 1993	124	(1)
January 1994--June 1995	124	(1)
November 1995--April 1997	124	(1)
Dot-Com Companies, May 1997--March 2000	125	(20)
Summary	145	(7)
Factors Affecting Discounts for Lack of Marketability for Minority Interests	152	(13)
Size of Distributions	153	(4)
Prospects for Liquidity	157	(1)
Pool of Potential Buyers	158	(2)
Risk Factors	160	(3)
Summary	163	(2)
Discounts for Lack of Marketability for Controlling Interests	165	(13)
Discounts for Lack of Marketability for Controlling Interests: A Controversial Concept	167	(1)
``Control, Marketable'' Is an Oxymoron	167	(1)
Bases from Which Controlling Interest Discounts for Lack of Marketability May Be Deducted	168	(2)
Factors Affecting Controlling Interest Discounts for Lack of Marketability	170	(2)
Public Versus Private Company Acquisition Multiples	172	(1)
Court Treatment of Controlling Interest Discounts for Lack of Marketability	173	(3)
Summary	176	(2)
Quantitative Marketability Discount Model	178	(18)
Introduction	178	(1)
What Is the Quantitative Marketability Discount Model?	179	(2)
Quantitative Marketability Discount Model: Base Case	181	(4)
Quantifying the Quantitative Marketability Discount Model Base Case	185	(1)
Marketable Minority Valuation Concepts	186	(2)
Nonmarketable Minority Valuation Concepts	188	(2)
Expected Growth and Expected Returns	190	(3)
Summary	193	(3)
Marketability Discounts in the Courts	196	(12)
Gift and Estate Tax Cases	197	(2)
Employee Stock Ownership Plan Case	199	(1)
Dissenting Shareholder Cases	200	(2)
Minority Oppression Cases	202	(1)
Marital Dissolution Cases	203	(2)
Summary	205	(3)
Voting versus Nonvoting Stock	208	(16)
Voting versus Nonvoting Stock Scenarios	209	(1)
Empirical Studies Show Little Differential for Small Minority Interests	209	(2)
Transactions Involving Premiums for Control Blocks	211	(9)
Court Cases Involving Voting versus Nonvoting Stock	220	(3)
Summary	223	(1)
Key Person Discounts	224	(13)
Empirical Evidence Supports Key Person Discount	225	(1)
Factors to Consider in Analyzing the Key Person Discount	226	(1)
Quantifying the Magnitude of the Key Person Discount	227	(1)
Internal Revenue Service Recognizes Key Person Discount	228	(1)
U.S. Tax Court Cases Involving Key Person Discounts	229	(4)
Key Person Discounts in Marital Dissolutions	233	(2)
Summary	235	(2)
Discounts for Trapped-in Capital Gains Taxes	237	(13)
Rationale for Trapped-in Capital Gains Tax Discount	237	(1)
``General Utilities Doctrine''	238	(1)
Tax Court Recognizes Trapped-In Capital Gains	239	(2)
Internal Revenue Service Acquiesces to Trapped-In Capital Gains Discount	241	(1)
Subsequent Tax Cases Regularly Recognize Trapped-in Capital Gains Tax Discount	241	(2)
Trapped-in Capital Gains in Dissenting Stockholder Actions	243	(1)
Trapped-in Capital Gains in Bankruptcy Court	243	(1)
Trapped-in Capital Gains Taxes in Marital Dissolutions	244	(3)
Treatment of Capital Gains Tax Liability in S Corporations	247	(1)
Summary	248	(2)
Blockage Discounts	250	(10)
Blockage Is Distinct from Restricted Stock	251	(1)
Factors to Analyze in Quantifying Blockage Discount	252	(2)
Must Consider Ways of Selling Stock	254	(1)
``Price Pressure'' and ``Market Exposure''	254	(1)
Block Buyer Could Ameliorate Blockage Discount	254	(1)
Blockage Discounts Recognized in Estate and Gift Tax Regulations	255	(1)
Blockage Discounts in U.S. Tax Court	255	(3)
Summary	258	(2)
Nonhomogeneous Assets (``Portfolio'') Discounts	260	(9)
Portfolio Discount Principle	260	(1)
Empirical Evidence Supporting Portfolio Discounts	261	(3)
How to Value Companies with Disparate Portfolios	264	(1)
Quantifying the Portfolio Discount	265	(1)
Portfolio Discounts in the U.S. Tax Court	265	(2)
Summary	267	(2)
Discounts for Environmental, Litigation, and Other Contingent Liabilities	269	(4)
Concept of the COntingent Liability Discount	269	(1)
Financial Accounting Standard #5 May Provide Guidance in Quantifying Contingent Liabilities	270	(1)
Treatment of Contingencies in the U.S. Tax Court	270	(1)
Summary	271	(2)
Discount Adjustments for Limited Partnership Interests and Other Asset Management Entities	273	(19)
Introduction	275	(1)
Partnership Features	275	(1)
Other State Law and Regulatory Issues	276	(1)
Compliance with Federal Income Tax Regulations	276	(1)
Compliance with Federal Transfer Tax Regulations	277	(1)
Analysis of Ownership and Classes of Interests	277	(1)
Analysis of Underlying Adjusted Net Asset Value	278	(1)
Analysis of Income Capacity Value	278	(1)
Valuation of Noncontrolling Entity Interests	279	(2)
Discounts for Lack of Control and Marketability	281	(8)
Court Cases Regarding Limited Partnership Values	289	(2)
Summary	291	(1)
Premium and Discount Issues in Undivided Interest Valuations	292	(24)
Description and Characteristics of Undivided Interests	293	(3)
Appraisal of Assets in Fee-Simple Interest	296	(4)
Factors Affecting the Value of an Undivided Interest	300	(2)
Valuation Adjustments for Undivided Interests	302	(7)
Court Decisions Related to Undivided Interest Discounts	309	(5)
Summary	314	(2)
Common Errors in Applying Discounts and Premiums	316	(67)
Using Synergistic Acquisition Premiums to Quantify Premiums for Control	317	(1)
Assuming That the Discounted Cash Flow Valuation Method Always Produces a Minority Value	317	(1)
Assuming That the Guideline Public Company Method Always Produces a Minority Value	317	(1)
Valuing Underlying Assets Rather Than Stock or Partnership Interests	318	(1)
Using Minority Interest Marketability Discount Data to Quantify Marketability Discounts for Controlling Interests	318	(1)
Using Only Restricted Stock Studies (and Not Pre---Initial Public Offering Studies) as Benchmark for Discounts for Lack of Marketability	319	(1)
Inadequate Analysis of Relevant Factors	319	(1)
Indiscriminate Use of Average Discounts or Premiums	319	(1)
Applying (or Omitting) a Premium or Discount Inappropriately for the Legal Context	320	(1)
Applying Discounts or Premiums to the Entire Capital Structure Rather Than Only to Equity	320	(1)
Quantifying Discounts or Premiums Based on Past Court Cases	320	(1)
Using an Asset Appraiser to Quantify Discounts or Premiums for Stock or Partnership Interests	321	(1)
Summary	321	(2)
Appendixes
Appendix A Bibliography	323	(17)
Appendix B Data Resources	340	(5)
Appendix C Table of Cases	345	(6)
Appendix D How Much Can Marketability Affect Security Values?	351	(9)
Appendix E Internal Revenue Service Revenue Ruling 77-287	360	(6)
Appendix F Securities and Exchange Commission Rules 144 and 144A	366	(17)
CPE Self-Study Examination	383	(10)
Index	393