Abstract

The valuation profession employs a variety of statistical techniques, from simple attrition analysis to more complex retirement rate analysis, to assess customer population life characteristics. For many customer populations, the account survival characteristics are assumed to be constant across the various age cohorts of the population such that customer relationship value is indifferent to account age. However, relaxation of the constant attrition rate characteristic can have a direct influence on the magnitude of the value ascribed to the customer relationship value.

Abstract

The United States is increasingly a knowledge-based economy. However, corporate balance sheets still only present asset values at a given moment in time, and intangible asset values are often not disclosed. A recent accounting pronouncement, SFAS 157, requires more detail and is an important step toward more meaningful presentation of the value of companies' assets. However, analysis and reconciliation will still be required, particularly for intangible assets.

Abstract

Imagine the following two valuation scenarios:

• You are retained to value two interests in an S corporation for a possible acquisition of either shareholder by the other shareholder: a 49.5% interest, and a 50.5% interest. There is a shareholder agreement that directs valuation to be done at the fair market value of the interests.

• You are asked to value a 40% interest in an S corporation for purposes of the company redeeming a shareholder's interest at its fair market value. You complete your engagement. After completion, the company tells you that they have negotiated with the shareholder and will be acquiring the interest for a proportionate piece of the whole. They ask you to value the entire S corporation and, in your conclusion, ask you to indicate the proportionate value of the 40% interest.

What does the analyst do? For many analysts who continue to hold to the notion that S corporation adjustments only apply to minority interests, in the first example, the value of the 49.5% interest could be higher than the 50.5% interest, and in the second example, the minority valuation of the 40% interest could be higher than the proportionate piece of the whole (ignoring minority and lack of marketability discounts). Both of these real world assignments beg the question: Does this make sense?

Abstract

Capital market theory suggests that undiversified investors may have a higher cost of capital than do diversified investors. Private companies generally trade at a discount to similar publicly traded companies. From a discounted cash-flow viewpoint, this implies that the cost of capital for the private company is higher. We suggest that a large component of the private company discount is due to the entrepreneurial investor's lack of diversification. Using basic capital market theory, we provide a cost of capital model that depends on total risk faced by the entrepreneurial investor. We then propose a methodology based on a certainty-equivalent approach and Monte Carlo simulation to quantify this risk. We also provide a simple case to illustrate its application. Our results suggest that the risk borne by the undiversified entrepreneurial investor is a major contributor to the private company discount through the cost of capital.

Abstract

Caracci versus Commissioner was the first case to consider how the Internal Revenue Service (IRS) could levy intermediate sanctions pursuant to Internal Revenue Code (IRC) Section 4958, regarding “excess benefit transactions” with charitable organizations. The central issue before the Tax Court was the fair market value of unprofitable assets contained in a tax exempt home nursing care agency in rural Mississippi. The Tax Court's valuation methodology determined that the shareholders of the newly formed nonexempt organizations received assets in excess of liabilities assumed of $5.1 million and, therefore, were subject to Section 4958 taxes and penalties. Upon review, the Fifth Circuit reversed and rendered the final decision in the dispute, sighting clearly erroneous factual findings in applying the valuation method by the Tax Court, including failure to consider many of the key elements of fair market value outlined in Revenue Ruling 59–60. The Fifth Circuit's decision is a sharply worded reminder to appraisers of the importance of using the appropriate valuation framework for the property being appraised.

Abstract

Until now, the approaches to valuing S corporations have focused on two main aspects: differences in tax rates for subchapter S and C corporations and the appropriate discount rates to use in valuing them. The problem lies with the fact that traditional earnings methods of valuation, including discounted cash flow, are faced with the dilemma of having a “pretax,” that is, untaxed, cash flow passed through to the S corporation shareholder that should be discounted at the post-corporate, but preshareholder, tax discount rate. Empirical evidence is critically reviewed herein.