Business Valuation Review Volume 36: Issue 4

Hello, Everyone,

As this issue goes to press, tax reform is still taking place in Washington, DC. It will be interesting to see how tax reform affects our profession. Included here are two articles on valuations of pass-through entities: “Testing the S-Corp Value Premium for Realism and Reasonableness,” by Sarah von Helfenstein, and “Valuing S Corporations: An Extension of SEAM,” by Gabriel Ratliff. A basic tenet of valuation is that the after-tax cash flows are what are important to investors. I hope these two articles will contribute to the consideration of the issues with respect to pass-through entities. In addition,

Estimation of the terminal value of a business enterprise is a critical aspect of any corporate valuation. In a path-breaking article, Bradley and Jarrell showed that traditional constant growth methods for estimating the terminal value typically failed to deal properly with inflation. The premise underlying the Bradley-Jarrell analysis, namely, that inflation applies to a firm's capital stock in the same manner that it applies to other financial metrics, is straightforward. Unfortunately, the Bradley-Jarrell analysis is often misunderstood because of accounting issues that arise in its application and because of its apparent deviation from traditional formulas for plowback and growth. This article addresses those details. In doing so, we demonstrate how to handle the issues that arise when applying the Bradley-Jarrell model to GAAP-based financial statements or forecasts and we show how the Bradley-Jarrell approach can be reconciled with the traditional models.

Following a series of US Tax Court decisions during the late 1990s and early 2000s, appraisers revisited how to value privately held S corporations. In particular, the key issue concerned how to account for the differing tax burdens between C corporations and S corporations when financial data from the former are used to appraise minority interests in the latter. One method developed to address this issue is the Van Vleet model—also known as the S Corporation Economic Adjustment Model (“SEAM”)—which considers the differences in tax treatment between S corporations and C corporations, and their respective shareholders. The model produces the S Corporation equity adjustment multiple, which can be applied to the S corporation equity value when such value has been estimated using C corporation data. One of the primary assumptions of the model is that the S corporation organizational form of the subject company will continue in perpetuity. In practice, however, there may be instances when the appraiser is not comfortable adopting that assumption. In this article, we examine how to adjust the SEAM to account for specific valuation circumstances in which a subject S corporation will likely not retain its tax election in perpetuity.

For almost fifty years, the field of finance and the valuation profession have deliberated over the potential impact of taxation on security prices and costs of capital as well as the value effects of the tax attributes of pass-through entities (PTEs). Hundreds of papers on these topics have been published. Analytic models that offer various approaches to problem resolution have been proposed. Some have been widely used. Debates have been held in court and out. However, all this activity has resulted in a thicket of theory and practice that is neither conclusive nor easy to maneuver with clarity and common sense. The presenting issue for the valuation community—the potential value impact of taxation on PTEs—is only one of a number of nested issues that continue to be explored. To address these, we present and analyze findings from the finance and valuation literatures, as well as publicly available market evidence. We examine the core valuation assumptions currently framing the issues. We then demonstrate the ways in which the current valuation modeling of an S-premium for tax attributes exhibits flaws and fails the test of reasonableness. In closing, we propose that the only supportable value difference, whether positive or negative, between the subject S and its “otherwise identical” proxy C will be captured in the differing income tax rates applied to each. We offer a body of evidence from which the practitioner can prepare and defend realistic treatment of PTE tax attributes and value.

Editor's Column

Estimating Terminal Values with Inflation: The Inputs Matter—It Is Not a Formulaic Exercise

Valuing S Corporations: An Extension of the S Corporation Economic Adjustment Model

Testing the S-Corp Value Premium for Realism and Reasonableness

Book Review

From the Chair

Volume 36, No. 4 — Complete Issue

From the Editor

Customer Concentration: Good, Bad, or Ugly?

From the Chair

Delaware Valuation Decisions, 2021 to 2024

Volume 44, No. 1 — Complete Issue