Taxpayers and savvy professional service providers are often unaware of
the differences in discount valuation reports issues by supposedly competent
valuators. The Mentor Group approach is unique in providing these valuations.
Most discount valuations recite information from at least some these data sources.
- Control premium studies
- Closed end funds (CEFs)
- Real estate limited partnerships (RELPs)
- Restricted stock analytics
- Pre-initial public offering (IPO)
- Long-term equity anticipation securities (LEAPs)
- Court cases and revenue rulings
While this welter of data is somewhat compelling, there is enough variation
among the sources that wide ranges for each type of discount can emerge.
That does not prohibit the other valuation firms from simply plucking
a number from within a range, with little or no justification for the
selections.
Our approaches and detailed analysis are well-known to and accepted by
the Internal Revenue Service (IRS), the ultimate arbiter (prior to Tax
Court) upon audit. Different IRS offices treat discount valuations very
differently, as well as how they respect the purveyor of the report.
The value of a partial interest is the net value discounted to reflect
the effects of some or all of the following:
-
Minority – discount for lack of control (aka DLOC); minority owner cannot
effect compensation; strategic and operational business decisions; dividend
and distribution policy; and divestiture alternatives.
-
Marketability - the limited market for trading interests in the entity or asset. Influencing
factors could include: lack of a liquid market; blockage from selling
shares in a short timeframe; the inability to expose the interest to a
wide selection of investors; added time and higher cost of locating investors;
larger brokerage and other costs to dispose; and the likelihood of receiving
only part of the proceeds in cash. Also known as DLOM, or discount for
lack of marketability.
-
Liquidity – a subset of the DLOM. It estimates the ability to convert an investment
into cash rather quickly and with minimum transaction costs.
-
Blockage – relates to selling large blocks of shares (even control interests)
or properties/other assets in a short period of time. Supply and demand
factors (over supply or insufficient demand or a combination of both)
are analyzed to estimate this price compression.
For the purposes of our valuation, we treat an LLC as a CHIC, or closely
held investment holding company. The U.S. IRS Valuation Guide (the Guide)
defines such companies as business entities which do not own any operating
assets. Instead, they own non-operating assets such as corporate securities,
LLC Interests in partnerships, private equity investments, government
obligations and real estate. The Guide further states that the valuation
emphasis with respect to these entities is their adjusted book value,
also known as net asset value (NAV). As such, the total of the fair market
values of all of the underlying assets, less actual liabilities, is the
best indication of the total value of the LLC. Revenue Rule 59-60 further
provides that the operating expenses of such an entity, and the cost of
liquidating it, merit consideration when appraising the relative values
of the entity and the underlying assets.
The primary factors which are set forth in the Revenue Ruling 59-60 are
as follows:
- The value of any interest of a CHIC is closely related to the value of
the assets held by the entity.
- The market values of the underlying assets give due weight to the potential
earning and cash distributions of the property in the LLC, capitalized
at rates deemed proper by the investing public at the date of the appraisal.
- The adjusted net equity value should be accorded greater weight in valuing
the interests of CHIC, whether or not family owned, than any other customary
yardsticks of appraisals, such as earnings and dividends or cash distribution
paying capacity. However, as a test of the reasonableness of our valuation
conclusion, we conduct a Capitalization of Earnings Approach for the Subject
Membership Interest.
We also find and analyze private sales of entity (e.g. LLC) interests.
In addition, we maintain an extensive client database of actual sales
of LP and corporate minority interests.
Unlike other valuation firms, who rely solely on market data to arbitrarily
select discounts, we perform numerous financial metrics to expand the
data points and solidify our conclusions. Some of these metrics, but not
all inclusive, are the following:
- Return on assets and equity
- Cost of a put option
- IRR – internal rate of return, the ultimate test of reasonableness
for our results