Valuing Pass-Through Entities

Eric J. Barr

• Publisher: Wiley
• Year: 2014
• ISBN:
  9781118848616
• Edition: 1
• Topic: Business
• Subtopic: Contabilità
• Index: Business

The clarity and guidance valuation analysts have been thirsting for

The business appraisal community regularly names the valuation of pass-through entities as a major issue of concern. Courts, appraisers, and the IRS have long been at odds on the topic, and the contention within the appraisal community itself over methods and inputs further complicates the issue. Valuing Pass-Through Entities provides clarity for the analyst tasked with valuation, offering clear explanations of the different perspectives and approaches to the process.

Valuing Pass-Through Entities cuts through the chatter to:

• Explain the advantages and limitations of different types of pass-through entities

• Analyze the different viewpoints currently dividing the appraisal community
• Gain a fresh perspective on landmark cases
• Explain how to properly utilize a court-tested model
• Examine detailed sensitivity analyses of different inputs under the income and market approaches

The book includes illustrative examples, templates, and a useful technical supplement, plus case studies that demonstrate the real-world effects of various pass-through entity valuation methods and inputs. Detailed analyses and an easy-to-apply model simplify the process while positively affecting outcomes. The companion website provides the text of landmark court decisions, a blog featuring industry trends and tidbits, additional articles, and the insight of the author and other industry leaders.

Valuation requires the successful juggling of multiple variables, many of which can have a major impact on value. Analysts need to know how to balance each factor and apply the appropriate rates and discounts, but a lack of standard practice often leaves the issue too subjective. Valuing Pass-Through Entities clears the air, providing real-world guidelines and tools.

Chapter 1
Introduction

In our daily lives we have come to expect—even demand—comfort, convenience, and choice. When we desire entertainment, we click on the remote and at our fingertips are hours of television viewing. When we want to speak with someone, we take out our portable telephone and dial the number, and we are instantly in conversation with someone who may be far away. We can change the climate in our home from hot to cold and back to hot simply by moving a dial. We can access encyclopedias with a few computer keystrokes. There is fast food, ethnic food, gluten-free food, carbohydrate-free food, fat-free food, and so on. Never before has so much been available so quickly to so many people.

Curiously, it seems like very few people—myself included—care how all of these things happen. I don't know what enables my car to do what it does. I don't know why my television, telephone, refrigerator, or any other household appliance works. Ask me why certain diets are better for me—I don't know and I don't care. It only matters to me that these things work when I want them to.

You may ask why any of this matters in a book about valuing pass-through entities. The reason is that if you are like the consumer who is described in the previous two paragraphs, looking for a quick and simple method to everything, including valuing any pass-through entity under any circumstance, then this book is not for you. This book does not offer a simple how-to valuation manual because there are no simple answers to complex valuation questions. This book is for business appraisers and users of business appraisals who need to look behind the curtain and understand the choices and issues associated with valuing a pass-through entity. It describes the process of developing a supportable, proper pass-through entity valuation conclusion.

Definition of Value

Value has been described by many people in many ways. Karl Marx said that “[n]othing can have value without being an object of utility.”¹ Publius Syrus said that “[e]verything is worth what its purchaser will pay for it.”² Contradicting Publius Syrus was John Ruskin, who said, “A thing is worth precisely what it can do for you; not what you choose to pay for it.”³ And leave it to Mark Twain to cleverly illustrate value: “Each person is born to one possession which outvalues all his others—his last breath.”⁴ For purposes of this book in connection with business appraisals, value is defined as the risk-adjusted present value of the future economic returns associated with the ownership of a business interest.

Beauty and Value

Value, like beauty, is in the eye of the beholder. What may have extraordinary beauty to someone may not be beautiful to another. The same holds true regarding the value of a business ownership interest. A business ownership interest may have great value to one person but not another. Therefore, one's perspective greatly impacts value.

When valuing a business interest, the appraiser must gain an understanding of the control attributes of the business ownership interest being appraised and the purpose of the appraisal. Let's discuss both of these factors.

Control versus Noncontrolling Interests

The business interest being appraised may permit the holder to exercise the prerogatives of control. When valuing a controlling interest in an entity, the controlling interest generally has greater value than the minority interest, all other things being equal. The issue of control relates to various factors, the most important of which is the ability of the controlling owner to make decisions and select strategies without regard to minority owners. Due to the absence of control in a minority interest, the appraiser of a minority equity interest may need to consider a reduction beyond the mere pro rata value of the minority owner's interest in the entity. Thus, when valuing a business ownership interest, it is important to be mindful of the degree of control associated with the subject interest.

Standards of Value

The next consideration is the purpose of the business appraisal. There are many different reasons that a business appraisal is required:

1. Transactions (including, but not limited to, leveraged buyouts, employee stock ownership plans, employee compensation plans, and initial public offerings)
2. Litigation (matrimonial dissolution, bankruptcy, contractual disputes, owner disputes, and employment and intellectual property disputes)
3. Compliance-oriented engagements (financial reporting and tax matters (i.e., corporate reorganizations, S corporation conversions, estate and gift tax compliance, purchase price allocatio...

Table of contents

• Cover
• Series Page
• Title Page
• Copyright
• Dedication
• Foreword
• Preface
• Acknowledgments
• About the Author
• Chapter 1: Introduction
• Chapter 2: The History of Federal Statutory Tax Rates in Maximum Income Brackets and the Evolution of Different Forms of Business Entities
• Chapter 3: Effective Federal Individual and Corporation Income Tax Rates
• Chapter 4: Comparison of Different Entity Forms
• Chapter 5: Income Approach and Value to the Holder
• Chapter 6: Inputs to Modified Delaware MRI Model
• Chapter 7: Income Approach and Investment Value
• Chapter 8: Income Approach and Fair Market Value
• Chapter 9: Fair Market Value Court Decisions
• Chapter 10: The Market Approach
• Chapter 11: Individual State Income Taxes
• Chapter 12: Discounts, Premiums, Bylaws, and State Laws
• Chapter 13: Valuing Complex PTE Ownership Interests
• Appendix A: Checklist
• Appendix B: Case Study: Bob's Cruises
• About the Website
• Index
• End User License Agreement