Q&A Forum FAQ Library

Question:

Industry to which it pertains: Personal service corporation

Engagement purpose: Divorce

Question being submitted: I am involved in a divorce proceeding in Alabama that involves a personal service corporation taxed as a C corporation. In other words, all income left in the company is federally taxed at 35% prior to 2018 and at 21% for 2018 since. I am opposing another valuation practitioner, and this valuation practitioner has testified in court that it is common knowledge that you do NOT recalculate income taxes based on normalized income but, rather, that you simply grow whatever taxes (in dollar amount) was previously paid by your assumed growth rate. EVERY treatise I have ever read on this issue when the subject company is a taxable entity states that you recalculate income taxes. I have no idea where this valuation practitioner has come up with the idea that it is common knowledge to do what he suggests. I am pretty certain that your organization taught recalculation of income taxes based on normalized income when I obtained my certification back in 2005 and I cannot imagine that would change. Please respond on the correctness of what is described above.

Response:

The NACVA does teach that income taxes should be recalculated based on normalized income. Generally speaking, using the historic income taxes with a growth rate will result in an incorrect benefit stream. That being said, we would suggest that you investigate and question as to why the other party is claiming that this is common knowledge that we do NOT recalculate income taxes based on normalized income but, rather, that you simply grow whatever taxes (in dollar amount) was previously paid by your assumed growth rate. Has the other practitioner taken some subjective assumptions?

If possible, secure a copy of the other expert’s report and find the sources he cites for this procedure. This would also be good information for your client’s attorney to consider.

Question:

Industry to which it pertains: Food and beverage and lottery

Engagement purpose: Marital dissolution division of assets

Question being submitted: One tax return/entity; six independent businesses and six leases; one ownership wants to outright sell the largest business; attorney wants me to value the remaining five businesses. How do I reasonably move forward? My thought: I need to do a “cut out” with the property to be sold and recreate financials for the five remaining properties.

Unique issues: Creating financials on a carve-out for five businesses.

Response:

There is no legal or accounting definition for carve-out financial statements. Rather, carve-out financial statements reflect the separate financial results and financial position of a portion of a larger entity, which can take the form of a subsidiary, an operating unit, a product line, or a brand. The financial statements presented may or may not be of a legal entity, which can lead to complexities in the basis of presentation of carve-out financial statements.

When determining whether carve-out financial statements are needed, the reporting entity should consider the nature of the planned divestiture, including any contractual or SEC reporting requirements. Often, the completion of a transaction or the related deal financing can be contingent on providing carve-out financial statements. The client should provide the “carved out” financials of each of the partitioned businesses and the analyst should ensure that the sum of the parts equal the whole. Any normalization adjustments should be done in a similar manner. In addition, particular attention should be given to any sharing of resources between the businesses so that each business being valued is completed on a standalone basis.

That being said, in the case presented, our NACVA colleague should both value the business under consideration and also the rest of five businesses (after the carve-out). Whatever documentation (verbally or written) is provided, the assumptions used by the analyst should be clearly documented. Ideally, the limitations of the analysis and initial assumptions should be described in the engagement letter as part of the scope of work.

Question:

Industry to which it pertains: Valuation

Engagement purpose: General

Question being submitted: Age old question. I struggle with the correct tax rate to apply (using build-up method for the cap rate) to pass through entities. Assuming some level of S corporation premium, is the premium reflected in the tax rate that is applied (Delaware Chancery)? If so, what rate is everyone using? If not, what rate is everyone using?

Unique issues: 100% control valuation.

Response:

This question is related to a particular jurisdiction and we would request you contact a NACVA member in that particular jurisdiction to discuss this question. Thus, you may wish to follow-up by asking a cohort or someone found in our Mentor Support Exchange Directory: https://www.nacva.com/AF_MemberDirectory.asp?version=1#Mentor.

You may also review the following case (see page 61) for additional information: http://nynjct-bv.com/MRIde.pdf.

Vice Chancellor Strine, of the Delaware Chancery Court, was faced with this issue recently in an appraisal/entire fairness action called Delaware Open MRI Radiology Associates, P.A. (Consolidated C.A. No. 275-N, April 26, 2006). This case highlights one of several methodologies used to develop an appropriate tax rate. The key is the methodology used here, not the specific rate. It is critical that whatever analysis is done, it is completed based on the specific facts and circumstances of your case in hand. Each case will likely have different variables. Research other methodologies (e.g., Van Vleet, Fannon) as well as the “big four” texts on business valuation (Pratt, Trugman, Hitchner, Mercer) which should describe various methodologies.

In general, the current schools of thought are as follows:

That there should be no tax effect on the company as the entity pays no taxes;
That a C corp tax rate with no S corp premium should be utilized as other inputs in the income approach are based on after-tax rates;
That a C corp tax rate with an S corp premium should be utilized.

Keep in mind, there is no one “perfect” or generic answer; the key is developing your own approach using the available references and resources, applying it to your situation case by case, and telling the story—documenting your assumptions and rationale supporting what and why you did what you did.

Question:

Industry to which it pertains: Real estate investor

Engagement purpose: Gifting of shares

Question being submitted: I have a client who is a real estate investor and wishes to gift a portion of his shares. As a CVA, I believe I would need to prepare a Conclusion of Value report. In addition, I would typically receive real estate appraisals for the properties. In this circumstance, the client is asking if he could provide the fair market values instead of getting formal appraisals. Since he is in this business of buying and selling properties in a specific geographic location, he feels he can provide these fair value estimates. I believe it could be challenged by the IRS if looked at, but just wanted to make sure if I prepared a report without formal real estate appraisals, it is not a violation of due professional care as a CVA.

Response:

I have included guidance according to Treasury Regulation Reg §301.6501(c)-1. There is various information needed for the filing of the Form 709 Gift Tax return as required by the regulations, see attached. The following information is required to be disclosed:

A detailed description of the method used to determine the fair market value (FMV) of property transferred, including any relevant financial data (for example, entity balance sheets and income statements, etc. with explanations of any adjustments) that were utilized in determining the value of the interest.
Any restrictions on the transferred property that were considered in determining the FMV of the interest.
A description of any discounts, such as discounts for blockage, minority or fractional interests, and lack of marketability, claimed in valuing the interest transferred.
A description of any discount claimed in valuing any assets owned by the entity subject to the interest transferred.
If the value of the entity is determined based on the net value of the assets held by the entity, a statement of the assets FMV will be needed.

Typically, for a Conclusion of Value report, a real estate appraisal is obtained since we are not certified in coming up with real estate values and are not qualified to determine if the FMV provided by the owner is reasonable. However, to the extent limitations are imposed on you, it is important to include those in the scope and limiting conditions section of your report.

Question:

Industry to which it pertains: Intellectual property

Engagement purpose: Summary valuation

Question being submitted: What are good databases for IP valuation?

Unique issues: This is for a startup without revenue or profit.

Response:

Since the industry nor the purpose of the intellectual property valuation was disclosed, the answer here is more generic; however, should move you in the right direction.

There are many types of intellectual property and each type has its own nuances on how to value them. Like many other private company valuation projects, there is limited direct data and evidence of value. Especially in the case of a new venture or start up, there is no history to use in conjunction with benchmarks that may be derived from various databases. One of the places to start is with a forecast of the new venture with enough detail to identify the expected net cash flow to be generated by the specific intellectual property being valued. These types of valuations are a subset of total business valuation and follow many of the same principles. The Certified in Entity and Intangible Valuations (CEIV) designation was developed several years ago, primarily to provide more specific guidance and formality of fair value projects. The principles and education here will also help in similar scoped projects not necessarily needed for public company disclosures.

There are several books and publications that deal specifically with intellectual property. The following is a short list of ones that I think would be helpful:

BVR’s Guide to Intellectual Property Valuation, Michael Pellegrino (ISBN-13: 978-1935081609/ISBN-10: 1935081608) www.BVresources.com
The Handbook of Business Valuation and Intellectual Property Analysis 1st Edition, Robert Reilly and Robert Schweihs (ISBN-13: 978-0071429672/ ISBN-10: 0071429670)
Guide to Intangible Asset Valuation Revised Edition, Robert Reilly and Robert Schweihs (ISBN-13: 978-1937352257/ISBN-10: 1937352250)
Also books written by Russell Parr and Gordon Smith may be helpful

Along with valuation methodology, these reference books and publications will also reference appropriate databases.

Question:

Industry to which it pertains: Manufacturing

Engagement purpose: Buy-sell agreement

Question being submitted: Is there any suggested language available regarding the valuation clause of a buy-sell agreement?

Unique issues: Language will be submitted to an attorney for review.

Response:

There is no prescribed language for buy-sell agreements or related provisions; each case is somewhat unique and can take many forms. What is practical for one business and their owners may not be for another business. Working with an open-minded attorney is also important. There are various types of agreements or provisions which can be customized to your client’s particular situation. The six critical factors relating to the valuation portion of the buy-sell process to keep in mind are:

The standard of value (fair market value, fair value, etc., and source of the definition)
The level of value (e.g., control vs. non-control; what discounts if any should be applied)
The effective or “as of” date (keep it simple to nearest month end, quarter end, or year end)
The qualifications of the appraiser used for the valuation/appraisal of the subject business or the interest (experience, training, credentials)
The professional standards to be followed in performing the appraisal (USPAP, ASA, SSVS-1, NACVA)
The funding mechanism (how will the buy-out price be paid)

In order for the valuation portion of the buy-sell agreement to work as intended, these six factors must be well defined. These elements that define and frame the valuation process have been written about by Chris Mercer in many articles and blog posts, as well as in a book specific to transition and buy-sell agreements. Check out his firm’s website at https://mercercapital.com/about/about-mercer-capital/. Here is the book that I have used in doing all of my work with buy-sell agreements: https://mercercapital.com/product/buy-sell-agreements-for-closely-held-and-family-business-owners/. Paul Hood has also written a book on buy-sell agreements which looks at all the elements of good agreements, not just the valuation aspect. You can buy that book on amazon: https://www.amazon.com/Buy-Sell-Agreements-Last-Testament-Business/dp/1647043441/ref=sr_1_2?dchild=1&keywords=buy-sell+agreements&qid=1628014286&sr=8-2.

One additional point I would add here is, when doing a valuation for a buy-sell, it is important to always get a copy of the operating agreement first and read through it. Oftentimes, the buy-sell agreement will define how the interest should be valued.

Additional Comments:

Not all buy-sell agreements are conducive to having a credentialed professional perform a full-fledged Conclusion of Value. But, where that is called for, I would suggest that the “what” being valued be addressed. For example, is this to be a one share/1% kind of valuation or the value of the entire company? The answer would affect discounting and perhaps that is addressed in #2 of the six critical factors.
To the extent that a calculation is to be made but not necessarily by a credentialed professional, then the source of information should be addressed and an example calculation should be included.

Question:

Industry to which it pertains: Construction

Engagement purpose: Stock option valuation

Question being submitted: I have a client that has requested we perform an "incentive stock option" valuation. They are planning to distribute (as "bonus compensation") treasury stock to certain key employees. This year, they plan to distribute 10% evenly to three key employees. They have asked that I value these options so as to provide an amount to include on these employee's W-2s. The stock being given as incentive compensation is identified as "preferred stock, no dividends, no voting rights, cannot be sold, and convert to common stock in 10 years". With no dividends, I am stumped at what value, if any, these options might have.

Unique issues: Initially, I performed a minority interest value as of today (applying discounts for both marketability and minority). I was then going to apply a substantial discount related to the non-voting, non-dividend paying, and non-sale characteristics, but had no clue how to come up with that kind of discount.

Response:

I would direct them to Revenue Procedure 98-34, which I have attached.

In addition to this reply, I would request our colleague to consider applying the Black-Scholes option pricing model for valuing such securities. The methods of application are discussed in detail in the following article from The CPA Journal: https://www.cpajournal.com/2020/09/09/valuing-securities-using-the-option-pricing-method/

In conducting the additional discount analysis, be aware of “double counting” or over-discounting since there is no direct, discrete way to determine each valuation adjustment. Also keep in mind that the expensing of options to be included in W-2s is directly tied to the value of each tranche issued, albeit a separate analysis.

Question:

Industry to which it pertains: Real estate

Engagement purpose: Gift of a minority interest

Question being submitted: I am valuing a minority (4%) interest in a closely held company for gifting purposes. I have utilized the Duff & Phelps Cost of Capital Navigator and the build-up method to determine a capitalization rate. I then applied a minority interest discount to the pro-rata share of the capitalized value. The client is questioning the application of the discount since the equity premium used in the build-up method is described as the “return expected on a portfolio of the largest publicly traded companies”. The client's point is that this premium is already based on minority interests and that by discounting the value I am double counting. My question is, when using a capitalization rate obtained from the Duff & Phelps Cost of Capital Navigator, is it appropriate to also then take a minority interest discount?

Response:

Capitalization rate and the cash flow are two different things. I am assuming that the person who did the valuation must have used control cash flow, which is why he/she applied a DLOC (i.e., he/she adjusted the non-controlling cash flow and then had to apply a discount to take into consideration the fact that it is a 4% shareholding being valued and not a control value). The equity risk premium from the Duff & Phelps Cost of Capital Navigator is one input in the build-up method. A minority share in a publicly held company is not the same as a minority share in a privately held company.

Question:

Industry to which it pertains: Moving and storage company

Engagement purpose: M&A—ownership percentage change

Question being submitted: I have a client who would like to sign legal documents on January 1, 2022, which results in a change of ownership between the two current owners. To achieve this timing, they would like us to prepare a valuation as of August 31, 2021, and use this value to change ownership on January 1, 2022. Do you see any issue with this scenario? It seems to me a potential legal question. I wanted to make sure there is not an established certain limited length of time (say 90 days, 120 days, etc.) from the utilized valuation date to a valuation date four months after the date of valuation.

Response:

Ultimately, in an M&A transaction, the purchase/sale price is based on the price the buyer and seller agree on. In an M&A transaction, the valuation is used as a baseline/starting point for negotiations. If there is no gifting, stock compensation, etc., and the parties agree to the purchase price being the determined value as of August 31, 2021, I do not see an issue.

However, in order to make sure you have a fair price, you should confirm that there are not going to be any significant changes in the business from September 1, 2021 to December 31, 2021 that would impact the business.

Question:

Industry to which it pertains: Wholesale beer distribution

Engagement purpose: Valuation for tax purposes

Question being submitted: At year-end, we performed a valuation using the discounted cash flow (DCF) method for our client. Now the client wants a valuation date of October 31 of the following year. If the 10 months unfolded as we had forecast, is it acceptable to use the discount rate we used in the initial valuation to accrete 10 months of added value to the enterprise?

Response:

If you are performing the valuation as of a different date for IRS purposes, I would advise on updating the valuation report. There could have been a number of factors that changed during the period, such as: industry information, growth rates, interest rates, etc. You should be able to leverage much of the information you already have, but I would advise updating anything that is specific to the valuation date of the date of valuation.

Question:

Industry to which it pertains: Healthcare

Engagement purpose: Determine FMV for potential acquisition

Question being submitted: For valuations involving 100% interest in a company, is a discount for lack of marketability ever required when using a discounted cash flow or other method that results in a control, marketable level of value? Are there situations were such discounts are prohibited?

Unique issues: For healthcare transactions, regulations require that the payment be at FMV. If the transacted price is deemed to be “too high”, it could be construed that the purchaser was paying extra so that the seller would refer future business.

Response:

Discounts for lack of marketability (DLOM) are never required and only used to arrive at a non-marketable value. Applying a DLOM to a 100% control value is not unheard of and, in some cases, would be appropriate. Generally, a discount in that circumstance would be significantly lower than a DLOM applied to a non-control value and would be more akin to a liquidity discount.

There are cases where a DLOM would be “prohibited.” Those involve litigation matters where the application of a DLOM is prohibited by statute, precedence, or court rules.

Question:

Industry to which it pertains: Real estate holding company

Engagement purpose: Gift tax

Question being submitted: How detailed of a real estate appraisal is required to support a valuation of a real estate holding company? Full appraisal? An appraiser's opinion letter for each property or in total? A CMA report from a quality real estate broker?

Unique issues: Five total commercial properties held in the entity. If each property requires a full appraisal, at $2–3k per appraisal, the costs could be prohibitive to the client.

Response:

The real estate appraisals prepared should be a USPAP compliant Appraisal Report (reference Standard 10), i.e., a detailed report. The real estate appraiser should be certified and licensed in the state where the subject properties are located. I would not accept anything less, otherwise it increases the risk for the entity appraiser. As the entity appraiser signing the report, you are taking on the responsibility that all the other expert reports included or referenced in your report have been completed competently. This judgement can be based on their training, certification, and licensing; and should be stated at least in your assumptions and limited conditions. If the holding company report is not being submitted to the IRS or any other regulatory agency, then a Restricted Appraisal (USPAP Standard 10) may be appropriate. If your assignment is consulting and does not require the issuance of an Appraisal Report, in certain circumstances you may be able to use a broker’s opinion of value or other market-based data provided by a third party. In each case, you should document and describe what and how any third-party report and data was used in your report or analysis.

I believe anything less than an Appraisal Report increases the risk as a signing entity appraiser. If each of the properties held in the holding company are discrete and none of the research and information can be used for other properties in the group, then individual reports may be necessary. If the properties are in the same general market or there are other similar characteristics, there may be ways for the real estate appraiser to “package” the project and provide a better price for the five properties.

NACVA standards state that “If the work of a third-party specialist, such as a real estate or equipment appraiser, was relied upon in the engagement, a description of the reliance (if any) and the level of the member’s responsibility should be documented.” A copy of the appraisal report should be attached to your report and, in addition to discussing your reliance, it should be noted in your report that the standard of value used for the appraisal is the same standard of value used for the valuation, if applicable. To the extent a different standard of value was used, either new appraisals should be obtained or there must be a reconciliation in your report between the two standards (for example, “no material difference if FMV was used”).

The level of appraisal to be obtained should be a matter that is determined by the taxpayer, and/or their tax professional, as the sufficiency of those reports will affect them.

Question:

Industry to which it pertains: Real estate

Engagement purpose: Gift tax

Question being submitted: An unfinished personal residence held in LLC; valuing for gift.

Unique issues: Feel no minority discount (not a business, not income producing), but doing marketability discount for cost to sell? Is that appropriate?

Response:

Unfortunately, there is not enough information to give full feedback. What is the ownership of the LLC? How much is being gifted? Are they voting or non-voting interests? Has a real estate appraisal been completed that meets USPAP Standard 10 (Reporting) to support the value? What does the LLC operating agreement state about transfers and other rights of members? As in most cases, it depends ... on the facts and circumstances of the specific case. That being said, the cost to sell is typically not netted out of the value of an asset to determine its fair market value. Real estate appraisals will discuss marketing and exposure time in determining the fair market value of a particular property; however, I have never seen the sales cost deducted from that value.

The basic business valuation books written by Gary Trugman, Shannon Pratt, James Hitchner, and Chris Mercer should provide at least some guidance on the situation at hand.

The practitioner must remember that they are being hired to value an interest in the LLC; not to appraise the value of the asset. Therefore, the appraisal and the LLC member agreement are equally important. Control and marketability discounts could apply to the interest in the LLC. Selling costs are never deducted to arrive at value; they would be deducted to arrive at proceeds.

Question:

Industry to which it pertains: Construction

Engagement purpose: Valuation date as of January 1, 2021

Question being submitted: Want to value a small business for gifting purposes barely above annual exclusion. Can we use a valuation date of January 1, 2021, if the report will be dated November or December of 2021?

Response:

The short answer is “yes”. The “as of” or effective date of the value opinion effectively puts a line in the sand—what was known or knowable at that date is the relevant data; many reports are written well after the effective date. The report date, or the date the report is issued, is important so the appraiser can point to the set of standards that are in effect and the current business appraisal body of knowledge.

Question:

Industry to which it pertains: Freight Services NAICS 484121

Engagement purpose: Appraisal

Question being submitted: When could it be appropriate to combine asset (adjusted book method) approach and earnings (market and income approaches) approach when valuing a trucking company? If so, how?

Response:

Although the purpose listed is generic—“an appraisal”, it would be helpful to know the purpose of the appraisal and the specific interest being appraised to refine the answer a bit. The short answer is that I cannot think of a situation where I would combine an asset with a pure income or market approach. The following notes provide the context for the initial short answer. The general guideline for an operating company is binary; that is, there are two premises that can be used. First to value the business as a going concern (employing the income and/or market approach) or under a liquidation premise (assuming no special circumstances, an orderly liquidation is generally the benchmark whereby a market approach is used to determine the value of the assets in question). Generally speaking, if there is enough information to do all the approaches, they should be considered to determine the highest value. However, the asset approach should not be combined with an income-based approach (either using earnings or multiples derived from market transactions) because the baseline assumption is different, so they are considered mutually exclusive. The excess earnings method (as partly described in Revenue Ruling 68-609 and in more detail in most valuation texts) is a hybrid method that requires the use of an asset approach, market approach, and elements of the income approach combining the principles of all approaches with the core being an income approach because the total income generated by the business is allocated across the tangible and intangible assets. If there is enough information to perform the excess earnings method, there is likely enough information to complete the valuation using the income approach and thus avoid several assumptions needed to work through the excess earnings method.

Question:

Industry to which it pertains: Healthcare

Engagement purpose: Determine value for potential sale

Question being submitted: What tax rate, if any, should be used when calculating the net cash flow to equity for a 501(c)(3) organization?

Unique issues: The scope of the engagement was to determine the purchase price for the sale of a tax-exempt healthcare organization.

Response:

You cannot sell a 501(c)(3) organization. The assets of the non-profit would need to be transferred to another non-profit.

That being said (that the entity cannot be sold), if the assets are, they still need to be valued and, in some states, there are some regulatory guidelines (e.g., filing with the state’s business office or perhaps the attorney general). I would treat it like any other valuation assignment—Who are the likely buyers, a for profit entity; another 5019(c)(3); a different form of non-profit? Go back to basics—facts and circumstances of the specific case. If the buyer is known, then the analysis may have a few different facets vs. fair market value. To the extent there is a valuation needed regarding the cash flow of an entity, it should be valued as if it were tax effected, and then a version of a premium such as a pass-through entity premium should be applied.

Question:

Industry to which it pertains: General valuation

Engagement purpose: Divorce

Question being submitted: I am valuing a veterinary business. She purchased it in 2017 for 1.8 million. Today, she has a bank note of 1.4 million. When I normalize the BS, I plan to remove the goodwill. Do I also remove the debt associated with the goodwill? When I come up with my value under the income approach using DCF, do I remove the debt to get the true value since those will be paid with separate funds?

Unique issues: I am new to valuations; thus, my questions may seem basic.

Response:

Although there is not enough information in the question, the following comments may assist your approach in this case. Typically, in a divorce setting, the equity value of a specific interest (100% or some other fractional ownership) will be considered. The goodwill recorded is an operating asset of the company; it is what the buyer paid for. As a result, there is no need to adjust the goodwill off the balance sheet and remove the debt. If the income approach is best, and you decide to consider the invested capital (i.e., debt plus equity), then the debt should be considered separately, and a weighted average cost of capital developed which includes the market rate of debt. The goodwill recorded should not be removed, although any tax amortization benefits the company receives should be considered separately since the benefit has a finite life (vs. an assumption of in perpetuity). It is also possible that the acquisition debt could be considered a non-operating liability and removed from the value. If other approaches are considered, the debt should be treated consistently through all methods. Although I do not believe your question relates to it, but note that the calculation of personal goodwill would be handled differently than the treatment of acquisition goodwill on the balance sheet.

It may also be helpful to refresh your understanding of adjustments and developing the appropriate approach. Use any of the “big four” texts on business valuation (Pratt, Trugman, Hitchner, Mercer) to help here.

Question:

Industry to which it pertains: Family investment company

Engagement purpose: Valuation for gift tax purposes

Question being submitted: Applicability of discounts for lack of control and marketability for a valuation (gift tax purposes) of a family LLC.

Unique issues: The family LLC was created in May of 2021, and funded with approx. $23 million of marketable securities. In October of 2021, the 35% owner (husband) gifted his entire ownership to a trust (FBO of wife and children). On the same date, the 65% owner (wife) gifted her entire ownership to a separate trust (FBO husband only). The attorney I am working with believes that discounts (DLOM and DLOC) apply, but I am questioning their applicability.

Response:

This sounds like a family limited partnership and, I would agree, discounts for control and lack of marketability would apply. Generally, the minority interest discount corresponds to the degree of control or influence inherent in the transferred interest, whereas the lack of marketability discount corresponds to the transferred interest’s degree of liquidity. The two are interrelated because a minority interest tends to be harder to sell and is therefore less marketable.

In determining the appropriateness and level of each discount, the rights of the limited partners, as delineated by state law and the partnership agreement, are reviewed. Specific attention is focused on the relevant provisions that restrict transfers and withdrawals by limited partners. Since limited partners exercise no control over partnership assets and the marketability of their interests are often limited, the value of a limited partnership interest is discounted for gift tax purposes.

Question:

Industry to which it pertains: Captive insurance

Engagement purpose: Alleged significant discrepancy

Question being submitted: I have a potential new case dealing with the captive insurance "industry". I understand it somewhat but would like to make sure I am correct in my understanding. Do you know of any "quick" resources or can give me an overview? The issue deals with an alleged significant discrepancy.

Unique issues: I have not worked with clients dealing with this industry before.

Response:

I would suggest looking to a partner with someone/firm that has experience in the industry as I am sure there are nuances that only an experienced professional would really know. On the surface, this seems like a risky one to dive in alone on.

This book is very comprehensive and has many relevant case studies: The Valuation of Financial Companies: Tools and Techniques to Measure the Value of Banks, Insurance Companies and Other Financial Institutions (The Wiley Finance Series) https://www.amazon.com/s?k=9781118617335&i=stripbooks&linkCode=qs

Question:

Industry to which it pertains: Retail; convenience stores with gasoline (truck stops)

Engagement purpose: Value of two corporations for gifting purposes

Question being submitted: Taxpayer owns 100% of stock in a corporation that owns 18 convenience stores and collects rent from the operating corporation that pays the rent to the asset owning corporation. Appraisals on each store as owned by the asset owning corporation include value on the income approach as well as cost and comparative market approaches. All income and expenses of the stores are reporting by the operating corporation. Both are S corporation status. Owner wants to gift the asset owning corporation to a trust for gift/estate tax planning purposes. Is it possible to determine a value of each corporation?

Response:

The short answer is “of course.” The process including approaches used to determine the value is based on the type of normalization adjustments to make supported by your analysis and due diligence. You will need appraisals of the real property that is owned by the “asset owning corporation.” If the appraisals mentioned do not breakout the stores and the real property, they will need to be since those are separate “assets” owned by two different companies. Although the stores and the real property are integrated, they do provide separate returns to the stockholders of the respective corporations that own those assets.

Question:

Industry to which it pertains: Valuation and M&A

Engagement purpose: Expert witness

Question being submitted: What are the typical (market rate) fees I should charge for being an expert witness?

Response:

There is no one rate. The short answer, as in many cases, is “it depends” ... on several factors:

How you value your time.
Do you want to be competitive, seen as a premium service, or take on more work at a below “market” rate?
Talk to local litigation attorneys to get a sense of the range of rates so you know what the market is working with.
Reach outside of regional market and research rates.
Set rates accordingly.

Tips for being engaged:
Always collect a retainer and replenish regularly.
Do not attend depositions, arbitration hearings, or court without being paid before at some estimate of time, i.e., you should be paid in full before appearing.
If you are hired as an independent expert, there should be no cloud over whether your fee is contingent on what you say or how successful (or not) your client thinks you were.
Consider charging a premium over your standard hourly rate for litigation work.
If the lawyer is the engaging party, make sure it is clear who will be paying your fees.
Set boundaries for contact (e.g., are you okay with calls after a certain time at night or before a certain time in the morning).
Ask and ask again for the relevant dates—reports due, briefs due, scheduled events (depositions, court, etc.), and define your role/responsibility.

Question:

Industry to which it pertains: General

Engagement purpose: Fair value of equity

Question being submitted: I am working on a project to derive the fair value of equity. I have developed a long-term P&L model and have EBITDA projections from 2022 to 2030. In conjunction with the P&L, our long-term plans consist of significant capital investments. This capex will be funded with debt through 2030. Therefore, the DCF model will consist of EBITDA, less changes in W/C, less capex, less debt service. The DCF and terminal value calcs will then derive fair value (at an assumed WACC and LT growth rate). Should I utilize a WACC discount rate or an equity discount rate in this situation?

Response:

While there are not enough case specific facts (including the purpose and who will be using the report) to provide explicit guidance, the key is to be consistent in the application of valuation methods and calculations, matching the net cash flow to the appropriate level of discount rate. It is not entirely clear from your explanation that the cashflows are consistent with using a WACC. You state that your forecast calculates “… EBITDA, less changes in W/C, less capex, less debt service.” Do not forget that income taxes need to be included as a reduction in cash flow. With this information to calculate net cash flow (to equity), it does not appear you should be using WACC; rather, the equity discount rate since you are deducting debt service (interest and principal). How your terminal value is calculated (e.g., EBITDA multiple, capitalization of cash flow) will determine how the debt is treated. Given the complexity of estimated capital financing, I would be inclined to use equity cash flows. On the other hand, does the purpose and scope of work provide for you to alter the capital structure, increasing leverage and perhaps the value of the subject company and changing how it operates? The keys to getting the mechanics right are ensuring you are matching the modeled cash flows to the appropriate level of discount rate and ensuring your use of debt to finance the company’s capital plan is consistent with the purpose and expected use of the report.

New Question: I am performing a discounted cash flow with a projection that assumes a significant amount of debt being added over the projected eight years with a very large debt balance in the final projected year of 2030. Therefore, to derive fair value of equity, would I take the PV of the 2030 debt balance and net this out of fair value or simply use the outstanding balance of debt at that point in time?

Question:

Industry to which it pertains: Construction

Engagement purpose: Valuation for gift tax return

Question being submitted: I am valuing a company that has a deferred compensation plan. The plan states that specific management-level employees have no stake in the company’s assets, the plan is unfunded and non-transferable, the employee has no right to future payment nor does the employer have the obligation to pay it, and that the plan strictly adheres to 409a. The plan was enacted in 2013 and employees fully vest in year 15. Two management professionals receive 15% of net income each year until the plan vests, the remaining four individuals receive $100k each year until the plan vests. I am valuing the company mid-way through the deferred compensation plan, October 31, 2021. I have a schedule indicating vesting percentages by year from the start of the plan to its completion. I am thinking that the plan liability needs to be adjusted to fair market value. Per management, the liability is the total of the vested and unvested amount of the plan. I am thinking the fair market value of the liability should be the vested amount at the date of valuation, plus the unvested amount that has been discounted to today’s dollars (e.g., a spreadsheet showing the unvested amount spread over the future years in the plan, then discounting each year to its net present value, and then summing the result). If you have seen this before and can direct me to articles or items to read, or even just correct me if you think I am on a wrong track, I would appreciate it. It has been hard to find concrete information on this subject. I have read the IRS publication 5528, Nonqualified Deferred Compensation Audit Technique Guide, which has helped me better understand these plans, but these plans are something new that I have not had to deal with before.

Response:

While I have not dealt directly with the situation described in your question background, I would agree (in general) with you, that treating the expected discrete funding as a liability at its estimated present value, if in fact those payments are funding the deferred compensation plan (but that is not clear). Without the benefit of the plan in hand and understanding the business and how it works, take this advice as mere guidance; not a specific set of instructions. Are the two management professionals receiving 15% of the net income (but not as owners) in lieu of the deferred compensation plan until vested? Are these payments connected to the plan itself or are they benefits provided by the owners to bridge until the plan vests? And the same with the four receiving $100k until the plan vests? These payments do not sound like they are deferred, so are they future liabilities or just expected payments as part of their pre-vesting compensation? Not entirely clear with the limited description you provide. You do not mention whether this is a C corporation or S corporation or another pass-through entity; that would impact the tax attributes of such payments relative to the company.

The devil, as they say, is in the details—make sure your modeling of the cash flows match the deferred compensation plan requirements. If the non-owners receive payments before vesting, why would that not just be an expense of the business? Keep it simple.

Question:

Industry to which it pertains: Valuation

Engagement purpose: Divorce

Question being submitted: I have been asked to partner with and/or provide a referral fee to divorce mediator/divorce financial analyst. This person would refer business to me for business valuation work. Is this possible? If so, what is the range of referral fees you have seen (dollar-wise, percentage-wise, etc.)?

Response:

Referral fees are possible and must be disclosed and clearly stated in your engagement letter and your report (or whatever is published, even if verbal) so there is no doubt about the source of the work and fees paid/received. Refresh your memory on the ethics rules and disclosure requirements.

I am not aware of any particular range of referral fees dollar-wise or as a percentage of fees. If you are inclined to consider this arrangement, I would discuss it with attorneys you may work with on these matters and get their feedback. Specifically, would they hire you for their client if they knew you paid a fee to get the referral? How would they treat you if you were the opposing expert who paid a fee for the valuation work? It would likely come up during deposition or testimony, so be aware of this potential issue if you are involved in litigation matters.

Question:

Industry to which it pertains: Retail; convenience stores with gasoline (truck stops)

Engagement purpose: Gift of corporate stock

Question being submitted: Taxpayer owns 100% of stock in a corporation that owns 18 convenience stores and collects rent from the operating corporation that pays the rent to the asset owning corporation. Appraisals on each store as owned by the asset owning corporation include value on the income approach as well cost and comparative market approaches. All income and expenses of the stores are reporting by the operating corporation. Both are S corporate status. Owner wants to gift the asset owning corporation to a trust for gift/estate tax planning purposes. Is it possible to determine a value of each corporation? The appraisals of the individual stores seem to include the income that is earned by the operating corporation and not the asset owning corporation.

I am thinking my report should determine the value of the combined/complete business with some allocation to each corporation based on assets or resources provided? Some of the appraisals report a business/enterprise value separate from the real estate and equipment, and some have it all combined.

Response:

To answer the first question, yes, you can value each corporation. The key is identifying the assets and associated cash flow that is structurally and legally connected with each company. Convenience stores with gas stations/truck stops are a type of business that is real property dependent and sometimes it is hard to separate the value. I would start by making sure that each company is properly recognizing the income it is due along with reviewing the depreciation schedules to determine where the real property assets have been accounted for. The real estate appraiser should provide, at a minimum, the value of the land and facilities for each store that is owned by the asset company; if the values are combined with the store operations, the appraiser needs to break the real property out since there are two different entities—each owning a different part of the business. Remember that your report is a story and it has to be believable and not arbitrary or an exercise in math. I would not allocate value the way you describe as it may or may not represent the true economics of a particular location. Furthermore, based on your question, it sounds as though the assignment is to simply provide a value for an interest in the asset owning corporation. As a result, the individual values will likely roll up to the owning corporation on its balance sheet, allowing for a net asset value method analysis on that entity to be performed.

Question:

Industry to which it pertains: Private foundation

Engagement purpose: Private foundation valuation of real estate

Question being submitted: Can a broker's price opinion (BPO) be used for the five-year valuation of the real estate? According to the IRS guideline, a certified appraisal can be replaced by an annual appraisal (done internally); "Any valuation of real property by a certified, independent appraisal may be replaced during the five-year period by a later five-year valuation by a certified, independent appraisal or by an annual valuation."

Here is the IRS guideline: https://www.irs.gov/charities-non-profits/private-foundations/valuation-of-assets-private-foundation-minimum-investment-return-other-assets

Response:

Generally speaking, if any work I do is going to be submitted to the IRS, or any other statutory or regulatory authority, I do an opinion of value—a BPO is akin to a calculation or less. And if the assets are inside an entity that is the vehicle for the transaction, I would say the same. Perhaps a “litmus” test would be asking the broker who provided the BPO what they would say or think if you told them that their BPO was being submitted to the IRS as support for a charitable contribution. You may stop right there. In addition, there are specific reporting requirements for appraisers who provide services for charitable contributions. See https://www.govinfo.gov/app/details/CFR-2019-title26-vol4/CFR-2019-title26-vol4-sec1-170A-17/summary and research the requirements/

Question:

Industry to which it pertains: Olive Oil and Artichoke

Engagement purpose: FMV of ownership interests in two different entities

Question being submitted: Hello, I have been asked to value two companies in foreign countries that are owned by an American holding company. I have been researching the level of valuation I need to provide the client. If we are distributing stock from the parent entity, I would think a simple calculation of value would be appropriate. However, because this is a distribution that will be taxed, I was not sure if it needs to be in accordance with 59-60. I cannot find any regulations specifically related to the valuation of property on the IRS website other than S Corp valuation material.

Response:

Yes, you should follow IRS Revenue Ruling 59-60 as this valuation directly relates to a taxable event and is subject to review by the Service. Following are the varying standards and premises of value, and you should be mindful of the definition that most appropriately aligns with the subject matter and purpose of the valuation assignment.

Option 1: Fair Market Value Definition (International Glossary of Business Valuation Terms):

The engagement will use fair market value as the standard of value. Fair market value is defined in the International Glossary of Business Valuation Terms, issued by the American Institute of Certified Public Accountants (AICPA), the American Society of Appraisers (ASA), the Canadian Institute of Chartered Business Valuators (CBV), the National Association of Certified Valuators and Analysts, and the Institute of Business Appraisers (IBA), as:

“The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”

Option 2: Fair Market Value-Definition (Gift Tax):

The engagement will use fair market value as the standard of value. Fair market value is defined in Section 25.2512-1 of the U.S. Treasury regulations (Gift Tax Regulations) as:

"The price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts."

Option 3: Fair Market Value Definition (Estate Tax):

The engagement will use fair market value as the standard of value. Fair market value is defined in Section 20.2031-1(b) of the U.S. Treasury regulations (Estate Tax Regulations) as:

"The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts."

Option 4: Fair Market Value Definition (Charitable Contributions):

The engagement will use fair market value as the standard of value. Fair market value is defined in Section 1.170A-1(c)(2) of the U.S. Treasury regulations (Charitable Contributions) as:

Option 5: Fair Value (Shareholder Dissent and Oppression Litigation):

The engagement will use fair value as it relates to [shareholder dissent litigation/shareholder oppression litigation] as the standard of value. As the definition of fair value for these engagements is a judicially mandated concept, we will rely on the appropriate definition of fair value that will be provided to us by [Attorney].

Option 6: Fair Value (Financial Reporting under U.S. GAAP):

The engagement will use fair value as the standard of value. The definition of fair value for financial reporting purposes under United States generally accepted accounting principles (GAAP) is found in Statement of Financial Accounting Standards No. 157, Fair Value Measurements¸ issued by the Financial Accounting Standards Board (FASB) and is stated as:

“The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

Question:

Industry to which it pertains: Technology

Engagement purpose: Valuing 100% of non-voting stock for estate and tax purposes

Question being submitted: How do I calculate the discounts on non-voting stock? DLOC? DLOM?

Unique issues: The CEO owns 99% of all voting and non-voting stock.

Response:

The appropriate standard of value to use here is the fair market value standard. The FMV standard contemplates the value of a subject interest from the perspective of a hypothetical seller and hypothetical buyer. Accordingly, the subject interest stands on its own and the fact that the owner of the non-voting stock is the same person as the owner of the voting stock is of no consequence. Accordingly, the discounts for lack of control and marketability should be determined without regard to the owner of the voting shares. If you are utilizing an income approach, then your discounts for lack of control will most likely be incorporated into the cash flows being valued. If you are using an asset approach, you will consider discounts for lack of control by asset classification, with more liquid assets garnering a lesser discount. You may additionally consider a separately identified “discount for lack of voting rights,” which often ranges from 2 percent to 5 percent based on facts and circumstances. Discounts for lack of marketability will be determined in a typical manner, such as through a review of comparative transactions, restricted stock studies, and quantitative marketability discount models.

Question:

Industry to which it pertains: Oil and Gas Exploration and Production

Engagement purpose: M&A

Question being submitted: I am being asked to write my first fairness opinion. Does anyone have a good example or layout recommendation?

Unique issues: Buyer is publicly traded; the seller is privately held; transaction is an asset sale.

Response:

A “fairness opinion” is a professional analysis and report, typically provided by a valuation expert, to assess whether the terms of a transaction are fair and equitable to the parties involved, most typically to the minority shareholders of the seller. As for the report layout, it will be similar to that provided in the reporting standards promulgated by NACVA and should include the following:

Cover Page: Title; identification of subject interest; as of date; date of report; identification of the parties.

Executive Summary: A brief summary of the subject interest, the transaction, the parties, and the statement of opinion with an as of date.

Table of Contents: Classified listing of the subject matter in the report and page numbers.

Introduction: Purpose of the engagement/report; retaining parties; description of the subject interest; description of the transaction.

Sources of Information: Either discuss here or refer to the appendices for a discussion of the financial data reviewed, legal and purchase documents examined, interviews with management, site visits, and other research.

Industry and Market Analysis: Identify the industry; industry overview; competitive landscape; economic outlook.

Description of the Subject Assets: Detailed description of the assets being sold; discussion of their historical performance; liabilities associated with the subject assets; intended use of the subject assets by the seller absent the sale transaction.

Valuation Methodologies and Assumptions Used: General introduction of approaches and methods; the appropriateness of each; discussion of underlying assumptions.

Transactional Analysis: The terms of the proposed sale; discussion of consideration paid; comparison with industry benchmarks/comparable transactions; return on assets sold to the seller.

Statement of Opinion: Statement regarding the fairness of the transaction (from a financial perspective) and analysis supporting the opinion.

Limited Conditions and Disclaimers: As typically included.

Conclusion and Signature: Restatement of the subject interest; the as of date; the opinion itself; and a signature.

Appendices: To include supporting graphs and financial data; definitions; resumes; limiting conditions if not expressed in the body of the report; detailed listing of documents considered; detailed market analysis.

Question:

Industry to which it pertains: Restaurant and Rent Agreement

Engagement purpose: Expert witness for the defense

Question being submitted: A law firm was hired to negotiate a lease on behalf of a landlord. The lease was supposed to include a percentage rent escalator in addition to a base rent. The rent escalator was missing from the signed lease agreement. The landlord is now suing the law firm for its failure to include the rent escalator in the lease. The term of the lease is for five years with two five-year renewal options. The expert witness for the prosecution has put together a report showing the projected percentage rent that the lender will not collect as a result of law firm’s failure to include the percentage rent is approximately $170,000 for each of the first five years / $190,000 for each of the second five-year extension and $210,000 for the second extension each year. The expert witness for the prosecution has present valued these yearly payments using the most recent treasury yield data as of July 2023; the treasury yield data is a small percentage of 5.4 percent going down to 4.26 percent. My question is, can I use a higher rate than the treasury rate; for instance, a discount rate or a cost of borrowing rate of 6 percent?

Response:

The short answer is a rate higher than the appropriate termed treasury issue is probably in order unless there is any guidance by statute in the jurisdiction where the trial is being held. The attorneys you are working with should provide guidance if any exists. At a minimum, looking at past cases where decisions about such a rate were made could be helpful. Based on the limited information presented, the appropriate rate to discount the prospective cash flows should be a rate commensurate with two primary factors. First, the time frame of the cash flows should be in sync with the estimated cash flows, i.e., if the period of cash flows is said five years, the rate should be a five-year rate or, depending on the structure, the rate for each tranche of payments could be laddered at some reasonable interval. Secondly, the rate should reflect the risk of the lessee as if they were a borrower—paying the additional rent via the rent escalator. Consider the credit worthiness of the tenant, including items such as: lessor collateral, guarantees (personal or corporate), and related questions a bank may ask in making a credit decision. This analysis can be modeled as if you were valuing a particular loan.

The treasury issues are generally thought of to be the “risk free” rate or at least the lowest risk measurement of any repayment obligation. With that in mind, a borrower (a lessee in this case) is arguably not as creditworthy as the U.S. Government (even perhaps despite the recent downgrade of government backed debt), so that would support a higher than treasury discount rate.

In addition to consideration of the borrower’s risk of non-payment that can be captured with an actual experience rate by the lessees (look to the tenants’ borrowing rate, which will be higher than a longer-term treasury rate), you should also consider the risk of renewal for the leases.

Just because there is a five-year lease and two five-year renewals does not mean damages for all leases should/will reasonably be 15 years. The length of damages for each lease should be tied specifically to each tenant. Consider risk elements such as:

Who are the tenants?
What is their age?
What type of businesses do they run from the spaces?
What is the likelihood of survival of the business (newer businesses have less chance of survival)?
What is the likelihood they will occupy the space for 15 years?

Look to the specific tenant leases impacted by the scrivener’s error and, if possible, backup the forecasted length of leases with the landlord's experience rate with renewals. Looking both at the specific tenant’s risk with the areas identified above, along with the consideration of the landlord’s renewal rates, will act as a sanity check or test of the assumed 15-year damages period by using the estimated average tenant term versus the potential to have a tenant for 15 years. If you do not have access to the landlord’s renewal rates/experience rate, look at general averages in the area. There is a lot of data out there to help support the concept of lease renewal rates generally not being as long as the potential term length identified in the lease where unrelated parties are negotiating.

Question:

Industry to which it pertains: Medical Research

Engagement purpose: NASDAQ direct listing

Question being submitted: I plan to use the guideline public company method to establish enterprise value. However, my objective is to value just the common shares. They have preferred shares also. Can I use the completed transaction method from when they last sold preferred shares to strip out the value associated to the preferred to arrive at the value of the common? If not, what approach should I use to get from enterprise value to just value of the common?

Unique issues: Company has preferred and common shares; needing the per share value of the common only.

Response:

Using the most recent sale of preferred shares should work as long as you believe that the transaction was a true “arm’s length” transaction and it was not a one-off deal to entice investors for a particular purpose; the date of sale was close enough to the current valuation that it could not be challenged; the systematic and non-systematic risks that could impact the company have not changed between the time of the preferred transactions and the valuation date for the shares of common; the preferred stock has been offered and sold on a consistent basis; the preferred share price makes sense in the context of the current position of the company; and the price makes sense given alternative investments along with the contractual rights of the preferred stock holders. The appraiser should also be sure to strip out the value of preferred shares on the same basis as the total value of the subject company, i.e., the total value should be its equity value.

Question:

Industry to which it pertains: Healthcare/Health Technology and Research

Engagement purpose: NASDAQ listing

Question being submitted: I have never done a valuation for a company planning to go public and am wondering what I need to consider in addition to the normal conclusion of value report. What scope considerations need to be made and are there certain things I need to make sure to include/avoid in my report?

Unique issues: Company is planning to self-list on the NASDAQ.

Response:

A report for this purpose would tend to get more scrutiny than most reports, especially if there is anything unique about the situation (insiders, some other relationship that may be hidden, etc.). You should ensure that your valuation report complies with all applicable regulatory requirements. The initial public offering (IPO) process is rigorous, and the SEC sets forth authoritative guidance for IPOs. Part of the IPO process is the SEC reviewing the 12 months prior to the IPO date for any compensation awards or other valuations that have been performed for the company. The IPO for a private company can be challenging if the private company has an employee equity compensation plan. If that exists in your situation, you will need to review any equity valuations prepared for the compensation awards at the grant-date as set out in FASB ASC 718. The SEC will review the company’s value with a focus on what is known as cheap stock, which are stock-based awards given as compensation. To this point, additional consideration should be given to:

Management’s discussion and analysis disclosures (MD&A), and
SEC authoritative guidance relating to equity compensation.

One of the more common issues relating to valuation is the estimation of the private company’s share price during the reporting periods leading up to the IPO. In addition to following Fair Value standards, there needs to be a supportable “story” behind any change in share price over the life of the company. Meaning, your valuation should consider all prior valuations of share price and present the reasons as to why the historical per share prices are different as of the IPO date. This is why you need to be aware if there were ever any equity compensation programs. Valuations of the share price need to properly incorporate pre-IPO transactions and the rights associated with the company’s equity. This can vary significantly across different equity classes of stock (e.g., common shares vs. preferred shares).

Question:

Industry to which it pertains: Agriculture/Finance

Engagement purpose: Gift of demand note receivable for estate planning

Question being submitted: Taxpayer (parent) has a note receivable from farm LLC (partnership) members of which are the parent’s children. The only documentation of a note is labeling the account on the LLC ledger as note receivable. No interest has been paid or imputed. Note balance is $4MM. Need to know how to discount from face value plus unpaid interest for lack of collateral, family members, etc. They want to give an irrevocable trust to remove from parent estate.

Unique issues: Will need to document valuation process for gift tax return.

Response:

Valuing a receivable, in essence, is a discounted cash flow analysis. The key pieces of information needed are:

Terms of the receivable even if client makes assumptions; ideally the receivable would be formally documented before the gift is made which would mean less assumptions.
- Interest rate on the receivable
- Payment (even if $0) and frequency
- Term of receivable, i.e., when will it be paid in full
Develop a discount rate based on benchmarking to other debt rates (corporate bonds, banks, etc.), considering:
- Likelihood of payment and willingness of the obligor to meet its commitments to make timely payments of interest and principal, i.e., estimate the credit worthiness of the borrower
- Collateral position (if none, higher rather than lower rate)
- What protections, if any, are provided by the borrower and through the debt contract in the event of bankruptcy or other credit type issues a borrower may face
Schedule the payments and discount them back to the valuation date using the discount rate developed as part of the analysis.

As in all report writing and presentation, make your assumptions, tell the story, and document how the cash flow schedule and discount rate was developed. There may also be references in the primary valuation texts (Pratt, Trugman, Hitchner, Mercer) on similar approaches.

Question:

Industry to which it pertains: Technology

Engagement purpose: Calculation of value for a non-compete agreement from a prior sale

Question being submitted: I looked at the NACVA website for potential samples or instructions and I also bought the book for valuing intangibles (700 pages) but it is still not clear. Do you have any advice or know where to find a sample report on the NACVA stockpile that has this type of specialty valuation?

Response:

You mentioned buying “the” book for valuing intangibles; however, there are several books and articles regarding the valuation of intangible assets. Some of the other books may have sample reports. The key issue is the understanding and implementing of the approaches, methodologies, and procedures used to value non-compete agreements. The report is the story of the process, which is important; however, start with the know-how from the technical side so the story can be written appropriately.

Question:

Industry to which it pertains: Real Estate

Engagement purpose: Estate valuation

Question being submitted: I have a technical question for which I am looking for guidance. I have a client that owns a small, minority position in a multi-member partnership (Partnership A). That partnership, in turn, owns a minority interest in a dozen closely held (10 or fewer members) partnerships (Partnerships 1–12) that own apartment buildings. Do I apply marketability and control discounts on each of the ownership interest of the dozen partnerships (Partnerships 1–12) owned by Partnership A, and then apply discounts again at my client’s membership level of Partnership A? Or only apply the discounts at my client’s ownership level of Partnership A?

Unique issues: The estate also directly owns minority position in a handful of the partnerships (1–12) in addition to the ownership reflected in Partnership A. All ownership levels are small/minority.

Response:

As in most cases, it depends on all the facts and circumstances of each partnerships/entity which includes a thorough reading of all the relevant partnership agreements, the assets owned, the method used to value the entity, and the cash flow out of the partnerships to the ultimate subject interest to be valued. Generally, there may be proper discounts (marketability and control at a minimum; keeping in mind there may be other adjustments needed) at different tiers in the ownership structure; however, the challenge is how to ensure that there is no overlapping or “double counting” of appropriate valuation adjustments. Have all the direct asset holding companies been valued? Have their assets been valued? Are the ownership interests the same from tier to tier? Just a few of the other questions to consider. Remember, it is more than a matter of math. As in all assessments of proper adjustments, you need to look at the underlying valuation approach and method to determine the applicability of any valuation adjustment. Once the valuation adjustments are made, some sort of reasonability analysis needs to be completed to make sure the result makes sense. It needs to be a balance between both buyer and seller; make sure there is no “bargain” being received by either party—hypothetically speaking, that is. An appraiser needs to really understand the fact pattern before a formal approach is followed. In these cases, if there is regular distributable cash and the details are assessable, an income approach may streamline the process.

Question:

Industry to which it pertains: NAICS 713940 Fitness and Recreational Sports Centers

Engagement purpose: Business planning

Question being submitted: A franchise-based independently owned gym such as Gold's Gym, for example, has receivables from members who sign a contract for, let us say, 12 or 18 months. The receivables are managed by a third party who handles billing, collections, etc. The gym is on the cash basis of accounting. No receivables or payables are listed on the gym's balance sheet. The gym has about 1,200 members. I have requested the balance of these member receivables as of the valuation date. The gym owner says he cannot get the number. Question 1: Should these receivables be estimated, and the estimate included on the normalized balance sheet? Question 2: If they should be estimated, is a reasonable way to do this to use the industry average percentage of receivables to total assets as the estimate?

Response:

A few thoughts on the situation described. If the owner has the receivables being managed by a third party, then he should be able to get the balance due at any time. And if they cannot do that, although a different issue, he should find a service that can. If the receivable and payables balance is needed for your analysis, then they should be estimated and used to develop a normalized balance sheet. Depending on the nature and purpose of the project you have been engaged on, it may not be needed. To the extent you need the information lacking any direct data for receivables and payables, I would not use the industry data; it is too generic and may not bear any resemblance to your client’s business reality. The estimate is best based on the company’s actual collection performance and their timing of paying vendors. You should be able to estimate the new receivables every month based on membership, and the collections based on funds sent to the company by the management company. You can then extrapolate that with other collection data from the management company. The payables can be estimated based on actual expenses and a discussion with the owner regarding when the invoices are generally paid. Working with the actual cash transaction information along with discussing the process with the owner will yield more accurate results than relying on industry data.

Question:

Industry to which it pertains: CPA Practice

Engagement purpose: Mediation

Question being submitted: Is there somewhere I can find the industry norms for lack of marketability and minority discounts that would apply in a partner exiting our firm?

Response:

There is no industry specific norm for these adjustments as there is no direct empirical evidence. The analysis of the subject company and interest, in conjunction with the use of quantification tools and methods, determines an appraiser’s perspective on appropriate discount adjustments. There are many experts in the industry that have written on this topic (i.e., Gary Trugman, Shannon Pratt, Chris Mercer, Jim Hitchner, Michael Gregory, to name a few).

Question:

Industry to which it pertains: Medical Research

Engagement purpose: NASDAQ direct listing

Question being submitted: Is a site visit required for a conclusion of value? If so, can a video tour be requested instead?

Unique issues: Pre-revenue medical research.

Response:

It is up to the discretion of the expert as to whether a site visit takes place. I suggest reviewing the NACVA Standards. Within the NACVA Standards, you will see that for a V.C.1.e) (9) Detailed (Summary Report) “may include … Site visit disclosure”. The NACVA Standards are principles-based with Section II. General and Ethical Standards as the only section of the NACVA Standards that “must” be adhered to. That being said, it is often the case that a CVA deems a site visit to be a necessary step in order to adhere to II. C. Due Professional Care. I would follow up with some research into tiered company ownership interest valuation. Here are two good sources:

Article written by Dennis Webb and Lari Masten; “A Methodology for Valuing Tiered Entities,” published in the Journal of Business Valuation and Economic Loss Analysis, (Berkley Electronic Press, 2006, Vol. 1, Issue 1):pages 1–40.
Book written by Dennis Webb, Valuing Fractional Interests in Real Estate 2.0, Pp. 350–356

Question:

Industry to which it pertains: Educational Software

Engagement purpose: Company is transferring its business to new company; for this company is looking to value its software which is under development

Question being submitted: For valuation of intangible asset, do we need to include industry data, DLOM in valuation report?

Response:

Yes, a DLOM would be factored in. You also need to address inclusion of industry data. The depth of the discussion of each topic will depend upon the type of report to be issued; is it to be detailed or just a summary.

Question:

Industry to which it pertains: Olive Oil and Artichoke

Engagement purpose: FMV of ownership interests in two different entities

Question being submitted: I have been asked to value two companies in foreign countries that are owned by an American holding company. One company is in Italy, and one is in Spain. I am going to use an excess earnings method and my question is about the cap rate. Because these companies are in foreign countries, would I still be able to use the build-up method? Or is it an American tool? Is there some other tool I should be using for determining the cap rate?

Unique issues: The valuation will be used to disburse the ownership interests for each company from the U.S. holding company and contribute it to a Spanish holding company.

Response:

The appraiser could use the international cost of capital model that considers the country risk premium. There are sources providing this information and one of them is KROLL: https://www.kroll.com/en/cost-of-capital.

Our colleague can also compute this figure by using the formula as described at the following link (page no.118): https://www.cfainstitute.org/-/media/documents/article/industry-research/igcc-summary-edition-2022.pdf

The inputs for this formula can be found from Dr. Damodaran website: https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html

Another helpful resource is survey done by Dr. Pablo Fernandez: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3861152

Question:

Question being submitted: Do you consider floor plan debt when subtracting interest bearing debt from the enterprise value?

Response:

Floor planning is a form of retail financing for large ticket items displayed on showroom floors or lots. Specialty lenders, traditional banks, and finance arms of manufacturers provide the short-term loans to retailers to purchase items and they are then repaid as the items are sold. For these types of businesses, the floor plan debt is considered to be operating debt and is typically offset by the inventory. Per the BVR What It’s Worth Automobile Dealership Value, "New inventory is typically purchased at book value (unless it needs adjustment for LIFO) and financed completely with floor plan debt … Generally, all dealerships use floor plan financing, typically financing 100% of new inventory, so essentially the consideration of inventory value is carved out from the valuation process. Interest expense from floor plan debt must be included as an operating expense.” Based on this, you have two options when arriving at market value of invested capital: (1) do not remove the floor plan debt as it is considered operating debt and is offset by the inventory or (2) remove the floor plan debt and add back the offsetting inventory as it would need to be sold in order to repay the debt.

Question:

Industry to which it pertains: Agriculture/Finance

Engagement purpose: Documentation of FMV of gift of note

Question being submitted: I am being asked to determine FMV of a note to be gifted from an individual's revocable trust to her irrevocable trust for estate planning purposes. The note is from a related party farm LLC (debtor) to an individual's revocable trust (lender). Treasury Reg 25.2512-4 states "the fair market value of notes, secured or unsecured, is presumed to be the amount of unpaid principal plus accrued interest to the date of gift, unless the donor establishes a lower value". From several sources of professional valuation publications, including a NACVA/CTI presentation, the FMV of a note should be determined at present value via an income-based method (usually a discounted cash flow method). Is the present value calculation deemed to be adequate evidence of a value lower than unpaid principal plus interest?

Unique issues: The debtor farm operating LLC is comprised of the children of the lender.

Response:

Is the present value calculation deemed to be adequate evidence of a value lower than unpaid principal plus interest? Yes, when it comes to valuing a note, the key factors that impact the value are the stated interest rate and the amortization schedule of the note. Simply stated, the value of the subject note is determined as follows:

Estimate the market rate of interest at the valuation date.
Estimate any additional adjustments to the interest rate based on the specific attributes of the borrower and any other case specific information.
Combine the market rate of interest with any estimated adjustment and calculate the estimated market rate of interest for this specific note and borrower.
Calculate the present value using the estimated rate of interest and the forecasted future interest and principal payments per the notes’ amortization schedule to determine the fair market value of the note.

Question:

Industry to which it pertains: Wealth management

Engagement purpose: FMV for bank financing

Question being submitted: If I do a calculation of value (as opposed to conclusion of value), is it accurate to say the result is still FMV?

Unique issues: Smaller practices in wealth management only trade on revenue multiples, not entire cash flow, DCF, etc., since none of the expenses will remain. Therefore, I think this is a calculation of value, correct?

Response:

Yes, it is accurate to say that the result of a calculation of value is the FMV. A calculation of value is a less formal valuation engagement in which the valuation analyst and the client agree on the valuation approaches and methods that will be used and the extent of procedures that will be performed. The valuation analyst is not required to consider all three valuation methods, and the report may not be as detailed as a conclusion of value report.

The standard and level of value can be defined to be consistent with the scope of the engagement, even though it is just a calculation of value. It is key to define the standard and level in the engagement letter and the report so it is not misleading to the client or the named users.

Question:

Industry to which it pertains: Restaurant and rent lease

Engagement purpose: I have been engaged to provide/write an expert opinion (my law firm is for the defense) on the opinion written by the plaintiff’s expert witness.

Question being submitted: Is there a specific format that I am to follow or can follow? I expect my report to include both Word and Excel documents. Please provide examples.

Response:

Here are some resources that may be of assistance:

What to Include in an Expert Rebuttal Report: https://www.expertinstitute.com/resources/insights/what-to-include-in-an-expert-rebuttal-report/

The Rebuttal Expert Report: 4 Steps For Critiquing An Opposing Expert: https://www.expertinstitute.com/resources/insights/the-rebuttal-expert-report-4-steps-for-critiquing-an-opposing-expert/

Guidelines for Critiquing and Rebutting an Expert Report: https://willamette.com/insights_journal/14/summer_2014_5.pdf

Rebuttal Reports: https://www.biz-valuation.com/litigation-support/rebuttal-reports/

Also, review NACVA’s Professional Standards; the development standards for the review engagements still apply.

Question:

Industry to which it pertains: Construction

Engagement purpose: Calculation of value for potential sale of equity

Question being submitted: Client personally withdrew funds from a forgiven PPP loan of over $1,000,000. I am considering withdrawing from the engagement and would like some guidance.

Response:

There is not enough detail to comment specifically on your situation nor should anyone unfamiliar with all the facts including your engagement agreement and related terms. In general, if at any time you are uncomfortable with the circumstances of your work and relationship with your client or the scope of work, you should consider withdrawing from the project. Hopefully, your engagement letter or retainer agreement allows for withdrawal without penalty. As a good faith measure, you could offer returning the retainer or initial payment made. Even if you have time in on the project, it is a small price to pay to exit gracefully.

You may also want to review NACVA’s Professional Standards, particularly the General and Ethical Standards.

Question:

Industry to which it pertains: Valuation

Engagement purpose: Date of death valuation for a client company

Question being submitted: What are the IRS standards for a valuation expert to perform a date of death valuation? Credentials, experience, etc.?

Response:

A few IRS resources that address this are:

IRS Publication 561 (02/2024): Determining the Value of Donated Property
Internal Revenue Manual 4.48.4 Business Valuation Guidelines
Internal Revenue Code section 170 (particularly 170A-13)

Question:

Industry to which it pertains: Real estate LLC

Engagement purpose: Estate valuation

Question being submitted: Using the NAV method of valuing an LLC holding real estate, how would the balance sheet be adjusted for a 1033 transaction that happened a couple of months before the DOD of the LLC member?

Unique issues: A 1033 transaction occurred months before the DOD. Cash and a deferred liability were booked to the balance sheet. The city purchased the condemned building for $3.5M from the LLC. The sale took place in August of 2022, DOD is January 2023. The building was not yet fully demolished as of DOD or appraisal. The condemned building was not included in the appraisal (intentionally omitted). LLC is also receiving TIF funds. In what way, if any, does the cash balance due to the transaction and deferred liability affect the value? The new building was still in process with $4.4M of construction contracts signed.

Response:

The impact of the 1033 transaction may vary due to local tax laws, accounting standards, and specific circumstances; however, the following can be considered.

The adjustment of the balance sheet should follow these steps:

a. Remove the old property from the balance sheet.

b. Add the new property to the balance sheet at its fair market value.

c. Adjust the equity section of the balance sheet to reflect the change in value (take FMV of new asset into consideration)

This adjustment would be made as of the date of the 1033 exchange, even if the LLC member's death occurred several months later.

Also, must include the rest of the balance sheet for any recorded and unrecorded assets and liabilities as you would in any project such as this.

Question:

Industry to which it pertains: General

Engagement purpose: Calculated business valuation

Question being submitted: In providing a range of value for a business, how wide a range of value is acceptable as industry standards (5 percent, 10 percent, etc.)?

Response:

Ranges, while helpful in certain jobs, may not be appropriate in others. With that said, there is no industry-specific range. The appropriate range would be one that can be supported by the documentation and relevant facts that you have collected.

Question:

Industry to which it pertains: N/A

Engagement purpose: Gifting

Question being submitted: The client wants to know: if they hire me (sole practitioner) to perform a valuation and I die before the end of the IRS audit period, who would defend them on my valuation?

Response:

In this situation, a separate valuator would likely need to opine on the valuation report if required. This would require a member/credentialed designee to determine if the report is reliable in accordance with the review standards.

If a succession/contingency plan for your practice was in place, the client would know who to call in such a case. Even if the report needed to be redone, knowing who to call would be a good first step for the client. In addition, depending on the nature of the IRS audit query, the report may not need to be redone.

Question:

Industry to which it pertains: Real estate properties

Engagement purpose: Estate tax

Question being submitted: I had a client that I signed as a CPA tax preparer in 2020. One of the members of the LLC died in May 2021. Am I considered independent? I started to practice valuation under my own firm name. Now in 2024, the trustee of the deceased wants me to do the valuation for lack of control and marketability discounts.

Unique issues: CVA with CPA inactive license in California.

Response:

If you prepare the tax return, you can also prepare the valuation. There is no conflict.

Check the AICPA and state CPA organization for applicable standards required for members if you are a member. From the valuation perspective, as long as you state your independence and disclose the client relationship in the report (typically in the certification and the assumptions and limiting conditions) this should suffice.

Question:

Industry to which it pertains: Insurance

Engagement purpose: Divorce

Question being submitted: I am looking for a MUM template breaking down personal goodwill versus enterprise goodwill.

Response:

There have been several articles (and perhaps sections of more recent valuation texts) discussing the MUM theory and practical application. I know some of the articles written have illustrated how to use the MUM analytical approach with each user to develop and customize it for their use. I would recommend that the professional seeking a template look at the sources of the theory and develop their own presentation of the facts and resulting analysis. A good resource is from BVR: Guide to Personal v. Enterprise Goodwill (https://www.bvresources.com/products/bvr-guide-to-personal-v-enterprise-goodwill-fifth-edition). There is likely more writing on the topic and would encourage the professional to search for additional resources.

Question:

Industry to which it pertains: Medical

Engagement purpose: Divorce

Question being submitted: I am a joint expert in a divorce case. The medical doctor files a schedule C, but all revenue comes from one referring doctor who has control of the patients, does the billing and collections, and charges divorcing doctor a fee. Most services are provided at a hospital and some limited office visits. Does the doctor who is divorcing have a value (other net AR)? There is no contract between doctors but has been in effect for at least five years. Net income is ~500K for divorcing doctor.

Unique issues: New Jersey case.

Response:

In this situation, I would consider discounts for lack of marketability. In the context of a hypothetical willing buyer and willing seller, the buyer may place a greater value on an ownership interest of an investment that is “marketable”. Buyers would rather own investments that can easily sell and will pay less if it lacks this ability. To fully assess the degree of the discount applicable to a subject interest, consider company specific factor when estimating the discount. The degree of marketability is dependent on a wide range of factors, such as payments of dividends, the existence of a pool of prospective buyers, restrictions on transfer, among other factors.

Additional considerations would be a review of the contract, if any, in place and specifically whether the arrangement is transferable contractually or under NJ state law. The attorney involved should assist in the interpretation of law.

Question:

Engagement purpose: Expert testimony

Question being submitted: Is it possible or appropriate under the professional standards to provide expert testimony on another valuation analyst's report?

Unique issues: Our firm was engaged to value a business for member dispute litigation purposes under the direction of one valuation analyst within our firm at the time. The attorney now needs to name an expert witness, but the valuation analyst who provided the opinion has now left the firm and is not willing to further assist with testimony on his report. I provided significant professional assistance with the report but ultimately, I did not sign the report or provide the opinion of value.

Response:

I would not just use the report prepared by a colleague. Work should be done to opine on the work and validate your opinion of value.

Members should refer to the Business Valuation Review (Section VI) of the NACVA Professional Standards. “… If the member provides a conclusion of value or calculated value as a part of the review of another valuation analyst’s work, the member must follow NACVA’s General Business Valuation Standards …” However, “If the member does not provide a conclusion of value or calculated value as part of the business valuation review, the member need only provide an opinion, including the basis and reason for the opinion, as to whether the report under review is appropriate and not misleading within the context of the requirements applicable to that work …” Specifically, members should consider Review Engagement Report Standards (Section VIII.A.3.) for additional detail.

The business valuation review is a type of service, whether written or oral, intended to provide users an opinion regarding the credibility of the work product of another valuation analyst. The member must “Develop an opinion as to whether the report is appropriate and not misleading within the context of the requirements applicable to that work; and develop the reasons for any disagreement.” Members should refer to Business Valuation Review (Section VI), Review Engagement Development Standards (Section VII), and Review Engagement Reporting Standards (Section VIII) when performing review engagements. Specifically, members should consider Review Engagement Report Standards (Section VIII.A.3.) for additional detail.

Under the NACVA Professional Standards you can rely upon another expert’s valuation report and testify to it or utilize it as a basis for your own opinion. However, this does not absolve an expert from complying with the general and ethical standards which require Due Professional Care (Section II.C.) and Sufficient Relevant Data (Section II.F.).

Question:

Industry to which it pertains: Rental real estate multi-unit building

Engagement purpose: Valuation of real estate using an income method

Question being submitted: I am reviewing a real estate appraisal. The appraiser ending with a stabilized market value. I am looking for support to subtract the debt from the market value and looking for some written supportable documentation.

Response:

It is not entirely clear if you are valuing a specific interest in an entity or just trying to calculate the equity in a particular real estate asset. In either case, valuing the equity of some sort of real estate holding company or the real estate asset itself, all liabilities should be deducted from the asset values. In the case of a legal entity, be sure not to forget all the other assets and liabilities. In terms of support and documentation, this is a basic concept using the asset approach. Refer to any of the valuation books: Pratt, Trugman, or Hitchner’s books should provide adequate support.

It is important to remember that as a CVA, we are not qualified to value real estate the way a real estate appraiser does. We can review their work product and pose questions, but we should not be valuing the underlying real estate asset. However, we can value the holding company or utilize the real estate value provided and remove debt to get to a net equity value for the asset.

Question:

Industry to which it pertains: Retail

Engagement purpose: Valuation

Question being submitted: When should working capital loans (as opposed to operating loans as for an equipment purchase) be considered non-operating and normalized out (but then added back in the conclusion of value)? Always or only when the amount is in excess of industry norms?

Response:

Any debt that is directly related to the business should be considered operating debt. Loans owed by the business used to finance non-operating assets should be netted against the non-operating asset and added to the final determination of value.

In terms of assessing when business debt is within, or outside, “normal” ranges is determined by the valuation appraiser using his/her professional judgement.

Additionally, the appraiser should review the terms of the operating loan to consider any necessary adjustments, for example, if the terms are outside fair market value loan terms (i.e., in the case of an unrecorded, arm’s-length, related party loan).

Question:

Industry to which it pertains: Commercial fishing

Engagement purpose: Estate

Question being submitted: I have an appraisal for a fishing boat, but the preparer of the appraisal will not tell me how he arrived at his conclusion nor send me information about the market comparables he utilized for the appraisal. Do I accept his appraisal without any backup?

Response:

Based upon the information provided, the valuation in question is assumed to be for IRS (specifically, estate planning) purposes, which mandates a report that adheres to IRS job guidelines, as well as the applicable valuation standards.

As it pertains to the NACVA/GACVA Professional Standards, Section IV. Development Standards, G. Identification “A member/credentialed designee must define the assignment and determine the scope of work necessary by identifying the following:

1. Subject to be valued;

2. Interest to be valued;

3. Valuation date;

4. Purpose and use of the valuation;

5. Standard of value;

6. Premise of value;

7. Intended users;

8. Valuation approaches or methods;

9. Assumptions, limiting conditions and scope limitations;

10. Ownership size, nature, restrictions and agreements;

11. Sources of information; and

12. Other factors that may influence value when appropriate in the opinion of the member/credentialed designee.” (emphasis added)

Additionally, Section V.C.1. Reporting Standards of the NACVA/GACVA Professional Standards notes that the reports (Detailed and Summary) “must be coherent, supportable, and understandable.” (emphasis added)

In direct reply to the question of “Do I accept his appraisal without any backup?”, more specific information pertaining to the question is needed; including, but not limited to: the purpose of the valuation, scope of the valuation, the valuator’s credentials, the type of report, and standard of value agreed to in the engagement agreement between the client and the expert. Upon receipt of this additional information, we will be able to further assist.

As a final note, in addition to NACVA/GACVA FAQs and Hotline, NACVA/GACVA also offers mentor/mentee services that prove to be invaluable for many newly minted CVAs and MAFFs, as well as those that have held their credentials for some time but are seeking more peer-to-peer guidance.