Accurate valuation of a closely held business is essential when resolving issues related to management planning, stock transactions, estate planning, tax planning, business disputes, or divorce settlements. Publicly traded companies are valued every day in the public stock markets. However, since closely held businesses do not have a similar market for their equity interests, estimates of value can be difficult to obtain. In the absence of this pricing information, interests in closely held business must be valued independently.
Closely held business interests are typically valued by one or more of the following methods:
Asset approach – based on the value of a company’s assets and liabilities
Income approach – based on the ability of the company to generate cash flow in the future
Market approach – based on the value of similar companies that are either publicly traded or have recently been involved in a transaction.
Adams Capital’s professionals are experts in selecting the most appropriate valuation approach based on a particular engagement’s circumstances.
The value of an interest in a closely held business can vary substantially based on its level of control and the degree to which its marketability is impaired (lack of a ready market versus an outright restriction on sale or transfer). We are knowledgeable in the selection and support of discounts and premiums in our determinations of value. We conduct our own proprietary discount and premium studies to provide additional support for our conclusions of value.
Adams Capital’s valuation conclusions provide the necessary support for business owners and their advisors to make well informed decisions regarding the purchase, sale, or transfer of interests in closely held businesses. Adams Capital has successfully defended its valuation conclusions both in court and before the IRS. Our backgrounds in finance, accounting, taxation, and law, and our experience with over 2,000 public and private transactions, allow us to provide credible and supportable valuation conclusions.
The selection and support of discounts and premiums is often the most important as well as the most difficult task in valuation. Discounts are typically applied for attributes such as lack of control (or a minority interest) and lack of marketability (based on lack of a ready market or restrictions on sale or transfer). Conversely, premiums are most often applied for the ability to control or a majority interest. The key to making the appropriate choice is combining the valuation expert’s instincts, honed by years of experience, and timely, exhaustive research. In fact, the quality and depth of the underlying research are often the deciding factors between an inappropriate discount selection and the proper choice.
Successful research requires 1) identification of the relevant studies that could be used to support (or refute) the choice of discounts or premiums, and 2) correctly interpreting and relating those studies to the valuation subject. Adams Capital combines its considerable experience in making appropriate selections with a comprehensive database of potentially relevant research studies. This database is updated constantly to ensure that it includes the latest research, and reevaluated to help identify emerging trends. We are also adept at identifying the studies that are most relevant based on our clients’ particular circumstances and our knowledge of legal precedents and IRS guidelines.
Adams Capital also conducts proprietary research and reviews markets for discounts related to marketability. This proprietary research provides a unique perspective and a competitive edge in helping our clients meet regulatory requirements. The combination of our experience, comprehensive database, and in-house research provides Adams Capital clients with expert selection and support for discount and premium conclusions.
Employee Stock Ownership Plans (“ESOP”) were created in 1974 by the Employee Retirement Income Security Act (“ERISA”) as a vehicle to motivate employees by giving them company ownership. An ESOP is structured as a legal trust and is classified as a qualified retirement plan under the Internal Revenue Code. A trustee serves in a fiduciary capacity solely in the interest of the ESOP and its participants. Retaining an experienced, independent appraisal firm in the valuation of the closely-held employer securities is paramount in satisfying the trustee’s fiduciary responsibilities.
Valuations for ESOP purposes are necessary for two reasons. First, when the ESOP is originally formed, the initial purchase from the owner must be fairly priced. Second, the shares owned must be re-valued annually to determine the repurchase price in the event of employee retirement, departure, disability or death.
ERISA requires an ESOP to pay no more than “adequate consideration”, or fair market value, when investing in a businesses’ equity. Consequently, plan trustees and fiduciaries must determine, in good faith, the fair market value. These ESOP valuation assertions are then scrutinized by the IRS, the ESOP trustees, and the Department of Labor. As a result of all these unique issues, an appropriate ESOP valuation must be well documented, unbiased, and supportable.
ESOP valuation is a complex matter and must consider each company’s unique facts and circumstances. Adams Capital’s professionals have substantial experience valuing businesses and providing financial advisory services for ESOP plan trustees.
Many companies reward their employees with stock options or bonus shares, which are taxable on issuance or at exercise. There are two primary regulations which apply to the issuance of employee stock options, IRC 409A and ASC 718. The value of options must also be disclosed in proxy statements and financial statement footnotes.
IRC 409A states that the exercise price of an option must be greater than or equal to the fair market value of the underlying stock to qualify as deferred compensation and avoid significant tax penalties. For privately held companies, determining the fair market value of the common stock often requires an independent valuation of the company. The process can be further complicated if the company has other equity classes in addition to common stock since subtracting preferred stock as debt is no longer accepted except in very specific circumstances. Adams Capital considers and applies the Current Value Method, the Option-Pricing Allocation Method, and the Probability Weighted Expected Return Method where appropriate. However, every situation is unique, so every valuation should be treated with a fresh perspective using the latest market data. Adams Capital has the experience and credentials to make defensible assertions on the value of any type of stock option or bonus share.
For ASC 718, the fair value of any stock based compensation, including employee stock options, restricted stock, and management preferred stock, must be expensed. Outside of determining the appropriate common stock value for the issuance of employee stock options, Adams Capital can assist with the determination of fair value for any stock based compensation for ASC 718 purposes.
All gifted or bequeathed assets must be assigned a value for federal transfer tax purposes. Consequently, the determination of such value serves critically to the estate planning process. Many estate and gift planning techniques are subject to intense scrutiny by the IRS, and any undervalued assets may be subject to tax penalties. Penalties are less likely to be levied if a valuation has been performed in good faith by an independent third party appraiser. A qualified appraisal prepared by a competent professional appraiser helps establish a “reasonable basis” for the valuation.
Family Limited Partnerships (“FLPs”) are a popular tool for estate planning. FLPs maximize family wealth while centralizing control of family assets for efficient management. The market considers the following factors when determining the fair market value of limited partnership interests:
Illiquidity – Limited partners cannot force the liquidation of the partnership assets to recover their investment.
Lack of marketability – These partnership interests are generally not transferable, and cannot be bought or sold as easily as equity that is regularly traded on a public market.
Lack of control – General partners control the partnership’s day-to-day operations and make decisions that have significant impact on a partnership’s financial performance. Limited partners have little, if any, influence on these decisions.
Market absorption (Blockage) – If the block of stock to be valued is so large in relation to the actual sales on the existing market that it could not be liquidated in a reasonable time without depressing the market price, an appropriate market discount should be applied. This discount reflects the present value of the future sale proceeds, taking into account the additional time required to sell the block of stock without depressing the market price.
Cash flow taxation – Limited partnerships potentially generate income tax liabilities that are payable by the partners. Because a partnership may not distribute adequate income to pay the taxes incurred, limited partners may not receive distributions sufficient to satisfy income tax liabilities resulting from their ownership of limited partnership interests.
For these reasons, the fair market value of a limited partnership interest and the value of a limited partner’s pro rata portion of the partnership’s net asset value are not equal; this difference is commonly referred to as a “discount”. The use of the FLP vehicle combined with appropriate discounting can significantly reduce the estate and gift tax burden on asset transfers between family members. Other commonly used estate planning techniques include: charitable remainder trusts, charitable lead trusts, private foundations, private annuities, generation-skipping trusts, grantor-retained trusts (GRAT), and annuity trusts.
Estate planning is an essential way to assure the desirable disposition of ones assets. Adams Capital’s professionals are experts in the valuation of assets for gift and estate tax planning. We use the latest available information regarding transactions of similar entities and quantitative discount models to determine the fair market value of partnership interests. We work closely with our clients’ legal and financial advisors to ensure that our work is conducted in a professional, timely, and economical manner.
We receive many questions about enterprise value when the enterprise may be entirely dependent on a single person for continued success. So, when we are asked to assess the difference between personal goodwill and enterprise goodwill what should we consider? The following describes attributes that could be important in segregating value between a person and an enterprise.
Personal goodwill is directly associated with an individual. Consumers seek out the individual, are referred to the individual, or repeat patronage due to the individual.
Enterprise goodwill is directly associated with the business. Consumers seek out the enterprise, are referred to the enterprise, or repeat patronage due to the enterprise.