Some business valuation assignments require fixed asset appraisals. In a recent one, I was asked to coordinate the work of both a real estate appraiser and a petroleum geologist, creating a three-ring circus with yours truly as ringmaster. Here are relevant excerpts from my engagement letter.
I will appraise the fair market values of specified non-managing, non-voting membership interests in LLC (the “LLC”) as of December 1, 2009 for gift taxation purposes relative to their prospective sale to intentionally defective grantor trusts.
It is my understanding that you presently own X acres of real property. You plan to partition it into two parts: one of Y acres (which you will retain, and which is not relevant to this appraisal) and another of Z acres which will be transferred to the LLC. The LLC will be capitalized with voting and non-voting units; the latter are the subject of this appraisal.
The Z-acre property is subject to an oil and gas lease which grants a third party exclusive exploration, drilling and production rights for a period of time. As consideration, you received an initial lease payment of $A. The property has not been assigned to a drilling unit, no wells have been drilled at or near the property, and you have received no other consideration.
An independent, qualified petroleum geologist / appraiser has opined that the value of potential oil and gas reserves on the subject property is not assessable and therefore zero at present as there are no active permits or producing wells on it. There are no assurances that permits will be granted, that wells will be drilled, that reserves will be found, and that they will be economic to develop and produce. The region in which the property is situated is still in the exploratory phase of development and there are no reliable reserve expectations for it.
For purposes of valuing LLC interests, however, the subject property to be transferred to it is encumbered by the oil and gas lease and the value of the associated exploration rights must be included in its value. The lease is between unrelated parties at arms’ length under no coercion, with reasonable knowledge, and thus established the $A fair market value of those rights. Any value above and beyond that is entirely speculative and hence zero for the reasons cited in the preceding paragraph.
I understand also that you have retained a qualified real estate appraiser to determine the fair market value of the subject Z-acre tract. That individual should do so, valuing the tract as vacant land, i.e., in its current use. The appraiser should not consider any alternative highest and best uses of the property, as that would contradict the limitations imposed by the oil and gas lease and the rights of the lessee.
The fair market value of the Z-acre tract will be the appraised value of the real estate as described in the preceding paragraph plus $A for the value of the oil and gas exploration rights. This will be the starting point for my appraisal of the value of the subject non-voting, non-managing LLC interests.