How Do You Handle This?

In each of the situations that follow, we appraised a non-marketable minority interest’s fair market value and concluded (with strong support) a combined (for lack of control and marketability) discount of (say) 25%.

1. For an estate or gift tax return.  The client is worried about an IRS audit and wants to take a lower discount.
2. For a charitable donation.  The client wants a higher (less discounted) value.
3. For an all-cash redemption pursuant to a dispute among the owners. The client wants to “get the deal done”.
4. For a redemption where payments will be made over time with no interest. The client wants to “get the deal done” but not overpay.

How do you handle each of these situations?

1. If the client wants to take a lower discount, that’s certainly their prerogative.  I discuss with them, however, that ANY discount can ALWAYS be challenged.  To my way of thinking, a lower than appraised discount leaves money on the table.  If the client chooses, say, 15%, the Service might counter with 10%.  But if they still want a lower discount, I will add language in my report that says a 25% discount was appraised, and therefore a 15% discount is eminently fair and reasonable.
2. This one is a no-no.  I cannot support a lower discount.  The only way I can see to reduce (or eliminate) the discount would be for the client to give the charity a put option at undiscounted value and set aside funds that guarantee the client’s ability to honor the put.
3. This is really an investment value decision; again, it’s up to the client.  If they think that a discount will kill the deal, and they can live with an undiscounted value, then go right ahead.
4. Here, I point out that payments over time are the same as a discount because of the time value of money.  I can do net present value calculations (at a discount rate ranging from the risk-free rate to the cost of equity capital) to show them what the effective discount is.  Stated another way, they pay the seller an undiscounted number of dollars, but the fact that the dollars are paid out over time gives them a discount.

I recently finished an engagement that was a variant of the first situation described above.  It was an estate tax valuation involving a large number of companies, each with a host of family member owners.  The estate owned minority interests in each company, and I concluded combined discounts of from 20 to 40%. The remaining owners, however, said that (after the estate settled) they were going to simplify ownership by redeeming a large number of other outstanding minority interests, and they did NOT want to discount them in order to avoid family conflict. Nothing was in writing (there were no buy sells, no past transactions, and no offers to do what they intended) but they were adamant about not wanting to discount interests, even though they realized that this would cost them some estate tax dollars for the current engagement.  As above, I indicated in my report that discounts were warranted, but the family elected not to take them.

Actually, the situation was even more extreme! Most of the businesses were construction related, and had higher values in liquidation than as going concerns.  The family also insisted on valuing the minority interests at liquidation values, even though there was no intent to do so, so that subsequent redemptions on the same basis would have higher values.  They were willing to pay more taxes!  (I wish I was a member of that family!)