I just completed (early July 2010) a valuation of a controlling business interest owned by a trust benefiting the children of a decedent (he passed away in 2009). The minority interest is owned by the husband of one of the beneficiaries. That individual has served very capably as the chief executive officer of the business for many years, and this has resulted in steady, profitable growth and a very strong balance sheet. The CEO wants to buy the controlling interest from the trust. There is no intention to sell the controlling interest to a third party: the trustee, beneficiaries, and son in-law are extremely concerned about the risks of exposing the company’s intellectual property to others and about the potential adverse consequences for employees (including the son in-law) if a third party acquired control.
The trustee, an independent individual unrelated to the parties, asked me to value the controlling interest without any knowledge of offers made by the son in-law. The trustee will use my valuation to evaluate those offers. The trustee was reluctant to direct me in any way as to the engagement parameters (date, level, standard, and premise of value). The purposes of the appraisal were clear: to assist the trustee in discharging his fiduciary responsibility to ensure fair dealing and a fair price for the beneficiaries; and to comply with tax laws to make sure there is no bargain purchase with adverse tax consequences.
The trustee provided financial statements through April 30, 2010. He asked me to recommend the other engagement parameters. This was a little different than most of my engagements, for which the parameters are clear. I not only gave a great deal of thought to my recommendations but substantiated them (in much more detail than presented below). This is a must when these fundamental assumptions are unclear; you do not want to get way down the road with a valuation only to discover than you erred on any of them.
Here’s what I recommended:
1. The valuation date was April 30, 2010, the latest for which financials were provided. I stated that the value as of this date would last as long as: (1) there was no subsequent material change in the business or its financial condition up to the report date; and (2) there was no knowledge of possible or actual events subsequent to April 30, 2010 that might materially impact the valuation. If more recent financials were provided, if there was a subsequent material change, or if knowledge of subsequent material events becomes available, I reserved the right to update my report accordingly, at additional cost.
2. I recommended a control marketable value level. Control was obvious. I recommended marketable because the existence of lack of marketability discounts for controlling interests is theoretically unproven and rather controversial. I indicated that I was open to developing a non-marketable value (applying a discount for lack of marketability) if the trustee so desired, but that because of the theoretical controversy and lack of empirical data, this would involve a great deal of subjectivity.
3. I recommended a going concern premise of value. As it turned out, this was obvious based on the profitability and cash flow of the business (a service firm). A brief analysis proved beyond doubt that going concern value exceeded liquidation value. There was no external compulsion (e.g. bank foreclosure) for liquidation.
4. I recommended a fair market value standard. This is obviously required for tax compliance. I explained additionally that the parties’ desire to restrict the sale to the son in-law took strategic buyers and synergistic value off the table. The son in-law, because he has run the business so well for many years, has in all likelihood maximized business value on a financial buyer basis. This reinforces the applicability of the fair market value standard. It represents the minimum price the son in-law should pay for the interest, which is also precisely the information the trustee needs to ensure financial fairness and tax compliance.