I have had to consider prior transactions in a company’s securities in a large number of recent fair market value-based engagements. As you know, prior transactions, because they are highly visible, attract a great deal of IRS scrutiny and are also quite naturally of great interest to the parties to, for example, a minority interest redemption.
I have found it very helpful to ask MANY questions about a prior transaction to determine its relevance to a current valuation.
First, was the prior transaction a “real deal”? A rejected offer to buy or sell was not a completed transaction.
Second, was fair market-based consideration paid? If a minority shareholder was bought out in exchange for a 20-year balloon note (no principal due for 20 years) or at an interest rate vastly different from an appropriate market rate, that would not be market-based. If the prior transaction was based on an outdated buy-sell agreement (value) or a stock option whose exercise price was established when the company’s value was much different, the consideration was probably not fair market.
Third, was the transaction negotiated at arms’ length? Were the parties interests truly opposed? In a family situation, they might not be. Son would want to buy out mother on the cheap, and if Mom was wealthy and generous, she might not be opposed to that. Was a qualified, independent appraiser retained, and did they do a good job? Were the parties represented by attorneys or other qualified advisors? Were there real negotiations?
Fourth, after the prior transaction and up to the valuation date, did anything material change with regard to the business, its operating or financial position or its environment? If so, this could invalidate the prior transaction’s comparability unless its value could, with strong support, be adjusted to account for the change(s).
Fifth, was the prior transaction at the same level of value as the current one? This reflects (lack of) control and liquidity factors.
Sixth, did the prior transaction reflect any investment value considerations (aspects unique to the buyer or seller)? Stated bluntly, was something else going on? I recently considered a prior transaction that involved a premium to resolve a costly, long-standing and bitter shareholder dispute. The buyer basically paid the seller to go away and avoid legal costs. That was not fair market value! Did it include other things, such as a covenant not to compete or a consulting agreement or other benefits? If the seller was not really in a position to compete (say disabled) or provide real consulting services (they retired and moved far away), maybe these payments were really structured to reduce buyer’s cost, since covenants and consulting fee expenses are tax-deductible.
Seventh, were the parties well informed? A widow with no knowledge of her late husband’s business would not be.
Eighth, was anybody compulsed? If the widow faced bankruptcy, she might cave in and accept an unfairly low buyout price.
The answers to these questions will provide ample and strong evidence of the relevance of a prior transaction. Ask all of them, and report the answers!