Business Valuation Discounts and Premiums / Edition 2

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Business Valuation
Discounts and Premiums
Second Edition

Discounts and premiums do not just affect the value of acompany; they play a crucial role in influencing a host of otherfactors and conditions that can make or break a deal. When it comesto business valuations, it's the business appraiser'sresponsibility to be intimately knowledgeable with every aspect ofdiscounts and premiums: the different types, the situations whenthey may or may not apply, and how to quantify them.

In this newly updated edition of Business Valuation:Discounts and Premiums, Shannon Pratt-one of the nation's mostrecognized and respected business valuation consultants-bringstogether the latest collective wisdom and knowledge about all majorbusiness discounts and premiums.

Addressing the three basic approaches to conducting avaluation-the income approach, the market approach, and the assetapproach-Shannon Pratt deftly and logically details the differentdiscounts or premiums that may be applicable, depending on thebasic valuation approach used, and how the valuation approachesused affect the level.

Clearly written and thorough, Business Valuation: Discountsand Premiums, Second Edition provides business appraisers,accountants, attorneys, and business owners with an arsenal ofinformation for their professional toolkit that can be applied toevery major evaluation case they might face in any deal.

This updated edition features timely, comprehensive coverageon:

  • Strategic acquisitions
  • Extensive empirical data
  • Pre-IPO marketability discount studies
  • Merger and acquisition negotiations, empirical evidence fromcompleted transactions, and positions taken by courts inlitigations
  • Strategic acquisition premiums
  • Studies on minority discounts

Detailed, authoritative, and complete in its coverage,Business Valuation: Discounts and Premiums, Second Editiongets to the core of one of the more complex challenges faced bybusiness appraisers, and arms readers with the understanding andtechniques needed to successfully meet and exceed their jobexpectations.

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Product Details

  • ISBN-13: 9780470371480
  • Publisher: Wiley
  • Publication date: 4/27/2009
  • Edition number: 2
  • Pages: 504
  • Product dimensions: 7.20 (w) x 9.90 (h) x 1.80 (d)

Meet the Author

Shannon P. Pratt, CFA, FASA, MCBA, CM&AA, is theChairman and CEO of Shannon Pratt Valuations, Inc., a premierbusiness valuation firm, and is the founder and Editor Emeritus ofBusiness Valuation Resources, LLC. Over a distinguished career ofclose to four decades, he has performed valuation engagements forM&A, ESOPs, gift and estate taxation, marital dissolution,shareholder oppression and dissent, and numerous other purposes. Hehas conducted many fairness and solvency opinions, has testified ina wide variety of federal and state courts across the country, andfrequently participates in arbitration and mediation proceedings.Dr. Pratt is one of the most successful and respected authors inhis field.

He is the author or coauthor of several industry standards,including The Market Approach to Valuing Businesses, Standardsof Value, Business Valuation and Taxes, Cost of Capital, BusinessValuation Body of Knowledge, all published by Wiley, as well asPPC's Guide to Business Valuation, Valuing a Business: TheAnalysis and Appraisal of Closely Held Companies, Valuing SmallBusinesses and Professional Practices, and The Lawyer's BusinessValuation Handbook.

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Table of Contents

List of Exhibits.

About the Author.

About the Contributing Authors.




1 Overview of Business Valuation Discounts and Premiums andthe Bases to Which They Are Applied.

Discounts and Premiums Are Big-Money Issues.

“Entity-Level” versus“Shareholder-Level” Discounts and Premiums.

How the Valuation Approaches Used Affect the Level of Value.

Use of Public Company Data to Quantify Discounts andPremiums.

How the Standard of Value Affects Discounts and Premiums.

American Society of Appraisers Business Valuation Standard VII:Valuation Discounts and Premiums.


2 Minority Discounts and Control Premiums.

Relevant Definitions.

Basic Minority/Control Value Relationship.

Prerogatives of Control.

Factors Affecting Degree of Control.

How the Valuation Methodology Affects the Minority Discount orControl Premium.

Do Publicly Traded Minority Stock Prices Reflect ControlValue?

Treatment of Control Premiums in the Delaware Courts.

How the Purpose of the Valuation Affects Minority Discounts orControl Premiums.


3 Empirical Data Regarding Minority Discounts and ControlPremiums.

Premiums Paid in Acquisitions.

Identifying Industries with Higher or Lower ControlPremiums.

Caveats Regarding Use of Control Premium Data.

Are Control Premiums Too High?

Percentage Discounts from Net Asset Value.


4 Minority Discounts and Control Premiums in theCourts.

Gift, Estate, and Income Tax Cases.

Discounts for Lack of Control in Employee Stock Ownership PlanCases.

Dissenting Shareholder Cases.

Shareholder Oppression Cases.

Marital Dissolution Cases.

Bankruptcy Case.


5 Discounts for Lack of Marketability for Minority Interests:Concept and Evidence.

Public Market Benchmark for Marketability.

Empirical Evidence to Quantify Discounts for Lack ofMarketability.

Restricted Stock Studies.

Pre–Initial Public Offering Discount for Lack ofMarketability Studies.

Courts’ Aversion to “Benchmarking”.

Regulatory and Court Recognition of Empirical MarketabilityDiscount Studies.


6 Synopsis of Restricted Stock Studies.

Securities and Exchange Commission Institutional InvestorStudy.

Gelman Study.

Trout Study.

Moroney Study.

Maher Study.

Standard Research Consultants Study.

Silber Study.

FMV Opinions Study.

Management Planning Study.

Johnson Study.

Columbia Financial Advisors Study.

LiquiStat Database.


7 LiquiStat Database (Restricted Stocks, Options, Warrants,and Convertible Securities).

Restricted Stock as a Basis.

Biases Beyond Illiquidity in Traditional Restricted StockStudies.

How LiquiStat Is Different.

Options and Warrants in LiquiStat.

Convertible Securities in LiquiStat.


8 Blockage Discounts.

Blockage Is Distinct from Restricted Stock.

Factors to Analyze in Quantifying Blockage Discounts.

Must Consider Ways of Selling Stock.

“Price Pressure” and “MarketExposure”.

Block Buyer Could Ameliorate Blockage Discount.

Blockage Discounts Recognized in Estate and Gift TaxRegulations.

Blockage Discounts in U.S. Tax Court.

Financial Accounting Standards that May Affect BlockageDiscounts.

Blockage Discounts Used to Estimate Illiquidity Discounts.


9 John Emory Pre–Initial Public Offering Discount forLack of Marketability Studies—Complete UnderlyingData.

Study #1: Adjusted Study, January 1980–June 1981.

Study #2: Adjusted Study, January 1985–June 1986.

Study #3: Adjusted Study, August 1987–January 1989.

Study #4: Adjusted Study, February 1989–July 1990.

Study #5: Adjusted Study, August 1990–January 1992.

Study #6: Adjusted Study, February 1992–July 1993.

Study #7: Adjusted Study, January 1994–June 1995.

Study #8: Adjusted Study, November 1995–April 1997.

Study #9: Adjusted Study, Dot-Com Companies, May1997–March 2000.

Study #10: Adjusted Expanded Study, May 1997–December2000.


10 Valuation Advisors Discount for Lack of MarketabilityStudy.

Description of Study.

Results of Study.


11 Factors Affecting Discounts for Lack of Marketability forMinority Interests.

Size of Distributions.

Prospects for Liquidity.

Pool of Potential Buyers.

Risk Factors.


12 Discounts for Lack of Marketability for ControllingInterests.

Discounts for Lack of Marketability for Controlling Interests: aControversial Concept.

“Control, Marketable” Is an Oxymoron.

Bases from Which Controlling Interest Discounts for Lack ofMarketability May Be Deducted.

Factors Affecting Controlling Interest Discounts for Lack ofMarketability.

Public versus Private Company Acquisition Multiples.

Court Treatment of Controlling Interest Discounts for Lack ofMarketability.


13 The Quantitative Marketability Discount Model: AShareholder Level DCF Model.


The Structure of the Shareholder Level DCF Model.

A Visual Representation of the Shareholder Level DCF Model.

Factors Contributing to Marketability Discounts.


14 Marketability Discounts in the Courts—MinorityInterests.

Gift and Estate Tax Cases.

Employee Stock Ownership Plan Case.

Dissenting Shareholder Cases.

Minority Oppression Cases.

Marital Dissolution Cases.


15 Marketability Discounts in the Courts—ControllingInterests.

Gift and Estate Tax Cases.

Marital Dissolution Cases.


16 Voting versus Nonvoting Stock.

Voting versus Nonvoting Stock Scenarios.

Empirical Studies Show Little Differential for Small MinorityInterests.

Transactions Involving Premiums for Control Blocks.

Court Cases Involving Voting versus Nonvoting Stock.


17 Key Person Discounts and Premiums.

Empirical Evidence Supports Key Person Discount.

Internal Revenue Service Recognizes Key Person Discount.

Factors to Consider in Analyzing the Key Person Discount.

Quantifying the Magnitude of the Key Person Discount.

U.S. Tax Court Cases Involving Key Person Discounts.

Key Person Discounts in Marital Dissolutions.

Key Person Discounts in Other Types of Cases.


18 Discounts for Trapped-In Capital Gains Taxes.

Rationale for Trapped-In Capital Gains Tax Discount.

General Utilities Doctrine”.

Tax Court Recognizes Trapped-In Capital Gains.

Internal Revenue Service Acquiesces to Trapped-In Capital GainsDiscount.

Subsequent Tax Cases Regularly Recognize Trapped-In CapitalGains Tax Discount.

Trapped-In Capital Gains in Dissenting Stockholder Actions.

Trapped-In Capital Gains in Bankruptcy Court.

Trapped-In Capital Gains Taxes in Marital Dissolutions.

Treatment of Capital Gains Tax Liability.

Treatment of Capital Gains Tax Liability in S Corporations.


19 Nonhomogeneous Assets (“Portfolio”)Discounts.

Portfolio Discount Principle.

Empirical Evidence Supporting Portfolio Discounts.

How to Value Companies with Disparate Portfolios.

Quantifying the Portfolio Discount.

Portfolio Discounts in the Courts.


20 Discounts for Environmental, Litigation, and OtherContingent Liabilities.

Concept of the Contingent Liability Discount.

Financial Accounting Standard #5 May Provide Guidance inQuantifying Contingent Liabilities.

Treatment of Contingencies in the U.S. Tax Court.

Treatment of Contingencies in Marital Dissolution.


21 Discount Adjustments for Limited Partnership Interests andOther Asset Management Entities.


Partnership Features.

Other State Law and Regulatory Issues.

Compliance with Federal Income Tax Regulations.

Compliance with Federal Transfer Tax Regulations.

Analysis of Ownership and Classes of Interests.

Analysis of Underlying Adjusted Net Asset Value.

Analysis of Income Capacity Value.

Valuation of Noncontrolling Entity Interests.

Discounts for Lack of Control and Marketability.

Court Cases Regarding Limited Partnership Values


22 Adjusting Values for Differences in Size.

Income Approach.

Market Approach.

Criticisms of the Size Premium.

Court Cases Involving The Size Premium.


Sources of Additonal Data.

23 Discounts and Premiums in Esop Valuations.

ESOP Definition, Types and Benefits.

“Adequate Consideration” for ESOP ValuationPurposes.

Control Premiums in ESOP Valuations.

Discounts for Lack of Marketability in ESOP Valuations.

ESOP Court Cases.


24 Discounts and Premiums In Divorce Disputes.

Control Premiums in Divorce.

Discounts for Lack of Marketability in Divorce.

Discounts for Lack of Voting Rights in Divorce.

Key Person Discounts in Divorce.

The Effective Discount for Personal Goodwill in Divorce.

Active versus Passive Appreciation.


25 Discounts and Premiums In Corporate and PartnershipDissolution and Oppression Cases.

Dissolution for Shareholder (Partner) Oppression.


California Oppression Cases.

Delaware's Approach.


26 Discounts and Premiums in Fair Value for FinancialReporting.


Fair Value Of Reporting Units.

Fair Value of Sharebased Compensation.


Additional Reading.

27 Premium and Discount Issues in Undivided InterestValuations.

Description and Characteristics of Undivided Interests.

Appraisal of Assets in Fee-Simple Interest.

Factors Affecting the Value of an Undivided Interest.

Valuation Adjustments for Undivided Interests.

Court Decisions Related to Undivided Interest Discounts.


28 Common Errors in Applying Discounts and Premiums.

Using Synergistic Acquisition Premiums to Quantify Premiums forControl.

Assuming That the Discounted Cash Flow Valuation Method AlwaysProduces a Minority Value.

Assuming That the Guideline Public Company Method AlwaysProduces a Minority Value.

Valuing Underlying Assets Rather than Stock or PartnershipInterests.

Using Minority Interest Marketability Discount Data to QuantifyMarketability Discounts for Controlling Interests.

Using Only Restricted Stock Studies (and Not Pre-Initial PublicOffering Studies) as Benchmark for Discounts for Lack ofMarketability.

Inadequate Analysis of Relevant Factors.

Indiscriminate Use of Average Discounts or Premiums.

Applying (or Omitting) a Premium or Discount Inappropriately forthe Legal Context.

Applying Discounts or Premiums to the Entire Capital StructureRather than Only to Equity.

Quantifying Discounts or Premiums Based on Past Court Cases.

Using an Asset Appraiser to Quantify Discounts or Premiums forStock or Partnership Interests.


Appendix A Bibliography.




Appendix B Data Resources.

Control Premiums/Minority Discounts.

Discounts for Lack of Marketability.

Discounts from Net Asset Value for Limited PartnershipInterests.

Discounts from Net Asset Value for REITs and REOCs.

Discounts from Net Asset Value for Closed-End InvestmentFunds.

Discount and Capitalization Rates.

Appendix C How Much Can Marketability Affect SecurityValues?

I. The Framework.

II. The Upper Bound.

III. A Comparison.

IV. Conclusion.


Appendix D Internal Revenue Service Revenue Ruling77-287.

Section 1. Purpose.

Sec. 2. Nature of the Problem.

Sec. 3. Background and Definitions.

Sec. 4. Securities Industry Practice in Valuing RestrictedSecurities.

Sec. 5. Facts and Circumstances Material to Valuation ofRestricted Securities.

Sec. 6. Weighing Facts and Circumstances Material to RestrictedStock Valuation.

Sec. 7. Effect on Other Documents.

Appendix E Securities and Exchange Commission Rules 144 and144A.


Appendix F Table of Cases.


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