More than half (54%) of respondents to last week’s poll on valuing pass-through entities (PTEs), such as S corporations, say they do not apply a “premium” to account for the difference between the data on publicly traded C corps, from which they derive the cost of capital, and the subject PTE, to which they will apply it. “I consider actual taxes/tax rate paid by the entity,” said one respondent, who reflected the consensus of this camp. “No phantom imputation.” Others said the driving question is: “What do buyers do?” Commented one, “Our position is that in the real world, buyers tax affect an investment … in terms of using after-tax cash flows as the metric for value.”
At the same time, just under one-third (29%) of those who do not apply a PTE premium adjust the discount rate instead. “This seems to be where the new Fannon/Sellers paper is going,” said one, “but there is no definitive way to determine how big an adjustment should be made.” (Another respondent believes this is the way the IRS is going, too.) “Interestingly,” noted another:
When I had my report reviewed to obtain my ASA in 1994, I prepared a DCF on which I did not tax affect but rather adjusted the discount rate.… The report was rejected on that basis; I still believe today that you cannot adjust the discount rate and get an adequate answer.
Among the 46% of survey participants who still apply an S corp premium, by far the most commonly used models were the ones by Van Vleet (checked off by 31%) and the Delaware Chancery (20%). “Yes, Fannon and others have provided sound and better analyses to do this,” commented one, “but so far, all the tax-affecting analyses still contain many assumptions and are too complex for everyday use.” Most business appraisers make “countless” assumptions, this commentator added, and “don’t consider tax affecting any more serious of an assumption than the company-specific premium, the WACC weightings, the discounts, etc.” We’ll have more from the survey results next week.
Taking a current look at an ongoing controversy: On Thursday, May 10, join Eric Barr (Fischer Barr & Wissinger) for The Pass-Through Premium: A New Perspective on an Old Issue, which takes a fresh look at how entity structure, applicable tax rates, and business performance impact the credibility of an ultimate value conclusion.