Our current online poll on valuing pass-through entities (PTEs) is rapidly collecting a record number of responses (second only to last year’s survey on BV credentials). Even as the number of participants continues to climb, however, the “split” among them has stayed steady, with just over half—55%, as of the most recent count—saying they do not add a PTE premium, but simply consider actual taxes paid by the subject entity. The complexity of the issue as well as the competition among various S corp valuation models may play a part in the split. As one survey participant commented, “To my knowledge, none of the models are widely used by appraisers because none of the models are simple. The principle of ‘Occam's razor’ will determine the winner here”—i.e., that the simplest among competing hypotheses is the best. “So far, no winner.”
As for the new research by Nancy Fannon and Keith Sellers, nearly two-thirds of respondents (61%) say they are still reviewing and processing it. Several are still not aware of it, or believe it will have no impact. A roundup of responses to the research includes:
- “It has broadened our understanding about the markets. We understand that market participants in the public equity market determine the cost of capital. The tax characteristics of the marginal investor in the public market have a meaningful impact on our pass-through adjustment, as these investors define the ‘level of value’ we are starting with when making the final adjustment.”
- “Simply more information to justify not tax-impacting the income stream.”
- “Their research has taken the BV profession in the right direction. There are costs to a company's earnings and cash flows (income taxes). Only after taking this into account can an owner determine their real cash flows available. To ignore the income taxes on the valuation of small business (pass-throughs) is to pretend that the company is worth more than it truly is.”
- “[Their] study has not been subject to Daubert [so I will not rely on it].”
- “We're monitoring the research debate, but we continue to tax affect, [as do] most valuations we see.”
- “There is no practical guidance provided in [the research]. I still ‘tax affect’ the net earnings if there will be distributions paid to shareholders to fund the payment of income taxes on S corp taxable income that flows through to them.”
- “[As a result of their research], I have tended to lower the S corp premium.”
A comprehensive overview of the continuing debate: 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.
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