Despite the recognition among academics and “financial sophisticates” of the “many faults” associated with the excess earnings approach—and despite the IRS “all but abandoning” the excess earnings ideology—it still enjoys wide acceptance among family law courts, both at the trial and appellate levels, for valuing small, closely held businesses, says Jerome Karsh (Karsh Consulting) in the current American Journal of Family Law (Fall 2012) (subscription only).
In his article, “Bringing Business Valuation Out of the Dark Ages,” Karsh attributes the entrenchment of the excess earnings method not only to its historical use and precedential value, but also to its “simplicity in both form and substance.” Further, “it has emerged as the method of choice in family law valuations of most professional practices where little or no market for such can be defined.” After exploring the many criticisms of the method—as well as the problems with using public market data as a proxy in private market valuations in general—Karsh concludes:
Perhaps it is time to add the same caveat as contained in Rev. Ruling 68-609, modified to read regarding the use of public securities data for the returns in the private market: Public securities data may be used in determining the fair market value of closely held business interests only if there is no better basis for making the determination.
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