What are valuators talking about?

BVWireIssue #70-3
July 16, 2008

At the late-June IBA Symposium in Chicago, lively discussions took place regarding three hot topics: 1) the nature of illiquidity; 2) whether to calculate deductions for built-in capital gains as if they would happen immediately or by taking the present value of future tax benefits; and 3) when should subsequent events be included in a valuation report

At the first utterance of “illiquidity discount,” multiple hands shot up, all with the same question: how does this differ from a discount for lack of marketability? The speaker acknowledged that he was unable to give definitions that would adequately differentiate the two, and instead chose to defer to the “statistician in the room;” namely Dr. Ashok Abbott (West Virginia University).  Dr. Abott then provided a 15 minute explanation, complete with examples. His presentation included a discussion of marketable public stock which had to be sold at an increasing discount to current market prices as the block size increased. At the end of the discussion, some of the room remained confused, while others still did not believe a difference existed between illiquidity discounts and marketability discounts.

The next notable discussion occurred after mention of the Jelke case (see the January 2008 issue of the Business Valuation Update, available as a Free Download here) and the topic of embedded gains.  Do you deduct embedded gains and if so, do you deduct them dollar-for-dollar (as if they would happen immediately) or discount the future tax benefits back to the present value?  Reviews were mixed, but many participants, including the presenter, said that if they were to deduct, they would deduct the embedded gains dollar-for-dollar (which the Jelke court agreed was appropriate, while the dissent referred to this as “adopting the doctrine of ignoble ease”—essentially calling the decision an easy way out of difficult mathematics).  But what are the benefits of adopting such a doctrine, you may ask?  Some additional thought from the group was, with so much uncertainty regarding future tax rates and timing of the sale, the easy road may not be any less accurate than the more complex method of discounting to present value.

The last significant discussion covered what was “known or reasonably knowable” on the valuation date and whether it could be used in a valuation report. The answers to the first question, “Would you use year end financials that would not have been available for several months after the year end valuation date?” were virtually all yes.  But what if those financials were revised many months after the valuation date?  Responses were mixed. Further questions dealt with what is “foreseeable” and whether a consistent way to handle this existed. Discussion even included what the courts considered to be “foreseeable,” and how subsequent events, foreseeable or not, factored into rulings (see BVWire #69-1 for more viewpoints from the courts).

The August issue of the Business Valuation Update contains an expanded discussion of these three topics. Have any comments on these subjects? Send them to BVWire@bvresources.com and we may publish them next week.

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