The Latest Development in Business Valuation: Burdens of Proof, Tax Affecting S Corporations, and Chapter 14 in Kress
The combination of the court’s acceptance of tax affecting an S corporation’s earnings, tax affecting by the Internal Revenue Service’s expert, and the court’s determination that no S corporation premium applies resulted in a monumental development in the valuation of pass-through entities for federal estate and gift tax purposes.
Contact: Todd G. Povlich
Families and organizations that own and operate portfolios of real estate make up a significant segment of MPI’s clients. We are engaged for a variety of real estate-based valuation assignments.....
Contacts: John Varga
MPI is often called upon by clients and wealth advisors to provide expert opinions in the context of establishing preferred stock and preferred freeze partnership structures, or simply valuing existing preferred equity.
Contacts: Todd G. Povlich
A “business combination” results in the need for a Purchase Price Allocation (“PPA”). A PPA is an allocation of the purchase price paid to the assets and liabilities included in a transaction. PPAs represent a reporting requirement for both financial and tax reporting purposes. This article focuses on PPAs for financial reporting purposes.
Authors Alon Brav and J.B. Heaton bring to light some of the problems evident in the use of event studies in securities litigation in their recent article.1 As every expert knows, Courts have become enamored with event study methodology for ascribing information effects to stock prices. An expert’s opinion on market efficiency and/or damages is at risk if it is devoid of a supporting event study analysis.
A common issue in the valuation of closely held businesses is the taxation of pass-through income derived from S corporations, limited liability companies and limited partnerships. Generally speaking, pass-through entities are not subject to tax at the entity level, but rather the income is passed through or allocated to the owners of the entity based on their ownership percentages, and includable on the owners’ personal income tax returns.
Private Client Valuation Update – Commentary on Tax Law, Court Cases, Market Multiples, Discounts, Interest Rates and More
What a difference a few months and an unusual election season can bring. Let’s recall what was, or was not, going through our collective brains on those hot summer days in late July 2016. Many of you were likely on the beach, and giving little thought to the potential for proposed 2704 regulations to disrupt the second half of 2016 or for the Presidential election to go the way of Donald J. Trump. In early August, the Treasury issued potentially far-reaching proposed regulations under Section 2704 of the Internal Revenue Code, and as Summer turned to Fall, Mr. Trump cut into Hillary Clinton’s projected lead and went on to a resounding electoral college victory.
In the Spotlight
Does funding your retirement depend on the sale of your business? There are some factors you may not have considered that can affect its monetary value, including how ready it is to be sold and how fast you want to exit.
MPI’s Mark Lingerfield talks about the business valuation industry and MPI's expertise.
Carried Interest Planning—From Structure to Valuation
IRS Takes Aim at an Estate-Planning Strategy
IRS Proposes Additional Rules Applying to Private Equity Management Fee Waivers
MPI conducted an update of its preferred stock database as of June 30, 2019, and compared general levels of interest rates to those observed on December 31, 2018. Interest rates and preferred stock yields have been low by historical standards, and may be heading lower in the coming periods.
This industry report provides an overview of M&A activity during Q2’ 2018, including transaction multiples, private equity transaction data and notable transactions. While the aggregate dollar volume increased 54.6% from Q1 2018, the number of transactions announced decreased approximately 7.8%.
The healthcare industry is poised for a growth opportunity in artificial intelligence (AI) and machine learning, with this segment of the market expected to reach $6.6 billion by 2021. This industry report takes a deeper look at the developing implications of machine learning for both consumer health and the healthcare industry as a whole. It includes a review of recent mergers and acquisitions, public market data, and the outlook for a dozen healthcare segments, including assisted living, diagnostic imaging, healthcare staffing and pharmacy management.
This publication focuses on major events, developments and trends within various segments of the Software Development Industry: business solutions, customer relationship management (“CRM”)/marketing, IT/data management/data analysis, design/development, diversified, entertainment, financial/accounting, security, supply chain/enterprise resource planning (“ERP”), and other software development. This industry as a whole is highly fragmented and continuously evolving. The Software Development Industry is currently in the growth phase of its life cycle, and is projected to continue to grow at a healthy rate into the future.
Despite a year consisting of commodity market volatility, worldwide currency concerns, interest rate adjustments, a growing threat of international violence, and political uncertainty, the S&P 500 realized a 19.42% increase in the twelve months ending December 31, 2017 to a closing price of 2,673.61. In the fixed income markets, the 10 and 30 year treasuries generally decreased over the past year to closes of 2.40% and 2.74%, respectively, as of December 31, 2017. 3-month LIBOR increased from 0.998% at the end of 2016 to 1.694% as of December 31, 2017, and the United States prime rate increased by 75 basis points to 4.50% over the same period.
The Asset Management Industry as a whole has returned to pre-crisis levels: Revenue grew at a compound annual growth rate of 0.4% in the traditional space in the last five years through 2017 and 8.0% in the alternative space over the same period. Revenue for alternative managers increased 10.9% in 2017, reaching a new peak. In the traditional space, revenues increased by 5.4% in 2017 but remained below levels seen in 2007 and in certain years after the recession. In the last twelve months, traditional asset manager stock prices have increased by 19.8%, while alternative asset manager prices have increased 42.6%.
This publication focuses on developments and trends within the Heavy Construction industry. The Heavy Construction industry is comprised of companies engaged in large-scale construction projects, often infrastructure. Heavy Construction companies provide a variety of services including; planning, design, engineering, consulting, and construction.
This publication focuses on major events, developments and trends happening within the natural and organic, retail, distribution, protein processing, snack products, agricultural, and ingredients segments of the Food Industry. Most of the companies operating within the Food Industry are currently in the mature stage of their lifecycles. Nonetheless, volatile input prices, evolving consumer preferences and key merger and acquisition activities have spurred divergent recent performance and a changing competitive landscape.
Court Case Summaries
Developments in the Cahill and Morrissette cases in June 2018 are expected to have significant ramifications on the structuring of split-dollar life insurance arrangements and may also have broader implications on intergenerational wealth planning and family entity structuring. The broader impact is borne out of the tax court’s use of Internal Revenue Code Sections 2036(a)(1) and 2038(a)(2) to pull previously gifted assets back into the decedent’s gross estate for estate tax purposes.
The Delaware Court of Chancery recently determined the value of ISN Software Corporation stock to be $98,783 per share, 158% more than the merger price. ISN did not rely on a financial advisor, investment bank, or fairness opinion, but self-determined that its stock was fairly valued at $38,317 per share. Petitioners Polaris and Ad-Venture objected, and promptly filed suit. With experts for all parties submitting wildly different valuations, the Vice Chancellor was forced to rely on his own, hybrid discounted cash flow (“DCF”) analysis, and ultimately pegged ISN’s fair value well above the merger price. Litigators would be remiss in neglecting to glean insight from the published opinion, which covers critical valuation parameters, including cash flow projections and discount rate factors.
In April 2016, the Tax Court entered a summary judgment on Estate of Clara M. Morrissette v. Commissioner of Internal Revenue. The case centered on two split-dollar life insurance arrangements entered into by the decedent’s revocable trust and three distinct trusts in 2006. The revocable trust contributed $29.9 million to the trusts. The trusts used these funds to purchase life insurance policies covering the decedent’s three sons. In 2013, the IRS issued a notice of deficiency against the estate in the amount of $13,800,179 plus a penalty of $2,760,036. 1 The IRS characterized the $29.9 million contribution as a taxable gift, and classified the split-dollar life insurance arrangements as loans.2 The estate challenged this classification, arguing that the arrangements should be governed by the so-called “economic benefit” regime.3 The Tax Court agreed with the estate, issuing a partial summary judgment under Rule 121(a) of the Tax Court Rules of Practice and Procedure that the economic benefit regime applies to the split-dollar arrangements in this case.
Vice Chancellor Laster’s recent decision in the Delaware appraisal action involving Dell, Inc. determined that Dell’s stock was valued at $17.62 per share, or some 26% above the going private offer worth $13.96 per share.1 The four day trial included testimony from both Petitioners’ and Respondent’s valuation experts, as well as testimony from the investment bankers who originally advised Dell’s board of directors. Ultimately, the Vice Chancellor developed a hybrid valuation model, selecting what was deemed to be the most reliable data from each of the experts, in arriving at his opinion on the value of the shares. Litigators would be remiss in neglecting to glean insight from the published opinion which speaks to critical valuation parameters, including financial forecasts, growth rates, taxes, and the cost of capital.
The Honorable Yvonne Gonzalez Rogers, in the Northern District of California, issued an order last week granting class status to an action brought under Rule 10b-5 of the Securities Exchange Act against Advanced Micro Devices, Inc. (Babak Hatamian, et al. v. AMD, et al., 14-cv-00226 YGR). Judge Gonzalez Rogers referenced Halliburton II standards, among others, in deciding two key issues – namely, whether Plaintiffs are entitled to invoke a presumption of reliance under the “fraud-on-market” theory to show reliance classwide; and whether Plaintiffs can show that a common damages methodology can be applied to all class members.
In December 2015, the Tax Court rendered its opinion on Sumner Redstone v. Commissioner of Internal Revenue. The focus of the dispute was whether a stock transfer made by Sumner Redstone in 1972 was a gift for Federal gift tax purposes, or, as Sumner Redstone claimed, was a transfer for “adequate and full consideration in money or money’s worth.”1 Following an examination that concluded in early 2013, the IRS issued against Sumner Redstone a gift tax deficiency of $737,625 for the calendar quarter ending September 30, 1972.2 In addition, the IRS determined an additional $368,813 for fraud,3 $36,881 for negligence, 4 and $184,406 for failure to file a timely gift tax return. 5 Ultimately, after a trial, the Tax Court found that the transfer was a taxable gift but Sumner Redstone was not liable for any additional penalties.
According to the Ninth Circuit, the answer to the question above is “Absolutely.” This case involved a limited partnership owning timberlands that was formed 15 years prior to Mr. Natale B. Giustina’s death. After the family’s lumber mills were sold, timberlands owned for decades within the family’s business entities were transferred to a new partnership in order to effect a family ownership and management restructuring. The timberlands continued to be held and managed by the partnership and there was no desire or intention to liquidate these assets at the time of Mr. Giustina’s death. In Tax Court, Judge Morrison opined that 25% weight ought to be given to the liquidation value of the partnership, and 75% weight ought to be given to its going concern value, which was determined through a capitalization of cash flow method.
In a recent decision in New Jersey Superior Court involving cross claims of shareholder oppression pursuant to N.J.S.A. §14A:12-7, the Court found it appropriate to apply a marketability discount to the value of the privately-held company stock at issue in determining the buyout price to the oppressive shareholder. As New Jersey is typically a “Fair Value” jurisdiction, marketability discounts are applied only under what is found to be “extraordinary circumstances,” such that failure to do so would unjustly enrich the oppressing shareholder or otherwise fail to adequately compensate the prevailing party.
MPI was contacted by the chief financial officer of a publicly traded company which had just completed a business combination transaction wherein it acquired 80% of the outstanding securities of a target company using its own publicly traded stock to fund the transaction.
MPI was contacted by a major law firm in the Southeast. Their client, a television and radio broadcasting company, had been informed by its CPA firm that management’s internal impairment analysis would not meet the qualifications required for a successful audit. The CPA firm recommended that the impairment test be prepared by an independent third party.
Private Client Bulletins
Preferred stock continues to trade at yields below historical averages. Despite increases in benchmark rates by the Federal Reserve, on the whole, we continue to be in a low interest rate environment. Preferred stock is often viewed as a debt-like instrument due to its fixed dividend rate. This implies that preferred stock is valued and trades like debt, meaning increases in market interest rates may push preferred yields higher and preferred stock prices lower, and vice versa.