October 2020 Forensic & Valuation Insight

Special Issue: BV Case Law Update

Dear Clients, Colleagues and Friends,

From a financial perspective, COVID 19 and the global impact to our markets and daily business activities has had profound effects on valuation, accounting and economic measurement issues. Experts have struggled with how to measure the pandemic’s impacts; what we have learned is to base assumptions on sound data and utilize relevant market information. Stay tuned for more on this in our current and later issues as we believe the economic impact will be with us for the foreseeable future.

Josh Shilts, CPA/ABV/CFF/CGMA, CFE

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BV Case Law Updates

• Valuation Discounts – Clark v. Clark, 2020 S.C. LEXIS 69 (May 13, 2020) – This South Carolina family law case involved valuing a spouse’s minority interest in a closely held business. The husband was gifted 100% ownership in his father’s business and gave 25% to his wife. In valuing the 25% minority share marital portion of the business, the expert imposed discounts for lack of control and marketability. The South Carolina Supreme Court ruled that discounts must be decided on a case-by-case basis and the valuation must follow the fair market value standard. In this case the court confirmed that applying the discounts were appropriate due to the willing buyer willing seller determination for fair market value even through the husband would be receiving 25% marital shares in the divorce.
• Importance of Correct Language in Shareholder Agreements – Hartman v. BigInch Fabricators & Construction Holding Co., Inc., 2020 Ind. App. LEXIS 183 (May 5, 2020) – This Indiana case involved a mandatory buy-back provision of a minority shareholder’s interest. In doing so, the provision called for the interest to be valued at “appraised market value by a third party appraisal subject to GAAP.” The appraiser who performed the valuation was instead instructed to perform the valuation at fair market value and as a result applied discounts for control and marketability. The court ruled that it was inappropriate to use fair market value when the buy-back provision called for appraised value and therefore the shares should not have been discounted. The panel noted that “appraised value” is not a business valuation term and if a valuation expert would have been consulted regarding the language in the shareholder agreement they would have been able to advise on using different language that would have included the discounts.
• Calculation v. Valuation – Horne-Ballard v. Ballard, 2020 Ala. Civ. App. LEXIS 50 (May 1, 2020) – This is an Alabama family law case involving a qualified expert’s estimate of the value of the owner spouse’s business based on a calculated engagement. Although the trial court did not make a specific finding as to the value of the business, it was clear from the amount of alimony awarded to husband that the court used the calculated value of $2.5 million versus wife’s expert’s value of $241,000. Importantly, and incorrectly, the wife’s expert testified at trial that her calculation of value involved less speculation than an opinion of value. Nevertheless, wife’s expert was unable to persuade the court that her expert’s opinion of value was more reliable than husband’s expert’s calculated value. This case shows how it is all the more important to engage a knowledgeable expert who can not only support their own conclusions but to also adequately rebut opposing experts and provide the court with appropriate guidance. It is clear that the trial court did not understand the difference between a calculation of value v. full valuation which requires that all three methods of valuation be considered.
• DCF Method Issues – Reynolds American Inc. v. Third Motion Equities Master Fund Ltd., 2020 NCBC 35 (April 27, 2020) – This North Carolina case used Delaware case law to render its decision and concluded that a discounted cash flow value is “an extreme outlier” when compared to other value indicators. The court noted that in the DCF method there is a wide variability and the potential for manipulation which has caused Delaware courts to question its reliability, particularly where the contested transaction was an arm’s-length merger.
• Appropriate Methodology and Theory – Grieve v. Commissioner, T.C. Memo 2020-28 (March 2, 2020) – This is a tax court (gift tax) case involving the fair market value of transferred Class A and Class B nonvoting units. The IRS issued a Notice of Deficiency increasing the value based on IRS’s expert using a novel valuation theory that any purchaser that were to buy the units would buy both the Class A and Class B units together. The tax court disagreed with the IRS stating that they do not engage in imaginary scenarios as to who a purchaser might be, and the valuations submitted in the taxpayer’s return was the most credible.
• Post Valuation Events Guidance – Office of Chief Counsel Internal Revenue Service Memorandum, POSTF-111979-17, Number(September 27, 2019) – This IRS Memorandum provides guidance on the issue of when a fair market value determine would consider a pending merger for gift tax purposes. On Date 1 shares for Corporation A were transferred to a trust, on Date 2 Corporation A’s company announced a merger with another company which substantially increased the shares of Corporation A. On Date 3 the merger was closed. The IRS states in its example that records showed that before the shares were transferred to the trust, owner was trying to find a merger and there were signs that a merger was in the works, including signed documents and communications. The question asked is should the merger be considered in determining fair market value for a Date 1 valuation? Yes, because there was evidence that the merger was “practically certain” to go through and a willing buyer and willing seller would have knowledge of all relevant facts, including the pending merger.

Shilts Speaks/Calendar of Events

Our President, Josh Shilts, is passionate about sharing his expertise. The following are upcoming events Mr. Shilts will be speaking at and we would like to encourage you to join us.

 

 

 

 

 

 

 

 

 

Cost of Capital in the Current Environment

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.