Valuing a Business. The Analysis and Appraisal of Closely Held Companies. Chairman and CEO Shannon Pratt Valuations, Inc. Alina V Niculita, CFA, MBA

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1 Valuing a Business The Analysis and Appraisal of Closely Held Companies Fifth Edition Shannon P. Pratt, CFA, FASA, MCBA, MCBC, CM&AA Chairman and CEO Shannon Pratt Valuations, Inc. Alina V Niculita, CFA, MBA President and COO Shannon Pratt Valuations, Inc. Me: Grauu Hill. > New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto

2 PART I State of the Profession, the Engagement, and the Basic Theory Business Valuation Standards and Credentials 3 Growing Consensus on Business Valuation Standards. The Appraisal Foundation. Background and Organization. Uniform Standards of Professional Appraisal Practice. Standards Published by Business Valuation Professional Organizations. Other Organizations That Have Offered Guidance on Business Valuation Issues. Internal Revenue Service. Department of Labor. Association for Investment Management and Research. The ESOP Association. Recognition of Professional Standards by Courts. International Acceptance of U.S. Standards and Practices. Professional Organizations Offering Accreditation in Business Valuation. American Society of Appraisers. Institute of Business Appraisers. National Association of Certified Valuation Analysts. American Institute of Certified Public Accountants. The Canadian Institute of Chartered Business Valuators. Summary. Bibliography. 2. Defining the Assignment 29 Basic Elements of the Valuation Assignment. Definition of Who Offered and Who Accepted the Assignment. Description of the Legal Interest or Interests to Be Appraised. Description of the Business Entity. Description of the Specific Business Interest. Interests Other than Direct Fee Simple Ownership. Description of the Specific Ownership Interest Characteristics. Control versus Minority. Degree of Marketability. Valuation Date. Purpose of the Appraisal. Standards of Value. Fair Market Value. Investment Value. Intrinsic or Fundamental Value. Fair Value under State Statutes. Fair Value for Financial Reporting. Going-Concern versus Liquidation Premise of Value. Sources of Guidance as to Applicable Standards and Premises of Value. Form of the Work Product. Scheduling. Fee Arrangements. Summary. 3. Business Valuation Theory and Principles 55 Generally Accepted Theory. Reliance on Projected versus Historical Benefits. Basic Variables Affecting Value. Impact of Risk on Value. Accepted Business Valuation Approaches and Methods. Background and Structure. Interrelationship of the Three Broad Approaches. Impact of Controlling versus Noncontrolling Ownership Interest. Impact of Marketability. Distinction between Discount for Lack of Control and Discount for Lack of Marketability. Other Qualitative Factors Affecting Value. Matching the Valuation Methodology with the Standard and Premises of Value. Sum of Parts Not Necessarily Equal to Whole. Summary of Business Valuation Principles. Bibliography.

3 PART II Gathering and Analyzing Data Gathering Company Data 75 Generalized Company Information Checklist. Financial Statements. Relevant Time Period. Levels of Financial Statement Preparation. Impact of Enterprise Legal Structure. Federal Tax Returns. Interim Statements. Other Financial Schedules. Current Assets and Liabilities. Plant and Equipment. Officers' and Directors' Compensation Schedule. Distribution of Ownership. Dividend or Partnership Withdrawal Schedule. Schedule of Key Person Life Insurance. Off-Balance Sheet Assets or Liabilities. Related Party Transaction Information. Operating Information. Company History. Brochures, Catalogs, Web Sites, and Price Lists. Key Personnel. Customer and Supplier Base. Contractual Agreements and Obligations. Industry and Trade Association Information. List of Past Transactions in the Stock or Offers to Buy. Budgets and Forecasts. Capital Requirements. Capital Expenditures. Deferred Maintenance. Working Capital Requirements. Company Documents Relating to the Rights of Owners. Corporate or Partnership Records. Buy-Sell and Employee Stock Ownership Plan Agreements. Employment and Noncompete Agreements. Summary. 5. Site Visits and Interviews 91 History. Description of the Business. Management and Management Compensation. Operations. Materials and Supplies. Labor and Government Relations. Plant and Equipment. Inventory. Markets and Marketing. Finance. Current Assets. Fixed Assets. Intangible Assets. Current Liabilities. Capital Structure. Off-Balance Sheet Items. Profitability and Budgeting. Insurance. Dividends. Prior Arm's-Length Transactions or Offers. Catch-All Question. Interviews of Outsiders. Professionals Related to the Company. Other Possible Outside Interviews. Summary. 6. Researching Economic and Industry Information 103 National Economic Information. The Federal Statistical System. Banks. Business Periodicals and Statistical Services. Regional Economic Information. Industry Information. General Industry Information. Composite Company Data. Information on Management Compensation. Online Information. Indexes to Economic and Industry Information. Summary. Bibliography. 7. Analyzing Financial Statements 129 Normalizing versus Controlling Adjustments. Adequacy of Allowance and Reserve Accounts. Allowance for Doubtful Accounts Accounts Receivable. Allowance for Doubtful Accounts Notes Receivable. Inventory Accounting Methods. FIFO, LIFO, and Other Methods. Write-Down and Write-Off Policies. Depreciation Methods and Schedules. Declining-Balance Method. Sum-of-the- Years '-Digits Method. ACRS and MACRS. Analytical Implications. Depletion. Treatment of Intangibles. Leasehold Interests. Other Intangible Assets. Capitalization versus Expensing of Various Costs. Timing of Recognition of Revenues and Expenses. Contract Work. Installment Sales. Sales Involving Actual or Contingent Liabilities. Prior-Period Adjustments. Accounting for Leases. Net Operating Loss Carryforwards. Treatment of Interests in Affiliates. Extraordinary or Nonrecurring Items. Ordinary versus Extraordinary Items. Other Nonrecurring Items. Discontinued Operations. Operating versus

4 ix Nonoperating Items. Management Compensation and Perquisites. Transactions Involving Company Insiders. Contingent Assets and Liabilities. Adjustments to Asset Valuations. Marketable Securities. Other Assets. Computation of Earnings per Share. Weighted Average Basis. Basic versus Diluted Earnings. Computation of Book Value per Share. An Example of the Effect of Alternative Accounting Methods. Adjusting the Balance Sheet to Current Values. Summary. Bibliography. 8. Financial Statement Ratio Analysis 153 Use and Interpretation of Ratio Analysis. Common-Size Statements. Short-Term Liquidity Measures. Current Ratio. Quick (Acid-Test) Ratio. Activity Ratios. Accounts Receivable Turnover. Inventory Turnover. Sales to Net Working Capital. Sales to Fixed Assets and Total Assets. Risk Analysis. Business Risk. Financial Risk. Balance Sheet Leverage Ratios. Total Debt to Total Assets. Equity to Total Assets. Long-Term Debt to Total Capital. Equity to Total Capital. Fixed Assets to Equity. Debt to Equity. Income Statement Coverage Ratios. Times Interest Earned. Coverage of Fixed Charges. Income Statement Profitability Ratios. Return on Investment Ratios. Return on Equity. Return on Investment. Return on Total Assets. Asset Utilization Ratios. Summary. PART III Business Valuation Approaches and Methods Income Approach: Discounted Future Economic Income Method 173 Introduction: Theoretical and Practical Soundness of the Approach. The Basic Discounted Economic Income Framework. The Numerator: Expected Prospective Economic Income. The Denominator: The Discount Rate. Estimating the Discount Rate. Return and Rate of Return Defined. Components of the Discount Rate. The Risk-Free Rate. The Equity Risk Premium. The Capital Asset Pricing Model. Systematic and Unsystematic Risk. Beta: The Measure of Systematic Risk. Using Beta to Estimate Expected Rate of Return. Levered and Unlevered Betas. Assumptions Underlying the Capital Asset Pricing Model. The Size Premium. The Build-Up Model. Formula for the Build-Up Model. Company-Specific Risk Premium. Industry Risk Premia. The Discounted Cash Flow or the Implied Method of Estimating the Cost of Capital. Arbitrage Pricing Theory. Sources of Data to Estimate the Cost of Equity Capital. Risk-Free Rate. Equity Risk Premium. Beta. Size Premium. Industry Risk Premia. Investment-Specific Risk. Arbitrage Pricing Theory Factors. Rate of Return Allowed to Regulated Companies. Cost of Capital Yearbook. Discounting Economic Income Available to Overall Capital. Defining the Capital Structure. Weighted-Average Cost of Capital Formula. Should an Actual or a Hypothetical Capital Structure Be Used? Specific Projection Period plus a Terminal Value. The "Midyear Discounting Convention." Example of Application of Discounted Economic Income Methods. Estimating an Equity Discount Rate. Discounting Net Cash Flow to Equity. Estimating a Weighted-Average Cost of Capital. Discounting Net Cash Flow to Invested Capital. Caveats in Using Discounted Economic Income Methods. Converting a Discount Rate Applicable to Net Cash Flow to a Discount Rate Applicable to Net Income. Does the Discounted Economic Income Model Produce a Control or a Minority Value? What Standard of Value Does a Discounted

5 Economic Income Model Produce? Common Errors. Mismatching the Discount Rate with the Economic Income Measure. Confusing Discount Rates with Capitalization Rates. Projecting Growth Beyond What the Capital Being Valued Will Support. Projecting That Extrapolation of the Recent Past Represents the Best Estimate of Future Results. Discounting a Terminal Value for an Incorrect Number of Periods. Internally Inconsistent Capital Structure Projection. Assumptions That Produce a Standard or Premise of Value Other Than That Called for in the Valuation Engagement. Summary. Bibliography. 10. Income Approach: Capitalized Economic Income Method 237 Essential Difference between the Discounting Model and the Capitalization Model. The Perpetual Economic Income Stream Model. Converting a Discount Rate to a Capitalization Rate The Constant Growth Model. The Gordon Growth Model, Sensitivity to Growth Rate Assumptions. When to Use the Discounting versus the Capitalization Method. Equivalence of the Discounting and Capitalization Methods. Implementing the Capitalized Economic Income Method. Projecting the Basic Economic Income Level and the Growth Rate. Start with Sustainable Expected Economic Income. The Projected Long-Term Growth Rate. Defining the Components in the Capitalization Method. Valuing Equity versus Invested Capital. Selecting the Appropriate Measure of Economic Income. Modification of the Capitalized Economic Income Method to Reflect the Midyear Discounting Convention. Using the Capitalized Economic Income Method to Develop a Terminal Value for the Discounted Economic Income Method. Why the Capitalized Economic Income Method Is Preferable. Implementation of the Capitalized Economic Income Method to Estimate the Terminal Value. Does the Capitalized Economic Income Method Produce a Control Value or a Minority Value? What Standard of Value Does the Capitalized Economic Income Model Produce? Relationship between the Capitalized Economic Income Method and the Market Approach. Derivation of Income Approach Capitalization Rates versus Market Approach Multiples. Economic Income Variables Used in the Income Approach versus the Market Approach. Summary. Bibliography. 11. Market Approach: Guideline Publicly Traded Company Method 261 Overview of the Guideline Publicly Traded Company Method. When Is the Guideline Publicly Traded Company Method Most Useful? Standard of Value. Ownership Characteristics. Going-Concern versus Liquidation Value. Quantity and Quality of Available Data. Criteria for Guideline Company Selection. How Many Guideline Companies? Time Period to Consider. Deciding Which Valuation Multiples to Use. Influence of the Ownership Characteristics. Going-Concern versus Liquidation Value. Type of Company. Availability of Data. Compiling Guideline Company Tables. Developing a List of Guideline Companies. Financial Statement Adjustments to Guideline Companies. Adjusting for Operating Leases. Comparative Ratio Analysis. Obtaining the Guideline Companies' Market Value Data. Presenting Guideline Company Tables. Selecting and Weighting Multiples for the Subject Company Based on Guideline Companies. Impact of Guideline Company Data Evaluation. Measures of Central Tendency and Dispersion. Multiples of Economic Income Variables. Capitalization of Dividends or

6 Dividend-Paying Capacity. Multiples of Revenue. Multiple of Stock Value to Asset Value. Treating Nonoperating Assets, Excess Assets, and Asset Deficiencies. Nonoperating Assets. Marginal Operating Real Estate. Excess Assets or Asset Deficiencies. Beware of Recent Acquisitions. Multiline Companies. Procedures for Valuation. "Portfolio Effect." Typical Adjustments to Reach a Value Conclusion. Valuation Multiples Using Market Value of Invested Capital. Common Errors. Failure to Conduct an Adequate Search for Guideline Company Data. Failure to Make Appropriate Financial Statement Adjustments to Guideline Companies. Multiples that Mismatch Numerator and Denominator. Simple Reliance on Average of Guideline Company Multiples without Comparative Analysis. Summary. Bibliography. 12. Market Approach: Guideline Merged and Acquired Company Method 309 Overview of the Merged and Acquired Company Method. When Is the Guideline Merged and Acquired Company Method Most Useful? Standard of Value. Going-Concern versus Liquidation Value. Quantity and Quality of Data Available. Control Transaction (Acquisition) Valuation Multiples. Announcement versus Closing Date Value. Caveat: Check the Deal Structure. Deal Terms. Exactly What Was Transacted? Noncompete and Employment or Consulting Agreements. Sources of Merger and Acquisition Data. Sources for Large Company Transactions. Sources for Middle-Market and Smaller Company Transactions. Past Subject Company Transactions. Past Subject Company Changes of Control. Bona Fide Offers. Past Acquisitions by the Subject Company. Formulas or Rules of Thumb. Nonoperating Assets, Excess Assets, and Asset Deficiencies. Selecting and Weighting Multiples for the Subject Company Based on Guideline Transactions. Impact of Guideline Transactional Data Evaluation. Multiple of Stock Value to Asset Value. Reaching the Value Conclusion. Summary. Bibliography. 13. The Capitalized Excess Earnings Method 331 The History of the Capitalized Excess Earnings Method. The Capitalized Excess Earnings Valuation Method. Practical Application of This Method. The Seeming Simplicity of This Method. An Illustration. Analysis of the Capitalized Excess Earnings Method. Estimation of the "Net Tangible Asset Value." Estimation of the "Normalized Level of Earnings." Appropriate Rate of Return on Tangible Assets. Appropriate Direct Capitalization Rate for Excess Earnings. Comprehensive Example. The Treatment of Negative Goodwill. Common Errors in Applying the Capitalized Excess Earnings Method. Failure to Allow for Shareholder/Employee Salary. Failure to Use Realistic Estimate of Future Normalized Earnings. Errors in Developing the Appropriate Direct Capitalization Rates. Summary. Bibliography. 14. Asset-Based Approach: Asset Accumulation Method 349 Fundamentals of the Asset Accumulation Method. Asset-Based Approach versus Book Value. Asset Accumulation Method and Capitalized Excess Earnings Method. Asset Accumulation Method Individual Revaluation. Combining Elements of Asset Accumulation Method and Capitalized Excess Earnings Method. Asset Accumulation Method Procedures. Obtain or Develop a Cost-Basis Balance Sheet. Identify Assets and Liabilities to Be Revalued. Identify Off-Balance Sheet Assets. Identify Off-Balance Sheet and Contingent Liabilities. Value the Accounts Identified Above. Construct a

7 Value-Basis Balance Sheet. Individual Asset Valuation Procedures. Financial Assets. Real Estate. Tangible Personal Property. Intangible Real Property. Intangible Personal Property. Categorization of Intangible Assets. Valuation of Intangible Assets. Remaining Useful Life Analysis of Intangible Assets. Example. Advantages of the Asset Accumulation Method. Disadvantages of the Asset Accumulation Method. Summary. Bibliography. PART IV Discounts, Premiums, and the Value Conclusion Control and Acquisition Premiums 383 Levels of Value. Elements of Control. Control or Lack of Control Covers a Spectrum. How the Standard of Value Affects the Control Premium. Fair Market Value. Fair Value. Fair Value for Financial Reporting. Investment Value. Market Evidence Regarding Control and Acquisition Premiums. The Mergerstat Review. The Mergerstat/Shannon Pratt s Control Premium Study. Negative Control Premiums. Means, Medians, and Effect of Negative Premiums. Robinson, Rumsey, and White Study. Summary. Bibliography. 16. Discount for Lack of Control 397 Lack of Control Covers a Spectrum. Factors That Influence the Lack of Control Discount. Effect of State Statutes. Articles of Incorporation and Bylaws. Potential Dilution. Preemptive Rights. Cumulative versus Noncumulative Voting. Contractual Restrictions. Financial Condition of Business. Highly Regulated Industries. Buy-Sell and Other Shareholder Agreements. Fiduciary Duties. Private Company with Public Securities. Private Company That Operates Like a Public Company. Control Has Already Been Dissipated. Nonoperating Assets. Empirical Evidence to Quantify Lack of Control Discounts. Discounts from Net Asset Value. Holding Companies. Limited Partnerships. Built-in Gains Discount. Trust and Estate Sales Study. Discounts for Direct Undivided Ownership Interests in Real Estate. Procedures for the Valuation of Noncontrolling Ownership Interests. The Discount Approach. The Direct Comparison Approach. The Bottom-Up Approach (Income Approach). Adjustments to Income Statement. Summary. Bibliography. 17. Discounts for Illiquidity and Lack of Marketability 415 Concept and Importance of Marketability. Adjustment for Lack of Marketability for Noncontrolling Ownership Interests. Evidence for the Quantification of Discount for Lack of Marketability. Marketability Discounts Extracted from Prices of Restricted Stocks. SEC Institutional Investor Study. Gelman Study. Trout Study. Moroney Study. Maher Study. Standard Research Consultants Study. Willamette Management Associates Study. Silber Study. FMV Opinions, Inc., Study. Management Planning, Inc., Study. Johnson Study. Columbia Financial Advisor Study. LiquiStat Database. Summary of Empirical Studies on Restricted Stock Transactions. Studies of Private Transactions before Initial Public Offerings. Robert W. Baird & Company Studies. Willamette Management Associates Studies. Criticisms of Willamette Management Associates Studies. Valuation Advisor Studies. Summary of Conclusions from Private Transaction Studies. Other Analysis of Discounts for Lack of Marketability for Minority Ownership Interests. Discounts for Lack of Marketability for Controlling Ownership

8 xiii Interests. Illiquidity Factors Affecting Controlling Ownership Interests. Benchmark for the Illiquidity Discount for Controlling Ownership Interests. Differences between Private and Public Company Acquisition Price/ Earnings Multiples. Factors That Affect the Discounts for Illiquidity and Lack of Marketability. "Put" Rights. Dividend Payments. Potential Buyers. Size of Interest. Prospect of Public Offering or Sale of the Business. Information Access and Reliability. Restrictive Transfer Provisions. Company Characteristics: Size, Performance, and Risk. Court Decisions on Discounts for Illiquidity and Lack of Marketability. Mandelbaum v. Commissioner Reviews Lack of Marketability Factors. Estate of Barge v. Commissioner Considers Lack of Marketability Factors. Okerlund v. United States Approves Pre-IPO Studies. McCord v. Commissioner Lacks Rebuttal. Howard v. Shay Upholds 50 Percent DLOM. Summary. Bibliography. 18. Other Valuation Discounts 459 Entity Level Discounts. Key Person Discounts. Discounts for Trapped-In Capital Gains Taxes. "Portfolio " (Nonhomogeneous Assets) Discount. Discount for Contingent Liabilities. Other Shareholder Level Discounts. Nonvoting versus Voting Stock. Blockage. Summary. Bibliography. 19. Valuation Synthesis and Conclusion 471 The Reconciliation Process. Criteria for the Selection of Valuation Approaches and Methods. Quantity and Quality of Available Data. Type of Business, Nature of Business Assets, and Type of Industry Subject to Valuation. Nature of the Business Interest Subject to Valuation. Statutory, Judicial, and Administrative Considerations. Informational Needs of the Valuation Audience. Purpose and Objective of the Analysis. Professional Judgment and Expertise of the Analyst. Reconciling Divergent Indications among Valuation Methods. Weighting of Valuation Method Results. At What Point Are Valuation Discounts and Premiums Applied? Concluding the Value Estimate. Explicit Weighting. Implicit Weighting. Final Value Estimate. Summary. PART V Writing and Reviewing Business Valuation Reports Writing the Business Valuation Report 485 Overview of the Business Valuation Report. USPAP Reporting Standards. Written Business Valuation Reporting Standards. Oral Business Valuation Reporting Standards. USPAP Ethics Provisions. Retention of Valuation Reports and Work Paper Files. Confidentiality Provision. Internal Revenue Service Business Valuation Guidelines. Valuation Industry Reporting Standards. American Society of Appraisers. The Canadian Institute of Chartered Business Valuators. National Association of Certified Valuation Analysts. Institute of Business Appraisers. American Institute of Certified Public Accountants. Guidelines for Effective Report Writing. What Causes Ineffective Report Writing? Make the Report "Incisive." Summary. Bibliography. 21. Sample Report 501 Introduction. Description of the Assignment. Summary Description of the Company. Capitalization and Ownership. Sources of Information. Analysis of the U.S. Economy. Overview. Outlook. Analysis of the Poultry Processing

9 Industry. Overview. The Current Market. Exports. Identification of Guideline Companies. Overview. Descriptions of Selected Guideline Companies. Financial Statement Analysis. Overview. Balance Sheets. Income Statements. Cash Flow Statements. Adjustments. Financial and Operating Ratios. Valuation of Common Stock. Overview. The Guideline Publicly Traded Company Method. The Discounted Cash Flow Method. Overall Valuation Conclusion. Discount for Lack of Marketability. Summary and Conclusion of Empirical Research. Selection of the Applicable Lack of Marketability Discount for a Warm Chicken Noncontrolling Ownership Interest. 22. Reviewing a Business Valuation Report 535 Identification of the Subject Property. Relevant Dates. Definition of Value. Standard of Value. Reason for the Selected Standard of Value. Purpose of the Valuation. Actual or Assumed Ownership Characteristics. Degree of Marketability. Degree of Ownership Control. Basic Company Information. Economic and Industry Outlook. Sources of Information. Site Visits. Management Interviews. Economic and Industry Data. Company Financial Statements. Income Approach Data. Market Approach Data. Asset-Based Approach Data. Financial Statement Analysis. Financial Statement Adjustments. Comparative Financial Statement Analysis. Valuation Methodology. Income Approach. Market Approach. Asset-Based Approach Asset Accumulation Method. Asset-Based Approach Capitalized Excess Earnings Method. Are the Data Used Appropriate for the Valuation Date? Cost of Capital Data. Market Approach Data. Asset-Based Approach Data. Valuation Synthesis and Conclusion. Analyst's Qualifications. Professional Accreditations. Education. Professional Association Memberships. Experience and Professional Involvement. Appraisal Certification. Statement of Contingent and Limiting Conditions. Overall Evaluation. PART VI Valuing Specific Securities and Interests Valuing Debt Securities 547 Common Situations Requiring Valuation of Debt Securities. Purchase or Sale for Cash. Exchange of Equity for Debt. Gift and Estate Taxes. Allocation of Total Enterprise Value among Classes of Securities. Adjusting a Balance Sheet for Debt Securities Owned or Owed. Lease Financing. Method of Valuation. Amount and Timing of Future Payments. Estimation of Yield to Maturity. Marketability Aspects of Closely Held Debt Securities. Special Characteristics of Various Debt Securities. Call Provisions. Sinking Fund Provisions. Collateral Provisions. Income Tax Status. Zero Coupon Debt. Convertible Debt. Summary. Bibliography. 24. Valuing Preferred Stock 563 Common Situations Requiring Valuation of Preferred Stock. Purchase or Sale for Cash. Exchange of Common Equity or Debt for Preferred Stock. Gift and Estate Taxes. Allocating Total Enterprise Value among Classes of Securities. Adjusting a Balance Sheet for Preferred Stock Owned or Outstanding. Income Taxes Code Section 409A. Special Characteristics of Closely Held Preferred Stocks. Dividend Rate. Liquidation Preference. Cumulative versus Noncumulative Dividends. Redeemable versus r Nonredeemable. Put Option. Voting versus Nonvoting. Participating versus

10 Nonparticipating. Convertible versus Nonconvertible. Method of Valuation. Assessing Dividend and Liquidation Payment Risk. Comparison with Publicly Traded Preferred Stocks. Capitalizing the Income Stream. Marketability Aspects of Closely Held Preferred Stock. Revenue Ruling Summary. Bibliography. 25. Introduction to Valuing Stock Options 585 Common Situations Requiring Valuation of Options. Terminology. The Basic Call Option Equation. The Black-Scholes Option Model. European Options on Non-dividend-Paying Stocks. European Options on Dividend-Paying Stocks The Merton Model. American Call Options The Pseudo-American Call Option Model. Empirical Tests of Black-Scholes Options Models. Valuing Options on the Stock of Closely Held Companies. The Binomial Model for American Call Options. Introduction. Methodology. Employee Incentive Stock Options. Using Option Pricing to Value the Built-in Gains (BiG) Tax Liability. Real Options. Summary. Bibliography. 26. Valuing S Corporation Stock and Interests in Other Pass-Through Entities 613 Case Law History. Gross v. Commissioner. Wall v. Commissioner. Estate of Heck v. Commissioner. Estate of Adams v. Commissioner. Empirical Research on Sales of Controlling Interests. Erickson-Wang Study. Mattson, Shannon, and Upton Study. Summary of Empirical Research. Models for Valuation of S Corporation Minority Interests. Summary. Bibliography. PART VII Valuations for Specific Purposes Valuations for Gift and Estate Tax Purposes 627 Introduction. Current Tax Rates and Penalties. Appraiser Penalty and Potential for Blacklisting. Guidelines for Federal Gift and Estate Tax Valuations. Weight to Be Accorded Various Factors. Capitalization Rates. Average of Factors. Restrictive Agreements. Summary of Guidelines. Chapter 14 Special Valuation Guidelines. Valuing Recapitalizations and Senior Equity Interests under Section Valuation Issues under Section Buy-Sell Agreements and Leases (Including Operating Agreements of LLCs) or Sale of Options under Section Valuation Rules for Lapsing Rights and Other Restrictions under Section Locking in the Three-Year Gift Tax Statute of Limitations. Shifting the Burden of Proof from the Taxpayer to the IRS. Valuation Issues in Estate and Gift Tax Planning. Placing Family Assets in Corporate, Limited Liability Company, or Partnership Form. Minimizing Taxes through a Series of Timely Minority Ownership Interest Transfers. Loss of Key Person. Trapped-In Capital Gains Discounts. Other Estate Planning Situations Requiring Valuations. Other Gift and Estate Valuation Issues. Summary. Bibliography. 28. Estate and Gift Tax Court Cases 661 Standard of Value. Approaches to Value. Burden of Proof. Selection of Guideline Companies. Buy-Sell Agreements. Covenants Not to Compete. Reliance on Subsequent Sales. Subsequent Events and Data. Discount for Lack of Marketability (DLOM). Discounts for Lack of Marketability Controlling Ownership Interests. Discount for Lack of Control (DLOC). Blockage

11 Discounts. Key Person Discount. Contingent Liability Discounts. Combined Discounts. Premiums. Trapped-In Capital Gains Taxes. S Corporations. Family Limited Partnerships. FLP Valuation Issues. Validity Issues. Focus on Willing Seller as Well as on Willing Buyer. Inadequacy of the Valuation. Must Use Empirical Data to Quantify Variables. Sufficiency of Data. Summary. References. 29. Buy-Sell Agreements 707 Types of Buy-Sell Agreements. Valuation Provisions of the Buy-Sell Agreement. Need for Clear Direction. Formula Approaches. Negotiation Among the Parties. Independent Outside Appraisal. Understanding an Agreement's Pricing Philosophy. Terms and Funding. Term Payment Provisions. Funding the Buy-Sell Agreement with Life Insurance. Restrictions on Transfer. Buy-Sell Agreement Values for Estate and Gift Tax Valuation under Chapter 14. Valuation Requirements under Section Bibliography. 30. Valuation for Income Tax Purposes 723 Introduction. Federal Income Tax Reasons to Conduct an Appraisal. Valuation of Property Received in a Transaction. Determining Basis in a Property. Joint Ownership of Property. Property Acquired from a Decedent. - Valuation Requirements for Charitable Contribution Deductions. Documentation Requirements Contributions of Property. Noncash Property Contributions. Appraisals for Noncash Contributions. Year^End Charitable Gifting Considerations. Limitations on Charitable Contribution Deductions. Valuation of Compensation. Multifactor Tests. Independent Investor Test. Valuation of Worthless and Abandoned Property. Worthless Securities. Valuation Aspects of Section 165. Abandonment Loss for Nondepreciable Business Assets. Worthless Stock Deduction. Summary of Worthless and Abandoned Property Valuation. Valuation Aspects of Cancellation of Indebtedness Income. Unfavorable Tax Consequences of Debt Restructuring. Insolvency Provisions of Code Section 108. Insolvency Test Illustrative Example. The "Costs" of Code Section 108. Valuation-Related Income Tax Penalties. The Section 6695A Appraiser Penalties. The Section 6662 Accuracy-Related Penalties. Negligence Penalty. Substantial Valuation Overstatement Penalty. Substantial Overstatement of Pension Liabilities Penalty. Definitions and Special Rules under Section Tax Return Preparer Penalties. Summary of Valuation-Related Income Tax Penalties. Valuation Aspects of Intercompany Transfer Pricing. Key Features of the Final Section 482 Regulations. Special Circumstances. Multiple Year Data. Purposes and Roles of Valuation and Economic Analysis Experts. Types of Experts. Summary of Transfer Pricing Valuation Issues. Valuation of Intellectual Properties for State Income Taxation Purposes. Trademarks and Trade Names. Transfer of Intellectual Properties. Creation of the Intellectual Property Holding Company. Valuation of the Transferred Intellectual Properties. Summary. Bibliography. 31. Income Tax Court Cases 753 Introduction. General Valuation Methodology Issues. Pabst Brewing Company v. Commissioner. Nathan and Geraldine Morton v. Commissioner. Caracci v. Commissioner. Gow v. Commissioner. BTR Dunlop Holdings, Inc. v. Commissioner. Charitable Contribution Issues. John T. and Linda L.

12 Hewitt v. Commissioner. John C. Todd v. Commissioner. Gerald D. and Catherine Leibowitz v. Commissioner. Koblick v. Commissioner. Reasonable Compensation Issues. Multifactor Tests. LabelGraphics, Inc. v. Commissioner 9th Circuit. B&D Foundations, Inc. v. Commissioner 10th Circuit. Brewer Quality Homes, Inc. v. Commissioner. O.S.C. & Associates, Inc. v. Commissioner. Law Offices Richard Ashare, PC. v. Commissioner. Alpha Medical, Inc. v. Commissioner. Beiner, Inc. v. Commissioner. E.J. Harrison and Sons, Inc. v. Commissioner. Independent Investor Test. Exacto Spring Corporation v. Commissioner 7th Circuit. Menard, Inc. v. Commissioner. Intangible Asset Valuation Issues. Nestle Holdings, Inc. v. Commissioner. Bemidji Distribution Company v. Commissioner. Frontier Chevrolet Co. v. Commissioner. DHL Corporation and Subsidiaries v. Commissioner. Other Income Tax Issues. Purchase Price Allocation. Indeck Energy Services, Inc. v. Commissioner. Present Value as Indicator of "For Profit" Status. Walford v. Commissioner. Stock Warrant Valuation. Kimberlin v. Commissioner. Valuation as Accounting Method. In re Heilig Meyers Company. Summary. 32. Valuations for Employee Stock Ownership Plans 809 General ESOP Framework. Types of ESOPs. Nonleveraged ESOPs. Leveraged ESOPs. All Parties to a Leveraged ESOP Transaction Benefit. Valuation of a Company for ESOP Purposes. Adequate Consideration. Independence of the Appraiser and the Appraiser's Role. Reporting Requirements. Valuation Approaches and Methods. ESOP-Specific Adjustments. ESOP Contributions. Normalized Employee Benefit Costs. Compensation Adjustments. ESOP Compensation Adjustment. Control Premiums. Discount for Lack of Marketability. Put Option and Repurchase Liability. Current Controversies. Posttransaction Value in Leveraged ESOPs. Legislative and Regulatory Issues in ESOPs. Section 1042 Rollover. 409(1) Employer Securities. Principal Deductibility and Code Section 415. Code Section 133 Interest Exclusion. The IRS Audit Guidelines. ESOP Specific Plan Administration Issues. Allocations to Participant Accounts. Distribution Policy. Diversification. Finance Issues in Leveraged ESOPs. Repurchase Liability. Repurchase or Recycling. Redemption. Managing the Repurchase Liability. Methods of Funding. Fiduciary Issues in ESOPs. Voting Issues. Trustee's Voting Rights. Circularity of Control. Independent, Directed, or Internal Trustee. Accounting for ESOPs. Nuances of S Corporation ESOPs. Limitations on S Corporation Tax Benefits. Voting Issues. Form of Distribution. S Corporation Distributions. Steps to Implementing an ESOP. Summary. Bibliography. 33. ESOP Court Cases 837 Introduction. Sommers Drug Stores. Introduction. The Facts of the District Court Case. The Facts of the Appeal. The Plaintiff's Position. The Defendants' Position. Commentary and Conclusion. U.S. News & World Report. Introduction. The Facts of the Case. The Valuation Issues. The District Court's Decision. The Appeals Court's Decision. Commentary and Conclusion. Andrade v. Parsons. Introduction. The Facts of the Case. The District Court's Decision. The Appeals Court's Decision. Commentary and Conclusion. Reich v. Valley National Bank of Arizona. Introduction. The District Court's Findings. Commentary and Conclusion. Howard v.

13 Shay. Introduction. The Facts of the Case. The District Court's Decision. The District Court's Decision Commentary and Conclusion. The Appeals Court's Decision. The District Court Retrial. The District Court Retrial Commentary and Conclusion. Eyler v. Commissioner. Introduction. The Issues of the Case. The Facts of the Case. The Issues before the Court. The Petitioner's Position. The Appeals Court Decision The Valuation Issues. The Appeals Court Decision The Fiduciary Issues. Commentary and Conclusion. Davis v. Torvick. Introduction. The Facts of the Case. The Issues of the Case. The Plaintiffs' Position. The Defendants' Position. The District Court's Decision. Commentary and Conclusion. Henry v. Champlain Enterprises. Introduction. The Facts of the Case. The Issues of the Case. The District Court's Decision. Commentary and Conclusion. Eckelkamp v. Beste. Introduction. The Facts of the Case. The District Court's Decision. The Appeals Court's Decision. Commentary and Conclusion. Horn v. McQueen. Introduction. The Facts of the Case. The District Court's Decision. Commentary and Conclusion. Chao v. Hall Holding Co., Inc. Introduction. The Facts of the Case. The District Court's Decision. The Appeals Court's Decision. Commentary and Conclusion. Keach v. U.S. Trust Co. Introduction. The Facts of the Case. The Issues before the District Court. The District Court's Decision. The Issues before the Appeals Court. The Appeals Court's Decision. Commentary and Conclusion. Armstrong v. LaSalle Bank National Ass 'n. Introduction. The Facts of the Case. The District Court's Decision. The Appeals Court's Decision. Commentary and Conclusion. Kennedy v. Trustmark National Bank. Introduction. The Facts of the Case. The District Court's Decision. Commentary and Conclusion. Summary. 34. Valuations for Ad Valorem Taxation 873 Introduction. Definitions of Ad Valorem Taxation Terminology. Market Value as the General Basis of Property Assessment. The Property Tax Valuation Process. The Property Tax Equalization Process. Assessment Ratio Studies. Use of Assessment Ratio Studies in Administrative Appeals and Litigation. The Property Tax Unitary Valuation Process. The Property Tax Appeal Process. Steps in the Ad Valorem Taxation Valuation Process: The Assessing Authoritys Objective. The Property Owner's Objective. The Independent Valuation Analyst s Objective. Special Topics. Identification and Quantification of Functional Obsolescence. Identification and Quantification of the Economic Component of External Obsolescence. Issues in Unit Valuation for Ad Valorem Purposes. Jurisdictional Differences. Value Excluded from the Taxable Unit. Identification and Valuation of Intangible Assets in the Unit Method of Assessment. Alternatives to Use of Stock Market "' Data. Problems with the Use of Stock Market Data in Property Tax Valuations. Introduction. Income Approach Valuation Issues. Resolving Circularity Due to Property Tax Expenses. Differences in the Risk and Expected Return Investment Characteristics between Operating Property and Negotiable Securities. Capitalization of Leased Equipment Rental Expense. Introduction. Operating Lease Rental Expense. Summary. Bibliography. 35. Dissenting Stockholder and Minority Oppression Actions 905 Dissenting Stockholder Actions. Interpretation of the Fair Value Standard in Dissent Cases. "That Which Has Been Taken." The Delaware Block Method.

14 xix Should Consider All Relevant Factors. Requirement for Entire Fairness. Fair Consideration. Procedural Fairness. Consequences of Lack of Entire Fairness. Minority Interest Dissolution Actions. Interpretation of the Fair Value Standard in Dissolution Cases. Summary. Bibliography. 36. Dissenting Stockholder and Minority Oppression Court Cases 915 Readers Must Interpret Cases Carefully. Fair Value Is Not Fair Market Value. Premise of Value. Breach of Fiduciary Duty Expands Plaintiffs' Potential Damages. Approaches to Value. Should Consider Market Value, Asset Value, and Investment Value. Market Approach. Guideline Merged and Acquired Company (Transaction) Method. Discounted Cash Flow Method. Net Asset Value. Excess Earnings Method. Weighting of Methods. Discounts and Premiums. Lack of Control Discounts Rejected. Lack of Control Discounts Accepted. Ownership Control Premium Accepted. Lack of Marketability Discounts Rejected. Lack of Marketability Discounts Accepted. Lack of Combinatorial Value Discount Rejected. Discounts for Trapped-In Capital Gains. Discounts Left to Court's Discretion. Sufficiency of Valuation Evidence. "Dr. Pangloss and Mr. Scrooge." Summary. 37. Valuations for Marital Dissolution Purposes 943 The Marital Estate. Community Property. Equitable Distribution. Active or Passive Appreciation During Marriage. Active or Passive Post-Valuation Date Appreciation. Standard of Value. Investment Value. Fair Market Value. Intrinsic Value. Fair Value. Internal Contradictions in the Case Law. Valuation Date. Discovery. Goodwill. Valuation Methods. Income Approach. Market Approach. Asset-Based Approach. The Capitalized Excess Earnings Method. Usually Employ More Than One Method. Compensation. Noncompete Covenants. Buy-Sell Agreements. Treatment of Trapped-In Capital Gains Taxes. Valuation Discounts and Premiums. The Role of the Analyst. "Jointly Retained" Assignments. Adequacy of Evidence. Summary. Bibliography. 38. Marital Dissolution Court Cases 963 Standards of Value. Fair Market Value. Fair Value. Investment Value. Premise of Value. Active versus Passive Appreciation. "Active" Appreciation as a Marital Asset. "Active" Appreciation Must Be Proven. Valuation Date. Goodwill. The "Market Value of Goodwill" Paradox. Personal Goodwill Not a Marital Asset in Many States. Personal Goodwill Is a Marital Asset in Many States. Other Goodwill Issues. The "Double Dipping" Issue. Valuation Methods in the Family Law Courts. The Size Argument. The Liquidity Argument. The Risk Argument. The Cost of Flotation Argument. Noncompete Covenants. Buy-Sell Agreements. Cases Rejecting Buy-Sell Agreements. Cases Finding Buy-Sell Price Controlling. Buy-Sell Agreement May Be Considered. Discounts for Lack of Control and Lack of Marketability. Discount for Lack of Control. Discount for Lack of Marketability. Adequacy of Evidence. The Need for a Solid Record. Preserving the Record. Inadequate Evidence. Greater Weight Given to Valuation Professionals. Rejection of Unqualified Experts and Unaccepted Methodolgies. Appraiser s Due Diligence Duties. Treatment of Tax Liabilities. Summary. 39. Fair Value for Financial Reporting 1005 Definition of Fair Value. Differences from Fair Market Value. Disclosures.

15 PART VIII Litigation and Dispute Resolution Litigation Support Services 1011 Valuation-Related Controversy Matters. Types of Litigation. Contract Disputes. Commercial Torts. Business Interruption Claims. Antitrust Claims. Shareholder Disputes and Securities Litigation. Marital Dissolution. Personal Injury or Wrongful Termination Cases. Estate, Gift, and Income Taxes. State and Local Property Taxes. Bankruptcy/Insolvency/ Reorganization. Intellectual Property Rights Infringement. Engaging the Appraiser. Qualifications. Conflicts of Interest. Engagement Agreement. Discovery. Assessing the Case. Business Appraisal Discovery. Permanent Files. Accountant's Files. Bank Files. Invoices. Interrogatories. Depositions. Research. Calculating the Amount of Damages. The Before-and-After Method. The Yardstick (Comparable) Method. Sales Projections ("But For ") Method. Mitigation. Summary of Damages. Work Product. Affidavits. Written Reports. Critique of the Opposition. Expert Testimony. Rebuttal. Assistance in Preparing Briefs. Summary. 41. Expert Testimony 1031 Background Preparation. Basic Preparation and Documentation. Federal Rules of Civil Procedure. State Rules Are Often Less Stringent. Discovery. Reading Prior Cases and Articles. Federal Rules of Evidence Regarding Expert Testimony. Use of Hearsay Evidence. Challenges to Testimony per Daubert/Kumho. Daubert. General Electric v. Joiner. Kumho Tire Company. Other Cases Rely on Daubert Factors. Depositions. What to Bring to the Deposition. Deposition Testimony. After the Deposition. Outlining Courtroom Testimony. Qualifying the Witness. Description of the Assignment. Summary of Conclusion. Description of Steps Taken. Findings. Final Conclusion. Exhibits. Preparation with the Attorney. In the Courtroom. General Guidelines for Testimony. Direct Examination. Cross-Examination. Redirect Examination. Rebuttal Testimony. Exclusion of Witnesses. Courts' Expectations Regarding Expert Testimony. Summary. Bibliography. 42. Arbitration and Mediation 1053 Advantages of ADR over Court Trial. Situations Suitable for Arbitration. Corporate and Partnership Dissolutions and Buyouts of Minority Interests. Dissenting Stockholder Actions. Damage Cases. Divorces. The Arbitration Agreement. Factors Specified in the Arbitration Agreement. Factors Left to the Arbitrators' Discretion. Other Factors to Address. Selection of Arbitrators. Criteria for Selection. Procedure for Selection. American Arbitration Association Procedure. Engagement and Compensation of Arbitrators. The Arbitration Process. Review of Arbitration Document. Initial Communication among Arbitrators. Field Visit. Hearings. The Valuation Meeting. Reporting the Results of the Arbitration. Mediation. How Mediation Differs from Arbitration and Litigation. Self-Determination Is the Fundamental Principle. Role of the Business Valuation Expert in Mediation. Mediation in Family Law. Mediation in Federal Tax Disputes. Summary. Bibliography. Professional Arbitration and Mediation Organizations. Appendix A International Glossary of Business Valuation Terms 1069 Index 1077