16 Mistakes to Avoid in Valuations According to Tax Court Decisions
According to Tax Court Decisions
Business valuation textbooks, training manuals, and conference presentations may do a good job of teaching the right ways to conduct valuations. But in some respects the most authoritative teacher of what is right and, just as importantly, what is wrong is the decision of the court in a dispute over the value of a privately held business or shares thereof.
In this article we have collected 16 examples of mistakes made by valuation experts, as reported in federal courts in tax decisions. It is important to note that there are two sides to every story, and courts do not always get it right. For this reason, we do not name any valuators in this collection of mistakes to avoid.
- Lacking Explanation Needed to Replicate
No matter how “correct” your conclusion of value is, the court may not accept it if you do not provide sufficient details and explanations about how you arrived at that conclusion. Another valuator should be able to replicate your work after reviewing your report or work-papers. In Winkler Estate v. Commissioner (T.C. Memo 1989-231. See also Former IBA Business Appraisal Standards Sec. 1.8. See also True Est. v. Comr., T.C. Memo 2001-167, aff’d., 390 F. 3d 1210 (10th Cir. 2004), the Tax Court provided perhaps one of the best arguments for a freestanding, comprehensive appraisal report:
Respondent’s expert appears to be extremely well qualified but he favored us with too little of his thought processes in his report. In another area, for example, his report briefly referred to the projected earnings approach, but the discussion was too abbreviated to be helpful. His testimony on the computer models he used, while unfortunately never developed by counsel, suggested that a lot of work had been done but simply not spelled out in his report. That may also be the case in his price-to-earnings computations, but the Court cannot simply accept his conclusions without some guide as to how he reached [them]. - Pure Reliance on Case Law for Discount
What constitutes the proper valuation discount is essentially caseby-case factual issue. Valuation discounts can be factored in as an element of the discount rate (sometimes characterized as implicit treatment) or applied as direct adjustment(s) to value after the enterprise level value has been determined. As such, pure reliance on case law for determination of valuation discounts is inadvisable, particularly when the economics, facts, and circumstances of the precedent cases do not reasonably parallel those of the subject interest. Nevertheless, some valuators have resorted to reliance on case law for determination of valuation discounts. In Berg Estate v. Commissioner (T.C. Memo 1991-279), the Tax Court was unimpressed with this practice:
The fact that petitioner found several cases which approve discounts approximately equal to those claimed in the instant case is irrelevant. - Failure to Find Available Information
Very few things look worse for a valuator than when he or she cannot f ind information that the opposing valuator finds. This happened in Barnes v. Commissioner (T.C. Memo 1998-413):
[Valuator A] used the market or guideline company approach to estimate the value of Home and Rock Hill stock, but he excluded three companies that [Valuator B] used as comparables because he did not have their market trading prices as of the valuation date. In contrast, [Valuator B] apparently easily obtained the stock prices by contacting the companies.