What are Business Valuation Discounts?

When drafting a buy-sell agreement, the owners of a closely-held (non-publicly-traded) company need to consider and agree on how the value of their ownership interests will be determined.   The first step is generally to calculate the value of the entire company.  The second step is then to determine the value per share or unit. 

Some buy-sell agreements require the owners to agree on a value per share at the end of each year.  Other agreements require a third party appraiser or panel of appraisers to set the value each year or upon the occurrence of a trigger event (such as death of an owner).  Still other agreements use an agreed-upon formula such as a percentage of book value or a multiple of earnings or cash flow. 

One of the things that owners often fail to consider and document is whether to apply valuation discounts when setting the value per share.  Business valuation discounts may be appropriate when valuing a minority interest in a closely-held company.  Part of the rationale is that a minority interest (50% or less) is worth less per share than a majority interest (more than 50%) because the minority interest cannot control company decisions.  The other part of the rationale is that interests in a closely-held company are worth less than interests in comparable publicly-traded companies because there is no ready market (NYSE, AMEX, NASDAQ or other stock exchange) for interests in a closely-held company. 

The IRS has allowed business valuation discounts of as much as 35% or more for gift and estate tax purposes.  And independent studies have demonstrated the appropriateness of even higher discounts.  So the value of a minority interest can be significantly reduced if valuation discounts are applied. Whether this is good or bad depends on your point of view.

Whether or not you want to apply valuation discounts in setting the value of a minority interest in your company, it is best to address this issue in the buy-sell agreement so there are no surprises.  If you need assistance with drafting a buy-sell agreement, or have questions about business valuation discounts, please give me a call.  Jsenney@pselaw.com or 937-223-1130.

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AND ONE MORE THING.  The Connor Group Foundation is looking for entrepreneurs with a University of Dayton connection who can use a $25,000 to $50,000 loan to get a new idea or project off the ground. The loan terms are very flexible.  You apply for the loan by completing a short application and providing the Connor Group Foundation with a business plan.  If you are interested in receiving an application or finding out more about the loan program, please give me a call.  Jsenney@pselaw.com or 937-223-1130.

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