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Discounts...Now You Have Them...Maybe You Won't

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An avalanche of business valuations for gifting could be looming.

COVID-19’s impact has been broad and has affected not only people’s health but also businesses, as US states have stay-at-home or other restrictive civil orders. The affected companies include family-owned and closely held businesses. Company valuations have generally decreased, some significantly, and the likelihood is that they will continue to decline if the economy remains shuttered. We do not know how long it will take businesses to return to their pre-COVID-19 financial position.

On the horizon is a threat and possibly an opportunity. As with prior U.S. presidential election years, if a new president of a party is different than the preceding incumbent is elected, he or she will be tempted to consider changes to the gifting and estate tax regulations. A change in how wealth is transferred will have both an immediate and multi-generational impact.

The Discount for Lack of Control (DLOC) and the Discount for Lack of Marketability (DLOM) are easy and favorite targets. The Discount for Lack of Control (“DLOC”) is an amount or percentage deducted from the pro-rata share of the value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control. The Discount for Lack of Marketability (“DLOM”) is an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability and liquidity of the interest. (International Glossary of Business Valuation Terms.)

If a new president is elected, these discounts could be at risk. Obama administration legislation to eliminate these discounts exist. Although never enacted, they are shelf-ready for the new president and Congress to consider.

Elimination or curtailment of these key valuation discounts would significantly impact this considerable wealth transfer benefit. With many businesses having experienced a recent and significant decrease in value, as the economy recovers and business valuations increase, this gifting at the lower valuation may benefit the recipient gift and estate beneficiaries as the business increases in value in the future.

In the event that the discounts are repealed, the demand for business valuations could see a dramatic increase in late 2020 and 2021 as estate attorneys, CPAs, financial and wealth planners take action to get their clients in under the wire, before a change becomes effective. We also would expect to see a significant increase in demand for real estate and machinery and equipment appraisals, as these assets are part of the underlying assets supporting the valuation on the balance sheet.

WOW, a measurable discount, I like that, I’ll take that.

However, when developing and applying these discounts, we use generally accepted valuation methodology, including academic and business studies, transaction histories, tax court cases, and consideration of company-specific characteristics, including shareholder and operating agreements. The discounts are multiplicative. First the discount for lack of control is applied and then the discount for lack of marketability. Typically, separate discounts are reflected. A valuation analyst should always reflect a calculated defensible percentage, and not an arbitrary one.

Will the discounts be eliminated or significantly restricted?  We expect business owners, their advisors, and other individual or group stakeholders (associations, industry groups) will be watching closely for developments in this area.

With the capability to perform all business related valuation and appraisal disciplines – business and intangibles valuations, real estate, and machinery & equipment – Sobel EAC Valuations is well-positioned to support and deliver on this potentially large volume of requests for gifting and wealth transfer appraisals and valuations.

 

Tom Gudowicz, Sobel EAC Valuations 
Tom.Gudowicz@sobelcollc.com