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The title of this month’s letter is not a typo. I am talking about transfers of private minority equity interests that precede the sales of businesses. This precedes many IPOs, mergers and acquisitions.
During the dotcom boom, many investors transferred such interests to their heirs before the IPOs occurred, so that the heirs would benefit from the subsequent hoped-for appreciation and the newfound liquidity. In those cases, the owners hoped for low values for estate and gift tax purposes.
Investors with philanthropic motivations often donate such interests to charities in advance of mergers and acquisitions. In those cases, they hope for high values for income tax deduction purposes.
The critical point about such transfers is that the impending sale (via IPO or acquisition) of the entire business eliminates the rationale for discounts for lack of control and lack of marketability, since all of the equity is to be sold. Based on Revenue Ruling 59-60 Section 3, Paragraph 3, the impending IPO or merger is known or reasonably knowable as of the valuation (transfer) date. It must be accounted for.
Because IPO and merger transactions are never certain until they actually close, there is a valid basis to discount the pre-transaction transaction values for this risk. In the dotcom era, I aggressively discounted such valuations by as much as 50% because I was highly skeptical that the IPOs would occur. For conventional mergers, however, this risk is usually much smaller, and I tend to apply discounts of 5 to 10% to reflect it. As always, the facts and circumstances of each transaction must be carefully considered.
In August of 2006, I was asked to appraise the value of a minority interest in a private company in New Orleans that had been scheduled to be sold to a public acquirer on August 1, 2005. The minority interest was donated to charity on June 1, 2005, which was the valuation date. The taxpayer had obtained filing extensions, which was why I did not become involved until over a year later. I valued the donation with a 5% discount for transaction risk. The fact that the transaction did not close (due to Hurricane Katrina on July 29, 2005) was IRRELEVANT to my appraisal because of the cited Revenue Ruling. Katrina was certainly not known or reasonably knowable as of the valuation date (June 1, 2005).
Valuations play a part in all tax, transaction, and litigation matters. For additional information or advice on a current one, please do not hesitate to call.
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