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from the Valuation Advisors Pre-IPO database. The case involved the valuation of gifts of stock on two different dates. Since the prospects for liquidity were remote, the taxpayer’s expert selected only the largest-block-size transactions in relation to shares outstanding from the FMV Restricted Stock database. (The relevance of block size to perceived holding period was explained in a previous section.) Since the subject company was very large, and studies show a lower discount for lack of marketability for larger companies than for smaller ones, only transactions in stocks of com- panies with more than $100 million in sales were selected from the Valuation Advisors Pre-IPO Transaction database. Since the company paid no dividends and was not likely to for the fore- seeable future, only non-dividend-paying stocks were selected from both databases. The expert for the Service testified to 30 percent on both dates, and the expert for the tax- payer testified to 45 percent on both dates. The court concluded that the appropriate discount was 40 percent on one date and 45 percent on the other date, in addition to a 5 percent dis- count for nonvoting stock (which the experts agreed to), resulting in total discounts of 45 per- cent on one date and 50 percent on the other date. Excerpts from the court’s opinion indicate the importance of strong empirical evidence and analysis: Both experts relied on two sources of empirical data for aid in quantifying the discount for lack of mar- ketability: (1) discounts on sales of restricted shares of publicly traded companies; and (2) discounts on pri- vate transactions prior to initial public offerings (IPOs). Based on these studies, and an examination of the perceived risks facing a potential investor in SSE stock, [the estate’s expert] concluded that a 45 percent dis- count for lack of marketability was appropriate, and [the Service’s expert] concluded that a 30 percent dis- count was justified. [The estate expert’s] reports contain a far more detailed analysis of the empirical studies of trading prices of restricted shares and pre-initial public offering transactions than the [Service expert’s] Report. The eight independent studies of restricted stock transactions reviewed in the [estate expert’s] Report reported aver- age discounts ranging from 25 to 45 percent. According to [the estate’s expert], the two most important fac- tors in determining the size of the discount were the amount of dividends paid (more dividends are associated with a lower discount for lack of marketability) and the perceived holding period (the longer the holding period the greater the discount for lack of marketability). The second major line of studies, involv- ing pre-IPO transactions, observed discounts averaging approximately 45 to 47 percent. Unlike the [Service expert’s] Report, the [estate expert’s] Report considered the pre-IPO studies more relevant for the purpose of determining the appropriate discount for lack of marketability. According to [the estate’s expert], the dis- counts observed in restricted stock studies reflect the existence of a public market for the stock once the tem- porary restrictions lapse. For a variety of reasons, . . . purchasers of restricted stock “generally expect to be able to resell the stock in the public market in the foreseeable future.” Pre-IPO discounts, on the other hand, are based on purely private transactions before a company enters the public market, a situation more com- parable to closely held companies such as SSE [T]he Court finds [the estate expert’s] analysis of the relevant empirical studies and shareholder risks more persuasive than the [Service expert’s] report’s rather truncated analysis. One of the most widely quoted cases is Mandelbaum et al., v. Commissioner, 24 where the parties stipulated to freely traded minority interest values, so the only issue was the discount for lack of marketability. 304 DISCOUNTS FOR LACK OF MARKETABILITY 24 Mandelbaum et al., v. Comm’r, T.C. Memo 1995-255. Appealed and affirmed, 91 F.3d 124, 1996 U.S. App. LEXIS 17962, 96-2 U.S. Tax Cas. (CCH) P60,240, 78 A.F.T.R.2d (RIA) 5159. The expert for the Service used three restricted stock studies, including the SEC Institu- tional Investor Study, from which he testified that the median discount for OTC nonreporting companies was between 30.1 and 40.0 percent. Taxpayer’s expert analyzed seven restricted stock studies and three studies on initial public offerings (IPOs). The court criticized the taxpayer’s expert for focusing only on the hypothetical willing buyer. The court observed, “[T]he test of fair market value rests on the concept of the hypo- thetical willing buyer and the hypothetical willing seller. Ignoring the views of the willing seller is contrary to this well-established test.” The court stated: Because the restricted stock studies analyzed only “restricted stock”, the holding period of the securities studied was approximately 2 years. [The Service’s expert] has not supported such a short holding period for Big M stock, and we find no persuasive evidence in the record to otherwise support it. In addition, the re- stricted stock studies analyzed only the restricted stock of publicly traded corporations. Big M is not a pub- licly traded corporation The length of time that an investor must hold his or her investment is a factor to consider in determining the worth of a corporation’s stock. An interest is less marketable if an investor must hold it for an extended pe- riod of time in order to reap a sufficient profit. Market risk tends to increase (and marketability tends to de- crease) as the holding period gets longer We find that the 10 studies analyzed by [the taxpayer’s expert] are more encompassing than the three studies analyzed by [the Service’s expert]. Because [the taxpayer’s] studies found that the average marketability dis- count for a public corporation’s transfer of restricted stock is 35 percent, and that the average discount for IPO’s is 45 percent, we use these figures as benchmarks of the marketability discount for the shares at hand. The court then listed nine factors: 1. Financial statement analysis 2. Dividend policy 3. Nature of the company, its history, its position in the industry, and its economic outlook 4. Management 5. Amount of control in the transferred shares 6. Restrictions on transferability 7. Holding period for the stock 8. Company’s redemption policy 9. Costs associated with a public offering. The court discussed each of these factors in detail. These factors have since become known as the Mandelbaum factors. Some commentators have criticized the opinion for possi- ble double counting in that some of the factors would have been reflected in the freely traded value to which the parties stipulated. However, as seen in the prior section Factors Affecting the Magnitude of Discounts for Lack of Marketability, some factors usually considered in fun- damental analysis also have a further impact on the marketability discount. The court concluded: Based on the record as a whole, and on our evaluation of the above-mentioned factors, we conclude that the marketability discount for the subject shares on each of the valuation dates is no greater than the 30 percent allowed by the respondent. Discounts for Lack of Marketability in the Courts 305 The Mandelbaum case is discussed in numerous subsequent court cases, and the entire text of the decision is produced in the Internal Revenue Service Valuation Training for Ap- peals Officers Coursebook. 25 In Estate of Davis, 26 the issue was the value of stock in a family holding company whose primary asset was more than one million shares of Winn-Dixie stock. The witness for the Ser- vice testified to a 23 percent discount for lack of marketability based on certain restricted stock studies. Experts for the taxpayer considered a broader list of restricted stock studies as well as pre-IPO studies, and testified to a 35 percent discount. In concluding a value which re- flected approximately a 32 percent discount, the court stated: [W]e found [the taxpayer’s experts’] reports and the additional testimony at trial of [one of taxpayer’s ex- perts] to be quite helpful in ascertaining the lack-of-marketability discount that we shall apply in this case [Service’s expert] should have considered the pre-valuation date price data reflected in those IPO studies because they, together with the restricted stock studies, would have provided a more accurate base range and starting point for determining the appropriate lack-of-marketability discount In Gow, 27 the Service’s expert testified to a 10 percent discount for lack of marketability and the taxpayer’s expert testified to 30 percent. The court concluded 30 percent was appro- priate, noting that the taxpayer’s expert used (unnamed) empirical studies that the court be- lieved appropriate, whereas the Service’s expert did not. To reiterate a point worth making, this demonstrates the fact that courts like relevant empirical evidence. In Barnes, 28 there were two companies in which stock was gifted. The Service’s expert testified to a 25 percent discount for lack of marketability for both, and the taxpayer’s expert testified to a 40 percent discount on one and a 45 percent discount on the other. Interestingly, both experts cited mostly the same studies. The court agreed with the taxpayer’s expert, and concluded the appropriate discounts were 40 percent and 45 percent. The Service’s expert cited eight studies in which the average marketability discount fell in the range of 50 to 60 percent. He admitted that the typical discount for restricted stock was 35 percent and that un- registered stock in a closely held corporation is subject to a larger discount. Thus, the court found the expert’s use of a 25 percent discount unconvincing. In In re Colonial Reality Co., 29 a bankruptcy court case, the court accepted a 35 percent discount for lack of marketability. Discounts for Lack of Marketability for Controlling Interests Discount for lack of marketability for controlling interests are usually modest when compared with discounts for lack of marketability for minority interests. 306 DISCOUNTS FOR LACK OF MARKETABILITY 25 Internal Revenue Service, IRS Valuation Training for Appeals Officers Coursebook (Chicago: CCH Incorporated, 1998), p. 9-6 and Exhibit 9-3. 26 Estate of Davis v. Comm’r, 110 T.C. 530 (June 30, 1998). 27 Gow v. Comm’r, 19 Fed. Appx. 90; 2001 U.S. App. LEXIS 20882 (2001). 28 Estate of Barnes v. Comm’r, T.C. Memo 1998-413, 76 T.C.M. (CCH) 881, November 17, 1998. 29 In re Colonial Realty Co., United States Bankruptcy Court for the District of Connecticut, 226 B.R. 513 (1998). The opinion in a 1982 case contained, for example, the following statement: Even controlling shares in a nonpublic corporation suffer from lack of marketability because of the absence of a ready given private placement market and the fact that flotation costs would have to be incurred if the corporation were to publicly offer its stock. 30 But the criteria for quantifying discounts for lack of marketability for controlling interests are quite different from those for minority interests. The restricted stock and pre-IPO data- bases are all minority interest transactions and are, therefore, not relevant empirical evidence to quantify discounts for controlling interests. Five factors must be analyzed in estimating discounts for lack of marketability for con- trolling interests: 1. Flotation costs (the costs of implementing an initial public offering [IPO]) 2. Professional and administrative costs, such as accounting, legal, appraisals, and manage- ment time necessary to prepare the company for a sale or IPO 3. Risk of achieving estimated value 4. Lack of ability to hypothecate (most banks will not consider loans based on private-company stock as collateral, even controlling interests) 5. Transaction costs (payments to an intermediary or internal costs incurred in finding and negotiating with a buyer). Cases Accepting Discount for Lack of Marketability for Controlling Interests In Estate of Hendrickson, 31 the interest at issue was 49.97 percent, but the court deemed it a controlling interest because the balance of the stock was divided among 29 shareholders. The court allowed a 35 percent discount for the 49.97 percent controlling interest. Other cases allowing a discount for lack of marketability for a controlling interest include, for example: • Estate of Dunn 32 (15%) • Estate of Jameson 33 (3%) • Estate of Dougherty 34 (25%) • Estate of Maggos 35 (25%) Discounts for Lack of Marketability in the Courts 307 30 Estate of Andrews v. Comm’r, 79 T.C. 938 (1982). 31 Estate of Hendrickson v. Comm’r, T.C. Memo 1999-278, 78 T.C.M. (CCH) 322 (1999). 32 Estate of Dunn v. Comm’r, T.C. Memo 2000-12, 79 T.C.M. (CCH) 1337 (2000). 33 Estate of Jameson v. Comm’r, T.C. Memo 1999-43, 77 T.C.M. (CCH) 1383 (1999). 34 Estate of Dougherty v. Comm’r, T.C. Memo 1990-274, 59 T.C.M. (CCH) 772 (1990). 35 Estate of Maggos v. Comm’r, T.C. Memo 2000-129, 79 T.C.M. (CCH) 1861 (2000). See also Estate of Desmond, T.C. Memo 1999-76, 77 T.C.M. (CCH) 1529 (1999) in testimony on marketability discounts combined with other discounts. Case Denying Discount for Lack of Marketability for Controlling Interest In Estate of Cloutier, 36 the interest at issue was 100 percent of the stock in a company that op- erated a television station. The taxpayer’s expert opined to a 25 percent discount based largely on restricted stock and pre-IPO studies. The court rejected the discount in its entirety because it was based on discounts related to minority interests. Marketability Discounts Combined with Other Discounts Although it is preferable to have experts quantify marketability discounts separately from other discounts or premiums, there are some cases where discounts for different factors have been combined. Estate of Desmond 37 involved an 82 percent interest in a paint and coating manufacturer. The expert for the Service opined to a 0 to 5 percent marketability discount. The expert for the taxpayer opined to a 25 to 45 percent discount, which took into consideration potential envi- ronmental liabilities. The court distinguished between the expert’s income approach and that expert’s market approach in applying that portion of the marketability discount that reflected environmental liabilities on the basis that the market valuation multiples would already reflect the environmental liabilities for the industry: [A] 30-percent lack of marketability discount is appropriate Of this 30-percent discount, 10 percent is attributable to Deft’s potential environmental liabilities. We shall apply the 30-percent lack of marketability discount to the unadjusted value we determined under the income method. We however shall apply only a 20-percent lack of marketability discount to the unadjusted value we determined under the market method because as discussed supra, the environmental liabilities have already been included in the unadjusted value under that method. 38 In Janda, 39 the taxpayer’s expert testified to a 65.77 percent discount for lack of mar- ketability based on Z. Christopher Mercer’s Quantitative Marketability Discount Model (QMDM), essentially a discounted cash flow model which takes as its inputs estimates of (1) the as-if-freely traded “base value,” (2) the probable holding period, (3) the growth rate of the base value over the holding period, (4) the interim cash flows over the holding period, and (5) the required holding period rate of return (discount rate). 40 The Service’s expert relied on var- ious restricted stock studies and prior Tax Court decisions. The court criticized these studies as being too general. Because information was not presented regarding marketability dis- counts for companies with the same characteristics as the subject, the court concluded that the Service’s analysis was too subjective. The court noted that business appraisers usually rely on “generalized” studies (e.g., restricted stock studies and pre-IPO studies) in determining the appropriate marketability discount, and that the court would prefer to have more specific data 308 DISCOUNTS FOR LACK OF MARKETABILITY 36 Estate of Cloutier v. Comm’r, T.C. Memo 1996-49, 71 T.C.M. (CCH) 2001 (1996). 37 Estate of Desmond, op. cit. 38 Marketability Discounts in the Courts, 1991–1Q2002 (Portland, Ore.: Business Valuation Resources, LLC, 2002): 30. 39 Janda v. Comm’r, T.C. Memo 2001-24; 2001 Tax Ct. Memo LEXIS 34 (2001). 40 Z. Christopher Mercer, Quantifying Marketability Discounts (Memphis, Tenn.: Peabody Publishing, 2001). for each appraisal engagement. The court (without any explanation) concluded that a 40 per- cent combined discount for lack of control and lack of marketability was appropriate. In Furman, 41 the Service’s expert testified to a 17 percent discount for lack of marketabil- ity, citing the Gelman, Moroney, and Maher studies. The court criticized reliance on the re- stricted stock studies as follows: We find [the taxpayer’s] reliance on the restricted stock studies to be misplaced, since those studies analyzed only restricted stock that had a holding period of 2 years. Inasmuch as we expect the investment time hori- zon of an investor in the stock of a closely held corporation like FIC to be long term, we do not believe that marketability concerns rise to the same level as a security with a short-term holding period like restricted stock. [footnote omitted.] In light of the foregoing, we find no persuasive evidence in the record to support our reliance on the restricted stock studies in determining an appropriate marketability discount. Stating that the determination of a marketability discount was a factual matter, the court looked at the following facts and circumstances regarding the FIC stock: The factors limiting the marketability of stock in FIC in February 1980 and August 1981 included the fol- lowing: (1) FIC had never paid dividends on its common stock; (2) the corporation was managed and con- trolled by one individual; (3) the blocks of stock to be transferred were minority interests; (4) a long holding period was required to realize a return; (5) FIC had no custom or policy of redeeming common stock; (6) because FIC’s annual sales were only in the $7 million range, it was not likely to go public; and (7) there was no secondary market for FIC stock. While FIC had significant potential for controlled growth, a healthy balance sheet, and robust earnings growth, we find the factors limiting marketability to be significant. With no discussion as to how it reached this figure, the court then held that a 40 percent combined minority and marketability discount was most appropriate. Although this may not be the definitive authority on combining the two discounts, the case may be instructive on the evidence and factors considered. CONCLUSION The discount for lack of marketability often is the biggest and most controversial issue in a business valuation done for gift and estate tax purposes. There are two distinct categories of empirical databases (and studies based on them): 1. Restricted stock studies (transactions in publicly traded stocks that are temporarily re- stricted from public funding) 2. Pre-IPO studies (trading in private companies’ stocks prior to an initial public offering) This empirical evidence is based on transactions in minority interests, and is not relevant to controlling interests. Controlling interests may be subject to some marketability discount, but the analyst should explain the factors on which the discounts are based, as discussed in this chapter. Chapter 19 discusses other shareholder-level discounts and premiums. Conclusion 309 41 Furman v. Comm’r, T.C. Memo 1998-157, 75 T.C.M. (CCH) 2206 (April 30, 1998). PARTIAL BIBLIOGRAPHY OF SOURCES FOR DISCOUNTS FOR LACK OF MARKETABILITY Bajaj, Mukesh, Denis J. David, et al. “Firm Value and Marketability Discounts.” The Journal of Corpo- ration Law (Fall 2001): 89–115. _____. “Dr. Bajaj Responds to Dr. Pratt’s February 2002 Editorial: Bajaj Attacks Restricted Stock and Pre-IPO Discount Studies; Pratt Replies, Defending Studies, Notes that Debate May Be Semantic.” Shannon Pratt’s Business Valuation Update (March 2002, Vol. 8, No. 3): 12–14. Bogdanski, John A. “Closely Held Businesses and Valuation: Dissecting the Discount for Lack of Mar- ketability.” Estate Planning (February 1996, Vol. 23, No. 2): 91–95. “Discounts for Lack of Marketability: Uses & Misuses of Databases.” Business Valuation Resources, LLC. Telephone Conference, May 13, 2003. Emory Sr., John D. and John D. Emory Jr. Emory Business Valuation, LLC. “Emory Studies: 2002 Re- vision.” Presented to the IBA 25th Annual National Conference, Orlando, Florida (June 3, 2003). John Emory Sr., F.R. Dengel III, and John Emory Jr. “Emory Responds to Dr. Bajaj: Miniscule Adjust- ments Warranted.” Shannon Pratt’s Business Valuation Update (May 2002, Vol. 8, No. 5): 1,3. Grabowski, Roger J. Standard & Poor’s Corporate Value Consulting. “The Bubbling Pot in Marketability Discounts.” Presented to the Foundation for Accounting Education, New York, NY (June 17, 2002). Hall, Lance. “The Discount for Lack of Marketability: An Examination of Dr. Bajaj’s Approach.” Shannon Pratt’s Business Valuation Update (February 2004, Vol. 10, No. 2): 1–4. Hertzel, Michael, and Richard L. Smith. “Market Discounts and Shareholder Gains for Placing Equity Privately.” The Journal of Finance (June 1993, Vol. XLVIII, No. 2): 459–485. Ibbotson, Roger, and Jay R. Ritter. “Initial Public Offerings,” Chapter 30, R. A. Jarrow, V. Maksimovic, W. T. Ziemba, eds., North-Holland Handbooks of Operations Research and Management Science 9 (Amsterdam: Elsevier, 1995): 993–1016. Lerch, Mary Ann. “Yet Another Discount for Lack of Marketability. Business Valuation Review (June 1997): 70–106. Patton, Kenneth W. “The Marketability Discount: Academic Research in Perspective—The Hertzel/Smith Study.” E-Law Business Valuation Perspective (June 5, 2003, Vol. 2003-02): 1–8. Pearson, Brian K. “Y2K Marketability Discounts as Reflected in IPOs.” CPA Expert (Summer 2001): 1–5. _____. “1999 Marketability Discounts as Reflected in Initial Public Offerings.” CPA Expert (Spring 2000): 1–6. Pratt, Shannon P. “Lack of Marketability Discounts Suffer more Controversial Attacks.” Shannon Pratt’s Business Valuation Update (February 2002, Vol. 8, No. 2): 1–3. Trout, Robert R. “Minimum Marketability Discounts.” Business Valuation Review (September 2003): 124–126. See also in Appendix C, other print sources and under “Lack of Marketability Transaction Databases.” 310 DISCOUNTS FOR LACK OF MARKETABILITY Chapter 19 Other Shareholder-Level Discounts Summary Minority Discounts/Control Premiums Measuring the Control Premium/Minority Discount Control Premiums and Minority Discounts in the Courts Voting versus Nonvoting Shares Blockage Discounts for Undivided Fractional Interests in Property Estimating the Appropriate Discount for an Undivided Interest Undivided-Interest Discounts in the Courts Conclusion SUMMARY A shareholder-level discount or premium is one that affects only a defined group of share- holders rather than the whole company. As with discounts for lack of marketability, other shareholder-level discounts should be applied to the net amount after entity-level discount, if any. Besides the discount for lack of marketability, other shareholder-level discounts and pre- miums largely fall into three categories: 1. Minority discounts/control premiums 2. Voting versus nonvoting interests 3. Blockage In addition, there can be discounts for fractional interests in property such as real estate. MINORITY DISCOUNTS/CONTROL PREMIUMS Minority discounts are often (and more properly) referred to as lack of control discounts be- cause it is possible to have a majority interest and still not have control, and, conversely, a mi- nority interest may have control, perhaps because of voting trusts and other arrangements. For example, on one hand, no limited partner has control, regardless of the percentage interest. On 311 the other hand, in Estate of Hendrickson v. Commissioner, 1 a 49.99 percent interest was deemed by the court to constitute control because the balance of the stock was divided among 29 small stockholders. After marketability, minority/control is the next most frequent issue in disputed valua- tions. Virtually everyone recognizes that, in most cases, control shares are worth more than minority shares. However, there is little consensus on how to measure the difference. As with lack of marketability, lack of control is not a black-and-white issue, but covers a spectrum: • 100 percent control • Less than 100 percent interest • Less than supermajority where state statutes or articles of incorporation require superma- jority for certain actions • 50/50 interest • Minority, but enough for blocking control (in states or under articles of incorporation that require supermajority for certain actions) • Minority, but enough to elect one or more directors under cumulative voting • Minority, but participates in control block by placing shares in voting trust • Nonvoting stock (covered in following section) • Minority, with no ability to elect even one director The value of control lies in the following (partial) list of actions that shareholders with some degree of control can take, and that others cannot: 2 • Appoint or change operational management. • Appoint or change members of the board of directors. • Determine management compensation and perquisites. • Set operational and strategic policy and change the course of the business. • Acquire, lease, or liquidate business assets, including plant, property, and equipment. • Select suppliers, vendors, and subcontractors with whom to do business and award contracts. • Negotiate and consummate mergers and acquisitions. • Liquidate, dissolve, sell out, or recapitalize the company. • Sell or acquire treasury shares. • Register the company’s equity securities for an initial or secondary public offering. • Register the company’s debt securities for an initial or secondary public offering. • Declare and pay cash and/or stock dividends. • Change the articles of incorporation or bylaws. • Set one’s own compensation (and perquisites) and the compensation (and perquisites) of re- lated-party employees. 312 OTHER SHAREHOLDER-LEVEL DISCOUNTS 1 Estate of Hendrickson v. Comm’r, T.C. Memo 1999-278, 78 T.C.M. (CCH) 322. 2 Shannon P. Pratt, Robert F. Reilly, and Robert P. Schweihs, Valuing a Business, 4th ed. (New York: McGraw-Hill, 2000): 365–366. • Select joint venturers and enter into joint venture and partnership agreements. • Decide what products and/or services to offer and how to price those products/services. • Decide what markets and locations to serve, to enter into, and to discontinue serving. • Decide which customer categories to market to and which not to market to. • Enter into inbound and outbound license or sharing agreements regarding intellectual properties. • Block any or all of the above actions. The traditional “Levels of Value” chart is shown as Exhibit 19.1. This schematic chart breaks the control premium into two elements: 1. The premium associated with the powers of control 2. The premiums that reflect the value of synergies with the buyer Minority Discounts/Control Premiums 313 Exhibit 19.1 Levels of Value in Terms of Characteristics of Ownership A combined 20% discount and a 45% discount for lack of marketability equals a total of 56% discount from value of control shares b 20% minority interest discount; 25% control premium Additional 20% discount for private-company stock (taken from publicly traded equivalent value $8.00 per share) 25% discount for lack of marketability for restricted stock 20% strategic acquisition premium Per-share value $12.00 $8.00 $6.00 $4.40 $10.00 Synergistic (strategic) value Value of control shares a Control premium or Minority Discount Discount for restricted stock of public company Additional discount for private-company stock “Publicly traded equivalent value” or “stock market value” of minority shares if freely traded Value of restricted stock of public company Value of nonmarketable minority (lack of control) shares 45% total discount for lack of marketability (25% + 20% may be taken additively) Notes: a. Control shares in a privately held company may also be subject to some discount for lack of marketability, but usually not nearly as much as minority shares. b. Minority and marketability discounts normally are multiplicative rather than additive. That is, they are taken in sequence: $10.00 Control value – 2.00 Less: Minority interest discount (.20 × $10.00) $ 8.00 Marketable minority value – 3.60 Less lack of marketability discount (.45 × $8.00) $ 4.40 Per-share value of nonmarketable minority shares Source: Shannon Pratt, “ ‘Levels of Value’ Chart to Reflect Difference in Restricted Stock versus Private Stock,” Shannon Pratt’s Business Valuation Update, Editor’s column (Business Valuation Resources, LLC, October 2004): 1. [...]... Premiums for Voting Rights Attributable to Minority Interests,” Business Valuation Review (December 1991): 165–171; and Paul J Much and Timothy J Fagan, “The Value of Voting Rights,” Financial Valuation: Business and Business Interests, 1996 Update, James H Zukin, ed (New York: Warren Gorham & Lamont, 1996) 15 Chris Robinson, John Rumsey, and Alan White, “The Value of a Vote in the Market for Corporate... v Kimberly, 97 F.2d 433, 434 (45h Cir 19 38) , affg per curiam a Memorandum Opinion of the Court; Helvering v Safe Deposit & Trust Co., 95 F.2d 80 6, 81 -81 2 (4th Cir 19 38) , affg 35 B.T.A 259 (1937); Commissioner v Shattuck, 97 F.2d 790, 792 (7th Cir 19 38) ; Estate of Amon v Commissioner, 49 T.C 1 08, 117 (1967); Standish v Commissioner, 8 T.C 1204, 1210-1212 (1947); Avery v Commissioner, 3 T.C 963, 970-971... States, 580 F.2d 86 3 (5th Cir 19 78) (taxpayer argued that strike price and property value were the same, and therefore, under value – strike price formula, he owed no tax The court rejected this reading, holding the options to be a dividend, taxable when received for the fair market value of the option) 8 Reg § 1 .83 -7; § 20.2031-2(b) General Principles of Option Valuation 333 in the future, and IBM... flexibility in both when and how, leaving it up to planners to determine when the option will be valued, and up to valuers to determine exactly how 20 Baumer v United States, 580 F.2d 86 3 (5th Cir 19 78) ; Redding v Comm’r, 630 F.2d 1169 (7th Cir 1 980 ) We use the term gifts to connote options for which the recipient paid little or no value 22 Rev Rul 80 - 186 21 Conclusion 339 CONCLUSION Option valuation is a difficult... Service uses complex valuation methods Generally speaking, option valuation issues may be thought of in four categories: when, how, what, and if When determines when options are valued Tax law limits valuation dates to two possibilities: when the option is received and when it is exercised The Regulations encourage use of whichever valuation date maximizes tax revenue How prescribes valuation methods... Munford, 150 F.2d 82 5 82 7 -82 8 (2d Cir 1945); Phipps v Commissioner, 127 F.2d 214,216217 (10th Cir 1942), affg 43 B.T.A 1010 (1941); Helvering v Maytag, 125 F.2d 55, 63 (8th Cir.1942), affg a Memorandum Opinion of this Court; Page v Howell, 116 F.2d 1 58 (5th Cir 1940); Gamble v Commissioner, 101 F.2d 565 (6th Cir 1939), affg 33 B.T.A 94 (1935); Helvering v Kimberly, 97 F.2d 433, 434 (45h Cir 19 38) , affg per... 2000-12, 79 T.C.M (CCH) 1337; rev’d 301 F.3d 339 (5th Cir 2002) 6 Estate of Smith v Comm’r, T.C Memo 1999-3 68, 78 T.C.M (CCH) 745 7 Estate of Andrews v Comm’r, 79 T.C 9 38 (1 982 ) 8 Id., quote from an abstract of case in Shannon Pratt’s Business Valuation Update, Business Valuation Resources, LLC (December 1999): 10 5 Conclusion 327 CONCLUSION For operating companies, most or all of the weight is usually accorded... For valuation of petitioner Borgeson’s stock, IRS expert opined to no blockage discount and petitioner’s expert opined to a 15% blockage discount 1 985 Robinson v Commissioner, T.C Memo 1 985 -275 18% Respondent opined to a 6% blockage discount; petitioner Robinson opined to a 40% combined discount for federal securities restrictions and blockage; petitioner Centronics opined to no blockage discount 1 983 ... Richard Walton, Esq., of Chain, Younger, Cohn & Stiles 3 28 Introduction and Background 329 What considers other factors that might be included in the analysis, such as administrative costs and credit risks If asks whether fair market value is readily ascertainable If it is, one valuation date and formula will be used If not, a different valuation date and formula will be employed These broad principles... highest and lowest quoted prices—or, if unavailable, bid and asked prices—on the date of the valuation, or as close to that date as possible Other factors may be included in the valuation if it can be established that the option was not trading for its true fair market value .8 Thus, if the option, or an option very similar to it, traded on the CBOT for a high of $40 and a low of $30 on the valuation . Comm’r, 19 Fed. Appx. 90; 2001 U.S. App. LEXIS 2 088 2 (2001). 28 Estate of Barnes v. Comm’r, T.C. Memo 19 98- 413, 76 T.C.M. (CCH) 88 1, November 17, 19 98. 29 In re Colonial Realty Co., United States. Marketability. Business Valuation Review (June 1997): 70–106. Patton, Kenneth W. “The Marketability Discount: Academic Research in Perspective The Hertzel/Smith Study.” E -Law Business Valuation Perspective. Debate May Be Semantic.” Shannon Pratt’s Business Valuation Update (March 2002, Vol. 8, No. 3): 12–14. Bogdanski, John A. “Closely Held Businesses and Valuation: Dissecting the Discount for Lack