Valuation Issues - Valuation Discounts for Business Interests

Valuation Discounts for Business Interests
Minority Discounts
If a transferred asset represents a minority interest in a business, then a reduction in the value of the asset is typically allowed, known as the "Minority Discount."


Example:
If Nate has a 30% minority interest in ABC Company, it does not entitle him to several of the benefits awarded to majority owners; therefore, he could receive a minority discount of 20%, thus bringing his transfer value down to a 24% ownership.

Properties of the Minority Interest:
  • Not a controlling interest (in terms of voting).
  • Minority discounts range from 15 to 50% (for transfer tax purposes).
  • Minority owners do not manage the business.
  • Minority owners cannot initiate a sale or liquidation of the business.
  • Buyers will pay less for minority interest versus a controlling or majority interest.

How do You Determine the Discount?
1) A pro-rata portion of the total business value minus a discount.
2) In comparison to market data involving similar minority ownership interest transfers.
3) As a present value of the economic benefits stream expected from ownership of the minority interest in the company.

Marketability Discounts
A reduction in the value of an asset transferred is commonly allowed if the asset transferred has an inherent lack of marketability, such as a house, farm or collectible items. The interest in a closely-held business or partnership interests might also be short of marketability as they are often more difficult to sell than other interests, such as a bank certificate of deposit (CD) or marketable securities.


Characteristics:
  • The lack of marketability discounts can be used in conjunction with the minority discount.
  • The discount range is 15 to 50% for both minority and majority interests.

Example:
Julie gave her daughter Alisha, a 5% interest in her closely held business. The business has a value of $400,000 and Julie applied a minority and lack of marketability discount that totaled 35% to the gift. What is the value of the gift?

Answer: $13,000. Julie would not have any gift tax due, since the amount falls under her annual gift exemption amount. [$400,000 x 5% x (1 - 0.35)]

Blockage Discounts
A substantial amount (or block) of corporate stock, that is listed on a public exchange, may be found in a decedent's gross estate. If this occurs, the stock may be somewhat difficult to sell due to the size of the block and the current trading volume of the stock in the company.


Why discount large blocks of stock?
  1. Liquidity and volume selling issues.
  2. Large volume is harder to sell than small volume.
  3. Market price will be less for a large block versus a small block.
  4. Discounts would be based on the decrease in the realizable price below the current market price of the stock.

Key Person Discounts
A discount will usually be allowed for a business in which a key person has died or becomes disabled. The rationale behind this discount is that the closely-held business may experience an interruption in production, decline in stock price and change of management if a key person (such as a founder) died or becomes substantially disabled or unable to return to the business.


In some cases, a key-person (employee) life insurance is purchased on the life of this employee (payable to the corporation) to give the corporation some additional capital and time to find a replacement in the event of death of this key person. The discount may be reduced if such insurance is in force.

Valuation Techniques and the Federal Gross Estate
Related Articles
  1. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
  2. Products and Investments

    How to Create a New Financial Product in 10 Steps

    The 10 steps outlined here are essential to the creation of a new financial product.
  3. Professionals

    A Day In The Life Of A Public Accountant

    Here's an inside look at the workdays of two experienced CPAs, to give you an idea of what it might be like to pursue a career as a public accountant.
  4. Professionals

    A Day in the Life of a Public Accountant

    There’s no typical day in the life of a public accountant, but one accountant’s experience may shed some light on what the career entails.
  5. Saving and Spending

    A Key Tip for Making Your Nest Egg Last Longer

    Retirees who don't want to deplete their nest eggs during a bear market should make sure to do the following.
  6. Mutual Funds & ETFs

    Fidelity Target Risk Funds Overview

    Get a brief overview of Fidelity's seven target risk funds, with a description of each fund's asset allocation and expense ratio.
  7. Investing News

    Is it the Right Time to Raise Interest Rates?

    Warning signs have started to emerge that point to a potentially dismal 2016 for the U.S. economy.
  8. Markets

    Four Big Risks of Algorithmic High-Frequency Trading

    Algorithmic HFT has a number of risks, and it also can amplify systemic risk because of its propensity to intensify market volatility.
  9. Mutual Funds & ETFs

    The Top 3 Invesco Funds for Retirement Diversification in 2016

    Explore analyses of the top three Invesco mutual funds for retirement diversification in 2016, and learn about the characteristics of these target-date funds.
  10. Investing Basics

    Hedging Risk for Beginners: How and When to Do It

    Hedging risk is always a good idea. Here is how sophisticated investors go about it.
RELATED TERMS
  1. Sortino Ratio

    A modification of the Sharpe ratio that differentiates harmful ...
  2. Equity Risk Premium

    The excess return that investing in the stock market provides ...
  3. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  4. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  5. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  6. Gross Exposure

    The absolute level of a fund's investments.
RELATED FAQS
  1. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  2. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  3. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  4. Why are mutual funds subject to market risk?

    Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>
  5. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
  6. Can your car insurance company check your driving record?

    While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
Hot Definitions
  1. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  2. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
Trading Center