Do Not Just Paint By Number When Preparing

A Business Valuation for a Controlling Interest

CPAs are subject to multiple standards. Often, the standards prevent CPAs from exercising their judgment or applying common sense. The author describes this as “miss[ing] the boat.” This article illustrates this and provides an actual example where a group of valuators missed the boat. The purpose here is not to belittle, but to prompt CPAs to reflect on how they manage engagements and to think outside the proverbial box.

As professionals, we are taught to be complicit with a myriad of guidelines. Below are a few of the rules CPAs who are members of the AICPA are required to follow:

• Accounting Standards Updates
• Statement on Standards for Attestation Engagements
• Auditing Standards
• Compilation and Review Standards
• Statements on Quality Control Standards
• Statement on Standards for Forensic Services
• Standards in Personal Financial Planning Services
• Statements on Standards for Consulting Services
• Statements on Standards for Valuation Services

We are also inundated with many tax laws we are obligated to follow.

Other professionals in the insurance and finance industries also have a number of rules they must follow. As valuators, we must adhere to the standards below:

• Revenue Rulings
• SVSS 1
• NACVA Professional Standards
• ASA Professional Standards
• Uniform Standards of Professional Appraisal Practice
• Others

In addition, when dealing with the Internal Revenue Service, we need to consider the Job Aid for IRS Valuation Professionals.

You may be wondering what the point is of listing all these policies. The point here is that most of us have not been taught to think; we are too busy complying with all these rules that we can miss the boat. This sets the stage for an actual example where a group of valuators missed the boat.

Several years ago, we received a call form a long-time client (over 30 years) and businessman who was helping a widow sort out her husband’s estate, and was also trying to save his businesses, which had been 100% owned by her husband and were as follows:

• A corporation in Detroit where one customer that accounted for the major portion of its revenue; that customer was one of the big four USA based automobile companies. The company had no contracts with the customer and operated only from purchase orders.
• A holding company (C corporation) that owned the following companies:
• A company that owned a golf course with potential environmental issues,
• A landscape company that also had a nursery, and
• A real estate company that owned valuable land but was nearing default on its major loan.
• Two cell phone equipment companies.

The above companies had been valued simply be increasing its assets to the appraised values and subtracting the company’s liabilities. The valuator took no discounts in arriving at their opinion of value. As to the Detroit Company, they did apply a 10% discount to net assets in arriving at its value. Now we go back to our client. (He is not a valuation professional but is a very successful and brilliant businessman). He had reviewed the valuation and was flummoxed that there were no valuation discounts as a purchaser would not only need to infuse funds to avoid foreclosures but would need to manage a diverse set of companies.

At that point he asked us to review the several large volumes, which included the business valuations, that comprised the estate tax returns. We then did a search of one owner companies in which the valuations contained in the estate tax returns had been subject to litigation and came up with the following:

• The first case we reviewed was the Estate of Jephson in which the IRS supported the position for a discount for lack of marketability.
• The next case we reviewed was the Estate of Bennett. In this case, the issue was the valuation of a 100% ownership interest in the common stock of Fairlawn Plaza development, in which the court allowed a 15% discount for lack of marketability. In that case, the court stated: “So too in this case, our holding that a lack of marketability discount is warranted is based on the totality of facts presented; here we have a real estate management company whose assets are varied and non-liquid. We think that the corporate form is a quite important consideration here: there is quite a difference in owning the assets and liabilities of Fairlawn directly and in owning the stock of Fairlawn, albeit 100% of the stock. We think that some discounting is necessary to buy Fairlawn’s package of desirable and less desirable properties. Thus, the line of cases in which we have recognized that difficulties arise in holding non-liquid assets in corporate form, even in the 100% ownership situation, is applicable in this case.”
• The case that we modeled our argument on was 59 T.C.M 772 (1990) Estate of Dougherty v. Commissioner. In this case, the Service allowed a 35% discount from net asset value for “non-marketability” and operating and liquidation costs.

Having completed our research, we determined that filing an amended estate tax return with values resulting from amended valuation reports containing applicable discounts would have a more-than-not chance of producing a sizable refund for the estate. (Previously, we had prepared amended valuations for another amended estate return which resulted in a refund of approximately $1,600,000). Part of our reasoning is that the IRS would see too much risk in litigating this case and losing another one-stockholder case that resulted in a sizable refund.

Based on the above, we arranged a meeting with our client, the decedent’s widow and adult children, the attorney for the big four automaker, and the attorney that had prepared the estate tax return. At that meeting, we laid out our reasoning for going forward with the amended valuations and the amended Form 706. We asked the estate attorney, on an estate of this size, why he had not had the valuations vetted by another valuator. His reply was that he did not want to spend the money. My reply to him was why did he not want to spend $5,000 to save $2,300,000. At that point, the widow retained us to prepare the amended valuations and amended Form 706. The amended return was subsequently filed and was audited, went to appeals, and subsequently to the joint committee.

The story has a happy ending. Treasury issued the taxpayer a refund of $2,689,269.72. Utilizing this money, the holding company and the company in Detroit were able to renegotiate their bank loans. A few years later, the Florida company was able to sell its real estate to a developer for approximately $25 million. The result of all that: descendant’s widow ended up being wealthy instead of bankrupt.

The point of this story is, sure, we need to follow the law and standards. However, we must utilize our intellect and some common sense in preparing business valuations. Our client, who has had no valuation training, had the sense to see that it would be difficult, costly, and time consuming to sell these companies. The question is, why did the valuators not see that as well? Do not be a “paint by the numbers” valuator. Combine all your knowledge and training along with your experience,  and common sense when preparing business valuations. Do not be afraid to think outside of the box!

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Edward Bortnick, CPA, CVA, MAFF, CFF, began his career in public accounting in 1971. He is a shareholder in the CPA firm, SKMB, P.A. He has served as Principal since 1977, including 18 years in his own practice prior to merging with Simon Krowitz Bolin & Associates, P.A. in 1998. Over the years, Mr. Bortnick has acquired a unique and varied background of skills in accounting, taxation, business matters, and valuation services. His primary focus is on litigation services, specializing in valuations, and bankruptcy and divorce support. He has appeared in Circuit, U.S. Bankruptcy, and Federal courts to serve as an expert in business disputes, divorce, and tax matters. Mr. Bortnick heads the firm’s Exit Planning and Litigation Support and Valuation Services practice. Mr. Bortnick also manages a conventional accounting practice, including audits, reviews, compilations, tax planning and preparation, and business consulting.

Mr. Bortnick has been an instructor for the National Association of Certified Valuators and Analysts, co-chairperson of the NACVA’s 2007 annual conference, and on the planning committee of their 2011 annual conference. He is also the former president of the Maryland/DC Chapter of the NACVA.

Mr. Bortnick can be contacted at (301) 468-7700 or by e-mail to EBortnick@skmb-cpa.com.