I read today in e-article that there’s is a Mercer Model for Pass Through Entities? We have almost every book you’ve written but were unable to find it. I called Mercer Capital and talked to Lisa, she said there is no such model.. I am aware of the QMDM which we use for the DLOM. Please clarify if there is Mercer Model for Pass Through Entities.(like Grabowski and others…). Thanks,
First, Lisa Doble, Mercer Capital’s Senior Vice President and Research Director, was absolutely correct. I was not in the office that day, or the call would have come to me — or Lisa would have gotten me on the line. I’m glad the questioner followed through with an email to me.
There is no “Mercer Model” for the valuation of tax pass-through entities. However, I have spoken on this issue a number of times at appraisal conferences around the country, although not recently, on this particular topic. I’ve also written a number of articles on the issues pertaining to the valuation of tax pass-through entities. The most recent article we (Mercer and Harms) have written on this topic is in Volume 27, Issue No. 1, 2008 of the Business Valuation Review and is entitled “S Corp Model Comparisons.” [There is a charge for this article, and it is worth it!]. The article reviews the issue of S corporation valuation (enterprise and shareholder levels) in the context of then current case law and valuation theory.
The question of whether there is a Mercer Model for S corporation valuations, and more general questions about the valuation of tax pass-through entities, keeps coming up, so let me address the the topic of illiquid minority interests in S corporations briefly here. My response to the LinkedIn question provides a good introduction to this post.
There is no “Mercer Model” for tax pass-thru entities. There is the Integrated Theory of Business Valuation, which enables appraisers to address virtually all valuation situations, including the valuation of minority interests in tax pass-through entities. I, like Chris Treharne, Nancy Fannon, Roger Grabowski, and Dan Van Vleet (and others for sure) have talked about the valuation of pass-through entities. Not every agrees with me — or with each other. Naturally, I think we have the most theoretically defensible positions on the topic.
My talks and articles on the topic of the valuation of illiquid interests in tax pass-through entities have been based on the book, Business Valuation: An Integrated Theory Second Edition (Mercer and Harms) (“The Integrated Theory“).
Chapter 10 of The Integrated Theory is titled “Application of the Integrated Theory to Tax Pass-Through Entities.” It discusses many of the same issues as the article noted above and shows how we consider a) the tax benefit at the shareholder level that can arise for shareholder distributions as result of the elimination of the (double) C corporation tax; and b) the potential tax benefit of the build-up in basis that can occur if an S corporation retains earnings.
These benefits are considered in the context of the latest version of the QMDM Companion (Version 4.0). “QMDM” stands for the Quantitative Marketability Discount Model, which was introduced (in speeches prior) in Quantifying Marketability Discounts in 1997. This book is no longer in print. The QMDM Companion provides a set of Excel worksheets that facilitate the use of the QMDM, which is a shareholder level discounted cash flow model. This “model” is a direct application of the Integrated Theory. This publication is accompanied by a pdf file which describes the use of the QMDM in detail.
I don’t know what version of the QMDM readers of this blog may have, or if you have the model. I’d suggest that you obtain the above-referenced book, The Integrated Theory, as well as the latest version of the QMDM Companion if you don’t have them. If you read these materials and actually experiment with the QMDM itself, you will see that it makes no sense to try to do cartwheels when valuing minority interests in tax pass-through entities. Their valuation is the result of the expected cash flows attributable to the interests over their relevant expected holding periods, and discounted to the present at an appropriate, risk-adjusted discount rate.