During the 2012 calendar year, individuals can gift, or give away, as much as $5.12 million and pay no federal gift taxes on the gifts, although this amount is reduced by the amount of any taxable gifts made in prior years. In the absence of a Congressional change in the law, however, the gift tax exemption will be reduced to $1 million on January 1, 2013.
I wrote a recent post on this topic and Mercer Capital prepared an interesting article, as well. These articles, and the changing gift and estate tax landscape, provide an excellent backdrop for a new series for this blog, ValuationSpeak.com.
We have written a series of posts on two timeless and important topics, buy-sell agreements and statutory fair value in the recent past. In the current tax environment, a series investigating the marketability discount is both important and timely.
The Marketability Discount Defined
The marketability discount, also called the discount for lack of marketability, or DLOM, is perhaps the largest and potentially most controversial valuation discount normally considered by business appraisers.
An amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability.
The International Glossary defines “Marketability” as:
The ability to quickly convert property to cash at minimal cost.
The capability and ease of transfer or salability of an asset, business, business ownership interest, security or intangible asset.
Marketability Discounts in Perspective
The ASA Business Valuation Standards provide important guidance regarding our consideration of the marketability discount in BVS-VII Valuation Discounts and Premiums, Para. II:
- A discount has no meaning until the conceptual basis underlying the base value to which is applied is defined.
- A premium has no meaning until the conceptual basis underlying the base value to which it is applied is defined.
- A discount or premium is warranted when characteristics affecting the value of the subject interest differ sufficiently from those inherent in the base value to which the discount or premium is applied.
- A discount or premium quantifies an adjustment to account for differences in characteristics affecting the value of the subject interest relative to the base value to which it is applied.
The definitions and standards references above can be placed in perspective in the conceptual levels of value charts below. The traditional levels of value chart, with three levels, is presented at left. The chart at the right reflects a growing consensus of business appraisers regarding a convergence between the marketable minority and financial control levels of value. In both charts, the marketability discount is that discount that converts a marketable minority value at the enterprise level into a nonmarketable minority value at the shareholder level.
For a detailed discussion of the levels of value charts, see the entire series of posts discussing the conceptual levels of value and their interrelationships in the Statutory Fair Value Category of this blog. Also, see the detailed discussion in my book (with coauthor Travis Harms) Business Valuation: An Integrated Theory Second Edition. If you haven’t done so already, let me suggest that you add the book to your library and read it. It is short (272 pages) and insightful (according to its reviewers!).
Marketability Discounts: The Coming Series
Many readers know that I wrote a book in 1997 entitled Quantifying Marketability Discounts (now, see Business Valuation: An Integrated Theory Second Edition). That book introduced the Quantitative Marketability Discount Model (aka QMDM), a shareholder-level discounted cash flow model, as a means of developing discounts for lack of marketability. This series on marketability discounts is not a series about the QMDM.
This series is intended to examine the concept of marketability discounts, how they are derived, popular valuation methods for determining a discount, as well as how the Tax Court has treated marketability discounts over time. While the content of this series will evolve, topics to be addressed include:
- What is a marketability discount?
- What is the base from which a marketability discount is to be taken?
- How can marketability discounts be measured and assessed?
- What research and studies are available to help in understanding and quantifying marketability discounts? In addressing this question, we hope to write about a variety of articles and studies, both from the past and the present.
- What are the elements that make up or determine the extent of marketability discounts?
- What is the Discount for Lack of Marketability Job Aid for IRS Valuation Professionals, and of what significance is it to appraisers and users of appraisal reports?
- In the words of the Discount for Lack of Marketability Job Aid for IRS Valuation Professionals (available here), what are the factors affecting marketability, or the lack thereof, and how can they be assessed?
- What valuation methods are appropriate for developing marketability discounts?
- What treatment has the Tax Court accorded to marketability discounts over time?
If readers pose additional questions, we will try to address them in the context of future posts in the series. We hope that this series on marketability discounts will raise the level of informed discussion on this important topic.