The Uniform Standards of Professional Appraisal Practice (USPAP) Standards Rule 9-4(c) outlines a number of factors that should be considered when valuing illiquid minority interests (USPAP, p. U-74):
An appraiser must, when necessary for credible assignment results, analyze the effect on value, if any, of buy-sell and option agreements, investment letter stock restrictions, restrictive corporate charter or partnership agreement clauses, and similar features or factors that may influence value.
Procedural Guideline 2 (PG-2) of the Business Valuation Standards of the American Society of Appraisers outlines a number of factors that may be appropriate in the valuation of partial ownership interests. We have previously examined a portion of the factors in the discussion of the valuation methods under the income approach of expected economic benefits, the expected holding period and the required return, or discount applicable to future benefits. These factors include the following:
- The purpose and definition of the valuation engagement in accordance with BVS – I General Requirements for Developing a Business Valuation, including the applicable standard (type) and premise of value.
- Factors related to the underlying enterprise or asset, including: 1. The value of the underlying enterprise or asset, if applicable. 2. Enterprise-level or asset level tax effects, if relevant.
- Provisions in the organizational and governance documents that affect the rights, restrictions, marketability and liquidity of the subject interest. Documents to consider may include partnerahip agreements, articles of incorporation, bylaws, operating agreements, buy-sell agreements, investment letter stock restrictions, option agreements, lock-up requirements or others that may be relevant.
- Applicable laws and regulations. Business examples include statutory rights to demand dissolution of a corporation under state law, restrictions on transfer pursuant to SEC Rule 144, and many others. An asset example is the right to partition.
- The existing ownership structure and configuration.
- Access to, availability of, and reliability of information regarding the underlying asset or entity.
- The relevant pool of potential buyers, if any.
- Ownership-level tax effects, if relevant.
- Prior transactions in the subject interest, entity or asset, and their relevance to a given assignment.
- Interaction of the factors listed above, and their cumulative impact on the degree of control, marketability and liquidity of the subject interest.
Many users of appraisal reports are not aware that prevailing business valuation standards call for such in-depth analysis in the determination of marketability discounts as has been discussed in this series.
Our next post concludes the discussion of business valuation standards and marketability discounts.