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Guest Article:
The IRS's winning discount for lack of marketability analyses in Gross1, McCord2, and Lappo 3 have set the valuation community abuzz. This new discount approach has Lance Hall been developed by litigation expert, Dr. Mukesh Bajaj, as an outgrowth of his research into restricted stock transactions.4 Clearly, Dr. Bajaj's arguments have resonated with the Tax Court, which has deemed them superior to the opposing experts' analyses. However, before the valuation community, the IRS, and the courts jump on the "Bajaj Approach" bandwagon, a closer examination of his underlying arguments and supporting data is required. Perhaps the best way to examine Dr. * Lance S. Hall is a Managing Director at FMV Opinions, Inc., a national business and real estate valuation firm (fmv.com). Mr. Hall manages FMV's estate and gift tax practice. 1 Gross v. Commissioner, 272 F.3d 333 (6th Cir. November 19, 2001). 2 McCord v. Commissioner 120 T.C. No. 13 (May 14, 2003). 3 Lappo v. Commissioner T.C. Memo 2003-258 (September 3, 2003). 4 Dr. Bajaj is the Managing Director of Finance and Damages Practices of LECG, LLC, which is an international consulting firm. Dr. Bajaj received his Ph.D. in finance from the University of California, Berkeley, where he teaches part-time. 5 Mukesh Bajaj, David J. Denis, Stephen P. Ferris, and Atulya Sarin, Journal of Corporation Law, Fall 2001.
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Shannon Pratts
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Shannon Pratt Alina Niculita Tanya Hanson Linda Kruschke Laurie Morrisey Paul Heidt Rihab Hamze Angelina Mckedy Kyla Westfall Doug Berger Pam Pittock
c) Economies of Scale (as represented by): a. High Dollar Placements In his analysis, Dr. Bajaj found that the greater the percentage block in a private placement, the higher the discount. According to Dr. Bajaj, "This is consistent with the speculation that firms with ambitious growth plans require closer scrutiny by investors prior to the consummation of the placement and greater monitoring subsequent to it." Moreover, Dr. Bajaj found that the greater the volatility of a company's returns, the higher the discount. Dr. Bajaj also found that financially distressed companies had higher discounts than did financially healthy firms. These findings also supported Dr. Bajaj's thesis that such companies required greater assessment, monitoring, advice, and future funding. However, Dr. Bajaj found that higher dollar placements did not significantly affect the discount. The first fatal flawall restricted stock is equally illiquid Dr. Bajaj's study, however, is fatally flawed, as the foundational assumptions of the study are wrong. The first erroneous assumption underlying the Bajaj Approach is that all restricted stock is equally illiquid. This is not true. Consider the following: Suppose you and I hold restricted stock in the same publicly traded company. However, your restricted stock block represents only one percent of the company's total shares outstanding, whereas my block represents 30 percent of the company's total shares outstanding. Under the Securities and Exchange Commission's (SEC) Rule 144, we each have a one-year holding period, after which we can sell our shares on the open marketplace. How-
JOHN A. BOGDANSKI, JD
Lewis & Clark Law SchoolPortland, Ore.
LANCE S. HALL
FMV Opinions, Inc.Irvine, Calif.
JOHN W. PORTER
Baker & Botts, LLPHouston, Texas
Shannon Pratts Business Valuation Update (ISSN 1088-4882) is published monthly by Business Valuation Resources, L.L.C., for $249 a year. Please call or write for multiple-subscription rates. Periodicals postage paid at Portland, Oregon. POSTMASTER: Send address changes to Business Valuation Resources, L.L.C., 7412 S.W. Beaverton-Hillsdale Hwy., Suite 106, Portland, OR 97225, phone (503) 291-7963 or (888) 287-8258, fax (503) 291-7955, e-mail: CustomerService@BVResources.com, Web page: www.BVResources.com. Editorial office and subscription requests should go to the above address. Please note that by submitting material to Shannon Pratts Business Valuation Update, you are granting permission for the newsletter to republish your material in electronic form. Although the information in this newsletter has been obtained from sources that Business Valuation Resources believes to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. This newsletter is intended for information purposes only, and it is not intended as financial, investment, legal, or consulting advice. Copyright 2004, Business Valuation Resources, L.L.C. (BVR). All rights reserved. No part of this newsletter may be reproduced without express written consent from BVR.