Tag Archives: valuation

Business Valuations – Litigation Landmines (Part 1)

It is not uncommon for the valuation of a privately-held business to be one of the central issues in a litigation matter, such as a shareholder dispute or a family law matter. When this is the case, the attorneys representing the parties to the dispute will need to be on the lookout for litigation landmines.

Recently, an attorney we were assisting on a family law matter in Virginia was provided a valuation report of a business in which his client’s spouse had a non-controlling ownership interest. Opposing counsel wanted the parties to stipulate to the value set forth in this valuation report. The attorney forwarded the report and asked us to give him our thoughts. After reading the first few pages of the report, we quickly realized that using the value stated in this report might cause the marital estate to be significantly undervalued.

Our immediate concerns had to do with the purpose of the valuation and the standard of value. The purpose of a valuation will often dictate litigationthe standard of value. For example, estate and gift tax returns are required to be based on a Fair Market Value standard, while valuations done for GAAP purposes are generally required to be on a Fair Value standard. The report provided by opposing counsel was prepared under the Fair Market Value standard in connection with a gift tax return.

In this case the litigation was based in Virginia, so the applicable standard of value was Intrinsic Value. The valuation report from opposing counsel included a discount for lack of marketability of 30% (not uncommon with a fair market valuation of a non-controlling ownership interest). This type of discount is typically not applicable under the Intrinsic Value standard. After we communicated our aforementioned concerns to the attorney, the stipulation was not agreed to. Fast-forwarding a bit … a new valuation was prepared on an Intrinsic Value basis, which the parties used to reach a settlement agreement that reflected a substantially higher value with respect to the interest in the company. Landmine avoided!

Navigating and deciphering a valuation report can be tricky business. Identifying the proper standard of value is only one of many issues to be addressed. To learn more about how Aronson’s Financial Advisory Services team helps attorneys untangle complex financial disputes and conduct accounting investigations, contact Will Kunz  at 301.222.8216 or wkunz@aronsonllc.com.

Valuation Hindsight Challenged in Recent ESOP Case

This article was co-authored by Amanda Fuller.

A recent U.S. District Court opinion has reiterated the principle that valuations should be based on information known or knowable as of the valuation date. In the case of Fish, et al. v. GreatBanc Trust Company, et al., Case No. 1:09-cv-01668 (N.D. Ill. Sept. 1, 2016), a valuation expert’s opinion was rejected because it relied too heavily on hindsight.

The Antioch Company (Antioch) was founded in 1926. Its well-known (at least in scrapbooking circles) Creative Memories direct-sales business fueled significant growth in the late 1990s and early 2000s, with Antioch revenues reaching approximately $350 million in 2002. In 1979, Antioch established an employee stock ownership plan (ESOP). The Antioch ESOP became the 100% owner of Antioch in 2003, when the remaining non-ESOP shares were redeemed at $850 per share. Less than five years later, Antioch was forced into a Chapter 11 reorganization, rendering the ESOP participants’ shares worthless.

In an action brought under the Employee Retirement Income Security Act of 1974 (ERISA), the plaintiffs, who were participants in the Antioch ESOP, sought more than $233 million in damages, alleging that the plan trustee and members of Antioch’s ESOP Advisory Committee and Board of Directors breached their fiduciary duties in connection with the 2003 share redemption.

In a 131-page September opinion following a 34-day trial, the U.S. District Court found in favor of the defendants, ruling that the defendants did not violate the standards set in ERISA sections 404, 405, or 406 and; furthermore, did not cause the plaintiffs’ alleged damages. Notably, the trustee was found to have “conducted a thorough and vigorous review of the Transaction and worked diligently to protect the ESOP’s interests by negotiating better Transaction terms.” That review process apparently included hiring qualified financial advisors and legal counsel, and scrutinizing their conclusions.

The Court also found that the $850 per share redemption price paid by Antioch in 2003, was no greater than fair market value and that the plaintiffs’ losses resulted from unforeseeable market declines:

Even assuming that plaintiffs succeeded in proving breaches by defendants under ERISA sections 404 and 405, the evidence shows that any such breaches did not cause any damages because (a) as explained in detail above, the Company did not overpay for the non-ESOP shares, and (b) it was not the Transaction that caused the Company to fail and the ESOP participants’ shares to become worthless; rather, the Company failed due to a sales decline caused by market forces and conditions outside the defendants’ control and that defendants could not have predicted in 2003.

The plaintiffs’ offered expert witness testimony suggesting the share price in the 2003 transaction was inflated. The Court was not convinced, finding the expert opinions on behalf of the plantiffs not to be credible because “they are not based on sound or commonly applied valuation methodologies, and are improperly determined ‘from the perspective of . . . hindsight’ based in part on telephone conversations with former Antioch employees sympathetic to plaintiffs more than ten years after the Transaction, rather than from ‘the time the investment was made’ in 2003.”

To the contrary, the Court held that “the consideration paid for the non-ESOP shareholders’ stock was supported by the financial analysis and valuations” conducted contemporaneously by financial advisors engaged around the time of the 2003 transaction as well as testimony from the defendants’ financial expert witness.

Antioch’s per-share value fell precipitously from 2006 to 2008 (see illustration). The Court found that the decline in Antioch’s share value was not caused by the 2003 redemption, but rather by factors generally unforeseeable at that time. Such factors included double-digit decreases in company sales starting in 2006, deterioration of the traditional scrapbooking industry, the emergence of broadband and social media, which altered customer buying habits, and, the financial crisis that began in late 2007 and continued into 2008.

The valuation of a company’s shares is a date-specific exercise. The fair market value of the shares should reflect what was known or knowable as of the valuation date. Among other things, this case demonstrates that retrospective valuations can present significant challenges compared to an analysis performed contemporaneously. In the end, it may be that the Court found the plaintiffs’ claims with respect to the share price in the 2003 transaction to be nothing more than creative memories (pun intended).

Further reading:



Aronson LLC works with ESOP-owned companies in a variety of capacities. To learn more about benefit plan audits and consulting visit here or contact Amanda Fuller at 301.231.6289. To learn more about feasibility studies, valuations and litigation support click here or contact Bill Foote at 301.231.6299.

IRS Targets Valuation Discounts in Proposed Regulations

The Treasury Department is proposing to significantly curb the use of certain adjustments (i.e., discounts for lack of control and/or marketability), which commonly apply in the valuation of transferred interests in operating businesses and family limited partnerships for estate, gift, and generation skipping transfer taxes.  The new proposed regulations aim to close a perceived loophole in Section 2704 of the Internal Revenue Code that enabled taxpayers to apply these discounts when transferring non-controlling business ownership interests.  In the eyes of the IRS, such transfers can have “minimal economic effects, but result in a transfer tax value that is less than the value of the interest…”

The implication of these regulations is increased gift and estate taxes for taxpayers, if they transfer interests in businesses to beneficiaries.  For some taxpayers, the increase in taxes may be substantial as valuation discounts can range from 10% to 50% depending on the facts and circumstances applicable to the fractional interest.  Thus, for business owners with a desire to eventually transfer part of their business to family members; it might make sense to consider tax planning strategies before the regulations go into full effect.

As always, a properly executed estate planning strategy involving transfers of business ownership interests should include an objective and well-supported valuation analysis. For information about how Aronson can provide assistance in this area, please contact Jimmy Zhou at 240.364.2698.

Don’t Miss our Latest Series on Valuation

In case you missed it, check out our latest two-part series, “What Construction Companies Need to Know about Valuation,” on The Aronson Construction & Real Estate Report.

In Part 1 – Do I Need a Valuation? we walk through the importance of working with a valuation expert that knows your industry and is actively involved in this industry. Understating the entity to be valued and the valuation trends and considerations for your particular industry is extremely important in terms of valuation reasonableness. Continue reading here…

In Part 2 – What Drives Value in M&A Deals? we look at recent M&A transaction activity in the Construction & Engineering (C&E) sector and discuss C&E value drivers. Continue reading here…

Aronson LLC’s Financial Advisory Services practice assists construction contractors with a variety of valuation and M&A-related services, including pre-acquisition due diligence and post-acquisition purchase price allocation analysis. To learn more about our platform of services, refer to our website or contact Bill Foote at 301.231.6299 or bfoote@aronsonllc.com.

The Price to Transfer Interests in Family-Controlled Entities May be Going Up

Written by Michael Esders and William Kunz

With the much anticipated release of proposed regulations under Section 2704 of the Internal Revenue Code expected to occur this fall, there has been heightened buzz over the continued availability of certain adjustments (i.e., discounts for lack of control and/or marketability) in valuing ownership interests in family-controlled entities (e.g., a Family Limited Partnership or a Family Limited Liability Company).

The governing documents of many businesses, including family-controlled entities, restrict the manner and circumstances in which ownership interests and associated rights can be transferred. When establishing the fair market value of an ownership interest in a family-controlled entity, such restrictions can give rise to valuation discounts for lack of control and/or marketability. The practical effect of the soon-to-be proposed regulations under Section 2704 may be to limit the application of such discounts for lack of control and/or marketability when arriving at values for transferred family-controlled entity interests, which in isolation will result in higher values.

Precisely when these new rules may take effect is not currently known. While regulations typically take effect when finalized, there are indications that these regulations could be effective as of the date the proposed regulations are released. As a result, business owners intending to transfer ownership in a family-controlled entity may want to take action now in order to take advantage of potential valuation discounts.

As always, a properly executed state planning strategy involving transfers of business ownership interests will require an objective and well-supported valuation analysis. For information about how Aronson can provide assistance in this area, please contact Will Kunz or Michael Esders at 301.231.6200.

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