A recently released internal IRS document sheds light on an important aspect of business valuation – the discount for lack of marketability (DLOM). Although informative and useful, the Job Aid will not likely change the practice of most quality-driven business valuation professionals in the private sector.
The IRS recently released to the public a document produced by an “engineering/valuation” group within the IRS entitled, Discount for Lack of Marketability Job Aid for IRS Valuation Professionals, dated September 25, 2009. According to this document, this “job aid” was developed to help the IRS’ own valuation staff properly review and/or develop DLOMs. Such discounts often play a crucial role in the valuation of many businesses and business interests.
The DLOM is important to the IRS because it affects the taxes the IRS can ultimately collect from certain taxpayers—taxpayers who own businesses or business interests. It is therefore also very important to these taxpayers – and others who might be affected.
What is a DLOM?
This discount is a reduction to the initial value of an appraised business or business interest, typically a privately-held business. The reduction is intended to account for the difficulty in selling this type of investment, relative to the ease and speed with which an investor can sell an interest in a publicly-traded stock, such as Microsoft.
The DLOM is primarily used in connection with valuing partial ownership interests, i.e., a 10% interest in a company. The application of a DLOM can result in a substantial reduction in the value of a partial ownership interest – often 20-40%, but sometimes much higher. For a business owner, for example, who desires to gift a portion of his or her business to a son or daughter, this reduction in value can translate into significant tax savings. In turn, the reduction also means less $$$ for the IRS. This is but one example. The DLOM can also be important in other valuation contexts, such as charitable contributions, estate tax returns, divorce, and shareholder disputes.
Included in the IRS’ Job Aid
- A description of 23 DLOM approaches and the factors that typically influence this discount
- Summaries of key approaches that have been developed and/or used by appraisers. For each key approach, the authors cover the following:
- An overview of each approach, including the size range typically produced by the approach and other statistics
- The areas the IRS appraiser should carefully explore when assessing a taxpayer’s determination of the amount of the discount
- Strengths and weaknesses of the approach
- The extent to which the approach is seen in professional practice
- What the Courts say about the approach
- How to approach marketability discounts from the perspective of both a reviewer and as a valuator
- Sources available to IRS valuators
Despite the IRS’ declaration that this internal document is NOT an official “IRS Position,” and was developed for “reference purposes only,” there is much useful information for other valuation professionals, as well for attorneys, accountants, business owners and certain fiduciaries.
The Job Aid is not billed as a best-practices guideline. For the most part, it refrains from either endorsing or disparaging the approaches it discusses, although there are exceptions; rather, the document is mostly an educational tool for IRS appraisers.
Most important in this document is the repeated statement that the determination of a reasonable discount for lack of marketability depends upon the unique facts and circumstances of the valuation and that there is no substitute for a thorough analysis; a one-size-fits-all approach is inadequate.
The above statement is true, of course, but it is no less true today than it has been in the past. The statement also holds for the valuation of an entire business. Again, there is no substitute for a thoughtful and thorough analysis. No news here for the quality-minded valuation professional.