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EDUCATION:  B.S. Business from Eastern Mennonite University BLOG:  None provided
CERTIFICATIONS:  Certified Valuation Analyst - NACVA CURRICULUM VITAE:  None provided


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Writing Sample

Business Valuation of Closely-Held Securities

 Business valuation is based upon two principles. These are the principle of substitution and the principle of future benefits. The principle of substitution states that the value of property is determined by the cost of acquiring an equally desirable substitution. Essentially, this means that an informed buyer will not pay more for property than the cost of acquiring a substitute property of equivalent utility.

The principle of future benefits states that the economic value of an investment reflects anticipated future benefits and not for past performance. Although the past may serve as a proxy for the future, a business that has had poor earnings in the past but has higher earnings potential in the future will be worth more than a business that has been successful in the past but is expected to be less profitable in the future.

The fair market value of securities trading on an active public market is determined by actual market quotations on a particular date, unless the market for a security is affected by some unusual influence or condition.  The determination of fair market value of securities of closely-held companies cannot be as precisely measured which creates the need for alternative valuation methodologies. Revenue Ruling 59-60 acknowledges this when it states:

A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases. Often, an appraiser will find wide differences of opinion as to the fair market value of a particular stock. In resolving such differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science. A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighting those facts and determining their aggregate significance.

Due to the lack of a ready market, determining the value of closely-held securities can be challenging. Therefore, the value of closely-held securities must be determined by a process of careful and impartial analysis.

It is important to keep in mind that when valuing a closely-held business, no single method of business valuation is an absolute. In order to produce sound results, the analyst must use as many or as few of the different methods that are appropriate under the given circumstances of the situation for which the necessary information is available.

The considerations and guidelines outlined in Revenue Ruling 59-60 are often categorized into three distinct approaches for valuing the stock of closely-held companies. Therefore, the development of a fair market value opinion is based on the utilization of three basic approaches to value. These are the Income Approach, Asset Approach and Market Approach. Values derived from appropriate methods under each approach are then analyzed in association with the specific entity and economic and industry data to formulate an objective opinion as to the fair market value of the particular equity interest of the subject business.

The three approaches, as well as the method used within each approach, is discussed in detail in the following sections.


Discounts must be considered when valuing a minority interest. The discounts to be applied are directly tied to the company’s level of value. There are three common levels of value. They are controlling interest, marketable minority interest and non-marketable minority interest.

A controlling interest is the value an investor would pay to acquire more than 50% of a company’s stock, giving the investor the prerogatives of control. These prerogatives include, but are not limited to, voting rights, selecting management and setting their compensation, changing the structure of the company, declaring dividends and selling the company or liquidating assets.

A marketable minority interest represents equity interests that are freely traded without restrictions. These interests generally are small blocks of stock representing much less than 50% of a company’s stock and are traded on an exchange.

The primary discounts applied to the values of closely-held companies are the minority discount and discount for lack of marketability (DLOM). The minority discount is applied first. Then the DLOM is applied to the net amount after taking the minority discount.

Minority Discount

The cash flows of a company that does not have any control adjustments and the is managed to the benefit of the shareholders may be treated as minority cash flows which produces marketable minority value (MMV). However, the value is considered as control stand alone and not MMV as policies of current owners can change or new owners can come in to the company. Therefore, a minority discount adjustment is appropriate to reflect the risk of potential future changes in ownership or policies or both.

Discount for Lack of Marketability (DLOM)

Marketability of the interest being valued must be considered. Marketability is defined as the ability to convert the business interest into cash quickly, with minimal transaction and administrative costs, with a high degree of certainty as to the amount of net proceeds. There are often significant costs associated with the selling of interests in privately-held companies as well as a significant amount of time it takes to sell those interests. This is because there is no ready market of available buyers and sellers. An interest in a publicly traded entity is more valuable because it is readily marketable.

Several factors are considered when evaluating the appropriate DLOM and they include:

  •  Financial Statement Analysis
  • Dividend Policy
  • History and Nature of the Business
  • Management
  • Location
  • Ownership

When valuing a business, one can arrive an appropriate discount for lack of marketability after evaluating Restricted Stock Studies, Pre-IPO Studies and taking into consideration the Mandelbaum factors and how they apply to the business being valued. Court cases serve the purpose of adding credibility to conclusions reached regarding the discount for lack of marketability.