Over the past twelve to eighteen months, we have heard considerable discussion about how the economic downturn has affected valuations of private companies. All of us who have 401ks understand the volatility of public company valuations. Private company values have been affected similarly. However, some valuation professionals have instituted the “smoothing” method to lessen the market volatility on business valuations.

I recently wrote about one of the most dramatic changes since the inception of the fair value concept for financial reporting imposed by Statement of Financial Accounting Standards No. 157 (“FAS 157”). Nearly a year since the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, accounting standards have been codified and the nomenclature used when referring to FASB statements has changed. FASB Statement No. 157 is now encompassed in Accounting Standards Codification (“ASC”) 820.

There are so many timely and topical valuation issues today that it’s difficult to focus on a single subject. Many topics remain timely month after month, like the importance of establishing the value of a company for purposes of buying cross-purchase life insurance. Some topics are always important, but become more timely because of economic conditions, like the increased ability to transfer assets for estate planning purposes while valuations are depressed (as we’ve been saying for some time, the current economic environment provides an outstanding opportunity in the estate planning realm). Another topic that is always important is consideration of entity selection for companies. A number of factors make this topic even more important today.

Statement of Financial Accounting Standards No. 157 (FAS 157) first impacted financial statements issued for years beginning after November 15, 2007. Its effect on the most recent round of year-end financials issued by companies, underscores the critical role of independent appraisers with market knowledge when navigating these new financial reporting guidelines.

As an owner of a privately held business, you have significant personal wealth already invested in your company. When reviewing the annual returns your business delivers, it’s easy to calculate returns based on the book value of the company. For example, book value of $4 million and pre-tax earnings of $1 million generates an attractive 25% return. However, you certainly wouldn’t sell your company for book value, so the returns on the “investment” you have in your private business should be based on market value. (Market value of $20 million with the same $1 million of earnings generates a less impressive 5% return.)

The question is “how much to transfer” rather than “whether to transfer”! Low values + low AFR = make transfers now

By now, I think we’ve all heard of the proposed legislation HR 436. I suppose that some sort of tax relief is contemplated. The question is “tax relief for whom?” The answer remains to be seen, but one thing is sure, the time to make transfers is now!

Holman vs. Commissioner, 130 T.C. No.12 (May 12, 2008), is an interesting case chock full of issues. The court considers whether the transfer of assets constitutes a direct or indirect gift, whether the LP should be treated as analogous to a trust, whether the LP passes the tests of 2703(a) and whether the valuation presented is appropriate. Some issues are addressed in more creative ways than others. One of the most creative is the analysis of the valuation discounts applied.

There are times in our lives when we look back and speculate “if only I had.” For many of us those regrets seem to focus on timing-related opportunities such as “if only I had invested in Microsoft in 1992” or “if only I had sold my business last year.” While the M&A activity is healthy, in terms of estate planning, owners of privately held companies may have an wealth transfer opportunities at lower values using low interest rates, and avoid looking back and seeing the “if only” moment.

Stock options are a form of compensation often paid to employees of a company to allow those employees participation in increases in the company’s value. Today, stock options are commonplace as part of incentive compensation packages and the Financial Accounting Standards Board (FASB) has issued standards regarding the amount of remuneration that is currently paid and recognized by the granting company, therefore eligible to be booked as an expense of the company.[1]