By Jason Thompson, CPA/ABV, ASA, CFE, CFF
Partner and Director of Valuation and Litigation Services
When performing a business valuation, a valuation analyst reviews numerous factors that may impact the resulting value. While the specific factors considered may vary from business valuation to business valuation, Internal Revenue Service (IRS) Revenue Ruling 59-60 identifies certain factors the IRS considers fundamental to analyze when valuing a closely held corporation’s stock.
IRS Revenue Ruling 59-60 was developed to provide guidance for valuing a closely held corporation’s stock, when market quotations are not available, for estate and gift tax purposes. Because this guidance comes from the IRS, it is considered by most valuation analysts as a relevant guidance when performing any valuation engagement.
The following is a discussion of the “Factors to Consider” identified in IRS Revenue Ruling 59-60:
- The nature of the business and the history of the enterprise from its inception – This factor deals with issues like stability or instability, growth or lack of growth, the diversity or lack of diversity of operations, and other facts needed to form an opinion of the degree of risk involved inside the business.
- The economic outlook in general and the condition and outlook of the specific industry in particular – This factor considers the current and prospective economic conditions as of the date of the valuation, both in the national economy and in the industry or industries the business operates within. These factors are issues outside the business that impact risk.
- The book value of the stock and the financial condition of the business – This factor addresses issues like liquidity, reported values of assets, liabilities, working capital and debt, capital structure and net worth. These factors are helpful in identifying financial risk for the business.
- The earning capacity of the company – This factor deals with financial performance and the use of trends in financial performance as predictors for future financial performance. This is another mechanism for identifying the financial risks of the business.
- The dividend-paying capacity – This factor, which differs from the previous factor, addresses the amount of funds flowing through the business to owners and the amount of funds that could reasonably flow through to owners without jeopardizing the financial stability of the business.
- Whether or not the enterprise has goodwill or other intangible value – This factor deals with whether the business has value beyond that of its tangible assets. In many cases, the existence of “excess” net earnings over and above a fair return on the business’ tangible assets is an indication of goodwill or intangible value. In certain situations, the identification of goodwill or intangible value is needed as part of the business valuation.
- Sales of stock and the size of the block of stock to be valued – This factor and the next both address the consideration of known transaction data. In this case, the transaction data is other sales of the subject closely held corporation’s stock. While this information may exist, careful consideration of the terms and the block/position previously transacted is necessary before applying this data in a current business valuation.
- The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter – This factor directs a valuation analyst to consider published transaction data for other companies when valuing a closely held corporation. We refer to this as a Market Approach. The market approach is based on the theory of substitution, meaning that the known value of a business’ stock can serve as a benchmark indicator of value for the subject closely held corporation’s stock.
At Sponsel CPA Group, our team of valuation experts is well versed in not only the factors to consider from IRS Revenue Ruling 59-60, but also many of the other factors that influence the value of a business.
If you have questions about the value of a business or the valuation process, please call Jason Thompson at (317) 608-6694 or email [email protected].