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Articles From Lumsden McCormick

Should Subsequent Events Be Factored into the Valuation Equation?

When valuing a business interest for federal transfer tax purposes, it's usually taboo to consider events that happen after the valuation date, but there are two important exceptions to this general rule: 1) subsequent events that are “reasonably foreseeable,” and 2) unforeseeable subsequent events that provide an “indication” of value. Here's a summary of the tax guidance and a recent IRS private letter (PLR) ruling on this issue.

Valuation Basics

When determining the fair market value (FMV) of an interest in a business for federal transfer tax purposes, FMV is “the price that a hypothetical willing buyer would pay a hypothetical willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.”

For public companies, a fundamental indicator of FMV is the stock's selling price on the date of transfer. However, there are times when the public stock price might not represent FMV, and the valuation expert needs to make “some reasonable modification of the value” based on relevant facts.

The principle that the hypothetical willing buyer and seller are presumed to have reasonable knowledge of relevant facts affecting the value of business interest applies even if the relevant facts at issue were unknown to the actual owner of the property or the public at large.

Both parties are presumed to have made a reasonable investigation of the relevant facts. So, in addition to facts that are publicly available, reasonable knowledge includes those facts that a reasonable buyer or seller would uncover during the course of private negotiations over the property's purchase price. In other words, during due diligence procedures, a hypothetical willing buyer is expected to ask the hypothetical willing seller for information that's not publicly available.

Subsequent Events

Subsequent events may be considered when valuing a business if they're “reasonably foreseeable” and relevant to the question of value. Some examples of potentially relevant subsequent events are:

  • A pending offer to purchase the business or an interest in the business,
  • A bankruptcy filing,
  • The emergence of new technology or government regulations,
  • A natural or human-made disaster,
  • A pending legal investigation or lawsuit,
  • An initial public offering, and
  • The loss of a key person or major contract.

Not all of these examples would be reasonably foreseeable. For example, you probably couldn't predict when your company will be affected by a fire, a data breach or a terrorist attack.

A subsequent event that's unforeseeable as of the valuation date also may be considered if it provides an indication of value. However, it generally must be within a reasonable period and occur at arm's length.

PLR 201939002

A recent PLR addresses the issue of whether subsequent events are fair game with determining FMV for federal gift tax purposes.

The taxpayer who requested it had transferred shares of a public company's stock to a newly formed grantor retained annuity trust (GRAT). After the date of the transfer, the subject company merged with another company. After the merger was announced, the company's stock price increased. The increase was, however, less than the agreed merger price.

The merger came about after extensive M&A negotiations with multiple parties. The IRS reviewed the underlying transaction documents from the year preceding the merger. Those documents include the company's board meeting minutes, as well as an exclusivity agreement and various correspondence between the merger parties.

Based on these documents, the IRS concluded that, as of the valuation date, a hypothetical willing buyer of the stock could have reasonably foreseen the merger and anticipated that the company's stock would trade at a premium when it was announced and consummated. On the date the stock was transferred to the trust, the merger was “practically certain” to go through. As a result, the IRS ruled that value of the company's stock must account for the pending merger.

Because the publicly traded stock price doesn't represent FMV on the valuation date, other relevant facts and elements of value must be considered. Specifically, a hypothetical willing buyer and willing seller would have been “reasonably informed” during the course of M&A negotiations and would have knowledge of all relevant facts, including the pending merger. The IRS concluded that “to ignore the facts and circumstances of the pending merger would undermine the basic tenets of [FMV] and yield a baseless valuation.”

Important: A PLR is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer's represented set of facts. It's typically used when a taxpayer wants to confirm with the IRS's Chief Counsel that a prospective transaction won't result in a tax violation. It may not be relied on as precedent by other taxpayers or by IRS personnel.

Got Questions?

When you hire a business valuation expert, it's important to share all information that could potentially be relevant to the value of the business. This includes information about subsequent events that affect value or provide an indication of value. Once the valuation expert is aware of this information, they can determine whether it's appropriate to consider when valuing the business interest. Contact Bill Allen, CPA/ABV, CFE for further advice.

Should Subsequent Events Be Factored into the Valuation Equation?

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Bill is a partner with Brisbane Consulting Group Business Valuation Division, providing business valuation, forensic accounting, and litigation support services. His valuation experience includes the valuation of closely held companies, covering a wide range of industries and engagements including: marital dissolution, dissenting shareholder disputes, estates, and gift tax planning, merger/acquisition, and due diligence reporting.


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