Anyone who’s played the stock market can appreciate the benefit of hindsight. Before investing in a company, who wouldn’t like to know that a hurricane will destroy the business’s primary warehouse, or its technology will become obsolete next year — events that might affect the price knowledgeable investors are willing to pay per share?
Like investing in public stocks, private business appraisal must be based on information available at the time — specifically, on the required date of appraisal, according to Revenue Ruling 59-60. The valuation date is an important cut-off. Valuators generally consider only information that was “known or knowable” on the valuation date.
Business valuation experts cannot benefit from hindsight any more than investors can. But there are exceptions.
In Estate of Jung v. Commissioner, the U.S. Tax Court considered a subsequent sale when valuing a business interest more than a year after Jung’s death. The court concluded, “Actual sales made in reasonable amounts at arm’s length in the normal course of business within a reasonable time before or after the valuation date are the best criteria of market value.”
Jung made an important distinction between subsequent events that affect fair market value and those that provide an indication of value. Within the first category, only reasonably foreseeable subsequent events may be factored into a valuator’s analysis.
But if a subsequent event provides an indication of value, it might be considered — even if it wasn’t foreseeable — as long as it occurs within a reasonable time frame and at arm’s length. A valuator also considers whether intervening facts and circumstances have drastically changed the value of the business since the valuation date.
Several gray areas exist when a valuator handles subsequent events. In some circumstances, an event is knowable yet unknown on the valuation date.
For instance, suppose corporate counsel has confided in the company president about an imminent criminal investigation. Should a valuator factor confidential information, such as a pending criminal investigation, into the value conclusion if it’s undisclosed on the valuation date? In general, unknown subsequent events that would be uncovered during reasonable acquisition due diligence may be considered in an appraisal.
Appraisers consider all subsequent events and rule out some of them when valuing a business. The “known or knowable” benchmark isn’t the only guideline for proper handling of subsequent events. Courts may view actual arm’s-length transactions of a private company’s stock before or after the valuation date as the best indicator of value.
This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. In addition, any discounts are used for illustrative purposes and do not purport to be specific recommendations.