BUSINESS VALUATION: Valuing the Operations and Assets of Privately Held Companies

By Raymond J. Dragon, ASA

What do business valuation (“BV”) experts do?
Business valuation experts value companies that are privately held (not publicly traded). The value of a publicly traded stock can be found by looking at its price in the stock market. For a privately held company, the BV expert is acting in the role of the market. BV experts also value partial interests in companies or partnerships and the intangible assets of a company, such as customer relationships, intellectual property, and trade names. Many also provide forensic accounting, litigation support and expert witness testimony for disputes.

Why do executives hire BV experts?
Executives and business owners hire BV experts at critical points in a company’s history. Those events include:

  • buyout of a major shareholder or partner
  • disputes over the value of a business when the owner is getting divorced
  • estate and gift tax planning
  • acquisition or sale of a business
  • strategic planning and benchmarking to increase the value of the business
  • valuing stock options and deferred executive compensation arrangements (especially in start-up companies)
  • litigation over economic damages to a business
  • fair value reporting under Generally Accepted Accounting Principles

What are the major issues in private company valuation that might not apply to public company stocks?
The several issues that need to be considered are:

  • separating the income a business owner gets for working in a business from the income received from owning the business
  • separating the value of the business from the value of the real estate if the business owns the building from which it operates
  • removing non-business expenses and separating out the value of non-business assets
  • determining whether related-party transactions and expenses, such as rents and salaries, are at market rates
  • separating the income attributable to physical assets from the income attributable to intangibles, such as trade names or technology
  • determining discounts for lack of control and lack of marketability for partial interests
  • determining the appropriate standard and premise of value

Do I need audited financial statements when undergoing a business valuation?
No. The BV expert often works from tax returns and internal general ledgers. Even audited financial statements, however, might not represent true economic income. The BV expert will use his forensic accounting skills to adjust the financial statements. Doing so might include converting cash basis accounting to accrual accounting, removing non-business expenses from the financial statements (vacation houses, etc.) and adjusting expenses that are not at market rates (family employees who are under- or over-paid, etc.). Then the true economic income of the business is revealed, which is one foundation of its value.

What are “standards of value” and “premises of value?”
The standard of value is the set of rules under which the business is being valued. Usually this is fair market value in valuations for transactions or tax purposes. In certain cases, such as shareholder disputes and divorce valuations in New Jersey, the standard might be fair value. The premise of value reflects the operating condition of the business. It usually is going concern value, but might be liquidation value or another premise in certain circumstances.

What is the discount for lack of control (“DLOC”)?
A DLOC is a discount applied to the value of a partial interest in a business to reflect that the owner of the interest does not have 100 percent voting control regarding the decisions made by management.

What is the discount for lack of marketability (“DLOM”)?
A DLOM is a discount applied to the value of a privately held business to reflect that it usually cannot be sold as quickly or easily as stock in a publicly traded company. Many privately held companies and
partnerships have restrictions on the sale of interests to people outside the original investor group.

Why are DLOMs and DLOCs important?
Applying these discounts will make a partial interest worth less than its prorated share of the whole. That can generate significant tax savings in estate and gift planning.

This blog reprinted by permission of the author. It was originally published with the same title in the Best Practices section of’s (201) Executive magazine.

Paintings Undervalued By $1.77 Million In Estate Tax Case

By Lynn Magnusson, ASA with Becky Lipnick

At the AuctionIf the IRS determines that you gave them a misleading appraisal report, expect to pay.  In Estate of Kollsman v. Commissioner, the Tax Court found that the evaluation used for the Estate’s taxes was off by $1.77 Million. What went wrong?  The Estate expected a Sotheby’s auction house specialist would satisfy the IRS’s appraisal requirements. However, it was found that the expert’s valuations were “lowballed” in order to secure the future sale of the works.

Two Old Master Paintings

The Estate of Kollsman possessed two 17th Century Old Master paintings, one created by Pieter Brueghel the Younger and the other by either Jan Brueghel the Elder, Jan Brueghel the Younger, or a Brueghel studio.  A Sotheby’s specialist examined the two paintings, evaluated them for $500,000 and $100,000 respectively, and offered to have Sotheby’s sell the works at auction. The Executor then submitted the specialist’s appraisal with their estate tax reports.

The Tax Courts found that the Sotheby’s specialist “had a significant conflict of interest.”

The fact that Sotheby’s is an auction house significantly hurt the Estate’s case. Because the specialist would receive commission rewards for procuring the consignment and Sotheby’s Auction House would benefit from the sale of the paintings, the Tax Court found “a significant conflict of interest.” Additionally, the Court determined that the specialist “had a direct financial incentive to curry favor with [the executor] by providing ‘lowball’ estimates that would lessen the Federal estate tax burden borne by the estate.”

The IRS first issued a notice of deficiency asserting values of $1.75 million and $300,000.  After the Estate’s filed its petition, the IRS revised the values to $2.1 million and $500,000.  Sotheby’s sold the Elder’s painting for over $2.4 million.  Nonetheless, the specialist did not adjust his valuation opinion.

Dance around the Maypole by Pieter Brueghel the Younger
Dance around the Maypole by Pieter Brueghel the Younger, courtesy of Sotheby’s
Exaggerated Condition Issues

The appraisal noted the works were dirty and there were risks involved in cleaning them. The specialist lowered the fair market value of the works because of their “dirtiness.” However, the Court noted that the paintings were cleaned with relative ease. Sotheby’s also did not raise these concerns with the Estate when they were pitching to gain the consignment. According to the Commissioner’s case, Sotheby’s valuation report did not seem to match reality.

The IRS has its own experts

The IRS relies upon the expertise of its own, unbiased team of appraisers, the Art Panel, to review suspicious appraisals. With the help of these appraisers, the Tax Court determined that the Estate of Kollsman were off in their estate tax valuation by 1.77 Million, nearly four times the amounts they reported.

Auction house estimates are not appraisal reports

Clients are often confused when the Fair Market Value in my appraisal differs from an auction house estimate. I explain to them that an auction house establishes auction sales estimates, typically a range of values, to procure consignments and encourage bidding.  My duty as an independent appraiser is to give them an objective Fair Market Valuation, reinforced by comparable, recent sales data. Sometimes they are not the same.

An appraisal report prepared in compliance with the Uniform Standards of Professional Appraisal Practice (USPAP), the generally recognized performance standards for the appraisal profession in the U.S., includes a certification that the opinions expressed in those reports are the appraiser’s unbiased professional opinions, and that the appraiser has no present or prospective interest in the property being appraised or personal interest with respect to the parties involved (or if such interests exist, they must be disclosed). These certifications serve to clarify the parties’ relationship and create a paper trail that can help estates avoid problems down the road.

This blog reprinted by permission of the author. It was originally published as Paintings Undervalued By $1.77 Million In Estate Tax Case.

How Does The IRS Define A “Qualified Appraiser?”

By Lynn Magnusson, ASA with Becky Lipnick

IRS Qualified AppraiserMany households donate personal property like clothing, furniture, artwork, or collections to a non-profit organization in order to take an income tax deduction. If you need to consult an appraiser for your personal property donation, shouldn’t that appraiser meet IRS standards?

IRS Publication 561 defines a “Qualified Appraiser” for the purpose of evaluating charitable donations.

The IRS Definition Includes These Requirements
  • Accredited by a recognized professional appraiser organization.
  • USPAP-Compliant: Follows the Uniform Standards of Professional Appraisal Practice, which Congress authorized the Appraisal Foundation to define.
  • Professional: Regularly prepares appraisals for a fee.
  • Competence: Is an expert examiner of the type of item in the appraisal.
  • Preferred Providers: Insurance companies have preferred providers for appraisals (i.e., The Magnusson Group is a Preferred Provider for Chubb and AIG).
  • High-Quality References from your peers and previous clients. Because personal property appraisers are not licensed, like real estate appraisers, by a state agency, you should ask a trustworthy colleague or professional for a recommendation.
What Does It Mean To Be Accredited?

You can trust an appraiser who is accredited by one of the top three national and international associations offering accreditation. They are the ASA (American Society of Appraisers), AAA (Appraisers Association of America), and the ISA (International Society of Appraisers).

To achieve accreditation from these organizations, an appraiser must pass a series of tests in core subject areas:

  • Appraisal methodology
  • Connoisseurship in a specialization area
  • Report writing
  • Professional standards, i.e., USPAP
  • IRS guidelines

All Certified or Accredited Members of the top professional organizations are required to take a prescribed minimum number of hours of Continuing Education to retain membership in good standing.  For the ASA, 100 hours are required every five years!

Some appraisers (myself included) obtain additional credentials in particular sub-specialties. And Gems & Jewelry appraisers who are designated Master Gemologist® Appraisers also must take precious stone and jewelry exams on a regular basis to remain current.


USPAP: Uniform Standards of Professional Appraisal Practice.  A set of standards for valuing anything.

  • The Appraisal Foundation and Congress established mandatory industry standards — USPAP — in response to the 1980’s Savings and Loan Crisis.
  • USPAP governs appraisals of businesses, real estate, machinery & equipment, in addition to personal property.
  • USPAP is revised every 2 years. Therefore, an appraiser must re-qualify every 2 years by completing USPAP update course and passing an exam on the current standards.

In general terms, USPAP covers the following aspects of appraisal practice:

  • Ethics
  • Scope of work
  • Records retention
  • Purpose & use
  • Defining and analyzing market data

This blog reprinted by permission of the author. It was originally published as How Does The IRS Define A “Qualified Appraiser?” 

So … What is Personal Property?

By Lynn Magnusson, ASA with Becky Lipnick

What is Personal PropertyCommon definitions of personal property often include “movable property; belongings exclusive of land and buildings…Any asset other than real estate.” After 20 years in the business, I find that the definition most people immediately understand is the simplest: “Stuff.” The only danger with this definition is that people often have a preconceived notion of their “stuff’s” value. Some underestimate, while others overestimate the monetary value.  Just look at these different examples of what you can own!

As you can see, there are a lot of types of personal property. And, the same type of item can vary drastically in price: Someone selling a “car” could have a $100 junker or the latest Tesla. “Stuff” can sell for six-figures or pocket change, depending on the particular items’ characteristics of value. How can you tell what your collection is worth, if you aren’t sure?

Call the Magnussons! 973-425-1550

This blog reprinted by permission of the author. It was originally published as So … What is Personal Property?