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Which Door to Take?

I can’t resist one last visit to the font of valuation nuggets that is the recent case of James F. Kress and Julie Ann Kress, v. United States of America, (Case No. 16-C-795, United States District Court Eastern District of Wisconsin, March 25, 2019).

 

In this case, the court was faced with a Let’s Make a Deal scenario when it came to the discount for lack of marketability (“DLOM”) that was applicable to the gifts made by Mr. & Mrs. Kress of non-controlling interests in Green Bay Packaging Inc. (“GBP”). GBP was a substantial family-owned company with over $1.3 billion in revenues that paid out distributions ranging from $15.6 million to $74.5 million per year between 1990 and 2009. In classic game show fashion, the court was presented with three opinions on the appropriate discount.

  • Behind Door #1 was the discount as determined by the expert retained by the IRS – a relatively low 11.2% based on the costs that would be incurred to obtain liquidity for the shares in question through an IPO.
  • Door #2 hid taxpayer’s expert #1’s opinion of a discount of 20% - which used restricted stock and pre-IPO studies and adjusted the discount to reflect qualitative factors related to Green Bay Packaging
  • Door #3 concealed the highest proposed discount of 28% proposed by taxpayer’s expert #2 using a similar methodology to taxpayer expert #2

 

In true game show style, I should now pause for a long time to build up the maximum dramatic effect before revealing how the court ruled…this is hard to do through the medium of an e-mail. I could just stop here, leaving you on a classic cliffhanger until next month. But probably its better for you just to imagine that we have cut to a commercial break….OK – now that’s done, back to the show…

 

The court rejected the IRS discount  - it was too low since the company did not expect to go public and the discount did not reflect the true difficulty of selling an interest in a company like GBP.

 

I would like to give you definitive reasons why the court did not accept the 20% discount – but it did not, choosing instead to endorse the methodology behind the 28% discount. The court was persuaded by taxpayer expert #2’s approach to all aspects of the valuation and adopted the discount as part of its bromance with this expert.

 

In this case, the taxpayer walked off with the star prize – a low value for the gifts which was a great takeaway for them….but what are the takeaways for us? First, the idea that IPO costs can provide evidence for a DLOM for a non-controlling interest was well and truly squashed (although this may be relevant for a DLOM for a controlling interest). Second, the discount was fairly high despite the fact that the company had made significant distributions – normally regular cash flows to shareholders are regarded as lowering the applicable discount on the basis that cash in hand keeps shareholders fairly happy). Third, it's important to note that no separate discount for lack of control was applied which is in line with current valuation theory for operating companies– in this case, the DLOM reflects the non-controlling aspects of the shares.

 

Despite my earlier comments, I will in fact leave you with a cliffhanger – can I squeeze any more e-mails out of the Kress case? Tune in next month to find out!