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June 2017 | Issue 86 Background Constellis Group,  Inc. is a private security firm.  In December 2013, the Company formed an Employee Stock Ownership Plan (“ESOP”), which purchased 100% of Constellis’s voting stock.  Wilmington Trust NA was named Trustee of the ESOP.  Less than a year after the ESOP was created, the ESOP sold all […] More...


March 2017 | Issue 85 Introduction Richard and Steven Parker are brothers who ran a flower business in Scotch Plains, New Jersey.  Richard is the President of Parker Interior Plantscapes (“PIP”), which installs and services plants and flowers in commercial settings.  Steven is the President of Parker Wholesale Florists (“PWF”), which is a garden center.  […] More...

Dell Appraisal Spawns a Multitude of Valuation Approaches

February 2017 | Issue 84 Introduction A Delaware Chancery appraisal case involving computer company Dell Inc. gave rise to a multitude of valuation measurements.  It is instructive to see how the court sorted through them in coming up with its final appraisal conclusion.  The case is In re Appraisal of Dell Inc., 2016 Del. Ch. LEXIS […] More...

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Estate of Gallagher is a Valuation Tutorial

August 2011 | Issue 53


A recent opinion by the U S Tax Court, Estate of Gallagher v. Commissioner (T.C. Memo. 2011-148, June 28, 2011), deals with  a full range of the issues frequently  encountered in valuing a privately-held company for estate tax purposes.  We’ll comment on a few of the highlights of the opinion and the lessons that they teach for appraisers.

The Valuation at Issue

The IRS determined a deficiency of $7,000,000 in Federal estate tax due from the estate of Louise Gallagher.  The deficiency arose out of a difference of opinion between the IRS and the estate over the fair market value as of July 5, 2004 of 3,970 units of Paxton Media Group, LLC (“PMG”) included in the decedent’s gross estate.  These units represented 15% of the total units outstanding.  Paxton, privately held, is the publisher of a chain of newspapers.

Positions of the Parties

Each party had a valuation expert.  The estate’s expert valued the interest at $7,100 per unit or $28,200,000.  The IRS’s expert valued the units at $10,293 each, or $40,863,000 for the interest.

Both appraisers employed the Discounted Cash Flow (DCF) approach to performing a valuation.  The IRS also applied a market approach employing market data about publicly-traded newspaper publishing companies.

Adjustments to Income Statements

Both appraisers made adjustments to the income statements to remove items of income that they believed to be “nonrecurring.”  Included among the income statement adjustments made by the estate’s appraiser were a $700,000 gain from a life insurance policy and a $1,100,000 positive claim experience from self-insured health insurance.  Both of these adjustments had the effect of reducing the value conclusion reached by the estate’s appraiser.

The Court rejected both of these adjustments because the appraiser “provides no explanation as to why the gains were nonrecurring.”

The estate’s appraiser also made a number of other adjustments which the Court similarly rejected, saying, “(b)ecause we fail to understand his adjustments, we shall disregard them.”

The lesson here for appraisers is clear; explain your adjustments, thoroughly.

The Guideline Company Method

The guideline company method is a market-based valuation method that estimates the value of a company by comparing it to similar public companies.  Both appraisers considered using a guideline company analysis.    The estate’s expert concluded that he would not use the method because no companies existed that were sufficiently similar to PMG.

The IRS’s appraiser zeroed in on four public newspaper companies, calculated their price-earnings multiples, adjusted them, and applied them to PMG’s earnings.  After making an adjustment for lack of marketability, he went on to ascribe a 50% weight to the guideline company approach in arriving at his valuation conclusion.

The court took exception to his use of the guideline approach, for the following reasons:

  • The number of comparables was too small,
  • PMG was considerably smaller than the guideline companies,
  • PMG, alone in the group, had no Internet news component,
  • PMG had a higher historic  growth record than the median of the guideline companies, and
  • PMG was more highly leveraged than the median of the guideline companies.

The Court concluded as follows; “We find that Mr. (……) improperly relied on the guideline company method because the four guideline companies alone were not similar enough to PMG to warrant its application.”

It is seldom possible to find multiple perfect comparable companies. Therefore, there is always a risk that a judge will throw out a valuation based on guideline companies on the grounds that he deems them to be “not comparable.” An appraiser should, therefore, if possible, back up a comparable company analysis with one or more alternate approaches.

Subchapter S Tax Adjustment

PMG was a pass-through tax entity, not itself subject to income taxes.  Since much of the data on which a stock valuation is based is derived from publicly-traded C corporations, appraisers often adjust (or “tax affect”) an S corporation’s earnings to reflect the taxes that might be payable on its earnings if it were to be acquired by a C corporation.

The estate’s expert assumed a 39% tax rate on the company’s earnings in calculating PMG’s future cash flow.  The IRS’s expert, on the other hand, did not apply a tax rate, assuming that the entity would pay no income taxes.  Needless to say, this adjustment, or lack thereof, had a considerable impact on the level of projected cash flow.

The court noted that the estate’s expert had failed to explain his reasons for tax affecting PMG’s earnings.  Absent an argument for such tax affecting, the court also declined to do so, saying, “the principal benefit enjoyed by S corporation shareholders is the reduction in their total tax burden, a benefit that should be considered when valuing an S corporation.  Mr. (….) has advanced no reason for ignoring such a benefit, and we will not impose an unjustified fictitious corporate tax rate burden on PMG’s future earnings.”

Once again, an appraiser was deprived of a proffered adjustment as a result of his failure to explain it to the judge’s satisfaction.


The court reached its final conclusion by performing its own discounted cash flow analysis.  This produced a value of $8,212 per unit or $32,602,000 overall.

This case is a study on the importance of providing the court with a clear and convincing explanation of the assumptions and arguments you have employed in carrying out a business appraisal.  If you don’t fully explain your line of reasoning, you give the judge an easy way to disregard it.