IRS Revenue Ruling 59-60 describes the rules that define what constitues an acceptable (for IRS purposes) business valuation. Many courts also require that the valuations presented there follow these standards too. If you need a valuation that will be used to calculate tax liability or in court, the 59-60 standard is the way to go.
The numbers 59-60 refer to the year the rule was first used (1959) and the number of the ruling in that year (60). Internal Revenue Code (IRC) 59-60 states that valuations used for tax purposes should address the following:
- The nature and history of the business
- The general economic outlook and the conditions of the specific industry
- The book value of the stock
- The financial condition of the company
- The earnings capacity of the company
- The dividend paying capacity of the company
- Whether the company has goodwill or other intangible value
- Previous sales of stock
- The market price of publicly traded companies who are engaged in the same or similar lines of business
Some other items to consider are:
Historical Performance
The past and future earnings power of a business is often the single most significant factor in the valuation of a business. The quality and completeness of the company’s accounting and financial records also have a significant impact on the valuation. An incomplete set of financial records will cause the valuator to have to make significant “normalized” adjustments to reflect the true financial position of the company.
Company Management
The quality and depth of management is obviously a critical factor in the value of a business.
Company Ownership
The size of the ownership interest being valued has a significant impact on the valuation. A minority interest in a business might have to be adjusted for a lack of control discount, while a controlling interest may be given a premium for having control.
Conditions of Operations
The physical aspects of a business are important as well. A company with current systems and new equipment will have a higher value than a company that has deferred investment in infrastructure and equipment for several years.
Proprietary Products and Services
Proprietary products, services or processes add significant value to a business. These legal rights can insulate a company from its competition and allow it to charge higher prices in the market.
Industry
The macroeconomic condition of the company’s industry is also an important consideration in a business valuation. A company in a high growth industry will have a higher value than a company in a mature industry.
Competition
As all business owners know, the company’s position in the competitive marketplace has a significant impact on the overall financial performance of the business. Valuators put a great deal of stock in market share and on the basis in which the company competes in the markets that it operates in.
Government Regulation
As laws change so do their effects on businesses. Unfortunately many laws and regulations are designed for Fortune 1,000 companies. As an example, General Electric may be able to easily comply with certain environmental laws, but these same laws may be a significant burden to a small business. The valuation must consider these regulatory roadblocks.
The Valuation Report
While every valuator will write and present their reports a little differently, a valuation report the IRS will consider acceptable should have the above components. Many courts follow this standard too. It is very important that your valuator follow these standards or your valuation may be rejected by the IRS or the court.
