Size of Block Valued 2018-03-02T01:11:02+00:00


Issue: Revenue Ruling 59-60 requires, among other things, consideration of the size of the block of stock being valued. This is a very important issue which is often overlooked by valuation consultants.

Discussion: This issue is of particular importance when corporate stock is being contributed to a family limited partnership. In such a situation, the first step is to value the stock of the corporation prior to its contribution to the limited partnership. In doing so, several issues must be considered relative of the size of the block of stock being contributed.

First of all, unless a majority of the stock of the corporation is being contributed to the limited partnership, it will not be valued on a controlling interest basis. Owners of companies often feel justified in gifting, contributing or selling minority interest in their companies for a controlling interest price. This sounds good, but it won’t work. A majority, or controlling interest, price can be justified only if control is being passed both in fact and in form.

Secondly, in most situations, if a minority interest in a corporation is contributed to a limited partnership, then it will be valued at a significantly reduced price per share, compared to a controlling interest price per share. The spread between a controlling interest and a minority interest price per share can easily be in the 35% range (in some situations, up to 70%).

Thirdly, there are at least two other situations which cause valuation aberrations. The first one concerns the value of a block of stock equal to one third of the issued and outstanding stock of the corporation. In this case, the value is not equal to one third of a controlling interest value. This point should be obvious in that one third of the stock does not constitute a majority issue. One the other hand, a one third block is usually worth more that a straight minority interest per share.

The second aberration referred to above concerns swing votes. This situation occurs when there are, in effect, three shareholders owning 49%, 49%, and 2%, respectively. In this situation, one might think that the 2% shareholder is virtually overwhelmed by the other shareholders and that the value of this minority holding would be nil. This is not necessarily the case, however. Consider the situation where the two 49% shareholders disagree as to a course of action. All of the sudden, the 2% shareholder becomes the focus as the swing vote. In such situations, the swing vote can wield tremendous influence, thus increasing the value of this small holding far beyond the minority interest price first indicated.

Application: It is becoming commonplace to see contributions of corporate stock to a family limited partnership. The purpose of course is to reduce gift and estate taxes through additional discounts available through the limited partnership structure. The beginning point, however, is the contribution value of the underlying assets – in this case, stock in a corporation.

If the goal is to gift a significant portion of stock to other family members, then a majority interest should probably be contributed to the limited partnership. In doing so, the contribution value of the contributed shares is at its highest level, allowing for a substantial discount on the limited partnership level and the passage of a maximum amount of control and value at the lowest possible taxable value.

If a minority block were contributed to the family limited partnership the value of those shares is greatly depressed at the point of contribution due to a minority interest discount. This situation is acceptable assuming that the ultimate goal is not to pass controlling interest to other family members. However, if the goal is to pass maximum value and eventual control to one’s heirs, then a majority block of shares should be contributed. It is also important to realize that, where stock valuations are concerned, the sum of the parts does not necessarily equal the whole. In other words, the sum of three one third interests would not equal the controlling interest value of the company. Likewise, a per share minority value times the total issued and outstanding shares would not equal controlling interest value of 100% of the company. Be careful!!! PLAN!!