The Impact of Valuation Errors on Estate Planning | Arxis Financial, Inc.

Type of Matter:

A large closely-held business had engaged expensive attorneys and valuation experts to facilitate a complex multi-year and phased gifting and estate plan commensurate with a large estate.  The first five years into the implementation of the plan produced unusual results and the forecasted long-term results of a fully implemented gifting plan caused the board of directors to seek a second opinion.

Background:

Arxis Financial was retained to prepare a current valuation and to prepare analysis of the previous reports and calculate values as of the previous dates using current assumptions. The board of directors had obtained two valuations over the five years of the plan. The company value dropped over 20% between those two valuation dates even though there had been little change in the operations. The board retained Arxis Financial to review prior valuation reports to provide affirmation of the value conclusions and the methodologies employed to arrive at the values.

Arxis Work:

Arxis Financial was retained to prepare a current valuation and to prepare analysis of the previous reports and calculate values as of the previous dates using current assumptions. We found several anomalies that clearly demonstrated that the company was being vastly overvalued and that the estate plan was completely overblown for the size of the business.

The valuation errors ranged from basic mistakes to subjective judgments that vastly misstated the reality of the business enterprise and the fractional interests being valued/gifted:

  • An after-tax risk rate was used to value pre-tax income. This is a common error that results in a theoretically inaccurate conclusion.
  • Risk rates (capitalization and discount) appropriate to value very large public companies were used to value the income of a comparatively tiny company.
  • The appraiser added back marketable securities held by the company as non-operating assets without asking management about the investments. Management inquiry would have prevented that mistake.
  • Discounts for lack of control and marketability for fractional interests in the business were negligible.

Result:

Arxis Financial’s conclusion was that the business was overstated by more than 300%. As a result the complex gifting plan was abandoned, multiple prior gift tax returns were amended, and the estate plan was restructured to more reasonably reflect the size of the estate.