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11.2 Overview of Business Valuation Techniques
The foundations of business valuation techniques and practice lie in the tax law, as it has long been necessary to value businesses for estate and gift taxation. Though over 50 years old,The first two digits in a Revenue Ruling number signify the year of issue. Thus, Revenue Ruling 59–60 was issued in 1959. Revenue Ruling 59–60 is still recognized by professionals and by the courts as an important source of standards for valuation. Section 1 of the Ruling states its purpose:
The purpose of this Revenue Ruling is to outline and review in general the approach, methods, and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes. The methods discussed herein will apply likewise to the valuation of corporate stocks on which market quotations are either unavailable or are of such scarcity that they do not reflect the fair market value.
Subsequent rulings enhance and expand these basic standards:
- Revenue Ruling 65-193 clarifies that the procedures outlined in RevRul 59-60 apply to intangible as well as tangible assets.
- Revenue Ruling 68-609 extends the provisions of RevRul 59-60 beyond estate and gift taxation to any type of business interests and any tax purpose, and provides a “formula approach.”
The basis for business valuation is the familiar concept of fair market value, which is defined in Section 2.02 of RevRul 59-60 as follows:
Fair market value [is] the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.
This definition remains the common definition of fair market valueThe price negotiated by well-informed, willing, and able buyers and sellers who are not compelled to act.: the price negotiated by well-informed, willing, and able buyers and sellers who are not compelled to act.