Adjusting the Comparable-Company Method for Tax Differences When Valuing Privately Held "S" Corporations and Llcs
Journal of Applied Finance, Vol. 12, No. 2, Fall/Winter 2002
Posted: 10 Jul 2003
Participants in the private equity market often use the share prices of publicly traded regular (or C) corporations as bench marks for valuing pass-through entities, such as S corporations and limited liability companies (LLCs). This paper analyzes the tax-related valuation adjustments that are required to account for the different tax status of C corporations and pass-throughs, which are not subject to corporate income taxation. I show that a pass-through entity has the same value in a tax-free corporate acquisition as an otherwise identical C corporation, but that the pass-through entity is more valuable in a taxable acquisition because of the available step-up tax elections. I also show that tax factors cause a minority interest in a pass-through entity to generally be more valuable than the same minority interest in a C corporation. I quantify the pass-through's tax-related valuation premium and show how this premium is related to the tax regime and to the firm's dividend policy.
JEL Classification: G12
Suggested Citation: Suggested Citation