The majority of business valuations do not become a component of litigation. Other than professional litigation support appraisers and appraisers working on valuations for gift or estate taxes, most appraisers don't think in terms of defending their valuation or components of the valuation, such as the DLOM, in court. Yet many valuations do become evidence in court proceedings, sometimes years after the valuation report has been delivered. Certainly one of the most challenged aspects of valuations in recent years has been the DLOM. The DLOM is a major concern of the IRS (See Discussions on DLOM, "The Job Aid for IRS Valuation Professionals"). The following checklist was developed from the many court decisions, from both the Tax Court and the appellate courts, that found one party's (or both parties') evidence and/or development process of the DLOM to be lacking.

1. Your DLOM, like the rest of your valuation, must take into account all of the factors that influence the operation and success of the underlying business, as well as the liquidity and marketability of the subject business interest, including the so-called Mandelbaum factors:
   • The value of the subject corporation's privately traded securities vis-a-vis its publicly traded securities (or, if the subject corporation does not have stock that is traded both publicly and privately, the cost of a similar corporation's public and private stock);
   • An analysis of the subject corporation's financial statements;
   • The corporation's dividend-paying capacity, its history of paying dividends, and the amount of its prior dividends;
   • The nature of the corporation, its history, its position in the industry, and its economic outlook;
   • The corporation's management;
   • The degree of control transferred with the block of stock to be valued;
   • Any restriction on the transferability of the corporation's stock;
   • The period of time for which an investor must hold the subject stock to realize a sufficient profit;
   • The corporation's redemption policy;
   • The cost of effectuating a public offering of the stock to be valued, e.g., legal, accounting, and underwriting fees.ⁱ

   This view has been reinforced by numerous court decisions, including Berg, where the court commented, "...the valuation of the appropriate discounts must take into account all relevant facts and circumstances of the particular corporation at issue," and "Because of his analysis of specific factors related to the value of the decedent's interest in [the subject company], [the IRS' expert's] methodology is convincing and superior to that of petitioner's expert witnesses."ⁱⁱ

   [Ed: Note the references to "corporation" in the foregoing and remember to substitute the appropriate form of business for your valuation, noting the impact the form of business (FLP, LP, LLC, etc.) may have on marketability, such as the Tax Effect issue in Grossⁱⁱⁱ.]

2. Don't "borrow" a DLOM range or value from a court case unless the underlying facts of the subject interest closely match those of the case. Otherwise, the court is likely to disregard your DLOM. As the court stated in Peracchio, "To the extent [the expert] believes that the benchmark range of discounts we utilized in Mandelbaum v. Commissioner, supra, is controlling in this or any other case, he is mistaken." See also Berg^v.
3. Carefully document the factors and empirical data that went into the development of the DLOM, or risk the Court finding the other party's explanation and data to be more persuasive. In Okerlund, the court remarked, "...we are troubled by the lack of any clear connection between the [expert's] reports' general discussion of restricted stock and pre-IPO studies and the marketability discounts applied to the [company] subject interests.^vi, See also True, "As noted, the estate's experts based their minority and lack of marketability discounts on general studies and not on the facts of this case"^vii and Thompson^viii. Wherever possible, use data from transactions from a time period close to the valuation date. See Dallas, where the court noted, "We believe [the expert] should have used the discount studies from the period that includes the transactions at issue.^ix
4. While appraisers are always expected to prepare a valuation in accord with the purpose of the valuation, appraisers should bear in mind the requirements of state statutes that specify how a business interest is to be valued. State courts have found repeatedly that a minority discount or DLOM may not be appropriate in such cases as statutory appraisals^x and dissenting shareholders^xi. Similarly, if issues of control affect the DLOM, be aware of state laws that control such issues as partition of a business interest^xii. State statutes may also impact the DLOM in the tax court, as the effect of state law transfer restrictions on the interests in True^xiii.
5. If you have previously prepared another valuation, especially with a DLOM, on the subject business interest or the underlying business itself, you may need to explain the factors and methodology that resulted in a different valuation or risk having your present valuation and DLOM questioned. See Gallo, where "The Court permitted respondent to cross-examine [taxpayers' experts] with regard to the earlier reports to uncover any inconsistencies in methodology with their later reports."^xiv See also Litchfield^xv
6. Be certain that any restrictions on sale of interests that are factored into your DLOM binds the interests themselves and not the present owner. If the owner dies, the restrictions would not affect the next owner. See Foster, where the court stated, "...because the restrictions applied only to decedent, not the underlying assets of the trust themselves."^xvi
7. If you have applied a discount for minority control and a DLOM, beware of an overlap and be sure that the two discounts are not combined. The courts view these as distinct, as the court noted in Andrews, "In their arguments, neither petitioner nor respondent clearly focuses on the fact that two conceptually distinct discounts are involved here, one for lack of marketability and the other for lack of control."^xvii Be aware that more than once the Tax Court has found the combined value to be too high, as in Litchfield, where the court commented, "We, however, regard the estate expert's ... marketability discounts, particularly when combined with the ...lack of control discounts we allow, to be high."^xviii See also Judge Laro's 2003 presentation^xix and Hess^xx.
8. Resist the urge to find a special group of investors to justify a DLOM different than that required for the hypothetical investor. This approach has been rejected not only by the Tax Court in Heck^xxi, but also by the 9th Circuit in Simplot^xxii. In Gallo, the court dealt with the IRS contention that the purchaser should be presumed to be a member of the family thusly, "Respondent is desperately reaching for some support for the unsupportable."^xxiii
9. Avoid reliance on previously published (or benchmark) studies, such as pre-IPO studies, as the courts have shown an increasing unwillingness to rely on aging data and discounts drawn on studies vs. the facts of the case, as in Thompson^xxiv. Be aware that using such studies may also introduce a range of discounts the court can draw on to select a DLOM adverse to your client's interests.
10. Note that an exposure to capital gains tax for the subject company may result in a higher DLOM, although the actual amount may be disputed, as the tax court noted in Estate of Luton^xxv, and quoted itself in Davis, "NOTWITHSTANDING THE POTENTIAL ELIMINATION OF ANY CORPORATE LEVEL TAX, WE DO RECOGNIZE THAT SOME DISCOUNT IS IN ORDER. WE BELIEVE SUCH DISCOUNT IS APPROPRIATELY CONSIDERED IN THE DISCOUNT FOR LACK OF MARKETABILITY."^xxvi (emphasis by the court).
11. If you favor pre-IPO studies as determinative of marketability discounts, you may wish to develop one of your own. Bear in mind that pre-IPO studies, both previously published and developed by the appraiser, have come under attack repeatedly, as in McCord^xxvii.
12. Use a restricted stock study in developing and supporting a DLOM. The Tax Court has found such studies to be probative in determining a DLOM, as in McCord^xxviii and Peracchio^xxix. The Mandelbaum^xxx court, in addition to its stress on factors (above) used one of the appraiser's restricted stock studies in determining its DLOM. Be sure to document the criteria used for selecting companies for your study and analyze the data from these companies as they relate to the subject business interest, or you run the risk of the court rejecting your conclusion. As the court noted in Lappo, "We are unpersuaded that these [selected] companies are comparable to the [subject company]".^xxxi The court made a similar comment in Deputy, where the court noted, "Neither party's expert attempted to persuade us to rely or not to rely on the various studies he referenced."^xxxii See also Peracchio, where the court commented, "While restricted stock studies certainly have some probative value in the context of marketability discount analysis, see, e.g., McCord v. Commissioner, 120 T.C. at 390-393, [the expert] makes no attempt whatsoever to analyze the data from those studies as they relate to the transferred interests."^xxxiii Finally, note that the Tax Court has stated that "as similarity to the company to be valued decreases, the number of required comparables increases'."^xxxiv

Because, as we noted above, the IRS is very focused on DLOMs in valuations, if there is a tax consequence of your valuation, it has a greater opportunity to be challenged—perhaps in court. It is certainly not our role to suggest how to construct your DLOM, but simply to point out those approaches to a DLOM that have drawn the ire of one court or another, along with some that have received support. Many of the cases mentioned in our not-exhaustive list illustrate appraiser approaches that have been criticized by the court, which is a learning opportunity for us all. As Brandon Mull, author of Fablehaven, noted, "Smart people learn from their mistakes. But the real sharp ones learn from the mistakes of others."