The Kress Case #3

Which Door to Take? Monty Hall and the Discount for Lack of Marketability…
July 14, 2020

I can’t resist one last visit to the font of valuation nuggets that is the recentcase of James F. Kress and Julie Ann Kress, v. United States of America,  (CaseNo. 16-C-795, United States District Court Eastern District of Wisconsin, March25, 2019).

Inthis case the court was faced with a Let’s Make a Deal  scenario when it came to the discount for lackof marketability (“DLOM”) that was applicable to the gifts made by Mr. &Mrs. Kress of non-controlling interests in Green Bay Packaging Inc.(“GBP”). GBP was a substantial family owned company with over $1.3 billion in revenues that paid outdistributions ranging from $15.6 million to $74.5 million per year between 1990and 2009. In classic game show fashion, the court was presented with threeopinions on the appropriate discount.

Behind Door #1 was the discount as determinedby the expert retained by the IRS – a relatively low 11.2% based on the coststhat would be incurred to obtain liquidity for the shares in question throughan IPO.

Door #2 hid taxpayer’s expert #1’s opinion of adiscount of 20% - which used restrictedstock and pre-IPO studies and adjusted the discount to reflect qualitativefactors related to Green Bay Packaging

Door#3 concealed the highest proposed discount of 28% proposed by taxpayer’s expert#2 using a similar methodology to taxpayer expert #2

Intrue game show style I should now pause for a long time to build up the maximumdramatic effect before revealing how the court ruled…this is hard to do throughthe medium of an e-mail. I could just stop here, leaving you on a classiccliffhanger until next month. But probably its better for you just to imaginethat we have cut to a commercial break….OK – now that’s done, back to the show…

Thecourt rejected the IRS discount  - it wastoo low since the company did not expect to go public and the discount did notreflect the true difficulty of selling an interest in a company like GBP.

Iwould like to give you definitive reasons why the court did not accept the 20%discount – but it did not, choosing instead to endorse the methodology behindthe 28% discount. The court was persuaded by taxpayer expert #2’s approach toall aspects of the valuation and adopted the discount as part of its bromancewith this expert.

Inthis case the taxpayer walked off with the star prize – a low value for thegifts which was a great takeway for them….but what are the takeaways for us?First, the idea that IPO costs can provide evidence for a DLOM for anon-controlling interest was well and truly squashed (although this may berelevant for a DLOM for a controlling interest). Second, the discount wasfairly high despite the fact that the company had made significantdistributions – normally regular cash flows to shareholders are regarded as loweringthe applicable discount on the basis that cash in hand keeps shareholdersfairly happy). Third, its important to note that no separate discount for lackof control was applied which is in line with current valuation theory foroperating companies– in this case the DLOM reflects the non-controlling aspectsof the shares.