There are different business valuation methods depending on the type of company.
Operating companies engage in a business other than holding assets for sale or rent. Two common methods of valuing an operating company are the income approach and market approach.
Under the income approach, estimated future cash flows are discounted to a present value. Due to the economic conditions present during a recession, the estimated amount of future cash flows typically declines for many companies as compared to non-recessionary periods.
In addition, increased risk associated with such cash flows increases the discount rate used. As a result, most operating company values are down, making a recession a good time to gift.
The market approach utilizes valuation multiples derived from market transactions to arrive at a company’s value. The valuation multiples from many public companies and merger and acquisition transactions could also decline in a weak economy, causing closely held company values to fall.
Asset-holding companies often hold investments in real estate or marketable securities. As such, it’s no surprise that asset-holding company values are based on their net asset values—market value of assets, less liabilities.
The values of assets held by these entities generally decline in recessionary economic conditions. It’s a good time to gift interests in these entities while values are depressed.
Discount for Lack of Marketability for Closely Held Companies
The discount for lack of marketability is applied in a business valuation context because no market exists for minority interests in closely held companies—such interests are illiquid.
During periods of high volatility, investors prefer to hold liquid investments in lieu of illiquid investments. In other words, the discount applicable to illiquid investments typically increases. Larger discounts for lack of marketability are applied to minority interests in closely held companies.
These discounts cause minority interest values to be lower than they would be in a less volatile, recessionary market environment and increase the estate benefits associated with gifting.