Valuing Pass-Through Entities

Preface

I have addressed many complex accounting, valuation, and forensic issues during my approximately 40-year career. In my work, with only one notable exception, I have generally found a consensus in technical literature, the industry, or expert opinions on the proper way to handle an issue. That notable exception is how or even whether one should tax-affect the earnings of a partnership, S corporation, limited liability company, or sole proprietorship (collectively, pass-through entities, or PTEs) when valuing such business ownership interests. I call this the PTE conundrum.

There have been many qualified, experienced professionals who have analyzed the PTE conundrum. It is a topic that has been the subject of articles and books. It has been contested in numerous litigations, in different courts, with varying facts and circumstances. In my opinion, there has been no lack of attention to this issue—only a lack of consensus and clarity.

I decided to take on this issue and started reading many court decisions, articles, and so on. Then I experimented with different Excel models, trying to develop a simple and understandable model that could properly address the different relevant possibilities that a potential buyer/seller would face when buying/selling an ownership interest in a PTE as compared with buying/selling an ownership interest in a C corporation. In time, my model evolved into something that I thought was practical, thorough, and worthy of consideration by the valuation ...