What Is Revenue Ruling 59-60 for Business Valuation?

The Internal Revenue Service (IRS) issued Revenue Ruling 59-60 in 1959 to provide a framework for valuing the stock of closely held corporations. Its primary purpose is to guide appraisals for federal estate and gift tax purposes, but its principles are now a foundational reference for mergers, acquisitions, and shareholder disputes.

The ruling establishes the standard of “fair market value,” defined as the price at which property would change hands between a willing buyer and seller. Both parties are assumed to be under no compulsion to act and have reasonable knowledge of all relevant facts. This standard is used to value businesses that are not publicly traded and therefore have no readily available market price for their shares.

Key Business Valuation Factors

Revenue Ruling 59-60 outlines eight fundamental factors that must be analyzed to determine the value of a closely held business.

The first factor is the nature of the business and its history. This involves a look into the company’s stability, its growth trajectory, and the risks associated with its operations to provide a historical context.

A second consideration is the broader economic outlook and the specific conditions within the company’s industry. An appraisal must consider both current and prospective economic conditions on a national and sector level. This analysis includes evaluating the company’s position relative to its competitors and the level of risk associated with its market.

The book value of the stock and the financial condition of the business are a third factor. An analysis of the company’s balance sheets for two or more years gives insight into its financial health by reviewing the stated value of assets and liabilities.

A fourth factor is the earning capacity of the company, as a buyer is purchasing future profits. Appraisers will analyze income statements from at least the prior five years to identify trends in profitability and project future earnings potential. Historical profit data is a tool to forecast future performance.

The company’s dividend-paying capacity is the fifth factor. The focus is on the company’s ability to pay dividends, rather than the actual dividends it has paid. In a closely held corporation, dividend policy can be influenced by the personal financial needs of the owners, not the company’s true capacity to distribute profits.

Whether the enterprise possesses goodwill or other intangible value is a sixth consideration. Goodwill refers to earnings that exceed a normal rate of return, driven by intangible factors like brand reputation or customer loyalty. These non-physical assets can provide a significant contribution to future earnings.

The seventh factor involves analyzing past sales of the company’s stock and the size of the block being valued. Previous arm’s-length transactions can indicate value, but they must be scrutinized. The size of the ownership stake is also relevant, as a controlling interest is worth more per share than a minority interest.

The eighth factor is the market price of stocks of comparable publicly traded corporations. An appraiser identifies companies in a similar line of business whose shares are actively traded. By analyzing the valuation metrics of these public “comps,” an appraiser can derive pricing benchmarks for the private company.

Common Valuation Adjustments

After an initial value is indicated by the core factors, it is often subject to adjustments. These discounts account for the specific characteristics of the ownership interest being valued and typically reduce the value of the stock.

A frequent adjustment is the Discount for Lack of Marketability (DLOM). This discount reflects that an ownership interest in a private, closely held company is illiquid. Unlike public stocks that can be sold almost instantly, selling private shares can be a difficult and lengthy process. This lack of immediate convertibility to cash reduces its fair market value.

Another common adjustment is the Discount for Lack of Control (DLOC), or minority discount. This is applied to ownership stakes too small to exert control over company decisions, such as directing corporate policy or compelling a sale. Because these rights are valuable, an interest that lacks them is worth less per share than a controlling interest. Conversely, a controlling interest may warrant a “control premium,” which is the inverse of this discount.

Weighting the Factors for a Final Value

A final conclusion of value requires more than a mechanical application of the factors and adjustments. Revenue Ruling 59-60 states that valuation is not an exact science and no single formula applies to all situations. The process depends on the reasoned judgment and experience of the valuation professional.

The weight assigned to each factor changes based on the nature of the business. For an operating company that sells goods or services, factors like earning capacity and dividend-paying capacity are often given the most weight. A buyer of such a business is interested in the future income stream it can generate.

For a business that functions as an investment or holding company, such as one owning real estate or securities, the emphasis shifts. In this case, the book value of the stock and the fair market value of the underlying assets are the most important considerations. The value of the business is tied directly to the value of the assets it holds. This flexible approach ensures the final valuation reflects the unique economic realities of the specific company.