What data is processed in a company assessment?

A frequently asked question in practice is: In which assessment processes is which data processed? At the core, the question is based on whether certain processes process past data and other processes plan data. The answer is often provided based on which the earnings values process will process the past data. Another reason to dedicate a few lines to this question.

The company assessment is future-oriented since the “salesman knows there is no profit in the past”. In other words, a company evaluation in the framework of a transaction consultation has to process plan data because only then meaningful conclusions can be made regarding the future ability to cover interest and principal payments on the investment. This statement applies not only for transaction consultations but also to all kinds of company assessments by an overall assessment system. Once again to be clear, it is irrelevant whether earnings values processes or discounted cash-flow processes are used for assessment, the processed data is always derived from a company plan. This planning data is not only required to present the documentation of the realizations derived from the past analyses, they also have to illustrate the future market development and the consequences for the company’s performance.

The reason for many misunderstandings may be the simplified earnings value process which is only regulated for tax purposes in §§ 199 et seq. of the BewG (Valuation Act). In certain ways, this process is a successor of the Stuttgart process. The simplified earnings value process is generally used with the objective of simplifying the administration and application or in conjunction with very small companies and generally processes past data. However, only assuming that this past data is representative for the future (§ 201 Para.1 of the BewG). Should this condition not be fulfilled, this process also leads to obviously inaccurate results (§ 199 Para.1 of the BewG), which cannot be used as the reason for the tax assessment.

Base interest rate, spot rates and forward rates – the secure interest rate in the company assessment

Distributions and withdrawals from companies are not secure. The calculation interest rate at which these amounts paid out to the shareholders are discounted must demonstrate the same dimension of insecurity as the company to be assessed as per the condition of risk equivalence and thus the distributions and withdrawal potentials. The starting point for modelling the calculation interest rate is a secure interest rate. The quality of the interest rate with regards to the freedom from risk ensures that risk surcharges are not recorded multiple times when developing the calculation interest rate. In addition, the secure interest rate must have the same term, i.e. the period within which the interest rate is available must be the same as the duration of the company. Since companies are generally assessed under the assumption of an infinite existence, approximate solutions must be selected for the secure interest rate due to a lack of infinite interest contracts. The expensive modelling of calculation interest rates plays a role in the framework of the assessment of companies only in the scope of statutory and social contract-related assessment reasons, i.e. when determining objective company values.

In earlier decisions regarding public law-related settlement cases, the focus of case law referred to historical lending interest rates for long-term securities. The past 15 to 30 years of empirical data are thus incorporated into the calculation. Since the interest structure curve is propagated in IDW S1, a clear change in the case law has begun so that primarily the interest structure curve is referenced when deriving the base interest rate. Interest structure curves model the future interest progression on the basis of spot rats and thus accommodate the requirements of the future relevance of the company assessment. Spot rates represent the interest rate of zero bonds or hypothetical zero bonds for maturity brackets of 1 to 30 years. This information which exists on the market regarding interest is processed into interest structure curves using the Svensson function. In cases of normal investor behaviours, higher interest rates are offered or required for longer investment maturities than for short maturities. This results in the typical interest structure progression of an increasing interest curve with a decreasing threshold growth. Interest information for maturities of up to 30 years represent good approximate solutions for the required maturity equivalence. To simplify the practical company evaluation, via the target value search function in table calculation programmes, a uniform interest rate can be determined at which the projected distributions or withdrawals can be discounted. This interest rate then represents the base interest rate for determining the calculation interest rate. There is thus no correlation between the base interest rate in the BGB (German Civil Code) and the base interest rate of the company assessment. To avoid the interest rate information from being distorted, IDW and case law recommend determining an average base interest rate which can be determined from the uniform interest rate of the last three months prior to the assessment date. The three-month period finds a correlation when determining the average stock market price as the minimum value of the corporate law-related settlement. If a uniform interest rate is not used for discounting and instead the interest rates for the exact maturity are to be used, forward rates apply. These are determined based on spot rates and describe the interest rate valid for the term steps t up to t+1. Forward rates are required for precise phase discounting since this is the only way to take the consideration of the phase-related degree of debt as per marketing values into account for the discounting. The rounding method for the base interest rate by 0.25 percent points recommended by the IDW has partially established itself. A theoretical foundation for this is lacking however. To determine the base interest rate for the purposes of the company assessment, the BaseRateGuide from WOLLNY WP is available on the homepage http://www.en.wollnywp.de/. Base interest rates for assessment dates from 8/1/1997 to the respective current date can be viewed here.

Minimum value rule and group valuation

The deterioration of the inheritance-tax related alleviation regulations to be expected through a decision of the German Federal Constitutional Court has motivated several medium-sized companies to implement planned order of succession. In this connection, the company to be transferred must be assessed for tax purposes. In doing so, the minimum value regulation based on the net asset value introduced in 01/01/2009 by the legislator and the inheritance tax reform law must be observed. In practice, increased problems concerning the application of this minimum value regulation in accordance with Article 11 para. 2 p. 3 of the BewG [German Fiscal Law] were mainly observed in companies in group structures. The question to be answered is:

“Does the minimum value regulation in corporations have to be applied at Group company level or does the comparison take place between the capitalised value and/or discounted cash-flow value and the net asset value at group level?”

The solution presented by Wollny in DStR 42/2014 leads to a comparison at group level. The first approach that was presented refers to Article 2 BewG and deduces the Group as a subject of valuation from its scope of provisions on the economic unit. The second approach that was presented, explains the logical contradictions which resulted from an observation at Group company level and proves this by using the “sale of a business” course of action by supporting the approach of net asset values. The understanding of the minimum value regulation demonstrated by the second solution is directly applicable to evaluation processes according to civil law.