Appraising a Minority Interest in a Farm/Ranch
If you work in or have clients that work in the agriculture industry, you understand that the cash flows generated from even a well- managed farm or ranch are very low in relation to the value of the underlying ground itself. Rising crop yields due to new and improved technology paired with historically higher commodity prices and low interest rates have resulted in higher land prices. However, cash flows from agricultural operations tend to be volatile with relatively high cash flows one year followed by less than break-even cash flows the following year. Even if a farm/ranch operator could realize cash flows that are consistently high, albeit unheard of in the ag industry, the cash flows would still be low in relation to the value of the underlying ground itself.
Therefore, when appraising a minority interest in a farm/ranch operating entity, it makes sense for the appraiser to weight the value derived by the interest’s cash flows with the highest and best use value of the underlying ground. This weighted approach has been upheld by the US Tax Court in Estate of Andrews v. Commissioner (79 T.C. 945) and Estate of Helen J. Smith v. Commissioner (99 T.C. 368). The valuation adjustments can be dramatic, but they are real.
For example, a hypothetical buyer of a 10% minority interest in an entity operating a farm or ranch, would not likely pay 10% of the value of the underlying ground because he/she knows the return on investment on a cash basis would be very low. Moreover, a minority owner cannot force liquidation of the underlying ground and does not have the right to step foot on the property to enjoy its aesthetic qualities or to hunt, for instance. However, the hypothetical buyer might purchase a 10% interest if he/she buys in at a price that is determined by weighting a value based on the interest’s cash flows with the highest and best use value of the underlying ground. The buyer could then hope the underlying ground would be sold in his/her lifetime to increase the return on investment.
If your clients need to know the value of their minority interest, please call us for valuation services.