Minerals & More

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Minerals & More Article (by Mr. Humphrey)

Minerals & More Article (by Mr. Humphrey)

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  • 1. Introduction An owner of such a significant asset such as in ground asset needs to establish a strong relationship with a consulting firm specializing in valuation, appraisal, and evaluation of mineral properties and mining operations. Mineral property owners, mining operators, attorneys, accountants, and investors have to rely on such consultants’ appraisals, mineral valuation, geological, and mining services for answers to questions about mineral property and mining business valuation, mineral properties and rights, mining operations and interests, leases and royalties issues. These consultants are generally independent and committed to providing you with practical, time, and cost effective resolution to your mineral property and mining business concerns. Such consultants are your resource for solid mineral property and mining business valuations. Ovadya Funding Group International, Inc. Copyright 2007 1
  • 2. Mineral Valuation - Appraisal Services Appraisal, or valuation, is defined by all of the professional appraisal organizations and regulatory agencies as the act or process of estimating a value for some type of property in an unbiased manner and as a disinterested third party, based on information obtained from the marketplace for that particular kind of property. Appraisers normally make distinctions among the terms value, price, and cost. The term price usually refers to a sale or transaction price and implies an exchange; a price is an accomplished fact. The term cost is generally used by appraisers in relation to production, not exchange; cost may be either an accomplished fact or a current estimate. Value, for appraisal purposes, is commonly defined as the monetary worth of a property, good, or service to buyers and sellers at a given time. For common stocks, bonds, financial instruments, and commodities that are listed on free and open exchanges and have thousands of trades every day, cost, price, and value are essentially the same thing and can be readily determined almost instantaneously. The shares of private companies and individual mineral properties, mineral interests, and mineral production royalties, on the other hand, are very infrequently traded and the actual selling price may not be readily available or easily determined. Mineral property appraisal or mining business valuation involves selective research into appropriate mineral property, mineral product, and mining company markets; collection and verification of relevant data and information; analysis of this value related data and information; and, the application of mineral industry knowledge, experience, and judgment to develop a credible estimate of the value of the whole, or some specific interest in, mineral property or mining business which reflects all pertinent market evidence. You should choose a qualified mining geologist, as by its very nature, the appraisal of mineral properties and the valuation of mining businesses requires a material and significant application of and reliance on geologic, mining, mineral processing, and mineral product markets research, knowledge, and experience, in addition to conventional real estate appraisal and business valuation knowledge and experience. Ovadya Funding Group International, Inc. Copyright 2007 2
  • 3. Minerals-Mining Consulting Services Appraisers are legally regulated under federal and state law by USPAP which considers three forms of appraiser engagement by a client: appraisal, review, and consulting. Appraisal is the act or process of estimating value and should be used whenever the appraiser could be perceived as an independent and disinterested party. Review is the act or process of critically studying a report prepared by another. Consulting is the act or process of providing information, analysis of data, and recommendations or conclusions on diversified problems, other than estimating value. Differentiation among these activities depends upon the purpose and intended use of the results. USPAP recognizes two types of consulting engagements: (1) performing an impartial consulting service as a disinterested third party that responds to the client's stated objective and (2) performing a consulting service that is intended to facilitate the achievement of the client's objective. If third parties, or the public, would reasonably perceive an appraiser to be acting as a disinterested, objective third party, that is enough to bar the appraiser from acting as an advocate for the client in that particular situation. If a person could be reasonably perceived by others to be acting as a disinterested third party, then the assignment must be performed with impartiality, objectivity, and independence. In either event the appraiser must clearly disclose which role is being performed for the client. USPAP identifies four defined activities as consulting: market analysis, feasibility analysis, and cash flow/investment analysis. Market Analysis: In conventional real estate work, market analysis is the study of market conditions for a specific type of property. In appraising mineral properties market analysis must be expanded to include the markets for the mineral products that are expected to be produced from a mineral property. Feasibility Analysis: Is a study of the cost-benefit relationship of an economic endeavor. Cash Flow Analysis: Is a study of the anticipated movement of cash into and out of an investment and is closely related to Cash Budget Analysis. Investment Analysis: Is a study that reflects the relationship between acquisition price and anticipated future benefits of an investment. Because USPAP defines any activity other than an estimate of value as consulting some of the commonly performed mineral property or mining business consulting services are: Highest and Best Use Analysis: v current/interim use. Physically Possible, Legally Permissible, Financially Feasible, and Maximally Productive (optimal/satisfying) Land Utilization: Zoning Analysis: Financing Analysis: Accounting/Tax Analysis: Ovadya Funding Group International, Inc. Copyright 2007 3
  • 4. Securities Analysis: Portfolio Analysis: Mineral Economics Studies: Mine Economic Studies: Economic Change Analysis: Breakeven Analysis: Productivity Studies: Availability/Utilization Analysis: Competitive Position Studies: Porter's 5-Forces Transportation Studies: Royalty, Joint Venture, or other Interest Analysis: Risk Analysis - Geologic, Technical, Economic, Legal, Socio-Political: Four Forces + Mineral Resource/Reserve Estimation, Review, or Audit: General or Specific Due Diligence: General or Specific Geological Analyses: Mining Geology Ovadya Funding Group International, Inc. Copyright 2007 4
  • 5. Choosing a Minerals Appraiser There are substantial differences between conventional real estate - single family residences, apartment houses, and downtown commercial office buildings - and mineral property appraisal. Mineral properties are a unique combination of geology, land, property rights, and mineral markets, possessing special attributes and characteristics that conventional real estate appraisers are normally not aware of. A mineral property is a location specific and dependent, special-purpose, limited-market property, and to properly perform an appraisal or evaluation of a mineral property and to communicate the results requires an appraiser with specialized knowledge, skills, and abilities. Acquiring the necessary geologic, mining, minerals industry and appraisal competency is a long and arduous process, but it is absolutely essential for increasing client and third party confidence and reducing uncertainty in the results. Questions for screening prospective minerals appraisers: Any appraiser you intend to engage for performing an appraisal of your mineral property or mining business should be able to answer these questions to your satisfaction. Listening carefully to the answers should help guide you in your selection. (1) What percentage of your time is devoted to the appraisal of mineral properties and mining businesses? Ideally, the appraiser would be performing only mineral property appraisals and mining business valuations, but the percentage of minerals appraisals should at least be greater than 50%. Some companies may be more interested in property or business brokerage, mining and processing equipment sales, private lending or investment schemes, or other non-valuation activities and may be using their appraisal services only as a lead-in for these activities. (2) How long have you been appraising mineral properties and mining businesses? You want a minerals appraiser with a minimum of five years experience actually appraising many different kinds of mineral properties and mining businesses for a broad variety of clients and for many different purposes. A conventional real estate appraiser who normally appraises houses or shopping centers would not have the required geologic, mining, and mineral marketing skills necessary for a credible appraisal. A typical geologist or mining engineer may only be capable of telling you how many tons you have because he does not understand the requirements for bank lending, estate and gift taxation, or legal proceedings such as business dissolution, divorce, or condemnation. (3) Are you a Certified or Designated member of the American Institute of Minerals Appraisers (AIMA) and/or the Mines and Quarries discipline of the American Society of Appraisers (ASA)? Are you current with your organization's Continuing Professional Development and Recertification requirements? These are the only two professional appraisal organizations in the United States that certify or designate members as an appraiser with a specialty in appraising mineral properties or valuing mining businesses. Both of these organizations require their designated members to possess an appropriate mineral industry college degree such as geology, mining engineering, metallurgical engineering, mineral economics, or accounting. In addition they require at least five years of full- time progressively more responsible professional minerals appraisal experience during which full competence has been demonstrated in the application of professional principles and methods involving the understanding of the appraisal approaches utilized in the market for valuing mineral rights and properties and mining businesses interests. Ovadya Funding Group International, Inc. Copyright 2007 5
  • 6. Both the American Institute of Minerals Appraisers and the American Society of Appraisers require applicants to submit actual appraisal reports for peer review of their work product in order to establish the required knowledge and experience requirements. The American Society of Appraisers also requires its applicants to complete a comprehensive examination covering both minerals and appraising knowledge. The American Society of Appraisers also requires it members to complete 100 hours of continuing education in their area of specialization every five years. (4) Are you a Certified General Real Property/Real Estate Appraiser in your state of residence? What is your license number? All states require real estate or real property appraisers to be certified as a general appraiser under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989 in order to appraise property for lending by a bank. Some states require this certification for any and all appraisals of real estate and interests in real property. (5) Are you a Registered Professional Geologist or Mining Engineer in your state of residence? What is your license number? As of early 1998, 22 states require some form of registration, certification, or licensing of persons performing geologic services for the public according to the National Association of State Boards of Geology (ASBOG). All states require registration as a Professional Engineer, but not all states recognize engineering specialties such as Mining Engineer, Geological Engineer, or Metallurgical Engineer. For bank lending purposes and certain legal proceedings some states may have a requirement for licensing or registration as both an appraiser and a mineral industry professional. (6) Are all of your mineral property appraisals and mining business valuations performed and reported in accordance with The Appraisal Foundation's Uniform Standards of Professional Appraisal Practice (USPAP)? Many otherwise competent mining engineers or geologists may be able to provide you with useful information about mineral resource potential, mineable reserves, or expected cash flows, but they are not normally aware of such appraisal issues as highest and best use, encumbrances, partial interests, comparison to sales of similar mineral properties, and other USPAP requirements. The Appraisal Foundation has been authorized by the US Congress as the organization responsible for establishing real property appraisal standards and appraiser qualifications. The Internal Revenue Service and other taxation and financial accounting authorities also have specific requirements relating to the appraisal of mineral properties and the valuation of mining businesses. (7) Have you performed appraisals on mineral properties or mining businesses that are like mine for similar purposes and uses? Do not be too surprised if a minerals appraiser has not performed an appraisal on a property exactly like yours or for exactly the same reasons. No minerals appraiser has appraised every type of mineral property. There are so many different kinds of mineral properties and mining businesses and reasons that they may be appraised that absolute agreement with yours may be asking too much. What you want is a minerals appraiser who has appraised a broad cross section of different types of mineral properties and mining businesses for a variety of purposes and who will be open and honest with you about his education and experience. Some minerals appraisers tend to specialize in certain types of mineral properties and may be reluctant to take on an assignment that concerns a different type of property and some are unwilling to perform appraisals related to litigation. Ovadya Funding Group International, Inc. Copyright 2007 6
  • 7. (8) Are you willing to sign explicit appraisal and confidentiality agreements? It is always a good idea to obtain a written agreement of some form, from an engagement letter to a detailed contract, for the performance of a minerals appraisal or consulting engagement. At a minimum this agreement should specify the mineral property to be appraised or the mining business interest to be valued, the scope of the work necessary to complete the minerals appraisal engagement, the purpose and intended use of the appraisal, any special conditions that may exist, along with an estimated completion time, working days and calendar days, and cost and payment terms. It is also a good idea to use an explicit confidentiality agreement because the confidentiality requirements of USPAP are significantly different than most mineral property owner's expectations. Any agreement should also specify who owns and has control of the appraisal report. This can be an important consideration for minerals appraisals performed for litigation purposes. (9) How long do you think this assignment should take and how much will it cost? The prospective minerals appraiser probably cannot give you a highly accurate time and dollar answer without knowing more about the type of mineral property, its stage of development, and the purpose and intended use of the appraisal, but he should be able to provide you with a range of completion times and professional fees and business expenses that similar engagements have required. (10) Will you give me the names and phone numbers of three clients for whom you have performed similar minerals appraisals? Follow up and call each one. (11) Will you give me the names of other minerals appraisers who also perform appraisals of the type and complexity I need? This may be asking too much, but at the least the prospective minerals appraiser should be willing to provide you with a contact name and phone number of the two nationally recognized minerals appraisal professional societies. American Institute of Minerals Appraisers: 303-443-2209 American Society of Appraisers: 800-ASA-VALU (800-282-8258)/703-478-2228 (12) What types of information will you need form me in order to successfully complete this mineral property appraisal or mining business valuation engagement? i The Mining Company Valuation Data Requirements pages that are part of this document will provide you with a good idea of the types of data that will normally be required. Ovadya Funding Group International, Inc. Copyright 2007 7
  • 8. Client Education Minerals Appraisal The purpose of this area is to provide some background information to potential and current clients, as well as other interested readers, about the general topics of mineral valuation- appraisal, geology, mining, mineral processing, mineral products and their markets, mining properties in general, and appraisal processes and practices. It is hoped that this information will give readers a better understanding of the role of minerals in the economy and an improved foundation on which to build specific questions they may want answered by a qualified minerals appraiser. A list of available topics follows. General Mining and Mineral Scamsii Mining Scamsiii Dirt Pile Scamsiv Indium & 'Strategic' Metals Scamsv Leveraged Precious Metals Scamsvi Gold Is Where You Find Itvii General Mineral Appraisal - Valuation Material What Is Mineral Appraisal-Valuation?viii The Mineral Valuation Process - Simplifiedix Mineral Product Market-Based Mineral Property Categorizationx USPAP/FIRREA & Mineral Property Appraisalxi Accounting For Mineral Reservesxii Mining Myths and Factsxiii Mineral Royalty Based Financingxiv Mineral Production Royaltiesxv Licensing: Mineral Appraisal/Mining Geologyxvi Common Minerals and Their Usesxvii In One Dayxviii Common Minerals & Their Usesxix Ovadya Funding Group International, Inc. Copyright 2007 8
  • 9. The IRS & Mineral Property Appraisal / Mining Business Valuationxx IRS Rules For Minesxxi IRS Regulations Section 1.611-2(c), (d)xxii Mining & IRS Revenue Ruling 59-60xxiii Mining & IRS Revenue Ruling 68-609xxiv Mining & IRS Revenue Ruling 77-287xxv Mining & IRS Revenue Ruling 83-120xxvi Mining & IRS Revenue Ruling 93-12xxvii Mining & IRS Revenue Procedure 79-24xxviii Internal Revenue Manual - Valuation of Real Propertyxxix Ovadya Funding Group International, Inc. Copyright 2007 9
  • 10. Mineral Appraisal-Valuation Reference Material Mineral Valuation-Appraisal Reading List - Books and Articlesxxx Mineral Appraisal-Valuation Reading List - Guidelines & Standardsxxxi Mineral Valuation-Appraisal Reading List - Periodicalsxxxii General & Specific Assumptions & Limiting Conditions-Part 1xxxiii General & Specific Assumptions & Limiting Conditions-Part 2xxxiv General & Specific Assumptions & Limiting Conditions-Part 3xxxv Mining Business Valuation Data Requirementsxxxvi Ovadya Funding Group International, Inc. Copyright 2007 10
  • 11. Mineral Valuation-Appraisal Related Links Mining Information Sources CoalCamp MiningUSA Robertson Info-Mine United States Geological Survey Appraisal Information Sources (follow the links below) American Institute of Minerals Appraisers American Society of Appraisers The Appraisal Foundation Appraisal Institute The Appraisal Subcommittee National Association of Independent Fee Appraisers Mineral Industry Publications Mining Business Digest Pit and Quarry Magazine Aggregates Manager Magazine International California Mining Journal Mineral Industry Companies Construction Market Research i Mining Company Valuation Data Requirements Ovadya Funding Group International, Inc. Copyright 2007 11
  • 12. The next step in the valuation process, after carefully defining the assignment, is to gather the data necessary to conduct the assignment. These data can be categorized into three groups: Company-specific data. Data about the company's industry and economic environment. Data about the subject property's market (market for ownership interests in the subject company). The company-specific data are gathered from the subject company in written form and during site visits and interviews with people knowledgeable about the company. The gathering of this information is the subject of this and the next chapter. The industry and economy data often can be provided by the subject company and can be gathered from publicly available sources. This is the subject of Chapter 6. Data about the market for ownership interests in the subject company include information about changes of ownership of competitors, about guideline company transactions, and about premiums and discounts that might apply to the subject property. These two categories of information gathering are covered in subsequent chapters in Part III. The manner and sequence in which the data are gathered are important only to the extent that the process be complete and efficient. For example, supporting analysts may be collecting industry, economic, rate of return, and guideline transaction information at the same time that the principal analyst is working directly with the management of the subject company. In any case, it is important to convey a sufficient overview of the company and the assignment to all valuation team members at an early meeting so that all the analysts will be in a position to recognize important data as they proceed on the project. If time allows, information gathered should be reviewed before the visit to the company so as to focus the interviewing process on the most essential factors that affect the value of the company, thereby minimizing the inconvenience of management interviews and also maximizing the productivity of the site visit. Some of the information necessary to conduct the business valuation will need to be obtained through interviews with company management. Sometimes, however, the analyst merely inspects voluminous or highly sensitive documents and gets copies only of the information necessary to perform the assignment. Written company-specific information that is generally used in business valuations is presented in Exhibit 4-1. This list is generic. Not every item on the list will be required for every appraisal, and in many circumstances, documents not listed must be reviewed. Working with this list, nevertheless, will assist the analyst in developing a subject-company-specific information request list. It will also be helpful to company officials and attorneys in the planning stages of a potential valuation engagement. Preliminary Documents and Information Checklist for the Business Valuation of a Typical Corporation Financial Statements for Typical Corporation Balance sheets, income statements, statements of changes in financial position, and statements of stockholders' equity for the last five fiscal years Income tax returns for the same years Latest interim statements and interim statements for comparable period(s) of previous year Other Financial Data Summary property, plant, and equipment list and depreciation schedule Aged accounts receivable summary Aged accounts payable summary List of marketable securities and prepaid expenses Ovadya Funding Group International, Inc. Copyright 2007 12
  • 13. Inventory summary, with any necessary information on inventory accounting policies Synopsis of leases for facilities or equipment Any other existing contracts (employment agreements, covenants not to compete, supplier agreements, customer agreements, royalty agreements, equipment lease or rental contracts, loan agreements, labor contracts, employee benefit plans, and so on) List of stockholders, with number of shares owned by each Schedule of insurance in force (key-person life, property and casualty, liability) Budgets or projections, for a minimum of five years List of subsidiaries and/or financial interests in other companies Key personnel compensation schedule, including benefits and personal expenses Company Documents Articles of incorporation, bylaws, and any amendments to either Any existing buy-sell agreements, options to purchase stock, or rights of first refusal Franchise or operating agreements, if any Other Information Brief history, including how long in business and details of any changes in ownership and/or bona fide offers recently received Brief description of the business, including position relative to competition and any factors that make the business unique Marketing literature (catalogs, brochures, advertisements, and so on) List of locations where company operates, with size and recent appraisals List of competitors, with location, relative size, and any relevant factors Organization chart Resumes of key personnel, with age, position, compensation, length of service, education, and prior experience Personnel profile: number of employees by functional groupings, such as production, sales, engineering/R&D, personnel and accounting, customer service/field support, and so forth Trade associations to which the company belongs or would be eligible for membership Relevant trade or government publications (specially market forecasts) Any existing indicators of asset values, including latest property tax assessments and any appraisals that have been performed List of customer relationships, supplier relationships, contracts, patents, copyrights, trademarks, and other intangible assets Ovadya Funding Group International, Inc. Copyright 2007 13
  • 14. Any contingent or off-balance-sheet liabilities (pending lawsuits, compliance requirements, warranty or other product liabilities, estimate of medical benefits for retirees, and so on) Any filings or correspondence with regulatory agencies Information on- prior transactions in the stock or any related party transactions When asking for historical financial statements on the subject property, one should endeavor to study statements during a relevant period. The most common period of such study is five years. However, conceptually, the relevant period covers the most recent time period immediately before the valuation date during which the statements represent the company's general operations. ii This portion of the document is designed to provide the reader with some elementary background information about various methods employed by con men to separate an investor from his money. Shady investment deals in mineral property, 'strategic' or precious metals, mining interests, and mining company shares are essentially no different than scams associated with any other investment vehicle. Mining Scams is a copy of consumer information presented by the Arizona Department of Mines and Mineral Resources and is presented in the hope that it may assist the reader in making a more informed decision about potential mining project investments. In some areas comments or other information has been the author. This information is in italics. A time-honored method to bilk the public of millions of dollars is the ubiquitous mining swindle. Since an unusually rich ore deposit, or bonanza, has historically produced enormous profits for the developer, many of us believe that we too, like the 49er, can strike it rich. The glamour attached to "discovery" create, in the imagination of some people, a relatively easy way to attain fantastic wealth. Dirt Pile Scams is a copy of consumer information presented by the Federal Trade Commission and is presented in the hope that it may assist readers in making a more informed decision about potential mining project investments. In some areas comments or other information has been added by the author. This information is in italics. Among the endless number of telephone investment frauds going on around the country, one variety is called the "dirt-pile scam." With this, a caller offers you the opportunity to invest in a gold mining operation (some of these scams are for platinum group metals and for other "strategic" metals). What you would buy is a quantity of unprocessed dirt from the mine, "guaranteed" to contain enough gold or other high value mineral to more than cover your investment. In reality, the mine contains little if any gold, and your investment is nearly worthless. Indium & 'Strategic' Metals Scams is a copy of consumer information presented by the Federal Trade Commission and is presented in the hope that it may assist readers in making a more informed decision about potential mining project investments. In some areas comments or other information has been added by the author. This information is in italics. What is indium? You may learn the hard way if someone calls and says, "This metal is the hottest investment today. Invest immediately! "If you do invest, you may join a growing number who have lost thousands of dollars to telemarketing firms that sell "strategic metals," such as indium, germanium, selenium, or cadmium. The telemarketers have sold the metals at prices that far exceed their worth. This brochure explains the sales tactics of the fraudulent telemarketing firms and how to protect yourself from them. It also lists resources you can use for inquiries or complaints. Leveraged Precious Metals Scams is a copy of consumer information presented by the Federal Trade Commission and is presented in the hope that it may assist readers in making a more informed decision about potential mining project investments. In some areas comments or other information has been added by the author. This information is in italics. Every year consumers lose billions of dollars to fraudulent telemarketing investments. Under one scheme, telemarketing companies may use high-pressure sales tactics to persuade consumers to make leveraged investments in precious metals, such as silver, gold and platinum. The companies may falsely claim such investments carry low risk and can be expected to generate high profits. However, the price of precious metals is volatile and an investment in these commodities is speculative and risky. And by leveraging, borrowing money to make the investment, the degree of risk is magnified. Before you agree to make a leveraged purchase of precious metals, read this brochure. Gold Is Where You Find It Published in the May 1997 issue of International California Mining Journal, who kindly provided the author permission to reprint. $30,000,000 scammed from duped investors in a phony mining promotion! Perhaps the Ovadya Funding Group International, Inc. Copyright 2007 14
  • 15. largest case on record, but only one of many incidents of miners and investors falling victim to scams, lousy advice, and/or shoddy analytical workmanship. iii Mining Scams This page is a copy of consumer information presented by the Arizona Department of Mines and Mineral Resources and is presented in the hope that it may assist readers in making a more informed decision about potential mining project investments. In some areas comments or other information has been added by the author. This information is in italics. A time-honored method to bilk the public of millions of dollars is the ubiquitous mining swindle. Since an unusually rich ore deposit, or bonanza, has historically produced enormous profits for the developer, many of us believe that we too, like the 49er, can strike it rich. The glamour attached to "discovery" create, in the imagination of some people, a relatively easy way to attain fantastic wealth. Although money can be made in mining and this Department certainly encourages mining, we also have a responsibility to urge the public to exercise prudence in its investment. Too many persons have lost their hard-earned savings on an ill- advised mineral scheme. Archives are full of outrageous examples of mining scams and swindles in which the only beneficiary was a glib entrepreneur with unbounded optimism. In most cases, he disappeared before his investors realized what happened. When making an investment in any mineral enterprise, there are a number of factors or key features to consider. A checklist of significant considerations follows: 1. Title 8. Reporting Procedure 2. Sampling and Assaying 9. Security and Safety 3. Type of Commodity 10. Marketing Procedure 4. Mining Method 11. Distribution of Profit 5. Mill Site and Method 12. Tax 6. Recovery Process 13. Sequence of Development 7. Permitting 14. Engineering Reports Prerequisite to the investment in the development of a mineral deposit is legal access to the resource. The potential investor should know who ultimately owns or administers the subject mineral property and commodity. The property may be controlled by the State, Federal Government, Indian tribe, or a private individual or organization. Moreover, jurisdiction over the land surface may be separate from the jurisdiction of the underlying mineral resource. Where ownership or control of the mineral rights is severed from the surface rights, obvious legal problems can arise. If a mining claim or prospecting permit for minerals is not legitimate, the money invested is wasted from the beginning. In addition, the investor should understand basic differences between leasable and locatable minerals and lode and placer deposits. These classifications determine the type of mining agreement and/or claim established on the resource. Very specific requirements must be met and procedures followed to gain the right to develop a mineral deposit. Furthermore, encumbrances against the deposit, though legal, may be detrimental to its development. Typical examples of cloudy or illegal title to a mineral deposit include oversized claims, inappropriate claim designation and improper filing, failure to perform annual assessment or to file affidavits of labor, or location of claims on a privately held mineral estate. The investor should establish exactly what rights he has to the property in question and what conditions are imposed before he spends one penny on exploration or development. Perhaps the next major consideration in evaluating a mineral investment is the sample and assay data. One sample does not make a mine. A person who brings a rock that contains two ounces of gold per ton, to an investor, may be carrying the entire mine in his hand. One such high-grade ore specimen is not representative of the deposit. Many samples, commonly numbering in the thousands, are required to give a reasonably accurate measure of the tenor, or quality, and tonnage of the ore. Depending on the configuration and geologic setting of a mineral deposit, there are recommended scientific procedures to follow and methods to use to properly sample the mineralization. The investor should be satisfied that the samples referred to by the mine promoter were collected specifically from the property of interest and also that they were collected in a proper way. The sampling method should be adequately described and each sample site precisely located, preferably on a map. Ovadya Funding Group International, Inc. Copyright 2007 15
  • 16. It is important not to forget the practice of deliberately salting, or adulterating, samples. Ingenious ways have been devised to fraudulently enhance the grade of samples either before or after they are collected, regardless of the method of collection. The temptation to salt is particularly appealing when dealing with a mineral of high unit-value such as diamond or gold. Once collected the samples must be properly prepared and assayed. In general, the final sample preparation and assay should be done by qualified laboratories. Assayers registered in Arizona are generally familiar with different types of ore and are knowledgeable about the proper method to test for particular metals or other components. All ores are amenable to rigid testing and comments to the effect that the ore is unassayable are simply not true. Statements belittling the methods of registered assayers, complaining for example that they never report all the gold, are immediately suspect. Modern copying devices also make it a rather simple procedure to later falsify the assayer's report. If there is any question, of course, the sample pulps (unused prepared portion) may be sent to another lab for comparison. Spectrographic analyses do not provide an accurate test of mineral samples. This type of analysis, though relatively inexpensive and useful in providing a list of components in a sample, does not yield a reliable, quantitative measure of tenor. often a billion- or trillion-dollar "ore body" is created by simply multiplying the generalized amount of each of the metals listed in a spectrographic analysis by their current market price. An ore body, however, is not that simple. At this time, there is no commercially acceptable process known whereby each element can be recovered from a deposit. A degree of skepticism should also be reserved for ores said to contain uncommon metals or minerals. Because of their rarity, these substances may command a very high price and are therefore extremely attractive to the investor. The platinum-group metals including platinum, palladium, rhodium, ruthenium, iridium, and osmium, are the darlings of the swindler. Considering their high unit-value, even minute amounts of these metals appear to be a reasonably good bet to the innocent investor. The problem here is usually the grade or tonnage, or a combination of both. The amount of platinum, for example, is generally too low to realistically consider extraction, or the tonnage is almost limited to a hand specimen. As a primary ore, platinum has never been mined in Arizona; its only production has come from trace amounts recovered in the final stage of refining copper ores. The geologic environment of Arizona, diverse as it is, does not encourage the search for platinum-group metals, graphite, cobalt, nickel, bauxite, diamonds, and a number of other commodities. As plans are drawn to mine an ore deposit, proposals are made which frequently are misinformed and ill-advised. There are innumerable examples of deep shafts and long adits driven to "nowhere". Many of these openings have been cut at great expense and with little or no evidence to suggest they would meet success. An example of a mining scheme which can be described at best as ignorant was recently sold to a number of investors in the Chemehuevis Placer District, near Lake Havasu City, Arizona. The plan called for an investor to purchase a plot of ground 60 x 120 feet in size from which 8,000 cubic yards of unconsolidated gold-bearing gravel would be dug and treated. In order to recover 8,000 cubic yards of gravel from this plot, the excavation would require vertical walls, 30 feet deep. Since loose gravel cannot be mined At a slope exceeding its natural angle of repose, approximately 45'j, the maximum amount of material that an investor could ideally and safely expect to obtain from an isolated parcel is about 62 1/2 percent of the total, or 5,000 cubic yards. No attempt was made to explain to the purchaser that, in this case, after an investment of $50,000 he would actually get less than two-thirds of what he paid for. This scenario illustrates one catch to a sales promotion involving fractional interests in a mineral property. The entire land package, comprised of all individually-owned parcels, must be mined together to insure each investor's return. An interesting twist to this story is the statement made later by the developer that only 40 percent of the aggregate was gold-bearing. Consequently the investor was now entitled to 20,000 cubic yards of gravel (to yield 8,000 cubic yards of gold-bearing material) from his plot. Since 5,000 yards was the maximum he could physically dig, this is truly adding insult to injury. There is a tendency among many of us to want to build. We want others to see our accomplishments. To some degree this attitude explains why a mine tunnel is begun with little justification. The same propensity for building might explain why a mineral processing mill is erected or a leaching facility is frequently constructed without any obvious sign of ore. Another reason these engineering marvels are installed is due to their impressiveness. The humming, turning, grinding, and screeching of equipment and the smoke and odors of a mine plant are exciting to the potential investor. He sees industry in action - his money at work - and profits just around the corner. Unfortunately, however, he is commonly one of a multitude who has emptied his pockets for a pipe dream. With a paltry amount of ore stockpiled, a dump laden with debris, or an old mine map showing the "lost" ore body, the developer spends the last dime of every investor getting ready to treat the mineral-rich rock. The $500,000 mill, designed to treat Ovadya Funding Group International, Inc. Copyright 2007 16
  • 17. 500 tons per day, mills nothing, and the dreams of many become a nightmare. Even when good ore exists, the treatment facility is often poorly designed. Frequently its component parts are improperly matched or not sized adequately. Materials handling procedures are commonly cumbersome and energy intensive. An adequate supply of water may be lacking. Hazardous operating conditions may be present. These circumstances are a few costly examples that can shut a plant down abruptly. The recovery process is in many cases a mystery to the investor. Technological methods vary according to the metal or mineral recovered. In addition there are many variants based on the size of the mineral component, its gangue association, its state of chemical alteration, the hardness and specific gravity of the ore, permeability of the ore, and a myriad of other factors. The milling and metallurgical treatment of ores is comprised of both physical and chemical means of beneficiation. These processes though technically sound and well understood by the professional are frequently vague and confusing to the lay person. An investor not familiar with basic physical-chemical laws is easily misled. Proprietary methods utilizing secret chemicals and "black box" techniques, therefore, are often praised as technological breakthroughs. According to the developer, these so-called miraculous inventions will convert formerly worthless rock to metal-rich ore or improve, manyfold, the recovery of a metal or other commodity that heretofore had been difficult to extract. one should exercise caution when evaluating such claims. Developers often speak of 100 percent recovery. Complete extraction, however, of most constituents is essentially unknown over the long term. At the turn of the century a mining firm in Ajo built a giant retort into which ores were to be shoveled and melted. Spigots were tapped into the vessel at various locations and labeled copper, lead, zinc, gold, silver, etc. All the investor had to do, after he had helped finance the operation, was turn the spigot for the metal he desired. Understandably the entire operation fizzled. In many cases difficult technical problems are oversimplified. The ill-informed investor is merely asked to retain faith in the management and to perhaps ante a bit more so that this "minor problem" can be speedily resolved. A host of other factors should be evaluated by the prospective investor before spending money on a mine or a beneficiation plant. Proper permitting must be obtained at various stages of development from local, state, and federal authorities. In addition to routine reports required by certain government agencies, internal reports generated for management and for the investors should be factual, accurate, and timely. On-site security should be adequate to protect expensive equipment and supplies as well as the mine or plant product. Of course appropriate security measures must be taken also whenever the product, especially a high-value material such as bullion, is transported from the treatment facility. Acceptable safety procedures must be implemented and must be adhered to rigidly from the start to finish of any operation. Even after termination of operations, it is imperative that hazardous materials be properly disposed of and unsafe conditions, such as open shafts, be resolved. Proposed or actual marketing of the mine or mill product should be reviewed thoroughly by the investor. There may be assessed charges for further treatment of the product. There may be by-product credits returned to the miner. The investor should also be aware of the involvement of any intermediate sales agents and their remuneration. Another obvious consideration is the distribution of profits. What liens, including ownership 'royalties, loan payments, and rental fees, must be deducted from the gross to determine the net profit? Are estimates of operating expenses and pro- forma statements realistic? The investor should be satisfied with the form of payment whether it is in cash, stock, or in- kind. Like other high-risk investments, mine and mineral developments are often subjected to careful scrutiny by the Internal Revenue Service. Beware of accelerated tax write-offs. Such an advantage was one of the attractions in the Chemehuevis Placer scam referred to earlier. Supposedly the investor would receive a $50,000 write-off on his tax statement the first year of his investment by merely paying an advance of $10,000 and signing a promissory note for an additional $40,000. (The prospectus projected within four years a net income, based on gold production, of $139,000.) In this particular case, the courts apparently upheld an IRS ruling disallowing the tax deduction. Reportedly the original developers of this program, some $3 million richer, are now unavailable. In every mineral development there is a logical sequence of events with which the enthusiastic, yet uninitiated, investor may be unfamiliar. Each project can be broken into phases, the completion of which can be evaluated before expending large sums of additional funds. There is no legitimate reason for throwing good money after bad. Classic examples exist which have expensive land being purchased on the basis of someone else's assays or a costly mill being constructed without proven ore. Engineering reports are useful tools that will assist the mine developer and investor. Decisions to pursue a project into the next stage, and in a particular manner, will be made easier and more logically after consultation with the appropriate Ovadya Funding Group International, Inc. Copyright 2007 17
  • 18. professional engineer, whether a geologist, mining engineer, or metallurgist. Other professional assistance such as financial and legal is generally warranted. In general, professional evaluation and advice should be sought outside of the developing organization. Principals with the firm and other vested partners, though well intentioned, may write overly optimistic reports. Statements, for example, referring to the attractiveness of a deposit because of its close proximity to a famous producer or the historically proven improvement of ore grade with depth in the mining district may have the ring of authority but are often pure speculation. Such reports frequently speak glowingly of questionable assets that may be virtually worthless, e.g., raw mill sites, dilapidated buildings or sheds, and rusted, dismantled equipment. Past production records may be doctored, and projected production/cost data may be presented in an unrealistic manner. Profits are often inflated or guaranteed in such company-prepared prospectuses. it is recommended, therefore, that most professional advice be obtained from consultants who have no financial connection with the company principals, the property, the mineral technology to be employed, or any part of the proposed operation. The Arizona Department of Mines and Mineral Resources, with offices in Phoenix and Tucson, is perhaps one of the first places an investor should go seeking information. Knowledgeable, qualified engineers can provide him existing historical data on numerous properties and discuss solutions to problems he may have. Lists of registered assayers and engineers are available at the department. In addition, an excellent reference library is maintained, as well as a museum in which the interested individual can obtain hands-on knowledge of rocks and minerals. While it is obvious that venture capital is needed to start a mine or mineral project, and the Department promotes the development of Arizona's mineral resources, we believe it is essential that the investor be as well informed as possible. Under the best of circumstances mining is a risky business and we should never tolerate fraudulent practices within the industry. An informed investor, therefore, is better prepared to take the risk without being fleeced at the same time. Adapted from Arizona Department of Mines and Mineral Resources Circular No. 11, January 1986, By Michael N. Greeley, Mining Engineer iv This page is a copy of consumer information presented by the Federal Trade Commission and is presented in the hope that it may assist readers in making a more informed decision about potential mining project investments. In some areas comments or other information has been added by the author. This information is in italics. Facts for Consumers from the Federal Trade Commission Dirt-Pile Scams: Mining for Gold -- December 1993 Among the endless number of telephone investment frauds going on around the country, one variety is called the "dirt-pile scam." With this, a caller offers you the opportunity to invest in a gold mining operation (some of these scams are for platinum group metals and for other "strategic" metals). What you would buy is a quantity of unprocessed dirt from the mine, "guaranteed" to contain enough gold to more than cover your investment. In reality, the mine contains little if any gold, and your investment is nearly worthless. Unfortunately, consumers from all walks of life have invested in these dirt-pile scams and were cheated out of millions of dollars. This fact sheet tells you how to recognize the scam, how to protect yourself, and what to do if you become a victim. How Dirt-Pile Scams Work Although there are many versions of this scheme, most dirt-pile scams have similar features. Typically, a promoter will either lease or buy a mining claim (a tract of land that legally can be mined) in one state and then set up "boiler room" sales operations in several other states. The mining claim, company headquarters, and boiler rooms are purposely located in different states to make it more difficult for law-enforcement officials to locate and investigate the company's activities. Usually, a boiler room is a rented space filled with desks and telephones, where experienced salespeople call hundreds of potential investors like you. These callers use high pressure tactics to sell you unprocessed dirt, also called "ore." Preying on most people's limited knowledge of "ore," they make false and exaggerated claims about the precious-metal content. A central feature of the dirt-pile scam is that you will be asked to invest several thousand dollars upfront, but will not be entitled to a return on your investment for at least one to three years. This gives the promoters time to get money from many investors, before anyone suspects foul play. There are a number of twists to this scam. In one variation, you buy the ore from the mining claim for one fee, then, for a second fee, you buy the services of an "independent" mining contractor who will process the ore and extract the precious metal. You will not be told, of course, that the contractor is also part of the scam. In another variation, you pay one fee for Ovadya Funding Group International, Inc. Copyright 2007 18
  • 19. both mining and refining the ore. Some investment schemes allow you to make monthly installment payments to the mining company. The sales pitch may change slightly, but the basic message is the same--pay now and receive a substantial return later. If you express interest in investing, the salesperson will follow up the phone call with a prospectus or a company publication. It often is a slick-looking brochure, which promoters hope will increase the credibility of their offering. The brochure may contain photographs of the mining site with mining equipment on it, a map of the area, pictures and resumes of company officials, and references for you to call. The brochure also may include a report from an assayer, one who analyzes a sample of dirt from the mining claim to determine the precious-metal content. Often the report will be from either a fraudulent assayer who inflates the amount of precious metal found in the ore, or from a legitimate assayer who is given a "salted" sample, one that contains added amounts of the precious metal. (Another variation used to implicate a legitimate assayer is to send him a concentrated or heavy mineral sample for assay and then fail to disclose the concentration ratio in the information sent to you. Remember also that "fire assays" are not normally performed on samples of placer gold.) The packet may include a contract for you to sign and return, locking you into the investment. If the caller senses any reluctance, you may be offered a "risk-free" investment to clinch the deal. Your investment will be "guaranteed" to contain a minimum quantity of precious metal per ton of ore, and, if your claim does not produce the specified amount of precious metal, the company will refine additional ore to satisfy the terms of the guarantee. Some companies or salespersons even will promise to make up the difference out of their own pocket. Once you have invested money in a dirt-pile scam, you may receive periodic progress reports or "lull letters." Their purpose is to keep you up-to-date on the fictitious progress of the mining operation and to keep you content with your investment. Because the mines often are not located in the state where you live, it is unlikely that you will visit the mine. If you do visit, you may recognize the worthless value of your investment and demand a refund. Promoters may willingly refund your money, possibly with newly invested money, in order to avoid complaints to law-enforcement officials. In some cases, promoters actually haul equipment out to the mining site and hire temporary employees to make it look as if work is in progress. (One of these scams "recycled" the "ore" by taking it from the mine during the day and hauling back at night.) Finally, when it is time for a return on your investment, if the promoters are still around, they will conveniently blame faulty equipment, bad weather, a labor shortage, or even the Government for any delay. They will assure you that they will resolve all problems quickly. Since you have already put considerable time and money into this investment, you may be satisfied to wait for a while. In the meantime, the promoters try to get more money from new customers or to get safely out of town. No matter how these scams unfold, they always end the same way: You are left with nothing--no capital and no profit. How To Protect Yourself The typical dirt-pile scam involves a highly sophisticated interstate network of swindlers. By the time you suspect the investment may be phony, it could be difficult to locate the promoter, the project manager, the salespeople, or anyone else connected with the company. Because the crux of the scam requires you to wait at least a year to realize a return on your investment, promoters are often long gone by the time law-enforcement officials are alerted to the scheme and can begin an investigation. The best protection you have is not to invest in a dirt-pile scam in the first place. The following suggestions may help you avoid losing money in a dirt-pile scam: Be wary of unsolicited investment opportunities. Be suspicious of guaranteed, high-return, risk-free investments in precious metals. If this is such a great investment, why isn't the company getting traditional financing from a bank (or raising the money from the stock market) instead of from you, a total stranger? The market for gold and other precious metals is unstable; be wary of any exaggerated claims. Few legitimate companies can afford to substantially undercut the market price for precious metals. Be skeptical of extraordinary claims, such as "secret formulas" for extracting otherwise unrecoverable precious metals from dirt. (This method appears to be especially prevalent in platinum group and "strategic" metals) Ask yourself, why am I hearing about this for the first time over the telephone? Don't let telephone salespeople convince you to invest on the spot. A person selling a legitimate investment opportunity will allow you to take some time to look over the company literature and to check out the credibility of the claims with someone whose financial advice you respect. Ovadya Funding Group International, Inc. Copyright 2007 19
  • 20. Don't be taken in by slick brochures and reports by so-called experts. The claims made in the brochure are only as good as the company that makes them. Don't be impressed by statements that the mining claim is on land managed by the Bureau of Land Management or the Forest Service. It is relatively simple to file a claim on federally managed land, but that does not mean the land is worth mining. Check out all the claims made in the sales call and in the written materials. Call the state Bureau of Mines in the state where the mine is located to get general information about the mineral content in the area to be mined. Get an independent, credentialed geologist (or a Certified Minerals Appraiser, or a Registered Mining or Metallurgical Engineer) to inspect the written materials. Call the state securities office in your state or in the state where the mine is located. They can tell you if the promoter has violated state securities laws in the past. When in doubt, say no. If you are not completely confident that you are investing in a legitimate offer, do not take a chance. Once a swindler has your money, it is very hard to recover it. What To Do If You Are A Victim Of A Dirt-Pile Scam If you thought you were investing in a legitimate mining operation and it turned out to be a dirt-pile scam, speak up. First, try to contact the mining company and attempt to get your money back. If you are not successful, report your problem to the state securities agency, state mining agency, Better Business Bureau, and Attorney General's office in your state and in the state where the mine is located. If law enforcement agencies are already looking into the company, your information will help in an investigation. If they do not know about the problem, your information may alert them to the need for one. You also may contact the Federal Trade Commission. Write: Correspondence Branch, Federal Trade Commission, Washington, D.C. 20580. Although the FTC generally does not intervene in individual disputes, the information you provide may indicate a pattern of possible law violations requiring action by the Commission. For More Information Additional information about telephone investment scams and how to protect yourself is found in the FTC fact sheet Telephone Investment Fraud. For a free copy, contact: Public Reference, Federal Trade Commission, Washington, DC 20580; 202-326-2222. You also may request Best Sellers, which lists all of the FTC's consumer and business publications. FTC CONSUMER & SMALL BUSINESS ADVISORY - PUBLIC DOCUMENT Please note that all Government Consumer Information Brochures appearing at this site are public domain documents and may be freely copied at will. We claim no copyright in the content of these documents. Comments and information in italics has been added by the author. v This page is a copy of consumer information presented by the Federal Trade Commission and is presented in the hope that it may assist readers in making a more informed decision about potential mining project investments. In some areas comments or other information has been added by the reader. This information is in italics. What is indium? You may learn the hard way if someone calls and says, "This metal is the hottest investment today. Invest immediately! "If you do invest, you may join a growing number who have lost thousands of dollars to telemarketing firms that sell "strategic metals," such as indium, germanium, selenium, or cadmium. Many of these firms are located in Canada. The telemarketers have sold the metals at prices that far exceed their worth. This brochure explains the sales tactics of the fraudulent telemarketing firms and how to protect yourself from them. It also lists resources you can use for inquiries or complaints. Part I: "Buy Now!" The scam unfolds like this. A telemarketer calls offering you indium as an investment that promises little risk and high returns. If you're reluctant to buy, the telemarketer may send you an impressive-looking brochure or even a video cassette that exaggerates indium's worth. Indium is a byproduct of zinc. It's used in digital screens (on watches and computers), architectural glass, and fire sprinklers. Because indium also is used by the defense industry, it sometimes is called a "strategic metal. "The term "strategic metal" may be confusing to the average investor. It may sound glamorous, and the fraudulent telemarketer may capture your attention by talking about new high-tech applications for indium. These telemarketers may claim that the demand for indium is growing while the supply is dwindling. They may explain that the U.S. imports most of its indium and that the overseas producers are threatened by political or economic problems. Ovadya Funding Group International, Inc. Copyright 2007 20
  • 21. These claims are false. There is no shortage of indium, and there are no forces that are driving up the price. Foreign suppliers of indium include countries like France, Italy, and Canada. Indium currently is selling for about $5 per ounce, but telemarketers have sold it for $80 or more for that amount. Worse yet, it's unlikely investors could ever resell their indium at any price. First, indium is an industrial-use metal, not an investment metal. It is not traded like a commodity or stock. Second, even if you found a company that uses indium, it probably would not be interested in buying your small supply. Because you would not be able to guarantee the quality of your indium, a company probably would not want to pay to do their own analysis. Part II: "Buy More!" If you buy some indium, your name may be traded on what is called a "sucker's list." The telemarketing firm that sold you the indium, or a different one, will call to give you updates on indium's latest selling price. Of course, each update will show a higher selling price. Because you believe the price of indium is rising, you may not suspect any problems with your investment. Most likely, one or more companies will try to pressure you into buying more indium to close a deal with an alleged buyer of your supply. For example, if you have 300 ounces of indium, you may be told that the "buyer" only wants to purchase quantities of 500 or more. However, if you buy more indium, you will only lose more money. The so-called "buyer" will disappear. Part III: "Good-bye" If you ever discuss selling your indium with the telemarketers, they may stall your action by telling you the price hasn't peaked yet or that you still need more indium for your portfolio. If, at some point, you discover you paid too much for the indium, you may find that the sales representative who was so eager to sell you indium before is no longer available to talk to you. Your phone calls may not be forwarded or your messages returned. Some companies often ask for the purchase money by wire because it's difficult to trace who receives the transfer. Others may shut down quickly, running with the money that investors have paid. It may be impossible to get your money back, especially if you're dealing with a foreign company. Before Parting with Your Money Be extremely cautious if someone calls offering to sell you indium or any other strategic metal as an investment. For general information, or to register a complaint against a telemarketing company, you may contact: National Fraud Information Center Consumer Assistance Hotline 1-800-876-7060 9:00 a.m. - 5:30 p.m. EST, Monday-Friday You also may file a complaint with the agencies listed on the next page. When writing to register a complaint, include a complete history of your involvement with the company. You should enclose copies of all letters, brochures, or other material you received from the firm in addition to any correspondence you may have sent. Federal Bureau of Investigation. Check your telephone directory for your local FBI office Federal Trade Commission Telemarketing Fraud, Room 200 6th Street and Pennsylvania Ave., NW Washington, DC 20580 Please note that all Government Consumer Information Brochures appearing at this site are public domain documents and may be freely copied at will. We claim no copyright in the content of these documents. vi Leveraged Precious Metals Scams This page is a copy of consumer information presented by the Federal Trade Commission and is presented in the hope that it may assist the reader in making a more informed decision about potential mining project investments. In some areas comments or other information has been the author. This information is in italics. Every year consumers lose billions of dollars to fraudulent telemarketing investments. Under one scheme, telemarketing companies may use high-pressure sales tactics to persuade consumers to make leveraged investments in precious metals, such as silver, gold and platinum. The companies may falsely claim such investments carry low risk and can be expected to generate high profits. However, the price of precious metals is volatile and an investment in these commodities is speculative and risky. And by leveraging, borrowing money to make the investment, the degree of risk is Ovadya Funding Group International, Inc. Copyright 2007 21
  • 22. magnified. During recent years, many consumers who have invested in these programs have lost a high percentage of their investments. Before you agree to make a leveraged purchase of precious metals, read this brochure. How the Scams Works A salesperson may call urging you to invest in precious metals. The caller may predict that the market price of metals is about to skyrocket during the next few days or weeks and that if you don't act now, your investment opportunity may be lost. Claims may be made that your investment can be expected to generate substantial profits, with little risk, in as little as six months. The salesperson may explain that, under their investment plan, you are to pay a portion of the cost of the metal in cash, often 20 percent, and a financial institution will loan you the balance. The financial institution will arrange for your metal to be held as collateral for the loan. During the sales pitch, you also may be given information about program fees and commissions. But, in fact, FTC cases against such telemarketers suggest that many of the fees and commissions charged were misrepresented or concealed and that fees ate up the majority of the money that the consumers actually paid into the program. In addition, consumers often do not receive written account statements that completely disclose program fees. Besides potentially losing your initial cash outlay to commissions and fees, a highly leveraged investment increases the risk of an equity call. An equity call occurs when changes in the price of the metals or program fees causes the value of your investment to fall to where the financing company considers your metal insufficient collateral to secure the loan. Upon receiving an equity call, you must decide whether to put more money into the investment or have the financing company sell the metal in order to pay off the loan. Either way, you are likely to lose some or all of your investment. How to Avoid Losing Your Money Consider the following precautions if you receive an investment solicitation. l) Be skeptical about any unsolicited phone calls about investments. You may be on a list that contains the names, addresses, phone numbers, and descriptions of people who have responded before to telephone solicitations regarding questionable schemes. 2) Avoid high-pressure sales tactics. Sales presentations that urge you to buy now or you'll lose your investment opportunity are clues to a possible fraud. If you feel pressured, simply hang up the phone. Ask the caller to send you information about the company and its operation and verify the data. Check out the company's offer with someone whose financial advice you trust. 3) Contact the consumer protection agency, Attorney General, and Better Business Bureau in your state and in the state where the company is located to learn if they know of any consumer complaints against the firm. What to Do If You Feel Victimized If you believe you are a victim of a fraudulent precious metals investment, first contact the company and try to get your money back. Write a complaint letter to the company that sold you the metal and to the company that financed the transaction. If possible, direct your complaint personally to the highest ranking officials in the company. Also, report your problem to your local consumer protection agency, state Attorney General, and the Better Business Bureau. In addition, you may wish to contact the National Fraud Information Center (NFIC), Consumer Assistance Hotline at 1- 800-876-7060, 9 a.m. - 5:30 p.m. EST, Monday - Friday, to report the company. The NFIC is a private, non-profit organization that operates a hotline to provide services and assistance in filing complaints. You also may file a complaint with the FTC by writing to: Correspondence Branch, Federal Trade Commission, Washington, D.C. 20580. Although the FTC generally does not intervene in individual disputes, the information you provide may help to indicate a pattern of possible law violations requiring action by the Commission. Please note that all Government Consumer Information Brochures appearing at this site are public domain documents and may be freely copied at will. We claim no copyright in the content of these documents. Ovadya Funding Group International, Inc. Copyright 2007 22
  • 23. vii "Gold Is Where You Find It" (But, Be Sure You Really Found It) by Paul J. Lechler, Ph.D, Chief Geochemist Nevada Bureau of Mines and Geology Published in the May 1997 issue of International California Mining Journal, who kindly provided permission to reprint it. $30,000,000 scammed from duped investors in a phony mining promotion! Perhaps the largest case on record, but only one of many incidents of miners and investors falling victim to scams, lousy advice, and/or shoddy analytical workmanship. During my long tenure as an analytical geochemist, I have come across many scams along with many confused prospectors and investors. Analytical geochemists are professionals who, after many years of college, two or three degrees in chemistry, geology, or the hybrid-geochemistry, are skilled at determining the concentrations of elements (such as gold, silver, platinum, copper, etc.) in rocks, minerals, soils, sediments, water and vegetation. Natural Earth materials are very complex, containing at least trace amounts of all of the naturally-occurring 92 elements on the periodic chart from hydrogen (atomic number 1) through uranium (atomic number 92), except for technetium (number 43, which has not been found to occur naturally) and promethium (number 61, also missing from Earth's crust). The complexity of these natural materials makes their analysis a difficult task, requiring extensive knowledge, experience, and expensive instrumentation. I have tried to help people whose, often times, very limited knowledge of minerals has gotten them in over their heads in one situation or another. Some people simply suffer from the misconception that, with a little financial investment and/or a very basic knowledge of prospecting and mining, one can successfully find a valuable mineral deposit just waiting for discovery. This is akin to a pot of gold at the end of the rainbow or finding buried or sunken treasure. The problem, I have found, is that when exploring a new field of knowledge we don't recognize just how ignorant we are on this subject. We find several types of people involved in mining imbroglios or promotions: (1) the classic con-artist who intentionally tries to sell worthless mining property, ineffective equipment or technology. (2) the prospector with marginal knowledge who inadvertently promotes a worthless property or process because he knows no better, (3) the devious laboratory owner, who intentionally reports high concentrations of valuable metals to encourage customers to continue prospecting, sampling, and bringing in analytical business, and (4) the incompetent assayer or self-taught, but incompetent, extractive metallurgist who inadvertently causes others to develop a worthless property or process through erroneous analytical results. It is often very difficult to convince people who fall victim to scams or erroneous analytical conclusions that what they are being told is wrong. But this, however, I have come to understand, is because the victim wants to believe that there are riches to be had. There are frequent claims that certain ores cannot be assayed by conventional methods. The story generally goes that the materials contain fabulous, ore-grade concentrations of precious metals but, because of some peculiarity, conventional assaying methods won't record their presence and "special" protocols or treatments are needed. Many of these claims and scams are recurring and one must have patience to deal with them over and over again. This problem of promoting worthless properties and procedures is a very old one. Mark Twain, in his book Roughing It, tells an interesting and not uncommon vignette: "Assaying was a good business, and so some men engaged in it, occasionally, who were not strictly scientific and capable. One assayer got such rich results out of all specimens brought to him that in time he acquired almost a monopoly of the business. But like all men who achieve success, he became an object of envy and suspicion. The other assayers entered into a conspiracy against him, and let some prominent citizens into the secret in order to show that they meant fairly. Then they broke a little fragment off a carpenter's grindstone and got a stranger to take it to the popular scientist and get it assayed. In the course of an hour the result came - whereby it appeared that a ton of that rock would yield $1,284.40 in silver and $366.36 in gold! ... Due publication of the whole matter was made in the paper, and the popular assayer left town 'between two days'." Ore Vs Mineralization, a Fundamentally Critical Concept Mineralization does not an orebody make. Water, for instance, contains at least trace amounts of all the elements, including gold. The critical point, however, is that given current technology, one cannot profitably extract gold from seawater or most other waters because the concentration of gold is too small. It has been tried repeatedly, notably by the Germans during WW1 to help fund their war machine. The problem is, it has always cost more to process the water than the value of the gold extracted. Ovadya Funding Group International, Inc. Copyright 2007 23
  • 24. Let's analyze this critical concept further. Natural processes recurring over the history of the earth have caused some minerals to become concentrated in extraordinary amounts in rocks in certain places. These areas of concentration of minerals are where we go to extract minerals at a profit. Finding areas of exceptional mineral concentration is the realm of prospecting or mineral exploration. In order for the extraction of minerals to be profitable, they must generally be: (1) highly concentrated (2) located near the earth's surface, (3) in an environmentally insensitive location (4) with accessible water, power, hospitable climate and transportation. This type of mineralization is referred to as an orebody because it can be processed and the minerals sold for a profit. The discrimination between mere mineralization and an orebody also requires three dimensional information about the volume of mineral-rich rock available for extraction. This requires drilling, tunneling, or trenching, combined with sampling and assaying the material. This is the only way to determine how many tons of mineralized rock are present and at what concentrations (and hence, value) the metals are present. The costs to extract the minerals from the ore must be determined. The value of the minerals in the ground, minus the costs to extract the minerals, minus the up-front costs of prospecting and permitting the mine, minus the end costs to decommission the mine and reclaim the area, tells us how much net profit might be available over the life of the mine. Only at this point can we rationally make a decision whether or not to pursue the project or investment. Some Recurring Assaying Scams Assaying scams are essentially limited to the precious metals, largely gold, platinum, and rhodium. There are reasons for this. Many elements are mined from the earth, but only the very valuable (precious metals) can be profitably mined at very low concentrations. At these low concentrations, the precious metals or minerals are generally very finely and widely dispersed throughout the rock. They are so finely dispersed that they are often difficult or impossible to see visually with microscopes, even when their concentrations are high enough to be mined profitably. This forces us to rely totally on the results of chemical assays to determine whether or not economic concentrations of these precious metals are present. This is where the incompetent and the unscrupulous find fruitful ground to err, to misconstrue, and to deceive. These problems and scams do not arise with other metals because the erroneous or fraudulent assay results could quickly be verified or dismissed through microscopic examination of the ore by a competent mineralogist, either professional or amateur. Prospectors who are on really tight budgets (and there are many) will often try to perform assays at home because they cannot afford the ten dollars or so that it costs to get a commercial assay done. When prospecting for precious metals, assays are necessary or one is limited to looking only for very high grade deposits in which the metals are visible. With home assays people often run astray. Assaying scams often involve convincing the clients that the "ore" in question is complex or, for some other reason, cannot be assayed by normal methods. Often some special pretreatment is required (such as adding a roasting step and then treating the ore with water, leaching first with sulfuric acid, subjecting the ore first to an arc similar to an electric welder, pretreating with sugar or salt, etc.) before fire assaying the sample. Sometimes it is said that the ore cannot be fire assayed at all because the gold is in a volatile form which will be burned off from the sample and lost during fire assaying. While this is largely untrue, such samples can always be analyzed by standard wet-chemical methods which do not involve heating the samples in high-temperature (1,050°C) furnaces. Good wet-chemical methods of determining the quantity of gold in a sample are used routinely by competent laboratories. The incompetent or unscrupulous, however, do not use the standard, scientifically-established methodology, but modify methods until they get results they want - however inaccurate they may be. Laboratory-Specific Ore-Grade Assays Certain laboratories repeatedly produce unreasonable data. Professionals in the mining industry have come to be leery of, if not simply to dismiss, assays from certain laboratories. Several years ago, the Nevada Securities and Exchange Commission (SEC) asked this writer to help determine how one laboratory was apparently salting samples from a cinder-cone property that they were promoting. After being unable to duplicate the results produced by the laboratory in question through umpire assays at other laboratories, the SEC visited the lab and videotaped their procedure for assaying samples. They then obtained a sample of all chemicals that were added to samples during the course of the assay so that I could check them for gold contamination. Had I detected contamination of gold in one of the chemicals (which I did not), it could have been argued that the "salting" was inadvertent and that we were dealing with mere incompetents. Results of my contamination check lead to the conclusion that gold was being added covertly and intentionally and that a scam was being perpetrated on investors. Some Recurring Property Scams Property promoters are not stupid people. They often conceive their scams so as to be at least partially believable, even to knowledgeable professionals. The difference between the typical victims of these scams and the knowledgeable Ovadya Funding Group International, Inc. Copyright 2007 24
  • 25. professional is that the professional knows how to quickly evaluate and verify or discredit the claims. He does this by calling on extensive knowledge about geology and ore deposits and through the use of the scientific method to avoid being confused and duped by the promoter. A couple of examples which attempted to promote platinum-bearing properties in southern Nevada and a silver property in Texas, will illustrate the nature of these endeavors to deceive and extract money from investors. Playa Deposits/Moapa Lake Bed Deposits Southern Nevada is one of the few areas in the United States where platinum mineralization is known to occur. The mineralization occurs in the lower elevations of a couple of mountain ranges both southwest and northeast of Las Vegas. Recurring property promotions occur in the valleys below these known occurrences, with the promoters trying to convince investors that platinum has washed out of the exposed occurrences in the ranges and has built up to ore grades in the adjacent, closed, basins in the valleys. In the semi-desert West, these normally-dry lake beds in closed basins are called playas, and playa scams concerning gold and the platinum-group elements (platinum, palladium, rhodium, ruthenium, osmium, and iridium) recur on a regular basis. The Moapa lake bed deposits, regionally adjacent to the platinum-bearing Bunkerville mining district northeast of Las Vegas is a favorite area in which to attempt to promote platinum properties. Although it is at least possible that such enrichment processes occur, there is no reliable evidence that they have. Colleagues and I have assessed and discredited these scams more than once. The Grand-Daddy of Them All In 1976 there occurred perhaps the boldest and richest mining scam ever recorded. The amount extorted from eager investors was estimated to have exceeded $30,000,000! Three con artists, McCord, Deaton, and Wolstencroft, enticed investors with a phony, proprietary extraction technology which was to extract substantial silver from vast reserves of ore near Llano, Texas (never mind that there was actually no silver in the rocks to be extracted). Up-front money was needed from the investors to secure the mining property in Texas and attract a $10,000,000 loan with which to build the needed refinery. Investors were told that they would double their money in one week and some were enticed to invest substantially. A widow from the South invested $450,000 and a former Chrysler Corporation president invested $150,000. Needless to say, investors never realized any profit from their investments and, in fact, lost essentially everything that they had invested. Was it the con artists' skill and charisma or the investor's eagerness to see unbelievable returns, or both, that resulted in this debacle? The money was funneled into a bank In the Bahamas where it was essentially out of reach of American officials who eventually were brought into the scam to investigate the broken promises. Other favorite areas in which to try to deceive investors have been basaltic cinder cones, lavas in general, Mancos Shale, Humboldt Sink, Nevada platiniferous brines, high-gold content water from any area, etc. The Problem of Quartz Veins I have probably seen more prospectors confused by quartz veins than any other type of mineralization. There are many examples in the western United States where prospectors found outcropping quartz veins containing gold. Many times, however, while the quartz vein continued underground its gold content did not. Prospectors happening upon these prospects will grab residual high-grade samples left in the wall of the hole. Thinking they have found a valuable vein they will begin mining the quartz at depth only to find it contains no gold. The problem is that geologic processes that have deposited quartz in the fracture in the rock are different than the processes that normally cause gold to be deposited along with the quartz. Because of the difference in depositional mechanisms for quartz and for gold, the fracture may be filled with quartz to great depths but the gold may only have been deposited in the shallow portions of the vein. Prospectors can waste a lot of time and money unjustifiably pursuing gold in barren quartz veins below productive horizons. Devious promoters can likewise make a worthless vein appear to be exceptionally valuable by guiding you to sample remnants of the gold-rich, shallow vein material and indicating that the quartz vein continues with depth. The Scientific Method and Reliable, Unambiguous Data: How to Avoid Being Duped! Scams generally involve attempts to convince someone that a rock is enriched in gold and/or other precious metals. Using principles of the scientific method, we can confirm or discount this assertion in an unambiguous, accurate, and reliable way. Let's look at a probably familiar analogy to review how the scientific method works and why we have come to trust its results. We are probably all familiar with medical studies which make use of the scientific method. We have probably all heard (more than once) about blind studies in which one experimental group is administered a new medicine while another Ovadya Funding Group International, Inc. Copyright 2007 25
  • 26. group is not. The researchers are looking for differences between the two groups which are unambiguously attributable to the treatment. So the scientists have gone through the mental exercise of hypothesizing that a medicine will cause a particular effect in patients and then designing an experiment to demonstrate conclusively that the medicine does or does not cause the anticipated effect. These scientists go to great lengths to be certain that the effects that they see or measure between the two groups are the result of the treatment alone. In a similar way, in establishing whether or not a rock contains gold, we must take steps to ensure that the results of our assay accurately reflect only the presence or absence of gold. We generally do three things during the analysis. First, we carry a blank through the entire analysis, treating it as though it were a sample by adding to it all the chemicals that we add to the real sample in the course of the assay. In this way, we would measure any small amount of gold that we might inadvertently add to the sample because we would also add it to the blank as we add the chemicals to them both. Secondly, we carry a standard along through the analysis. This is a natural sample, similar to the unknown, in which we already know the gold content with high confidence. At the end of our analysis, after treating the standard just like another unknown sample, we expect to find the certified amount of gold in the standard, indicating that our assaying method was an accurate one. Finally, we analyze more than one replicate of each sample, carefully assessing the variation in results between the duplicate or triplicate determinations of gold in a given sample to ensure that we can repeat our results time after time. After having taken these precautions during the conduct of our analysis we have high confidence that we know the concentration of gold in the unknown sample. We have monitored the analysis for inadvertent contamination by including a blank, we have verified the accuracy of the analysis by including a standard (or even several different standards), and we have demonstrated the reproducibility of our method. We can further assure ourselves that we have the proper answer by conducting the analysis with two entirely different methods. All methods should give similar results. Final Advice Before investing money in any mining-related endeavor, seek advice from a knowledgeable friend or hire a consultant to help you assess the risks inherent in the venture. Spending a little money on a consultant in the beginning may save a lot of money in the long run. If you are having material assayed, take it to a reputable laboratory (make some telephone calls to mining companies, state geological surveys, the Better Business Bureau, etc.). If you think that you have found samples that have ore grade concentrations of precious metals in them, have them re-assayed at a second commercial laboratory to confirm the results. If the two laboratories do not agree within some reasonable margin of error, after you have provided them with identical , carefully split samples, seek a third or fourth assay, until you are satisfied that you know what the concentrations are with a high degree of confidence. While many are attracted to mining because of the potential to obtain riches from rocks, prospecting or investing in mining is an expensive and risky venture. It is often said that if it sounds too good to be true, it probably is. But in this business, it might not be either because there are indeed some valuable ore deposits left to be discovered. Proceed with great care, and seek assistance if necessary. Be systematic, redundant, and apply liberal doses of common sense. viii What Is Minerals Appraisal-Valuation? Ovadya Funding Group International, Inc. Copyright 2007 26
  • 27. Mineral property appraisal or mining business valuation is not so much a matter of obtaining the "correct answer" as it is of how the appraiser selected the relevant data, analyzed this data and applied logical reasoning to arrive at a value conclusion that has the necessary level of reliability, supportability and defensibility for the purpose and intended use of the appraisal. The value of a qualified minerals appraiser to a client is a combination of his being a fiduciary (by law) and that he is able to apply his experience and judgment to a variety of mineral property and mining business appraisal situations and to arrive at reasonably probable solutions that are consistent with the purpose and intended use of the appraisal and meet the client's needs as well as the requirements of USPAP and those of any professional societies the minerals appraiser may belong to. In appraisal theory there are no truly "correct values", there are only estimates or opinions of value that are implicitly assumed to be based on some amount and quality of facts that are then interpolated and/or extrapolated as the appraisal situation demands. The appraiser's assumptions and limiting conditions are added to this imperfect information. In the end the appraiser must usually decide on a single number that is a reasonably probable estimate of value that is governed by the purpose and intended use of the appraisal as well as the client's time and money constraints. From the initial assumptions and limiting conditions that are inherent in the definition of value to be found and the purpose and intended use of the appraisal, to the final ones employed in any reconciliation, the value of the appraisal service is not the appraiser's ability to add or subtract, or to dazzle the client with elegant high level mathematical skills, or to recall some obscure factoid, but is the appropriate use of education, training, experience, and professional judgment to arrive at a conclusion of value that is appropriate for a given appraisal situation. The following is from Kieso and Weygandt’s Intermediate Accounting, with substitution of "appraisal" or "valuation" for "accounting" and seems to apply with equal validity to appraisal. "Mineral appraisal may appear to be primarily procedural in nature. The visible portion of appraisal - collecting and verifying data and preparation of valuation reports - too often suggests the application of a low-level skill in a mundane occupation that offers no challenge and demands no imagination. In minerals appraisal today a large body of theory does exist, however. Philosophical objectives, normative theories1, interrelated concepts, precise definitions, and rationalized rules constitute this body of theory (the conceptual framework) which may be unknown to many people that mineral appraisers work with. Thus minerals appraisers theorize, judge, create and deliberate as a significant part of their professional practice. The subjective aspects that are so critical to current mineral valuation practice, such as searching for truth and fact, judging what is fair presentation and considering the behavior induced by presentations, are often overshadowed by the appearance of exactitude, precision, and objectivity that accompanies the use of numbers to express a value estimate of a mineral property or mining business interest. "The principles of mineral appraisal are unlike the principles of natural sciences and mathematics, because they cannot be derived from or proved by the laws of nature, and they are not viewed as fundamental truths or axioms. Mineral valuation principles cannot be discovered; they are created, developed or decreed. Minerals appraisal principles are supported by intuition, authority and acceptability. Because it is difficult to substantiate minerals appraisal principles objectively or by experimentation, arguments concerning them can degenerate into quasi-religious dogmatism. As a result, the sanction for and credibility of mineral appraisal principles rest upon their general recognition and acceptance, which depend upon such criteria as usefulness, relevance, reliability, cost-benefit, and materiality considerations. "Possibly the most influential environmental force flows from user groups. User groups consist of parties who are most interested in or affected by mineral valuation standards, rules, and procedures. User groups play a significant role because the setting of minerals appraisal standards is a social decision: that is mineral valuation standards are as much a product of political action as they are of careful logic or empirical findings." (1, normative theories are judgments about "what ought to be". Normative appraisal views cannot be proved false, because they are based on value judgments, while positive theories are based on studies of "what is" among economic relationships.) ix A Simplified Outline of the Mineral Property Appraisal/Valuation Process I. Introduction Grossly simplified overview of the appraisal problem in relation to a mineral property. Ovadya Funding Group International, Inc. Copyright 2007 27
  • 28. Follows basic real property appraisal process as illustrated in the Mineral Appraisal/Valuation Process Flow Sheet with additional data, analysis and explanation of mineral specific items, such as: Regional & Local Geology Mineral Deposit Geologic Controls Mineral Resource & Reserves Mineral Product Market(s) II. What is a mineral property? Highest & Best Use is still the basic determinant A mineral property is more valuable for what it contains than for what can be built upon it. Not just that is has some interesting, or even economic, mineral content, but that the extraction of this mineral and its sale will provide the highest and best use of the land. Contrary to much opinion minerals are not usually an "increment to value" since the mineral operation may very well preclude other land uses during the time of active mining. Also contrary to much opinion a mine is not a business carried out on the property. Instead it is the incremental sale of the real estate itself. Physically Possible - A valuable economically mineable mineral must be present, not just suspected to exist. Legally Permissible - A mineral right does not necessarily confer upon the owner a right to mine the mineral. Mining is basically a zoning decision and many permits are required in addition to a reclamation plan. Financially Feasible - The owner, or lessee, must be capable of financing the relatively large capital expense required to develop and operate the mineral property. Lenders for mineral property development are few and far between. Maximally Productive - Operation as a mineral property must provide at least equal risk adjusted returns as alternative property uses. Basic Types of Mineral Properties: Precious Metals - Gold, Silver, Platinum Base Metals - Copper, Lead, Zinc Energy Minerals - Coal, Uranium, Petroleum, Geothermal Construction Materials - Sand, Gravel, Crushed Stone Industrial Minerals and Rocks - Rocks and minerals valuable for specific chemical and physical properties and applications: Talc, Asbestos, Trona, Limestone, Diamonds Gemstones - Diamonds, Rubies, Emeralds, Semi Precious Stones Mining methods: Open pit (aka surface or quarry), underground, in-situ leaching Processing methods - Placer (mechanical), roast, autoclave, chemical leach, smelt, refine. Depletion - a form of physical depreciation of land value III. Minerals Appraisal/Valuation Under FIRREA OCC statement in Federal Register, v57, No 69, p 12199, 9 April 1992 "... if the transaction only involves the severable interest rather than the parcel or tract of land. Where mineral rights, timber rights, or growing crops, and the associated parcel or tract of land, are the subject of a real-estate related financial transaction, the services of an appraiser would be required ..." Ovadya Funding Group International, Inc. Copyright 2007 28
  • 29. At a minimum, a possessory interest in the parcel or tract of land is required in order to extract the valuable mineral - the physical land itself must be taken in order to extract the mineral. Any appraiser must be a Certified General Appraiser - raw land and nonresidential Federal Level Competency: USPAP Competency Provision - If one is not competent to deal with mineral reserve estimation, development of mining plans, marketing of the mineral product(s) and their associated economics it means the appraiser would be leaving the guts of the appraisal to some outside expert while accepting full responsibility for the work product. Securities and Exchange Commission and U S Government Condemnation Authority- Appropriately qualified minerals industry professional - geologist and/or mining-metallurgical engineer Individual State Requirements FRT v Mandatory state Registration as a Geologist, Mining Engineer or Metallurgical Engineer, state required competency provisions above and beyond licensing as an appraiser IV. Surface and Subsurface Ownership Issues Jurisdictional dependence on where the dividing line between surface and subsurface is located in depth Jurisdictional dependence on whether or not sand and gravel are part of the surface or subsurface (mineral) estate) Mineral right is only one of the bundle of rights inherent in fee simple and mineral right is a separable interest from the surface and in respect to type of mineral and depth and/or geological formation and/or the mineral in question Fee simple v Privately Leased v Unpatented Mining Claims v Federal-State Lease Royalties, Working and Nonworking Interests - are they real and tangible or are they personal and intangible? Status of property as a mineral producer: Prospect, Exploration, Development, Extraction, Post Production or Speculative, Exploration, Resource, Reserve, Development, Production, Reclamation V. Mineral Resources and Reserves SEC Requirements - defined physical and economic conditions SME Requirements - defined physical and economic conditions USPAP Requirements - current physical and economic conditions or hypothetical Under USPAP certain cases of "defined physical and economic conditions" of the SEC and SME may well be considered to be hypothetical Resource - a term not recognized by the SEC but usually interpreted to mean the physical quantity of some specified quality of mineral in the ground Reserve - A term used to describe the physically present, mineable, processable, recoverable and salable mineral quantity that is economically justified to be mined and is legally able to be extracted. Ovadya Funding Group International, Inc. Copyright 2007 29
  • 30. Any appraiser that would take the property owner’s word for the reserve has not met any reasonable requirement for exercising independent third party judgment. At the very least the appraiser must be verify (not necessarily a complete audit or certification) the reserve or hire a competent person to do it. VI. Mineral Property and Product Markets If a market is considered to exist, it may be entirely local or it may be international in scope All real mineral markets, property or product, are characterized by a relatively small number of highly specialized and generally sophisticated sellers and buyers. The table called Mineral Product Market-Based Mineral Property Categorization illustrates one possible way to envision different mineral products and their market types as global, regional or local. VII. Approaches to Value Cost - Reproduction v Replacement, only really applies to property improvements and fixed and mobile plant, machinery and equipment Mineral Occurrence v Property Improvements Mineral occurrence and concentration in the ground is a natural occurrence and is not replaceable nor reproducible by the actions of man What constitutes an improvement to a mineral property? Samples, geological mapping, drill holes, benches, shafts, etc. Often treated as such within the industry. Similar to improvements to developed land. Direct Sales Comparison Whole property v mineral right v some royalty or other interest? The mineral itself, its product and the place and time Was it truly an arms-length sale? Was it even a sale? Adjustments - physical and chemical properties of the mineral commodities v specialized products natural mineral characteristic/quality v specialized processing amount and quality of reserves cap on royalty or mineral interest amount Is any royalty a fixed amount per unit or a percentage of some price Should payment-in-kind, forward contracts, hedging and/or commodity loans be considered as a return to property or a return to management? Income Approach Ovadya Funding Group International, Inc. Copyright 2007 30
  • 31. Whole property v mineral right v royalty or some other interest What income or earnings to use (defined by purpose of appraisal) How to treat depletion Reversion value – may be far removed in time and limited or nonexistent due to location Holding period - some fixed length or until exhaustion of reserves Discount rate selection - if no open market exists? Contract terms v "market" terms - if no open market exists? Include - payment-in-kind, forward contracts, hedging, commodity loans? Is a royalty actually ground rent? When valuing a mineral property is there really such a thing as "relief from royalty"? VIII. Choosing a Mineral Property Appraiser Ask the minerals appraiser three questions: 1) What percentage of his time is devoted to minerals appraisal? (It should be greater than 50%) 2) Does he belong to and participate in the American Institute of Minerals Appraisers (AIMA) and/or the American Society of Appraisers - Mines and Quarries discipline? State licensure as a Registered/Professional Geologist or as a Professional Engineer-Mining 3) Check his library to see if he has a good selection of geology, mining, processing, mining law, and appraisal books. Understanding, by education and experience, of normal practices in the mineral industry in general and with certain minerals and their markets x A Mineral Product Market-Based Mineral Property Categorization Mineral Product Category Mineral or Element Mineral Market Type Precious Metals Gold, Silver, Platinum Global Base Metals Copper, Lead, Zinc, Tin Global Chromite, Cobalt Manganese, Iron Alloys Regional, Global Molybdenum, Nickel, Vanadium Light Metals Aluminum, Magnesium, Titanium Global Energy Minerals Coal, Uranium, Oil, Gas, Geothermal Local, Regional, Global Sand, Gravel, Crushed Stone Local Construction Materials/ Construction Dimension Stone, Shale, Slate Regional, Global Aggregates Cement Products Regional, Global Diamonds, Rubies, Emeralds, Gemstones Regional, Global Semiprecious Stones Fertilizer Minerals Phosphates, Potash, Nitrates Regional, Global Chemical Minerals Sulfur, Salt, Limestone Local, Regional, Global Ovadya Funding Group International, Inc. Copyright 2007 31
  • 32. Clay, Feldspar, Silica, Trona, Barite, Ceramic and Glass Minerals Local, Regional, Global Boron Refractory and Flux Minerals Clay, Magnesia, Chromite Local, Regional, Global Abrasives Sandstone, Garnet, Industrial Minerals Local, Regional, Global Insulation Materials Asbestos, Mica, Silica, Gypsum Local, Regional Clay, Barite, Diatomite, Ochre, Pigment and Filler Local, Regional, Global Titanium, Zircon Drilling Muds Barite, Bentonite Regional, Global xi The voluntary adoption of the original Uniform Standards of Professional Appraisal Practice (USPAP) in 1987 by the eight leading professional appraisal organizations in the United States, formalized the scope of appraisal services and the documentation required to support an estimate of value. The USPAP provides appraisal standards and guidelines for performing and reporting appraisals and valuations for real estate and real property, personal property, and businesses or other intangible assets. In 1989 the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) legislation was enacted by Congress. The Title XI appraisal requirements of FIRREA only apply to real estate and/or real property and established education and experience requirements for licensing/certification of all real estate appraisers who perform appraisals for a federally related real estate transaction. This act also created the Appraisal Subcommittee and mandated the use of the USPAP for all real estate and/or real property appraisals involved in federally related transactions. Further Federal regulation of real estate and real property appraisers and appraisals came in 1991, when the Office of Management and Budget's (OMB) Circular A-129 became effective. This circular mandated the use of state licensed or certified real estate appraisers for all federal actions by Federal agencies under the OMB's jurisdiction. The current, 1998, USPAP defines three levels of scope for appraisals, three effective appraisal dates, and three methods of presenting the results of an appraisal. A Complete Appraisal is the act or process of estimating value or an estimate of value performed in accordance with all of the requirements of USPAP Standard 1. A Limited Appraisal is the act or process of estimating value or an estimate of value that departs in some fashion from USPAP Standard 1. A Hypothetical Appraisal is the act or process of estimating value or an estimate of value under an assumption of some hypothetical condition that is clearly required for legal purposes, for purposes of reasonable analysis, or for purposes of comparison and which would not be misleading. Two dates are essential to an appraisal report. USPAP requires that each report specify the effective date of the appraisal and the report date. The effective date of the appraisal establishes the time context for the appraisal . Three effective dates may be used according to the purpose, function and intended use of the appraisal. Current appraisals or analyses occur when the effective date of the appraisal is contemporaneous with the date of the report. Current is usually considered to be the date of examination of the property for an appraisal engagement. Retrospective appraisals or analyses indicate that the effective date of the appraisal is prior to (in the past) the date of the report. Retrospective appraisals or analyses may be required for property, estate or other tax matters, condemnation proceedings, suits to recover damages and similar situations. Prospective appraisals or analyses indicate that the effective date of the appraisal is subsequent (in the future) to the date of the report. Prospective appraisals or analyses may be required for valuations or analyses of property or business interests related to proposed developments, as the basis for value at the end of a cash flow period, and for other reasons. A prospective appraisal cannot be based on a hypothetical condition. Each written real property appraisal report must be prepared under one of the following three options as defined in USPAP Standard 2: Self-Contained Appraisal Report, Summary Appraisal Report or Restricted Appraisal Report. The essential difference among the three options is in the use of the terms describe, summarize, and state respectively. Describe is used to connote a comprehensive level of detail in the presentation of information. Summarize is used to connote a more concise presentation of information. State is used to connote the minimal presentation of information. While the USPAP does not specifically address the appraisal of mineral properties or the valuation of mining companies, mineral rights are normally considered to be a part of the "bundle-of-sticks" that comprise real property. The USPAP does indicate that mineral rights may be considered an intangible property associated with a business. It is this web site author's professional opinion that all income producing real property has a business of some kind associated with it. It also appears to be that income generated primarily from the use of real estate and/or real property has traditionally been valued as real property and not as a business enterprise. Most property tax regimes also consider mineral property to be real estate in the same manner as an apartment or office building. Therefore this author is of the opinion that mineral rights and/or other mineral interests should normally be valued and reported under USPAP Standards 1 and 2. If the mining business enterprise itself is to be appraised it should be valued and reported under USPAP Standards 9 and 10. Ovadya Funding Group International, Inc. Copyright 2007 32
  • 33. xii SUMMARY: The purpose of this paper is to review the current methods of accounting for ore reserves by exploration cost: Expense all, Successful Efforts and Full Cost. An alternate approach, Reserve Recognition Accounting, that was used by the SEC for a brief period of time, is reviewed and it is suggested that this method be readopted. Also addressed is the possible need for the mineral industry to adopt cumulative Income and Cash Flow Statements. BASIC CONCEPTS: Mining companies have operating characteristics that differ significantly from other industries and pose special accounting questions. The principal inventory items, ores and concentrates, differ significantly from inventory in most businesses and estimating their amount and value is a complex determination. Developing new resources is a highly uncertain and expensive undertaking. mining also has some unique situations in timing of costs and income. This paper is only going to discuss those items that appear to be relevant to determining the "value" of the solid mineral reserve asset. The SEC defines reserves as follows: "Reserves are that part of a mineral deposit (resource) which could be economically and legally extracted or produced at the time of the reserve determination." The economic element means that all cost data have been completed and an analysis of costs and returns has been made using established capital resources, and also that a market for the product(s) is viable. This economic analysis is usually called the feasibility study and it is at this point in time that the mineral resource exploration cost become mine development costs. Under GAAP the "value" of the ore reserve asset is a function of the costs required to put the asset into service. These costs are made up of the following individually identifiable costs: acquisition, exploration and development. The Acquisition Cost of the deposit is the price paid to obtain the property right to search and find an undiscovered natural resource or the price paid for an already discovered resource. This cost does not seem to present any theoretical problems except for accounting for inflation and the possibility of transfer pricing questions. Development costs begin after the feasibility study and are the costs necessary to put the reserve into production. Again, this cost would seem to be a rather straight forward bookkeeping task with the possible exceptions of inflation and transfer pricing. Exploration costs are those that begin after acquisition and before development. All kinds of accounting chicanery can be performed in this area. RESERVE ACCOUNTING METHODS: GAAP and the SEC provide three means for recording the exploration costs: (1) All exploration costs may be expensed in the period in which they are incurred ("Full Expense" approach). (2) In the Successful Efforts approach only those exploration costs that are associated with a project that results in an ore reserve are capitalized. All others are expensed in the period of incurrence. (3) In the Full Cost approach all exploration costs are capitalized until an ore reserve is eventually found. Coopers & Lybrand show five methods, not counting "not disclosed", but three of them are basically internal allocations of Successful Efforts. Cost is used as the value for the ore reserve asset because of the Continuity assumption even though a tentative income producing value was determined at the feasibility study point. Conservatism requires that special care be taken to avoid overstating assets. The Matching principle requires that a value for the ore reserve asset be established so that the future revenues from the mine can be matched with appropriate expenses incurred in earning those revenues. Obviously, the Full Expense method is the most conservative of the three and the Full Cost method is the most liberal. Depreciation is used to allocate costs of property, plant and equipment assets to indicate that their usefulness has declined. With natural resources the term depletion is used. A natural resource, or wasting asset, has two main characteristics: (1) the complete removal or consumption of the asset, and (2) only an act of nature can replace the asset. Normally, the depletion expense is computed on a unit of production basis, which means that depletion expense is a function of the number of units withdrawn during the period. The unit of production is usually tons. The total cost of the ore reserve is divided by the number of units estimated to be contained within it to arrive at the unit depletion cost. This cost per unit is multiplied by the number of units extracted to arrive at the depletion expense. Property, plant and equipment assets are depreciated over their useful life or the ore reserve life, whichever is shorter. ANALYSIS and DISCUSSION: A number of controversies and special accounting problems occur in dealing with non-renewable natural resources. Three major accounting concerns are; (1) the establishment of the physical and economic in-situ mineral inventory itself; (2) the Ovadya Funding Group International, Inc. Copyright 2007 33
  • 34. timing of mineral inventory development costs and revenues generated from the mine; and (3) the method of allocation of exploration expenses to their associated mineral properties. The establishment of the physical and economic mineral inventory is a very complex undertaking and except for being the point in time that costs switch from exploration to development has little to do with accounting. Therefore no additional discussion is provided on this topic. The timing problem is perhaps the simplest to understand and the most straight forward to deal with. The typical manufacturing company may require two or three years to acquire and prepare its property, plant and equipment for production and to begin earning revenue form them. The typical gold mine in Nevada has required almost 11 years of diligent exploration from discovery to feasibility study. Many larger or more complex mineral deposits have taken more than 20 years to arrive at the feasibility study stage. Ore deposits located in remote or environmentally sensitive areas can easily require another decade of development work before they can be put into production. This creates some obvious questions concerning the costs associated with these long delayed revenues. Regardless of the exploration cost allocation method that is used there may be serious asset "value" problems due to an unstable currency. Even though long term inflation rates are relatively lower than in recent history, the generational time frame involved can cause a serious undervaluation of what may be a company's only asset. This may be important from a theoretical accounting point of view but from a practical mine operating or financing perspective it seems relatively unimportant. The major cost associated with exploration is drilling. While drilling costs have risen significantly over time these increased costs may have been offset by improvements in drilling technology that have resulted in higher penetration rates and sampling quality. As for the mine operator being able to obtain adequate financing to put the mine into production, the book value has little to do with this determination. Almost all mine financing decisions are made as a result of a quite detailed feasibility study that simply reduces the mine production to a series of net cash flows that are then used to evaluate the soundness of financing alternatives. Basically, if the project can repay its debt it will receive the financing regardless of its book value. The exploration cost capitalization method, though, presents a more serious set of concerns. The most conservative approach is to expense all exploration costs as they are incurred but, because there is no cumulative income statement to track these expenses over the long time frames that are involved it can be difficult to evaluate a given company's true efficiency (return on assets?) as an operator in the minerals industry. Assuming the company has an operating mine with a relatively long life that can supply funds for exploration and the company is an inefficient explorer, when the company finally does find another exploitable ore deposit the true cost of that asset may easily be in excess of even its feasibility study defined present value. But, that cost will not be reflected in the asset value shown in the current or subsequent financial statements as only development costs determine its carrying value. The majority of companies involved in exploration never find their first mine and of those that do, my opinion is that the majority of them do not locate another that will replace the reserves they mined. This is a very inefficient, and ineffective, use of scarce financial resources. While this approach is considered the most conservative, it seems that it will serve better to obscure the true cost of obtaining an asset instead of serving to prevent the overvaluation of it. The Successful Efforts exploration cost approach states that only those costs associated directly to an ore reserve should be capitalized and all others should be expensed as incurred. A major problem with this approach is that until an ore reserve is defined one does not know which costs to capitalize. In this approach one would capitalize all exploration costs except those for properties that are clearly rejected (unsuccessful) in some period. Assuming that adequate internal accounting controls exist to record separate project expenses, the eventually successful ore reserve will have only directly related exploration costs allocated to it. But again, the true cost of the asset is obscured due to the lack of accounting for the unsuccessful projects that were required to be explored before the successful one was found. The Full Cost method of allocating exploration costs is conceptually and theoretically more correct but, it also has serious problems associated with it. Capitalizing all exploration costs causes significant distortions in net income, both in periods of large exploration expenses and in periods of write offs of these expenses. And then one is faced with the problem of "correctly" allocating these capitalized exploration expenses if more than one commercially viable ore deposit is found in the same period or in two closely related periods. Ovadya Funding Group International, Inc. Copyright 2007 34
  • 35. What is evident is that the general need for accounting information and the intended use of it for determining mining company efficiencies is not adequate for the task due to the long time frames that are normally encountered. Instead, the accounting profession has bogged itself down in the formulation of voluminous rules, regulations and procedures that seem designed to obscure the necessary and sufficient information instead of highlighting it. "Presented with financial statements certified by Big Six accountants, most people presumed they bore some resemblance to reality. Really they were prepared in accordance with a set of rules, but those rules didn't measure reality." In the same article, Breeden goes on to say, "If you are in a volatile business, then your balance sheet and income statement should reflect that volatility." This article was discussing valuing the idea that financial instruments held by financial institutions should reflect market value. While not directly related to mining companies and ore reserve asset carrying value the idea of volatility showing up in their financial statements is exactly analogous. Mining is a volatile, and quite uncertain, business. Mining companies have little control over the selling prices of the commodities they produce and these commodities have a record of swift and sharp changes in price. With the time frames involved from prospecting to production easily taking at least a generation, investors may well wonder why assets are not continually increasing in value. But, that is the nature of the business and until industry catches up with the Einsteinian idea of the convertibility of matter and energy, non-renewable natural resources will have to continue to be found the old fashioned way - chipping rocks and drilling holes. Accounting can be expected, though, to show users of financial statements the true costs of a company's operations. Some of this necessary information is currently shown in disclosures contained in the notes to the financial statements or alluded to in management's discussion and analysis section. Short of requiring companies to publish cumulative Income and Cash Flow statements the notes may be a good place to discuss the true mineral deposit asset cost. Because of the previously mentioned difficulties with exploration cost accounting and reserve asset value a financial statement user has no idea of the mining companies prospects for survival. In 1978 the SEC required certain natural resource companies to use Reserve Recognition Accounting (RRA), which it believed would provide more useful information and better reflect the economic substance of natural resource exploration. The SEC abandoned RRA for the primary financial statements in 1982, noting that the method did not possess the required degree of reliability for use as a primary method of financial reporting. Cited among the difficulties were practical problems in estimating (1) the amount of the reserves, (2) the future production costs, (3) the periods of expected production, (4) the discount rate, and (5) the selling price. These are indeed interesting "practical problems" because they are exactly the problems that must be solved by the company in order to change from exploration to development cost accounting! If a commercially viable deposit has been determined by solving the "practical problems" shown above, a Full Cost company can now allocate all those capitalized exploration costs to asset value. Where yesterday there was no asset, today there is a multi-million dollar asset in place and the user has no currently documented indication of how that value was arrived at. Admittedly, mining stock analysts who save every scrap of news release or gossip about a mining company they happen to be following, may be able to make a reasonably correct verification of value. I agree that RRA does not belong on the primary financial statements but it most certainly does belong in the notes. Oil and gas companies are required to show a "Standardized measure of Discounted Future Net Cash Flows" in the notes to the primary financial statements. Mining companies are not faced with this requirement. Mining companies say that they have additional uncertainties not faced by oil and gas companies that should exempt them from this requirement. But, even in the face of these overwhelming uncertainties, the mining companies seem to have little difficulty in convincing their Boards of Directors to approve the commitment of funds to a mining operation nor in convincing lenders to loan them hundreds of millions of dollars that are secured by these same woefully inadequately defined ore reserves. The shareholders of a mining company have the same relationship to the company as do U S citizens and the CIA - the shareholders and the citizens are the only ones that pertinent information is withheld from. Accounting data and information is presumed to be very precise by the accountants that assemble it and the auditors that verify it. The preciseness of the information is quite possibly less relevant than is its purported accuracy in reflecting the reality of the company's financial position. A short history of accounting is provided by Kieso and Weygandt (pp 7) that indicates that "from 1900 to 1929 the emphasis of accounting information has changed from "solvency and liquidity" to "income producing ability" due to the growth of large corporations with their absentee ownership and the increasing investment and speculation in corporate stocks". The balance Sheet is viewed as a statement representing a moment in time. In actuality it is the only statement that represents the cumulative effect of all past transactions. This statement provides the basic information for making liquidity Ovadya Funding Group International, Inc. Copyright 2007 35
  • 36. decisions but fails to provide adequate information to make a reasonable determination of solvency - ability to pay debts as they mature. Long term liabilities indicate a debt that must be repaid out of future revenue but, no presently required financial statement provides any indication of future revenue generation that is expected to be available to pay off the debt. If assets are greater than or equal to liabilities one often assumes that the entity is solvent. But, using this methodology results in abandonment of the continuity assumption. The business must be liquidated to pay its debts, in which case, assets are, by definition, misstated since they should now be reported at current market value instead of book value. The Income and Cash Flow statements represent the results of transactions over the most recent accounting period. SEC reporting companies must show the last three years of these statements but no cumulative Income and Cash Flow statements are required to be presented. Failure to require cumulative Income and Cash Flow statements distorts the calculation of many of the financial ratios used in evaluation of overall company performance and as a result these ratios become relatively meaningless at best. Rate of return on assets may be the only long term ratio that has any bearing on a mining company's chances of survival. This requires two values that are not available to anyone without a great deal of research: net income and total assets. We have already discussed the idea that the stated reserve asset value probably bears little relationship to reality. In a volatile industry such as mining, even an undistorted-by-accounting-chicanery net income figure for any one year is relatively meaningless because of the extreme price volatility seen in the spot metals market. Hedging activities and forward sales can serve to smooth revenue in any given year but the overall trend and results of the company's price taking abilities is the true measure of its profit making performance. Mining can not be looked upon as a short run industry and therefore a revised method of accounting for a company's only real asset is called for. The large dollar value of the plant and equipment account is totally meaningless without an adequate mineral reserve to justify it. I am of the opinion that if the physical and economic ore reserve, expected production, future production costs and commodity prices and discounted net cash flow calculations are good enough for management, auditors and certain sophisticated lenders than these values, which more clearly reflect true asset value than does cost, are good enough for financial reporting purposes. It is time for accounting related to mining to realize that cost is simply not an appropriate figure for the asset value of an ore reserve. A rather unique situation exists with one mining company operating in Nevada that tends to show the fallacy of current ore reserve accounting. This company has two mines of approximately the same physical size and relatively close to each other that probably required very similar true exploration costs to develop but, one of them contains about seven times as much recoverable metal content as the other. How is it then that the SEC and GAAP would have me believe that their asset values should be the same? REFERENCES 1. Ellis, Richard W. and Dennis J. McCarthy, Financial Reporting and Tax Practices in Nonferrous Mining, Coopers & Lybrand, Fourteenth Edition (no date). 2. Abbott, Jr., David M., SEC Reserve Definitions - Principles and Practice, 1984. 3. Ageton, Robert W., There is a Need to Change Disclosure of Reserves, 1987, NWMA, Spokane, WA. 4. Kieso, Donald E. and Jerry J. Weygandt, Intermediate Accounting, 1989, John Wiley & Sons, New York. 5. See number 1. 6. Richard C. Breeden, SEC Chairman, in "If life is volatile, account for it", Forbes, November 12, 1990. 7. See number 4. xiii Myth: Miners dig huge holes and leave them behind. Fact:- Before a mine Is even dug, numerous permits must be obtained. A plan of operation must be approved by the managing land agency. The plan must Include extensive detail on how mining will proceed and what the land will look like Ovadya Funding Group International, Inc. Copyright 2007 36
  • 37. when mining Is complete. Some open pit mines are being planned for use as recreational lakes and habitat for fish, birds, and other aquatic life. Mining companies are required to reclaim the land for beneficial use and abide by today's strict standards for protecting air and water. This includes posting reclamation bonds to Insure that the reclamation will be done. It is very important that everyone understand that mining is only a temporary use of the land. However, it must be noted that with mining there will be a change in the landscape. During the last part of this century, environmental concerns have played a major role in planning, operating and closing a mine. In the old days, miners only had the technology to recover the richest of ores. They moved from one location to another tunneling and digging for only the minerals that could be seen and easily removed. In the early days, mining was the key element in settling the new territories and environmental concerns were secondary to scratching a living from the barren and harsh setting they called the western frontier. The bottom line is that we all place demands on the earth In order to satisfy our basic needs, and we must all be willing to pay a certain price for obtaining those basic needs. We all make choices, each and every day, that impact our environment, but we can all try to minimize those impacts. One must remember that there are only two basic resource industries, mining and agriculture, and that all of our material needs must be grown or mined. Our horn of plenty truly begins with a hole in the ground. Myth: I'm just an average person. I don't have a need for minerals. Fact: Wrong! Everything you buy and consume comes from the earth. It simply doesn't come from the grocery or hardware stores. We forget that a brightly packaged tool or shiny new appliance Is but the end product of a complicated and expensive Industrial process starting with a hole in the ground. Society as we know it today could not exist without products of Mother Nature's storehouse, the earth. The food we eat, the materials that make up the clothes we wear, the components of the cars we drive and the gadgets we work and play with all must be grown or mined. We all have basic material needs - food, shelter an water and the only way to obtain these basic needs Is to tap into the earth's resources. Without the two basic resource industries, mining and agriculture, the tapping ends, so too, does our ability to sustain a progressive society. xiv Introduction: Funding for advanced exploration, feasibility studies, mine development and mine site capital improvements or production expansion is often a major problem for many small and mid-size mining companies. Traditional methods of financing these projects have been through personal loans from friends and relatives, bank loans, joint ventures and attempting to take the company public. Oftentimes, none of these financing methods are available or suitable for small and mid-size miners. Traditional financing methods may not be economically suitable because of drains on capital or operating income or problems associated with losing operating control or sacrificing the owner’s equity. Mineral product, lending and investment market conditions may also prevent miners from relying on typical capital funding methods at times when money is most needed. This article briefly describes royalty based financing techniques and some of the benefits which mining companies can obtain by using them. Royalty based financing is a specialized technical and financial niche in the mining industry which provides custom tailored methods for mining companies to acquire mine development and production expansion capital. Royalty companies and investment groups can provide the miner with capital for improvement, expansion or purchase while also providing the necessary return on investment to both the miner and the royalty group. One of the main benefits of royalty based financing is that a production royalty allows the miner to maintain 100% ownership in the mine. For many mining operations, capital funding can be obtained without any payback obligation except the creation of a royalty based only on mineral production and sales. Benefits: Creating a production based royalty on a mining property in order to secure capital funding has many advantages over conventional financing methods: (1) Royalty companies and investment groups are usually less restricted in geographical area, type of mineral or mining and processing method than more conventional funding sources; (2) Royalty companies can create a royalty financing package that is unique to the miner’s property and economic situation without undue reliance on more formal approaches and absolute debt coverage ratios; (3) Royalty based financing groups understand the geologic, mining, processing and marketing aspects of mine operation and do not require excess education efforts by the miner which usually allows for quicker decision making; (4) Production royalties do not Ovadya Funding Group International, Inc. Copyright 2007 37
  • 38. dilute the equity position of existing owners or operators and normally royalty companies will not be directly involved in or control the miner’s operation; (5) Royalty financing groups have the financial flexibility to close transactions ranging from several hundred thousand to fifty million dollars; (6) Payback of royalty based financings is normally covered solely from mineral production and sales while conventional sources always require inflexible payback schedules, even if the mine encounters production difficulties or fails to go into production; (7) Royalty investors also provide a market for the sale of existing royalties held by individuals, for royalties generated by farmouts, and for royalties that are established through the dilution of interest of small miners that are joint ventured with large mining companies. Royalty based financing can often be obtained for uses that would not meet the size or underwriting criteria of conventional sources. Royalty financing is a unique method for mining companies to obtain funding and is a useful technique for many operating and economic situations, including: (1) Partner or equity/debt holder buyout; (2) Completion of feasibility study; (3) Funding of mine development from feasibility through production; (4) Financing mine development in new areas; (5) Production or product line expansion; (6) Purchase of existing mine; (7) Establishment of completion guarantees, and; (8) Purchase of farmout royalties; (9) Purchase of existing royalties from individuals, partnerships and non-mining companies. Buyout Financing: A miner may want to buy out joint venture partners, or other equity or debt interest holders, but lacks the required cash. An equity interest holder could also want a miner to buy them out, but the operator lacks sufficient funds and the equity holder does not want a long term payment schedule. A royalty could be created that allows the miner to purchase these types of interests, and end up with 100% of the equity. This transaction benefits the miner by leaving him with full operating control and ownership which may improve his mining operations and financial standing. The departing interest holders now have cash they can use for other purposes. The royalty creator has achieved a necessary return on investment of its capital without being involved in day-to-day mining operations. A royalty created for partner buyouts on a producing mine usually provides royalty holder payments based solely on mineral production and sales. Completion of a Feasibility Study: Mining companies have run out of working capital after spending very large sums of money on exploration that resulted in a developable mineral resource. These miners may not have the necessary additional funds required to complete a feasibility study, which demonstrates the existence of proven and probable mineral reserves in sufficient detail to obtain conventional financing. A royalty can be created which would provide the miner with sufficient funding to complete a feasibility study. A royalty created at this stage of a potential mine often provides that the only return to which the royalty holder is entitled to, is payment of the royalty, if and when mineral production and sales occur. The mining operator may be able to acquire funds free from mandatory and inflexible repayment obligations, even if the mine encounters production difficulties or fails to go into production. Funding Mine Development from Feasibility to Production: Mining operators can also find themselves with a completed feasibility study that clearly demonstrates the existence of proven and probable mineral reserves, but they are still unable to obtain conventional funding to go into production. Conventional funding sources may be reluctant to advance funds because of the property’s geographic location, the type of mineral, the mining and processing methods or the size of the financing. Another conventional method to fund mine development is for the operator to take in a joint venture partner. A miner may not want to dilute its equity position or sacrifice operational control of the mine, which would be required by having a joint venture partner. It is possible to create a royalty on the mining property which will provide the necessary capital to develop the mine, construct the processing facility and provide working capital through initial mineral product sales. A royalty created at this stage of a mining operation usually does not result in any mandatory or scheduled repayment obligation. The royalty holder will normally only receive payment from actual mineral production and sales. Financing New Mine Development: Some miners could expand their production capacity by developing adjacent or nearby mineral property they control, but they cannot fund this work from existing cash flow. The miner is not generally willing to give up equity in the total mining operation to a joint venturer in order to develop an adjacent property and, a joint venturer may not be interested in participating in only the new operation. Just as in funding a totally new mining operation, a royalty may be created on the new property that will be sufficient to secure funding for the development work. If the new development area was unable to support an acceptable royalty on its own, an additional royalty could be created on the existing property that would allow both the miner and royalty company to proceed with funding. Alternatively a royalty could be created only on the existing mining property, leaving the new development area open for future royalty based funding. This type of royalty arrangement is not too common, but in the right situations, it is a funding method that is of value to both the operator and the royalty company. As in the other cases above, the royalty payments will only come from mineral production and sales. Production or Product Line Expansion: This situation is analogous to development of an adjacent mineral property. A mineral property may be capable of a dramatically increased rate of production, or of producing another mineral commodity from the same mining operation, or its processing system could be modified to produce a higher value-added product, but the operator cannot finance this expansion from existing cash flow. It is not uncommon for different minerals from the same deposit to have a different royalty structure applied to them. Depending upon the cash flow that is capable of being generated and the risk profile associated with the existing and new production level, or the new mineral product line, an acceptable royalty could be created on the existing operation, the new operation or a combination of them. Again, royalty payments will normally come only from mineral production and sales. Ovadya Funding Group International, Inc. Copyright 2007 38
  • 39. Purchase of an Existing Mining Operation: A miner may have an opportunity to purchase a producing mining property or one at an advanced exploration or development stage. Growth through acquisition of additional mining properties is often more cost and time effective than grass roots exploration, but the funds required to purchase operating mines or proven mineral reserves are usually due at closing, and may currently be beyond the miner’s reach. This situation is another excellent candidate for using royalty financing since the royalty company will be working with an established mining operator. This situation also allows for creating more than one royalty if the size of the funding is beyond the level that could be supported by only the existing or the new mine. As is the usual case with royalty based financing, the royalty company only receive payments from mineral production and sales. Establishment of Completion Guarantees: Conventional financing sources may require smaller or single-mine operators to take in a joint venture partner for up to 50% of a mining project in order to obtain sufficient financial guarantee strength. As an alternative to sacrificing a major portion of equity in a mine, the miner may arrange a completion guarantee from a royalty company which has sufficient financial strength to satisfy the lender. Conventional lenders are attracted to this method of financial guarantee because, in addition to the collateral provided by the mining property, they gain comfort from the financial strength and guarantee of the royalty company. The net effect of a production royalty would likely be much less than the equivalent percentage of equity that would have to be given up in order to attract a financially acceptable joint venturer. In addition, a production royalty does not dilute the owner’s equity interest and repayment would normally be accomplished only through mineral production and sales. Purchase of Farmout Royalties: Smaller miners are often unable to complete exploration on a mineral property because of a weak financial condition or the necessity to spend existing funds on more advanced properties. It may be in the small company’s best interest to farm out a property to a larger, more financially secure operator, and structure the farmout agreement to include a production royalty. Depending upon the development stage of the farmed out property, it is possible to sell this royalty to a royalty company for a cash payment. This cash payment could allow the miner to proceed to development and production on a more advanced property. A royalty usually has greater value than the working or net profits interests that small miners usually end up with as their joint venture interest is whittled away as a result of continuing cash calls that are required to bring the property into production. As is normal for royalty funding, payments to the royalty buyer are usually received solely from mineral production and sales. Purchase of Existing Royalties: Another important function that royalty buyers perform is providing a market in which non-mining company royalty owners can sell their existing mineral production royalties. Many times a mining property is owned by an individual, partnership or company that does not have a long term desire to stay involved in the mining industry and would rather have the present value of their periodic and fluctuating royalty payments in a lump sum cash payment. These royalty owners may have alternative uses for a single payment buyout of their royalty. Some royalty owners may not want to sell 100% of their royalty, but would rather sell only a portion of it, in order to have cash for some other use. Unfortunately, these mineral royalty owners have probably discovered that conventional or institutional sources of funds are not interested in purchasing all or a part of mineral production royalties. Royalty buyers understand the long term nature of the mining industry and the sometimes wildly fluctuating mineral prices, and can provide these royalty owners with an opportunity to sell their mineral royalty for a fair price. Qualifying Minerals: Most royalty based financings and royalty purchases have involved precious metals properties, but the interests of royalty financing and buying companies are expanding into base metals, construction materials, industrial minerals, coal, uranium, and geothermal properties. Conclusion: This article has provided a brief introduction to royalty based financing and purchasing by royalty creating and buying companies and groups. Perhaps the most important benefit to mining companies is that by using royalty financing they can retain, or even increase, their equity position in their mining operations. There are many methods available for royalty companies to work with miners, and their continuing needs for capital improvements, production expansions or new property development funding. In addition, these same royalty companies provide a market for individual and non-mining company royalty owners to find a willing buyer for a mineral royalty interest they would like to sell. xv When mineral property owners enter into a mining lease they will usually be paid by means of a series of Advance Minimum Royalties until commercial production commences and then they will be paid by a series of Mineral Production Royalties. Mineral production royalties usually take one of four basic forms: (1) A Flat Rate Unit of Production Royalty; (2) A Gross, or Net Smelter Return (NSR), Royalty; (3) A Net Revenue, or Net Proceeds, Royalty, or; (4) A Net Profits Royalty. The royalty is the mineral property owner's share of the minerals which are produced and sold from the owner's property. These descriptive royalty terms are not always used in the same sense in which they are described here and consequently, both the mineral property owner and the mining operator should ensure that the mining lease accurately describes the type of mineral production royalty they intend to have on the property. Mineral property owners should also be aware of the mining operator's rights in relation to recovery of all Advance Minimum Royalties, and the possibility that the mining operator may also be able to recover all, or a stipulated portion, of its capitalized expenses on, or related to, the mineral property. Mineral property owners and operators should also be Ovadya Funding Group International, Inc. Copyright 2007 39
  • 40. aware of the difference between royalties which call for payment based on production contrasted with royalties that are based on sales. Individual mining lease requirements determine the royalty payment schedule, which may vary from monthly to quarterly to annually. Mining lease clauses may also specify the amount of production or sales information that the mining operator must supply to the mineral property owner to demonstrate that the proper royalty payments are being calculated and paid. The Flat Rate Unit of Production Royalty is simply a fixed amount of money that the mineral property owner and mining operator have agreed upon will be paid for each ton, pound or ounce of mineral product that is produced or sold from the owner's property. This royalty is perhaps the simplest to understand and administer because it only requires an accurate count of the 'units of production' produced or sold during a royalty accounting period. This royalty does not take into account the selling price or any costs of production of the mineral product being mined from the property, and does not usually have any adjustment for inflation. This type of royalty appears to be most commonly used in construction materials properties, those that are mined for sand, gravel and crushed stone. This type of royalty has lost some of its popularity because mineral property owners realized that the payments did not keep pace with inflation, or were not providing them with a fair return for the use of their land. The Gross, or Net Smelter Return (NSR) Royalty, is characterized by royalty payments that are a fixed or variable percentage of the sales price, or gross revenue, the mining operator receives from the sale of mineral product from the property. The mining operator's gross revenue, in metal mines, is often referred to as Net Smelter Return because it is common for the mining operator to sell the mineral product in a form that requires further processing by a smelter or refinery. The Net Smelter Return is the amount of money which the smelter or refinery pays the mining operator for the mineral product and is usually based on a spot, or current price of the mineral, with deductions for the costs associated with further processing. In non-metal mines the selling price is usually 'fob mine site' because of the transportation costs involved in delivering the mineral product to the buyer. Gross, or NSR, royalty payments are also fairly simple to calculate and administer in that only the selling price and quantity of mineral product produced or sold are required for their determination. A mining lease clause usually specifies the selling price that is to be used because of the differences in price among the spot, contract and forward markets that exist for different mineral products. Because the mineral price and quantity of mineral produced or sold may vary considerably during a royalty accounting period, the mining lease must provide details regarding the amount of information that is supplied to the mineral property owner in order for the owner to verify, or audit, the royalty payment amounts. This type of royalty will usually have the highest market value of all the royalty types in the event the royalty owner should want to sell it to a royalty buying company. A Net Revenue, or Net Proceeds Royalty is often interpreted to mean that some operating costs associated with the on- site mining and processing of the mineral are allowed to be deducted from the gross revenue before calculation of the royalty. Net revenue is defined as gross revenue less allowable production costs. Net Revenue royalties are usually a fixed or variable percentage of this net revenue. It is usual for these allowable production costs to be actual direct cash costs at the mine site and not 'accounting' or 'standard' costs that include indirect expenses such as exploration and corporate overhead. The costs of production which are allowed to be deducted must be accurately described in the mining lease to eliminate future disagreements about the amount of the royalty payment. Some mining leases will contain an exhibit, that describes by example, exactly which mining and processing costs are allowable deductions, how these allowable costs will be determined, and the calculations used to arrive at the net revenue and royalty amounts. As in the Gross Royalty, a mining lease clause usually specifies the price that is to be used because of the differences in price among the spot, contract and forward markets that exist for different mineral products. Because the mineral price and quantity of mineral produced or sold may vary considerably during a royalty accounting period, the mining lease must also provide details about the amount of information that is supplied to the mineral property owner in order for the owner to verify, or audit, the royalty payment amounts. Depending upon the amount of the allowable deductions, a Net Revenue Royalty may be able to be sold to a royalty buying company for a lump sum cash payment. A Net Profits Royalty is similar to a Net Revenue Royalty in that certain production costs are allowed to be deducted prior to determination of the royalty payment. But, the allowable cost deductions in a Net Profits royalty may include all of the costs that can be tied to a particular mining operation, including exploration, corporate overhead, depreciation, depletion, amortization and any and all taxes. There seem to be two basic types of net profits royalties, one that is based on direct cash production costs, and one that is based on all production costs, direct and indirect and cash and non-cash, and may or may not be based on after income tax profit. In periods of high mineral prices, a net profits royalty may provide the mineral property owner with an attractive payment level because mineral production costs are usually the same regardless of the mineral's selling price. In periods of average to low mineral prices, net profits royalty payments can become quite small or disappear altogether. There are virtually no buyers for this type of royalty because of the creative accounting that the mining operator can use to depress the royalty payment amount. The distinguishing feature of a net profits royalty is that, depending upon the exact definitions in the mining lease and the actual calculations, it will very often be zero. Ovadya Funding Group International, Inc. Copyright 2007 40
  • 41. Advance Minimum Royalties are payments made by the mining operator to the mineral property owner before the commencement of commercial production. Many mineral property owners are not aware of the difference in meaning between a lease, or ground rental payment, and advance minimum royalties. Advance minimum royalty payments, unlike ground rent, are usually allowed to be recovered by the mining operator from any actual future mineral production royalty payments. Many leases that require the payment of minimum royalties after the commencement of commercial production also allow the mining operator to recover these payments out of future actual production royalty payments. Capitalized Expense Recovery: Some mining leases contain clauses that will allow the mining operator to recover its capital investment in the mining property before the mineral production royalty payments begin, or to pay a lower royalty rate until these costs are fully recovered. The definition of capital investment, or capitalized expense, contained in those mining leases with this provision, is usually very nebulous and may include all of the mining operator's expenses, direct and indirect and cash and non-cash, up to the point of commencement of commercial production. Total Royalty Payment Amounts: Many mining leases contain clauses that limit the total royalty payments to a specified maximum amount, at which time no more payments are made to the mineral property owner whether or not the mine is still in production. A knowledgeable and willing mineral property owner may have agreed to sell his property to the mining operator at an agreed upon price and to accept this selling price as a series of royalty payments. Many less knowledgeable mineral property owners have accepted a cap on the total royalty payment amount without an actual sale of the property to the mining operator. xvi The purpose of this page will be to present a discussion of the general issues involved in the licensing, certification, and/or registration of real property and minerals appraisers and geologists. All of the States require licensing or certification of real property appraisers for any federally related real estate transaction and some of the States require licensing or certification for all real property appraisals. To the best of our knowledge no Federal or State agencies have a specific requirement for licensing, certification, or registration of minerals appraisers. All of the States have a registration requirement for Professional Engineers, though not all of them recognize engineering specialties such as mining, metallurgical, or mineral processing engineering. According to the Summer 1998 issue of Arizona Geology, a quarterly publication of the Arizona Geological Survey, as of April 1998 the practice of geology is regulated in 22 States. Thirteen other states have statutes that control the profession of geology by title regulation, statutory definition, or partial certification, as shown in the table below. States With Geologic Practice Laws Practice Regulation Title Regulation (No Exam) Year State Year State 1956 Arizona 1980 Alaska 1968 California (1) 1980 Indiana 1971 Idaho 1981 Virginia 1972 Delaware 1988 Tennessee 1973 Maine 1975 Georgia (2) Statutory Definition 1977 Oregon (3) 1973 Colorado 1983 North Carolina 1993 Oklahoma 1986 South Carolina 1997 Nevada 1988 Arkansas (2) 1988 Florida Partial Certification 1991 Wyoming (2) Connecticut Nevada New 1992 Kentucky Iowa Jersey 1993 Pennsylvania Massachusetts Texas 1994 Missouri (2) Missouri 1994 Wisconsin 1995 Alabama (2) States Recently Attempting To 1995 Illinois Enact or Modify Existing Laws 1995 Minnesota (2) Delaware Ohio 1997 Kansas Indiana Oklahoma 1997 Mississippi (2) Nebraska Tennessee 1997 Puerto Rico New Mexico Texas New York Utah (1) Specialty Certification in Engineering Geology and Hydrology (2) Specialty Certification authorized but not implemented Ovadya Funding Group International, Inc. Copyright 2007 41
  • 42. (3) Specialty Certification in Engineering Geology Information compiled by James H. Williams, Missouri Department of Natural Resources xvii The purpose of this page is to present a discussion of the some of the uses of the more common minerals that are mined and consumed by society. An outline of daily mineral requirements in the United States is shown on the In One Day page. If It Can't Be Grown It Has To Be Mined Everyday Elements, Minerals, and Mineral Products Aluminum - Bauxite: Most abundant metal element in Earth's crust. Bauxite ore is a Rock composed of hydrated aluminum oxides and is the main source of aluminum and must be imported from Guinea, Australia, Jamaica, etc. Used in packaging (31%), transportation (22%) and building (19%). Antimony - Stibnite: A native element; antimony metal is extracted from stibnite and other minerals. Used as a hardening alloy for lead, especially storage batteries and cable sheaths; also used in bearing metal, type metal, solder, collapsible tubes and foil, sheet and pipes, and semiconductor technology. Used in fireworks. Antimony salts are also used in the rubber and textile industries, in medicine and glassmaking. Asbestos: Because this group of silicate minerals can be readily separated into thin, strong fibers that are flexible, heat resistant and chemically inert, asbestos minerals are used in fireproof fabrics, yarn, cloth, paper, paint filler, gaskets, roofing composition, reinforcing agent in rubber and plastics, brake linings, tiles, electrical and heat insulation, cement and chemical filters. Fibers are dangerous when breathed, so uses must protect against fibers becoming airborne. Barium - Barite: Used as a heavy additive in oil well drilling mud; in the paper and rubber industries, as a filler or extender in cloth, ink, and plastics products, in radiography ("barium milkshake"), deoxidizer for copper, sparkplug alloys, and in making an expensive white pigment. Beryllium: Used in the nuclear industry and in light, very strong alloys used in the aircraft industry. Beryllium salts are used in fluorescent lamps, in X-ray tubes and as a deoxidizer in bronze metallurgy. Beryl is the mineral of the gem stones emerald and aquamarine. Chromite: Found in South Africa and Zimbabwe. Used mainly in chemical and metallurgical industries (chrome fixtures, etc.). Clay - Clay Minerals: Clay is a rock term, and like most rocks it is made up of many different minerals in varying proportions. Clay also carries an implication of small particle size and usually refers to a fine-grained earthy material which becomes plastic when mixed with small amounts of water and then becomes firm, rocklike, and permantly hard on heating or firing. Among the various uses of clay are the manufacture of tile, porcelain, and earthneware, and in filtration, oil refining, and paper manufacture. Cobalt: Used in superalloys for jet engines, chemicals (paint dryers, catalysts, magnetic coatings), permanent magnets, and cemented carbides for cutting tools. Comes principally from Zaire, Zambia, Canada, Cuba and Commonwealth of Independent States (CIS). United States uses one-third of world production. Columbite-Tantalite Group: The principal ore of niobium and tantalum, used mostly as an additive in steel making and in superalloys; used in metallurgy for heat-resistant alloys, rust-proofing (stainless steel) and electromagnetic superconductors. Brazil and Canada are leading producers. Copper - Chalcopyrite: Used in electric cables and wires, switches, plumbing, heating; roofing and building construction; chemical and pharmaceutical machinery; alloys (brass, bronze and a new alloy with 3% beryllium that is particularly vibration resistant); alloy castings; electroplated protective coatings and undercoats for nickel, chromium, zinc, etc. Leading producers are Chile, United States, CIS, Canada, Zambia and Zaire. Feldspar: A rock-forming mineral; industrially important in glass and ceramic industries; patter and enamelware; soaps; bond for abrasive wheels; cements and u; insulating compositions; fertilizer; tarred roofing materials; and as a sizing, or filler, in textiles and paper. Fluorite - Fluorspar: Used in production of hydrofluoric acid, which is used in the pottery, ceramics, optical, electroplating and plastics industries; in the metallurgical treatment of bauxite; as a flux in open hearth steel furnaces and in metal smelting; in carbon electrodes; emery wheels; electric arc welders; toothpaste; and paint pigment. Garnet: Used as an abrasive and in the form of loose, angular grains and powders for grinding and lapping glass, Ovadya Funding Group International, Inc. Copyright 2007 42
  • 43. ceramics, and other materials; also for coated bonded products such as sandpaper, cloth and abrasive wheels for grinding and finishing metals, wood, rubber and plastic; as a gem stone in jewelry. Gold: Used in dentistry and medicine; in jewelry and arts; in medallions and coins; in ingots as a store of value; for scientific and electronic instruments; as an electrolyte in the electroplating industry. Leading producers are South Africa, United States, Australia, Brazil, Canada, China and CIS. Gypsum: Processed and used as prefabricated wallboard or an industrial or building plaster; used in cement manufacture; agriculture and other uses. Halite - Salt: Used in human and animal diet, food seasoning and food preservations; used to prepare sodium hydroxide, soda ash, caustic soda, hydrochloric acid, chlorine, metallic sodium; used in ceramic glazes; metallurgy, curing of hides; mineral waters; soap manufacture; home water softeners; highway de-icing; photography; in scientific equipment for optical parts. Single crystals used for spectroscopy, ultraviolet and infrared transmission. Iron Ore: Used to manufacture steels of various types. Powdered iron: used in metallurgy products; magnets; high- frequency cores; auto parts; catalyst. Radioactive iron (iron 59): in medicine; tracer element in biochemical and metallurgical research. Iron blue: in paints, printing inks, plastics, cosmetics, paper dyeing. Black iron oxide: as pigment; in polishing compounds; metallurgy; medicine; magnetic inks. Most U.S. production from Minnesota and Michigan. Australia, Brazil, China and CIS are major producers. Lead: Used in lead batteries, gasoline additives (now being eliminated) and tanks, and solders, seals or bearing; used in electrical and electronic applications; TV tubes and glass, construction, communications and protective coatings; in ballast or weights; ceramics or crystal glass; X-ray and gamma radiation shielding; soundproofing material in construction industry; and ammunition. United States is largest producer (mainly from Missouri) and consumer of lead metal. Lime - Limestone: Used for basic oxygen furnace steel, water purification, sulfur removal from stack gases, paper and pulp manufacture, electric steel furnaces and road and soil stabilization, and sewage treatment, sugar refining, alkali manufacture, and magnesia from seawater or brine; used in construction refractories and agriculture. Lithium: Compounds are used in ceramics and glass; in primary aluminum production; in the manufacture of lubricants and greases; rocket propellants; vitamin A synthesis; silver solder; batteries; medicine. Manganese: Essential to iron and steel production. Major producers: South Africa and CIS. Mica: Micas commonly occur as flakes, scales or shreds. Sheet muscovite (white) mica is used in electronic insulators; ground mica in paints, as joint cement, as a dusting agent, in well-drilling muds; and in plastics, roofing, rubber and welding rods. Molybdenum: Used in alloy steels (47% of all uses) to make automotive parts, construction equipment, gas transmission pipes; stainless steels (21%); tool steels (9%); cast irons (7%); super alloys (7%); and chemicals and lubricants (8%). As a pure metal, molybdenum is used because of its high melting temperatures (4,730 F) as filament supports in light bulbs, metalworking dies and furnace parts. Major producers are Canada, Chile and the United States. Nickel: Vital as an alloy to stainless steel; plays key role in the chemical and aerospace industries. Leading producers are Australia, Canada, Norway and CIS. Perlite: Expanded perlite is used in roof insulation boards; as fillers, filter aids and for horticulture. Phosphate Rock: Used to produce phosphoric acid for ammoniated phosphate fertilizers, feed additives for livestock, elemental phosphorus, and a variety of phosphate chemicals for industrial and home consumers. U.S. production from Florida, North Carolina, Idaho and Utah. Platinum Group Metals (PGM): Includes platinum, palladium, rhodium, iridium, osmium and ruthenium. Commonly occur together in nature and are among the scarcest of the metallic elements. Platinum is used principally in catalysts for the control of automobile and industrial plant emissions; in jewelry; in catalysts to produce acids, organic chemicals and pharmaceutical. PGMs used in bushings for making glass fibers used in fiber-reinforced plastic and other advanced materials, in electrical contacts, in capacitors, in conductive and resistive films used in electronic circuits; in dental alloys used for making crowns and bridge. Nearly all reserves are in CIS and South Africa. U.S. has one PGM mine. Potash: A carbonate of potassium; used as a fertilizer, in medicine, in the chemical industry and to produce decorative color effects on brass, bronze and nickel. Pumice: Used as an abrasive and extensively as a building consruction material. Pyrite: Used in the manufacture of sulfur, sulfuric acid and sulfur dioxide; pellets of pressed pyrite dust are used to Ovadya Funding Group International, Inc. Copyright 2007 43
  • 44. recover iron, gold, copper, cobalt, nickel; used to make inexpensive jewelry. Quartz (silica): As a crystal, quartz is used as a semiprecious gem stone. Crystalline varieties include amethyst, citrine, rose quartz, smoky quartz, etc. Cryptocrystalline forms include agate, jasper, onyx, etc. Because of its piezoelectric properties quartz is used for pressure gauges, oscillators, resonators and wave stabilizes; because of its ability to rotate the plane of polarization of light and its transparency in ultraviolet rays, it is used in heat-ray lamps, prism and spectrographic lenses. also used in manufacturing glass, paints, abrasives, refractories and precision instruments. Rare Earth Elements (lanthanum, cerium, praseodymium, neodymium, promethium, samarium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium ytterbium and lutetium): Used mainly in petroleum fluid cracking catalysts, metallurgical additives, ceramics and polishing compounds, permanent magnets and phosphors. Silica: Used in manufacture of computer chips, glass and refractory materials; ceramics; abrasives; water filtration; component of hydraulic cements; filler in cosmetics, pharmaceutical, paper, insecticides; anti-caking agent in foods; flatting agent in paints; thermal insulator. Silver: Used in photography, chemistry, jewelry; in electronics because of its very high conductivity; as currency, usually as an alloy; in lining vats and other equipment for chemical reaction vessels, water distillation, etc.; catalyst in manufacture of ethylene; mirrors; silver plating; table cutlery; dental, medical and scientific equipment; bearing metal; magnet windings; brazing alloys, solder. Mined in 56 countries, silver's largest reserves are in the United States Canada, Mexico, Peru and CIS. Sodium Carbonate (soda ash or trona): Used in glass container manufacture; in fiberglass and specialty glass; also used in production of flat glass; in liquid detergents; in medicine; as a food additive; photography; cleaning and boiler compounds; pH control of water. Most U.S. production from Wyoming. Sulfur: Used in the manufacture of sulfuric acid, fertilizers, chemicals, explosives, dyestuff, petroleum refining; vulcanization of rubber; fungicides. Tantalum: A refractory metal with unique electrical, chemical and physical properties used to produce electronic components, tantalum capacitor; for high-purity tantalum metals in products ranging from weapon systems to superconductors; high-speed tools; catalyst; sutures and body implants; electronic circuitry; thin-film components. Used in optical glass and electroplating devices. Leading producers are Australia, Brazil, Canada and Thailand. Titanium: A metal used mostly in jet engines, airframes and space and missile applications. Produced in western and central U.S., the UK, China, Japan and CIS. Tungsten: Used in metalworking; construction and electrical machinery and equipment; in transportation equipment; as filament in light bulbs; as a carbide in drilling equipment; in heat and radiation shielding; textile dyes, enamels, paints and for coloring glass. Vanadium: Used in metal alloys (titanium alloys important for aerospace); as a catalyst for production of maleic anhydride and sulfuric acid; in dyes and mordants; as target material for X-rays. CIS and South Africa are largest producers; large reserves also found in the United States and China. Zeolites: Used in aquaculture (fish hatcheries for removing ammonia from the water); water softener; in catalysts; cat litter; odor control; and for removing radioactive ions from nuclear plant effluent. Zinc: Used as protective coating on steel, as die casting, as an alloying metal with copper to make brass, and as chemical compounds in rubber and paints; used as sheet zinc and for galvanizing iron; electroplating; metal spraying; automotive parts; electrical fuses; anodes; dry cell batteries; nutrition; chemicals; roof gutter; engravers' plates; cable wrappings; organ pipes and pennies. zinc oxide used in medicine, paints, in vulcanizing rubber, sun block. Zinc dust used for primers, paints, precipitation of noble metals; removal of impurities from solution in zinc electrowinning. U.S. production mostly from Tennessee, Missouri, New York and Alaska. xviii "IN ONE DAY" In order to maintain our standard of living, every day: 18,000,000 tons of raw material must be mined, cut or harvested to meet the demands of U.S. citizens (about 150 pounds for every man, woman and child); Ovadya Funding Group International, Inc. Copyright 2007 44
  • 45. 640 acres (one square mile) of carpeting is woven using barite and calcium carbonate (limestone); 9,700,000 square feet of plate and window glass (about 223 acres) are used, enough to cover 200 football fields, using silica sand and trona; 2,750 acres of pavement are laid - four times as much surface area as is mined - enough concrete and asphalt to make a bicycle path 7 feet wide from coast to coast using sand, gravel, stone aggregate, and limestone; 94,000,000 eraser tipped pencils are purchased (enough erasers to correct all mistakes from 1,500 miles of notebook paper - about 129 acres of "goofs') using graphite, kaolin, pumice, copper and zinc; 426 bushels of paper clips (35,000,000) are purchased. Seven million are actually used, 8-9 million are lost and almost 5 million are twisted up by nervous fingers during telephone conversations, all using iron, clay, limestone, trona and zinc; 164 square miles of newsprint is used to print 62.5 million newspapers (enough to line a bird cage 12 miles wide and 13 miles long) using trona and kaolin; 400 acres of asphalt roofing are nailed down, utilizing silica, borate, limestone, trona, feldspar, talc, and silica sand; 187,000 tons of cement are mixed (enough to construct a four foot wide sidewalk from coast to coast) using limestone, sand, gravel, and crushed stone aggregate; 36,000,000 light bulbs are purchased, all made from tungsten, trona, silica sand, copper and aluminum; 10 tons of colored gravel is purchased for aquariums; 80 pounds of gold are used to fill 500,000 dental cavities; 50,000 pounds of toothpaste (2.5 million tubes) are used (enough to fill a small jet liner) requiring calcium carbonate, zeolites, trona, clays, silica and fluorite. 1,000,000 photographs are snapped (more than 29 acres of wallet sized photos) using silver and iodine. "ALL, JUST IN ONE DAY" WHO SAYS WE DO NOT NEED MINERALS!! Adapted from the April 1996, Blasters Newsletter. xix If It Can't Be Grown It Has To Be Mined We intend to categorize the common minerals as follows: Industrial Minerals (Boron, Clays, Diatomite, Mica, Soda Ash) Chemical Minerals Construction Materials (sand, gravel, crushed stone) Dimension Stone (Granite, Marble) Base Metals (Copper, Lead, Zinc) Non-Ferrous Metals (Aluminum, ) Precious Metals (Gold, Silver, Platinum Group Metals) Gemstones (Diamonds, Rubies, Sapphires) Energy Minerals (Coal, Uranium) Geothermal (Steam, Hot Water) Agricultural Minerals (Fertilizers, Soil Additives) Chemical Minerals (Antimony, Bromine, Cadmium, Soda Ash) Ovadya Funding Group International, Inc. Copyright 2007 45
  • 46. xx The IRS and Mineral Property Appraisal - Mining Business Valuation The United States Internal Revenue Service (IRS) has some specific requirements for appraising mineral properties and valuing mining businesses. It also has some generic rules that affect all real property appraisal and business valuations. This portion of the document is designed to provide some fundamental information about these generic and special IRS rules. These IRS requirements are necessary when valuing mineral properties and/or mining businesses for estate and gift taxes. Appraisals performed for clients that intend to use them for substantiating tax filings are performed under a definition of value referred to as Fair Market Value (FMV). The IRS is of the opinion that the fair market value of an asset should be the same whether it is being appraised for estate taxes or for gift tax purposes. In Anselmo v. Commissioner, the Court, in applying the definition of fair market value in a charitable contributions case, held that there should be no distinction between the measure of fair market value for estate and gift tax purposes and charitable contributions under the income tax law. Fair Market Value is defined as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts". The definition of fair market value for estate tax purposes is at Treasury Regulations § 20.2031-1(b) and, for gift tax purposes is at Treasury Regulations § 25.2512-1. Both definitions are the same. IRS Rules For Mines The United States Treasury Department has established rules applicable to mines, oil and gas wells, and other natural deposits under CFR Title 26, Section 1.611-2(c) and (d), concerning the determination of fair market value of mineral properties, and improvements, if any. If the fair market value of the mineral property and improvements at a specified date is to be determined for the purpose of ascertaining the basis, such value must be determined, subject to approval or revision by the district director, by the owner of such property and improvements in the light of the conditions and circumstances known at that date, regardless of later discoveries or developments or subsequent improvements in methods of extraction and treatment of the mineral product. Copies of relevant IRS Regulations and Revenue Rulings are available for review. IRS Regulations Section 1.611-2(c), (d) IRS Regulations Section 1.611-2(c) deals with the determination of the mineral contents of deposits: If it is necessary to estimate or determine with respect to any mineral deposit as of any specific date the total recoverable units (tons, pounds, ounces, barrels, thousands of cubic feet, or other measure) of mineral products reasonably known, or on good evidence believed, to have existed in place as of that date, the estimate or determination must be made according to the method current in the industry and in the light of the most accurate and reliable information obtainable. IRS Regulations Section 1.611-2(d) deals with the determination of fair market value of mineral properties, and improvements, if any: The district director will give due weight and consideration to any and all factors and evidence having a bearing on the market value, such as cost, actual sales and transfers of similar properties and improvements, bona fide offers, market value of stock or shares, royalties and rentals, valuation for local or State taxation, partnership accountings, records of litigation in which the value of the property and improvements was in question, the amount at which the property and improvements may have been inventoried or appraised in probate or similar proceedings, and disinterested appraisals by approved methods. Mining & IRS Revenue Ruling 59-60 The purpose of this Revenue Ruling is to outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes. The methods discussed herein will apply likewise to the valuation of corporate stocks on which market quotations are either unavailable or are of such scarcity that they do not reflect the fair market value. Mining & IRS Revenue Ruling 68-609 The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the currently outstanding portions of A.R.M. 34, C.B. 2, 31 (1920), A.R.M. 68, C.B. 3, 43 (1920), and O.D. 937, C.B. 4, 43 (1921). The "formula" approach may be used in determining the fair market value of intangible assets of a business only if there is no better basis available for making the determination. Mining & IRS Revenue Ruling 77-287 The purpose of this Revenue Ruling is to amplify Rev. Rul. 59-60, 1959-1 C.B. 237, as modified by Rev. Rul. 65-193, 1965-2 C.B. 370, and to provide information and guidance to taxpayers, Internal Revenue Service personnel, and others concerned with the valuation, for Federal tax purposes, of securities that cannot be immediately resold because they are restricted from resale pursuant to Federal securities laws. Ovadya Funding Group International, Inc. Copyright 2007 46
  • 47. Mining & IRS Revenue Ruling 83-120 The purpose of this Revenue Ruling is to amplify Rev. Rul. 59-60, 1959-1 C.B. 237, by specifying additional factors to be considered in valuing common and preferred stock of a closely held corporation for gift tax and other purposes in a recapitalization of closely held businesses. This type of valuation problem frequently arises with respect to estate planning transactions wherein an individual receives preferred stock with a stated par value equal to all or a large portion of the fair market value of the individual's former stock interest in a corporation. The individual also receives common stock which is then transferred, usually as a gift, to a relative. Mining & IRS Revenue Ruling 93-12 If a donor transfers shares in a corporation to each of the donor's children, the factor of corporate control in the family is not considered in valuing each transferred interest for purposes of section 2512 of the Code. For estate and gift tax valuation purposes, the Service will follow Bright, Propstra, Andrews, and Lee in not assuming that all voting power held by family members may be aggregated for purposes of determining whether the transferred shares should be valued as part of a controlling interest. Consequently, a minority discount will not be disallowed solely because a transferred interest, when aggregated with interest held by family members, would be a part of a controlling interest. This would be the case whether the donor held 100 percent or some lesser percentage of the stock immediately before the gift. xxi The United States Treasury Department has established rules applicable to mines, oil and gas wells, and other natural deposits under CFR Title 26, Section 1.611-2(c) and (d), concerning the determination of fair market value of mineral properties, and improvements, if any. If the fair market value of the mineral property and improvements at a specified date is to be determined for the purpose of ascertaining the basis, such value must be determined, subject to approval or revision by the district director, by the owner of such property and improvements in the light of the conditions and circumstances known at that date, regardless of later discoveries or developments or subsequent improvements in methods of extraction and treatment of the mineral product. The district director will give due weight and consideration to any and all factors and evidence having a bearing on the market value, such as cost, actual sales and transfers of similar properties and improvements, bona fide offers, market value of stock or shares, royalties and rentals, valuation for local or State taxation, partnership accountings, records of litigation in which the value of the property and improvements was in question, the amount at which the property and improvements may have been inventoried or appraised in probate or similar proceedings, and disinterested appraisals by approved methods. If the fair market value must be ascertained as of a certain date, analytical appraisal methods of valuation, such as the present value method will not be used: (1) If the value of a mineral property and improvements, if any, can be determined upon the basis of cost or comparative values and replacement value of equipment, or (2) If the fair market value can reasonably be determined by any other method. To determine the fair market value of a mineral property and improvements by the present value method, the essential factors must be determined for each mineral deposit. The essential factors in determining the fair market value of mineral deposits are: (i) The total quantity of mineral in terms of the principal or customary unit (or units) paid for in the product marketed; (ii) The quantity of mineral expected to be recovered during each operating period; (iii) The average quality or grade of the mineral reserves; (iv) The allocation of the total expected profit to the several processes or operations necessary for the preparation of the mineral for market; (v) The probable operating life of the deposit in years; (vi) The development cost; (vii) The operating cost; (viii) The total expected profit; (ix) The rate at which this profit will be obtained; and, (x) The rate of interest commensurate with the risk for the particular deposit. If the mineral deposit has been sufficiently developed, the valuation factors specified above may be determined from past operating experience. In the application of factors derived from past experience, full allowance should be made for probable future variations in the rate of exhaustion, quality or grade of the mineral, percentage of recovery, cost of development, production, interest rate, and selling price of the product marketed during the expected operating life of the mineral deposit. Mineral deposits for which these factors cannot be determined with reasonable accuracy from past operating experience may also be valued by the present value method; but the factors must be deduced from concurrent evidence, such as the general type of the deposit, the characteristics of the district in which it occurs, the habit of the mineral deposits, the intensity of mineralization, the rate at which additional mineral has been disclosed by exploitation, the stage of the operating life of the deposit, and any other evidence tending to establish a reasonable estimate of the required factors. The mineral content of a deposit shall be determined in accordance with paragraph (c) of section 1.611-2. In estimating the average grade of the developed and prospective mineral, account should be taken of probable increases or decreases Ovadya Funding Group International, Inc. Copyright 2007 47
  • 48. as indicated by the operating history. The rate of exhaustion of a mineral deposit should be determined with due regard to the limitations imposed by plant capacity, by the character of the deposit, by the ability to market the mineral product, by labor conditions, and by the operating program in force or reasonably to be expected for future operations. The operating life of a mineral deposit is that number of years necessary for the exhaustion of both the developed and prospective mineral content at the rate determined as above. The operating cost includes all current expense of producing, preparing, and marketing the mineral product sold (due consideration being given to taxes) exclusive of allowable capital additions, as described in § 1.612-2 and § 1.612-4, and deductions for depreciation and depletion, but including cost of repairs. This cost of repairs is not to be confused with the depreciation deduction by which the cost of improvements is returned to the taxpayer free from tax. In general, no estimates of these factors will be approved by the district director which are not supported by the operating experience of the property or which are derived from different and arbitrarily selected periods. The value of each mineral deposit is measured by the expected gross income (the number of units of mineral recoverable in marketable form multiplied by the estimated market price per unit) less the estimated operating cost, reduced to a present value as of the date for which the valuation is made at the rate of interest commensurate with the risk for the operating life, and further reduced by the value at that date of the improvements and of the capital additions, if any, necessary to realize the profits. The degree of risk is generally lowest in cases where the factors of valuation are fully supported by the operating record of the mineral enterprise before the date for which the valuation is made. On the other hand, higher risks ordinarily attach to appraisals upon any other basis. The mineral property valuation rules put forth by the Treasury Department are essentially the same as Standard 1 of the Uniform Standards of Professional Appraisal Practice, which covers the appraisal of real property, and those routinely used in the mining industry. xxii Internal Revenue Service Reg. Sec. 1.611-2(c); 26 U.S.C. 611 (c) Determination Of Mineral Contents Of Deposits. Reg. Sec. 1.611-2(c)(1); 26 U.S.C. 611 (1) If it is necessary to estimate or determine with respect to any mineral deposit as of any specific date the total recoverable units (tons, pounds, ounces, barrels, thousands of cubic feet, or other measure) of mineral products reasonably known, or on good evidence believed, to have existed in place as of that date, the estimate or determination must be made according to the method current in the industry and in the light of the most accurate and reliable information obtainable. In the selection of a unit of estimate, preference shall be given to the principal unit (or units) paid for in the product marketed. The estimate of the recoverable units of the mineral products in the deposit for the purposes of valuation and depletion shall include as to both quantity and grade: (i) The ores and minerals in sight, blocked out, developed, or assured, in the usual or conventional meaning of these terms with respect to the type of the deposits, and (ii) Probable or prospective ores or minerals (in the corresponding sense), that is, ores or minerals that are believed to exist on the basis of good evidence although not actually known to occur on the basis of existing development. Such probable or prospective ores or minerals may be estimated: (a) As to quantity, only in case they are extensions of known deposits or are new bodies or masses whose existence is indicated by geological surveys or other evidence to a high degree of probability, and (b) As to grade, only in accordance with the best indications available as to richness. Reg. Sec. 1.611-2(c)(2); 26 U.S.C. 611 (2) If the number of recoverable units of mineral in the deposit has been previously estimated for the prior year or years, and if there has been no known change in the facts upon which the prior estimate was based, the number of recoverable units of mineral in the deposit as of the taxable year will be the number remaining from the prior estimate. However, for any taxable year for which it is ascertained either by the taxpayer or the district director from any source, such as operations or development work prior to the close of the taxable year, that the remaining recoverable mineral units as of the taxable year are materially greater or less than the number remaining from the prior estimate, then the estimate of the remaining recoverable units shall be revised, and the annual cost depletion allowance with respect to the property for the Ovadya Funding Group International, Inc. Copyright 2007 48
  • 49. taxable year and for subsequent taxable years will be based upon the revised estimate until a change in the facts requires another revision. Such revised estimate will not, however, change the adjusted basis for depletion. Reg. Sec. 1.611-2(d); 26 U.S.C. 611 (d) Determination Of Fair Market Value Of Mineral Properties, And Improvements, If Any. Reg. Sec. 1.611-2(d)(1); 26 U.S.C. 611 (1) If the fair market value of the mineral property and improvements at a specified date is to be determined for the purpose of ascertaining the basis, such value must be determined, subject to approval or revision by the district director, by the owner of such property and improvements in the light of the conditions and circumstances known at that date, regardless of later discoveries or developments or subsequent improvements in methods of extraction and treatment of the mineral product. The district director will give due weight and consideration to any and all factors and evidence having a bearing on the market value, such as cost, actual sales and transfers of similar properties and improvements, bona fide offers, market value of stock or shares, royalties and rentals, valuation for local or State taxation, partnership accountings, records of litigation in which the value of the property and improvements was in question, the amount at which the property and improvements may have been inventoried or appraised in probate or similar proceedings, and disinterested appraisals by approved methods. Reg. Sec. 1.611-2(d)(2); 26 U.S.C. 611 (2) If the fair market value must be ascertained as of a certain date, analytical appraisal methods of valuation, such as the present value method will not be used: (i) If the value of a mineral property and improvements, if any, can be determined upon the basis of cost or comparative values and replacement value of equipment, or (ii) If the fair market value can reasonably be determined by any other method. Reg. Sec. 1.611-2(e); 26 U.S.C. 611 (e) Determination Of The Fair Market Value Of Mineral Property By The Present Value Method. Reg. Sec. 1.611-2(e)(1); 26 U.S.C. 611 (1) To determine the fair market value of a mineral property and improvements by the present value method, the essential factors must be determined for each mineral deposit. The essential factors in determining the fair market value of mineral deposits are: (i) The total quantity of mineral in terms of the principal or customary unit (or units) paid for in the product marketed, (ii) The quantity of mineral expected to be recovered during each operating period, (iii) The average quality or grade of the mineral reserves, (iv) The allocation of the total expected profit to the several processes or operations necessary for the preparation of the mineral for market, (v) The probable operating life of the deposit in years, (vi) The development cost, (vii) The operating cost, Ovadya Funding Group International, Inc. Copyright 2007 49
  • 50. (viii) The total expected profit, (ix) The rate at which this profit will be obtained, and (x) The rate of interest commensurate with the risk for the particular deposit. Reg. Sec. 1.611-2(e)(2); 26 U.S.C. 611 (2) If the mineral deposit has been sufficiently developed, the valuation factors specified in subparagraph (1) of this paragraph may be determined from past operating experience. In the application of factors derived from past experience, full allowance should be made for probable future variations in the rate of exhaustion, quality or grade of the mineral, percentage of recovery, cost of development, production, interest rate, and selling price of the product marketed during the expected operating life of the mineral deposit. Mineral deposits for which these factors cannot be determined with reasonable accuracy from past operating experience may also be valued by the present value method; but the factors must be deduced from concurrent evidence, such as the general type of the deposit, the characteristics of the district in which it occurs, the habit of the mineral deposits, the intensity of mineralization, the oil-gas ratio, the rate at which additional mineral has been disclosed by exploitation, the stage of the operating life of the deposit, and any other evidence tending to establish a reasonable estimate of the required factors. Reg. Sec. 1.611-2(e)(3); 26 U.S.C. 611 (3) Mineral deposits of different grades, locations, and probable dates of extraction should be valued separately. The mineral content of a deposit shall be determined in accordance with paragraph (c) of this section. In estimating the average grade of the developed and prospective mineral, account should be taken of probable increases or decreases as indicated by the operating history. The rate of exhaustion of a mineral deposit should be determined with due regard to the limitations imposed by plant capacity, by the character of the deposit, by the ability to market the mineral product, by labor conditions, and by the operating program in force or reasonably to be expected for future operations. The operating life of a mineral deposit is that number of years necessary for the exhaustion of both the developed and prospective mineral content at the rate determined as above. The operating life of oil and gas wells is also influenced by the natural decline in pressure and flow, and by voluntary or enforced curtailment of production. The operating cost includes all current expense of producing, preparing, and marketing the mineral product sold (due consideration being given to taxes) exclusive of allowable capital additions, as described in Reg. Sec. 1.612-2 and 1.612-4, and deductions for depreciation and depletion, but including cost of repairs. This cost of repairs is not to be confused with the depreciation deduction by which the cost of improvements is returned to the taxpayer free from tax. In general, no estimates of these factors will be approved by the district director which are not supported by the operating experience of the property or which are derived from different and arbitrarily selected periods. Reg. Sec. 1.611-2(e)(4); 26 U.S.C. 611 (4) The value of each mineral deposit is measured by the expected gross income (the number of units of mineral recoverable in marketable form multiplied by the estimated market price per unit) less the estimated operating cost, reduced to a present value as of the date for which the valuation is made at the rate of interest commensurate with the risk for the operating life, and further reduced by the value at that date of the improvements and of the capital additions, if any, necessary to realize the profits. The degree of risk is generally lowest in cases where the factors of valuation are fully supported by the operating record of the mineral enterprise before the date for which the valuation is made. On the other hand, higher risks ordinarily attach to appraisals upon any other basis. Reg. Sec. 1.611-2(f); 26 U.S.C. 611 (f) Revaluation Of Mineral Property Not Allowed. No revaluation of a mineral property whose value as of any specific date has been determined and approved will be made or allowed during the continuance of the ownership under which the value was so determined and approved, except in the case of misrepresentation or fraud or gross error as to any facts known on the date as of which the valuation was made. Revaluation on account of misrepresentation or fraud or such gross error will be made only with the written approval of the Commissioner. Reg. Sec. 1.611-2(g); 26 U.S.C. 611 (g) Statement To Be Attached To Return When Valuation, Depletion, Or Depreciation Of Mineral Property Or Improvements Are Claimed. Ovadya Funding Group International, Inc. Copyright 2007 50
  • 51. Reg. Sec. 1.611-2(g)(1); 26 U.S.C. 611 (1) For the first taxable year ending before December 31, 1967, for which a taxpayer asserts a value for any mineral property or improvement as of a specific date or claims a deduction for depletion, or depreciation, there shall be attached to the return of the taxpayer for such taxable year a statement setting forth, in complete, summary form, the pertinent information required by this paragraph with respect to each such mineral property or improvement (including oil and gas properties or improvements). The summary statement shall be deemed a part of the income tax return to which it relates. In addition to such summary statement, the taxpayer must assemble, segregate and have readily available at his principal place of business, all the supporting data (listed in subparagraphs (2), (3), and (4) of this paragraph) which is used in compiling the summary statement. For taxable years after such first taxable year, and ending before December 31, 1967, the taxpayer need attach to his return only an explanation of the changes, if any, in the information previously furnished. For example, when a taxpayer has filed adequate maps with the district director he may be relieved of filing further maps of the same area, if all additional information necessary for keeping the maps up-to-date is filed each year. In any case in which any of the information required by this paragraph has been previously filed by the taxpayer (including information furnished in accordance with corresponding provisions of prior regulations), such information need not be filed again, but a statement should be attached to the return of the taxpayer indicating clearly when and in what form such information was previously filed. For provisions relating to the data which shall be submitted with returns for taxable years ending on or after December 31, 1967, see subparagraph (5) of this paragraph. Reg. Sec. 1.611-2(g)(2); 26 U.S.C. 611 (2) The information referred to in subparagraph (1) of this paragraph is as follows: (i) An adequate map showing the name, description, location, date of surveys, and identification of the deposit or deposits; (ii) A description of the character of the taxpayer's property, accompanied by a copy of the instrument or instruments by which it was acquired; (iii) The date of acquisition of the property, the exact terms and dates of expiration of all leases involved, and if terminated, the reasons therefor; (iv) The cost of the mineral property and improvements, stating the amount paid to each vendor, with his name and address; (v) The date as of which the mineral property and improvements are valued, if a valuation is necessary to establish the basis as provided by section 1012; (vi) The value of the mineral property and improvements on that date with a statement of the precise method by which it was determined; (vii) An allocation of the cost or value among the mineral property, improvements and the surface of the land for purposes other than mineral production; (viii) The estimated number of units of each kind of mineral at the end of the taxable year, and also at the date of acquisition, if acquired during the taxable year or at the date as of which any valuation is made, together with an explanation of the method used in the estimation, the name and address of the person making the estimate, and an average analysis which will indicate the quality of the mineral valued, including the grade or gravity in the case of oil; (ix) The number of units sold and the number of units for which payment was received or accrued during the year for which the return is made (in the case of newly developed oil and gas deposits it is desirable that this information be furnished by months); (x) The gross amount received from the sale of mineral; (xi) The amount of depreciation for the taxable year and the amount of cost depletion for the taxable year; (xii) The amounts of depletion and depreciation, if any, stated separately, which for each and every prior year: (a) Were allowed (see section 1016(a)(2)), Ovadya Funding Group International, Inc. Copyright 2007 51
  • 52. (b) Were allowable, and (c) Would have been allowable without reference to percentage or discovery depletion; (xiii) The fractions (however measured) of gross production from the deposit or deposits to which the taxpayer and other persons are entitled together with the names and addresses of such other persons; and (xiv) Any other data which will be helpful in determining the reasonableness of the valuation asserted or of the deductions claimed. xxiii IRS Revenue Ruling 59-60 SECTION 1. PURPOSE. The purpose of this Revenue Ruling is to outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes. The methods discussed herein will apply likewise to the valuation of corporate stocks on which market quotations are either unavailable or are of such scarcity that they do not reflect the fair market value. SECTION 2. BACKGROUND AND DEFINITIONS. .01 All valuations must be made in accordance with the applicable provisions of the Internal Revenue Code of 1954 and the Federal Estate Tax and Gift Tax Regulations. Sections 2031(a), 2032 and 2512(a) of the 1954 Code (sections 811 and 1005 of the 1939 Code) require that the property to be included in the gross estate, or made the subject of a gift, shall be taxed on the basis of the value of the property at the time of death of the decedent, the alternate date if so elected, or the date of gift. .02 Section 20.2031-1(b) of the Estate Tax Regulations (section 81.10 of the Estate Tax Regulations 105) and section 25.2512-1 of the Gift Tax Regulations (section 86.19 of Gift Tax Regulations 108) define fair market value, in effect, as the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property. .03 Closely held corporations are those corporations the shares of which are owned by a relatively limited number of stockholders. Often the entire stock issue is held by one family. The result of this situation is that little, if any, trading in the shares takes place. There is, therefore, no established market for the stock and such sales as occur at irregular intervals seldom reflect all of the elements of a representative transaction as defined by the term "fair market value." SECTION 3. APPROACH TO VALUATION. .01 A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases. Often, an appraiser will find wide differences of opinion as to the fair market value of a particular stock. In resolving such differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science. A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance. .02 The fair market value of specific shares of stock will vary as general economic conditions change from "normal" to "boom" or "depression," that is, according to the degree of optimism or pessimism with which the investing public regards the future at the required date of appraisal. Uncertainty as to the stability of continuity of the future income from a property decreases its value by increasing the risk of loss of earnings and value in the future. The value of shares of stock of a company with very uncertain future prospects is highly speculative. The appraiser must exercise his judgment as to the degree of risk attaching to the business of the corporation which issued the stock, but that judgment must be related to all of the other factors affecting value. .03 Valuation of securities is, in essence, a prophesy as to the future and must be based on facts available at the required date of appraisal. As a generalization, the prices of stock which are traded in volume in a free and active market by informed persons best reflect the consensus of the investing public as to what the future holds for the corporations and Ovadya Funding Group International, Inc. Copyright 2007 52
  • 53. industries represented. When a stock is closely held, is traded infrequently, or is traded in an erratic market, some other measures of value must be used. In many instances, the next best measure may be found in the prices at which the stocks of companies engaged in the same or a similar line of business are selling in a free and open market. SECTION 4. FACTORS TO CONSIDER. .01 It is advisable to emphasize that in the valuation of the stock of closely held corporations or the stock of corporations where market quotations are either lacking or too scarce to be recognized, all available financial data, as well as all relevant factors affecting the fair market value, should be considered. The following factors, although not all-inclusive are fundamental and require careful analysis in each case: (a) The nature of the business and the history of the enterprise from its inception. (b) The economic outlook in general and the condition and outlook of the specific industry in particular. (c) The book value of the stock and the financial condition of the business. (d) The earning capacity of the company. (e) The dividend-paying capacity. (f) Whether or not the enterprise has goodwill or other intangible value. (g) Sales of the stock and the size of the block of stock to be valued. (h) The market prices of stock of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter. .02 The following is a brief discussion of each of the foregoing factors: (a) The history of a corporate enterprise will show its past stability or instability, its growth or lack of growth, the diversity or lack or diversity of its operations, and other facts needed to form an opinion of the degree of risk involved in the business. For an enterprise which changed its form of organization but carried on the same or closely similar operations of its predecessor, the history of the former enterprise should be considered. The detail to be considered should increase with approach to the required date of appraisal, since recent events are of greatest help in predicting the future; but a study of gross and net income and of dividends covering a long prior period, is highly desirable. The history to be studied should include, but need not be limited to, the nature of the business, its products or services, its operating and investment assets, capital structure, plant facilities, sales records and management, all of which should be considered as of the date of the appraisal, with due regard for recent significant changes. Events of the past that are unlikely to recur in the future should be discounted, since value has a close relation to future expectancy. (b) A sound appraisal of closely held stock must consider current and prospective economic conditions as of the date of appraisal, both in the national economy and in the industry or industries with which the corporation is allied. It is important to know that the company is more or less successful than its competitors in the same industry, or that it is maintaining a stable position with respect to competitors. Equal or even greater significance may attach to the ability of the industry with which the company is allied to compete with other industries. Prospective competition which has not been a factor in prior years should be given careful attention. For example, high profits due to the novelty of its product and the lack of competition often lead to increasing competition. The public's appraisal of the future prospects of competitive industries or of competitors within an industry may be indicated by price trends in the markets for commodities and for securities. The loss of the manager of a so-called "one-man" business may have a depressing effect upon the value of the stock of such business, particularly if there is a lack of trained personnel capable of succeeding to the management of the enterprise. In valuing the stock of this type of business, therefore, the effect of the loss of the manager on the future expectancy of the business, and the absence of management-succession potentialities are pertinent factors to be taken into consideration. On the other hand, there may be factors which offset, in whole or in part, the loss of the manager's services. For instance, the nature of the business and of its assets may be such that they will not be impaired by the loss of the manager. Furthermore, the loss may be adequately covered by life insurance, or competent management might be employed on the basis of the consideration paid for the former manager's services. These, or other offsetting factors, if found to exist, should be carefully weighed against the loss of the manager's services in valuing the stock of the enterprise. (c) Balance sheets should be obtained, preferably in the form of comparative annual statements for two or more years immediately preceding the date of appraisal, together with a balance sheet at the end of the month preceding that date, if Ovadya Funding Group International, Inc. Copyright 2007 53
  • 54. corporate accounting will permit. Any balance sheet descriptions that are not self-explanatory, and balance sheet items comprehending diverse assets or liabilities, should be clarified in essential detail by supporting supplemental schedules. These statements usually will disclose to the appraiser (1) liquid position (ratio of current assets to current liabilities); (2) gross and net book value of principal classes of fixed assets; (3) working capital; (4) long-term indebtedness; (5) capital structure; and (6) net worth. Consideration also should be given to any assets not essential to the operation of the business, such as investments in securities, real estate, etc. In general, such nonoperating assets will command a lower rate of return than do the operating assets, although in exceptional cases the reverse may be true. In computing the book value per share of stock, assets of the investment type should be revalued on the basis of their market price and the book value adjusted accordingly. Comparison of the company's balance sheets over several years may reveal, among other facts, such developments as the acquisition of additional production facilities or subsidiary companies, improvement in financial position, and details as to recapitalizations and other changes in the capital structure of the corporation. If the corporation has more than one class of stock outstanding, the charter or certificate of incorporation should be examined to ascertain the explicit rights and privileges of the various stock issues including: (1) voting powers, (2) preference as to dividends, and (3) preference as to assets in the event of liquidation. (d) Detailed profit-and loss statements should be obtained and considered for a representative period immediately prior to the required date of appraisal, preferably five or more years. Such statements should show (1) a gross income by principal items; (2) principal deductions from gross income including major prior items of operating expenses, interest and other expense on each item of long-term debt, depreciation and depletion if such deductions are made, officers' salaries, in total if they appear to be reasonable or in detail if they seem to be excessive, contributions (whether or not deductible for tax purposes) that the nature of its business and its community position require the corporation to make, and taxes by principal items, including income and excess profits taxes; (3) net income available for dividends; (4) rates and amounts of dividends paid on each class of stock; (5) remaining amount carried to surplus; and (6) adjustments to, and reconciliation with, surplus as stated on the balance sheet. With profit and loss statements of this character available, the appraiser should be able to separate recurrent from nonrecurrent items of income and expense, to distinguish between operating income and investment income, and to ascertain whether or not any line of business in which the company is engaged is operated consistently at a loss and might be abandoned with benefit to the company. The percentage of earnings retained for business expansion should be noted when dividend-paying capacity is considered. Potential future income is a major factor in many valuations of closely held stocks, and all information concerning past income which will be helpful in predicting the future should be secured. Prior earnings records usually are the most reliable guide as to the future expectancy, but resort to arbitrary five-or-ten-year averages without regard to current trends or future prospects will not produce a realistic valuation. If, for instance, a record of progressively increasing or decreasing income is found, then greater weight may be accorded the most recent years' profits in estimating earning power. It will be helpful, in judging risk and the extent to which a business is a marginal operator, to consider deductions from income and net income in terms of percentage of sales. Major categories of cost and expense to be so analyzed include the consumption of raw materials and supplies in the case of manufacturers, processors and fabricators; the cost of purchased merchandise in the case of merchants; utility services; insurance; taxes; depletion or depreciation; and interest. (e) Primary consideration should be given to the dividend-paying capacity of the company rather than to dividends actually paid in the past. Recognition must be given to the necessity of retaining a reasonable portion of profits in a company to meet competition. Dividend-paying capacity is a factor that must be considered in an appraisal, but dividends actually paid in the past may not have any relation to dividend-paying capacity. Specifically, the dividends paid by a closely held family company may be measured by the income needs of the stockholders or by their desire to avoid taxes on dividend receipts, instead of by the ability of the company to pay dividends. Where an actual or effective controlling interest in a corporation is to be valued, the dividend factor is not a material element, since the payment of such dividends is discretionary with the controlling stockholders. The individual or group in control can substitute salaries and bonuses for dividends, thus reducing net income and understating the dividend-paying capacity of the company. It follows, therefore, that dividends are less reliable criteria of fair market value than other applicable factors. (f) In the final analysis, goodwill is based upon earning capacity. The presence of goodwill and its value, therefore, rests upon the excess of net earnings over and above a fair return on the net tangible assets. While the element of goodwill may be based primarily on earnings, such factors as the prestige and renown of the business, the ownership of a trade or brand name, and a record of successful operation over a prolonged period in a particular locality, also may furnish support for the inclusion of intangible value. In some instances it may not be possible to make a separate appraisal of the tangible and intangible assets of the business. The enterprise has a value as an entity. Whatever intangible value there is, which is supportable by the facts, may be measured by the amount by which the appraised value of the tangible assets exceeds the net book value of such assets. (g) Sales of stock of closely held corporation should be carefully investigated to determine whether they represent transactions at arm's length. Forced or distress sales do not ordinarily reflect fair market value nor do isolated sales in small amounts necessarily control as the measure of value. This is especially true in the valuation of a controlling interest in a corporation. Since, in the case of closely held stocks, no prevailing market prices are available, there is no basis for making an adjustment for blockage. It follows, therefore, that such stocks should be valued upon a consideration of all the evidence affecting the fair market value. The size of the block of stock itself is a relevant factor to be considered. Although it is true that a minority interest in an unlisted corporation's stock is more difficult to sell than a similar block of listed stock, Ovadya Funding Group International, Inc. Copyright 2007 54
  • 55. it is equally true that control of a corporation, either actual or in effect, representing as it does an added element of value, may justify a higher value for a specific block of stock. (h) Section 2031(b) of the Code states, in effect, that in valuing unlisted securities the value of stock or securities of corporations engaged in the same or a similar line of business which are listed on an exchange should be taken into consideration along with all other factors. An important consideration is that the corporations to be used for comparisons have capital stocks which are actively traded by the public. In accordance with section 2031(b) of the Code, stocks listed on an exchange are to be considered first. However, if sufficient comparable companies whose stocks are listed on an exchange cannot be found, other comparable companies which have stocks actively traded in on the over-the-counter market also may be used. The essential factor is that whether the stocks are sold on an exchange or over-the-counter there is evidence of an active, free public market for the stock as of the valuation date. In selecting corporations for comparative purposes, care should be taken to use only comparable companies. Although the only restrictive requirement as to comparable corporations specified in the statute is that their lines of business be the same or similar, yet it is obvious that consideration must be given to other relevant factors in order that the most valid comparison possible will be obtained. For illustration, a corporation having one or more issues of preferred stock, bonds or debentures in addition to its common stock should not be considered to be directly comparable to one having only common stock outstanding. In like manner, a company with a declining business and decreasing markets is not comparable to one with a record of current progress and market expansion. SECTION 5. WEIGHT TO BE ACCORDED VARIOUS FACTORS. The valuation of closely held corporate stock entails the consideration of all relevant factors as stated in section 4. Depending upon the circumstances in each case, certain factors may carry more weight than others because of the nature of the company's business. To illustrate: (a) Earnings may be the most important criterion of value in some cases whereas asset value will receive primary consideration in others. In general, the appraiser will accord primary consideration to earnings when valuing stocks of companies which sell products or services to the public; conversely, in the investment or holding type of company, the appraiser may accord the greatest weight to the assets underlying the security to be valued. (b) The value of the stock of a closely held investment or real estate holding company, whether or not family owned, is closely related to the value of the assets underlying the stock. For companies of this type the appraiser should determine the fair market values of the assets of the company. Operating expenses of such a company and the cost of liquidating it, if any, merit consideration when appraising the relative values of the stock and the underlying assets. The market values of the underlying assets give due weight to potential earnings and dividends of the particular items of property underlying the stock, capitalized at rates deemed proper by the investing public at the date of appraisal. A current appraisal by the investing public should be superior to the retrospective opinion of an individual. For these reasons, adjusted net worth should be accorded greater weight in valuing the stock of a closely held investment or real estate holding company, whether or not family owned, than any of the other customary yardsticks of appraisal, such as earnings and dividend paying capacity. SECTION 6. CAPITALIZATION RATES. In the application of certain fundamental valuation factors, such as earnings and dividends, it is necessary to capitalize the average of current results at some appropriate rate. A determination of the proper capitalization rate presents one of the most difficult problems in valuation. That there is no ready or simple solution will become apparent by a cursory check of the rates of return and dividend yields in terms of the selling prices of corporate shares listed on the major exchanges of the country. Wide variations will be found even for companies in the same industry. Moreover, the ratio will fluctuate from year to year depending upon economic conditions. Thus, no standard tables of capitalization rates applicable to closely held corporations can be formulated. Among the more important factors to be taken into consideration in deciding upon a capitalization rate in a particular case are: (1) the nature of the business; (2) the risk involved; and (3) the stability or irregularity of earnings. SECTION 7. AVERAGE OF FACTORS. Because valuations cannot be made on the basis of a prescribed formula, there is no means whereby the various applicable factors in a particular case can be assigned mathematical weights in deriving the fair market value. For this reason, no useful purpose is served by taking an average of several factors (for example, book value, capitalized earnings and capitalized dividends) and basing the valuation on the result. Such a process excludes active consideration of other pertinent factors, and the end result cannot be supported by a realistic application of the significant facts in the case except by mere chance. SECTION 8. RESTRICTIVE AGREEMENTS. Ovadya Funding Group International, Inc. Copyright 2007 55
  • 56. Frequently, in the valuation of closely held stock for estate and gift tax purposes, it will be found that the stock is subject to an agreement restricting its sale or transfer. Where shares of stock were acquired by a decedent subject to an option reserved by the issuing corporation to repurchase at a certain price, the option price is usually accepted as the fair market value for estate tax purposes. See Rev. Rul. 54-76, C.B. 1954-1, 194. However, in such case the option price is not determinative of fair market value for gift tax purposes. Where the option, or buy and sell agreement, is the result of voluntary action by the stockholders and is binding during the life as well as at the death of the stockholders, such agreement may or may not, depending upon the circumstances of each case, fix the value for estate tax purposes. However, such agreement is a factor to be considered, with other relevant factors, in determining fair market value. Where the stockholder is free to dispose of his shares during life and the option is to become effective only upon his death, the fair market value is not limited to the option price. It is always necessary to consider the relationship of the parties, the relative number of shares held by the decedent, and other material facts, to determine whether the agreement represents a bona fide business arrangement or is a device to pass the decedent's shares to the natural objects of his bounty for less than an adequate and full consideration in money or money's worth. In this connection see Rev. Rul. 157 C.B. 1953-2, 255, and Rev. Rul. 189, C.B. 1953-2, 294. SECTION 9. EFFECT ON OTHER DOCUMENTS. Revenue Ruling 54-77, C.B. 1954-1, 187, is hereby superseded. SOURCE: Rev. Rul. 59-60, 1959-1, C.B. 237. xxiv IRS Revenue Ruling 68-609 The "formula" approach may be used in determining the fair market value of intangible assets of a business only if there is no better basis available for making the determination; A.R.M. 34, A.R.M. 68, O.D. 937, and Revenue Ruling 65-192 superseded. SECTION 1001. DETERMINATION OF AMOUNT OF AND RECOGNITION OF GAIN OR LOSS 26 CFR 1.1001-1: Computation of gain or loss. (Also Section 167; 1-167(a)-3.) Rev. Rul. 68-6091 The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the currently outstanding portions of A.R.M. 34, C.B. 2, 31 (1920), A.R.M. 68, C.B. 3, 43 (1920), and O.D. 937, C.B. 4, 43 (1921). The question presented is whether the "formula" approach, the capitalization of earnings in excess of a fair rate of return on net tangible assets, may be used to determine the fair market value of the intangible assets of a business. The "formula" approach may be stated as follows: A percentage return on the average annual value of the tangible assets used in a business is determined, using a period of years (preferably not less than five) immediately prior to the valuation date. The amount of the percentage return on tangible assets, thus determined, is deducted from the average earnings of the business for such period and the remainder, if any, is considered to be the amount of the average annual earnings from the intangible assets of the business for the period. This amount (considered as the average annual earnings from intangibles), capitalized at a percentage of, say, 15 to 20 percent, is the value of the intangible assets of the business determined under the "formula" approach. The percentage of return on the average annual value of the tangible assets used should be the percentage prevailing in the industry involved at the date of valuation, or (when the industry percentage is not available) a percentage of 8 to 10 percent may be used. The 8 percent rate of return and the 15 percent rate of capitalization are applied to tangibles and intangibles, respectively, of businesses with a small risk factor and stable and regular earnings; the 10 percent rate of return and 20 percent rate of capitalization are applied to businesses in which the hazards of business are relatively high. The above rates are used as examples and are not appropriate in all cases. In applying the "formula" approach, the average earnings period and the capitalization rates are dependent upon the facts pertinent thereto in each case. Ovadya Funding Group International, Inc. Copyright 2007 56
  • 57. The past earnings to which the formula is applied should fairly reflect the probable future earnings. Ordinarily, the period should not be less than five years, and abnormal years, whether above or below the average, should be eliminated. If the business is a sole proprietorship or partnership, there should be deducted from the earnings of the business a reasonable amount for services performed by the owner or partners engaged in the business. See Lloyd B. Sanderson Estate v. Commissioner, 42. F. 2d 160 (1930). Further, only the tangible assets entering into net worth, including accounts and bills receivable in excess of accounts and bills payable, are used for determining earnings on the tangible assets. Factors that influence the capitalization rate include (1) the nature of the business, (2) the risk involved, and (3) the stability or irregularity of earnings. The "formula" approach should not be used if there is better evidence available from which the value of intangibles can be determined. If the assets of a going business are sold upon the basis of a rate of capitalization that can be substantiated as being realistic, though it is not within the range of figures indicated here as the ones ordinarily to be adopted, the same rate of capitalization should be used in determining the value of intangibles. Accordingly, the "formula" approach may be used for determining the fair market value of intangible assets of a business only if there is no better basis therefor available. See also Revenue Ruling 59-60, C.B. 1959-1, 237, as modified by Revenue Ruling 65-193, C.B. 1965-2, 370, which sets forth the proper approach to use in the valuation of closely held corporate stocks for estate and gift tax purposes. The general approach, methods, and factors, outlined in Revenue Ruling 59-60, as modified, are equally applicable to valuations of corporate stocks for income and other tax purposes as well as for estate and gift tax purposes. They apply also to problems involving the determination of the fair market value of business interests of any type, including partnerships and proprietorships, and of intangible assets for all tax purposes. A.R.M. 34, A.R.M. 68, and O.D. 937 are superseded, since the positions set forth therein are restated to the extent applicable under current law in this Revenue Ruling. Revenue Ruling 65-192, C.B. 1965-2, 259, which contained restatements of A.R.M. 34 and A.R.M. 68, is also superseded. SOURCE: Rev Rul. 68-609, 1968-2, C.B. 327. 1 Prepared pursuant to Rev. Proc. 67-6, C.B. 1967-1, 576. xxv IRS Revenue Ruling 77-287 SECTION 1. PURPOSE. The purpose of this Revenue Ruling is to amplify Rev. Rul. 59-60, 1959-1 C.B. 237, as modified by Rev. Rul. 65-193, 1965-2 C.B. 370, and to provide information and guidance to taxpayers, Internal Revenue Service personnel, and others concerned with the valuation, for Federal tax purposes, of securities that cannot be immediately resold because they are restricted from resale pursuant to Federal securities laws. This guidance is applicable only in cases where it is not inconsistent with valuation requirements of the Internal Revenue Code of 1954 or the regulations thereunder. Further, this ruling does not establish the time at which property shall be valued. SECTION 2. NATURE OF THE PROBLEM. It frequently becomes necessary to establish the fair market value of stock that has not been registered for public trading when the issuing company has stock of the same class that is actively traded in one or more securities markets. The problem is to determine the difference in fair market value between the registered shares that are actively traded and the unregistered shares. This problem is often encountered in estate and gift tax cases. However, it is sometimes encountered when unregistered shares are issued in exchange for assets or the stock of an acquired company. SECTION 3. BACKGROUND AND DEFINITIONS. .01 The Service outlined and reviewed in general the approach, methods, and factors to be considered in valuing shares of closely held corporate stock for estate and gift tax purposes in Rev. Rul. 59-60, as modified by Rev. Rul. 65-193. The provisions of Rev. Rul. 59-60, as modified, were extended to the valuation of corporate securities for income and other tax purposes by Rev. Rul. 68-609, 1968-2 C.B. 327. .02 There are several terms currently in use in the securities industry that denote restrictions imposed on the resale and transfer of certain securities. The term frequently used to describe these securities is "restricted securities," but they are Ovadya Funding Group International, Inc. Copyright 2007 57
  • 58. sometimes referred to as "unregistered securities," "investment letter stock," "control stock," or "private placement stock." Frequently these terms are used interchangeably. They all indicate that these particular securities cannot lawfully be distributed to the general public until a registration statement relating to the corporation underlying the securities has been filed, and has also become effective under the rules promulgated and enforced by the United States Securities & Exchange Commission (SEC) pursuant to the Federal securities laws. The following represents a more refined definition of each of the following terms along with two other terms - "exempted securities" and "exempted transactions." (a) The term "restricted securities" is defined in Rule 144 adopted by the SEC as "securities acquired directly or indirectly from the issuer thereof, or from an affiliate of such issuer, in a transaction or chain of transactions not involving any public offering." (b) The term "unregistered securities" refers to those securities with respect to which a registration statement, providing full disclosure by the issuing corporation, has not been filed with the SEC pursuant to the Securities Act of 1933. The registration statement is a condition precedent to a public distribution of securities in interstate commerce and is aimed at providing the prospective investor with a factual basis for sound judgment in making investment decisions. (c) The terms "investment letter stock" and "letter stock" denote shares of stock that have been issued by a corporation without the benefit of filing a registration statement with the SEC. Such stock is subject to resale and transfer restrictions set forth in a letter agreement requested by the issuer and signed by the buyer of the stock when the stock is delivered. Such stock may be found in the hands of either individual investors or institutional investors. (d) The term "control stock" indicates that the shares of stock have been held or are being held by an officer, director, or other person close to the management of the corporation. These persons are subject to certain requirements pursuant to SEC rules upon resale of shares they own in such corporations. (e) The term "private placement stock" indicates that the stock has been placed with an institution or other investor who will presumably hold it for a long period and ultimately arrange to have the stock registered if it is to be offered to the general public. Such stock may or may not be subject to a letter agreement. Private placements of stock are exempted from the registration and prospectus provisions of the Securities Act of 1933. (f) The term "exempted securities" refers to those classes of securities that are expressly excluded from the registration provisions of the Securities Act of 1933 and the distribution provisions of the Securities Exchange Act of 1934. (g) The term "exempted transactions" refers to certain sales or distributions of securities that do not involve a public offering and are excluded from the registration and prospectus provisions of the Securities Act of 1933 and distribution provisions of the Securities Exchange Act of 1934. The exempted status makes it unnecessary for issuers of securities to go through the registration process. SECTION 4. SECURITIES INDUSTRY PRACTICE IN VALUING RESTRICTED SECURITIES. .01 Investment Company Valuation Practices. The Investment Company Act of 1940 requires open-end investment companies to publish the valuation of their portfolio securities daily. Some of these companies have portfolios containing restricted securities, but also have unrestricted securities of the same class traded on a securities exchange. In recent years the number of restricted securities in such portfolios have increased. The following methods have been used by investment companies in the valuation of such restricted securities: (a) Current market price of the unrestricted stock less a constant percentage discount based on purchase discount; (b) Current market price of unrestricted stock less a constant percentage discount different from purchase discount; (c) Current market price of the unrestricted stock less a discount amortized over a fixed period; (d) Current market price of the unrestricted stock; and (e) Cost of the restricted stock until it is registered. The SEC ruled in its Investment Company Act Release No. 5847, dated October 21, 1969, that there can be no automatic formula by which an investment company can value the restricted securities in its portfolios. Rather, the SEC has determined that it is the responsibility of the board of directors of the particular investment company to determine the "fair value" of each issue of restricted securities in good faith. Ovadya Funding Group International, Inc. Copyright 2007 58
  • 59. .02 Institutional Investors Study. Pursuant to Congressional direction, the SEC undertook an analysis of the purchases, sales, and holding of securities by financial institutions, in order to determine the effect of institutional activity upon the securities market. The study report was published in eight volumes in March 1971. The fifth volume provides an analysis of restricted securities and deals with such items as the characteristics of the restricted securities purchasers and issuers, the size of transactions (dollars and shares), the marketability discounts on different trading markets, and the resale provisions. This research project provides some guidance for measuring the discount in that it contains information, based on the actual experience of the marketplace, showing that, during the period surveyed (January 1, 1966, through June 30, 1969), the amount of discount allowed for restricted securities from the trading price of the unrestricted securities was generally related to the following four factors: (a) Earnings. Earnings and sales consistently have a significant influence on the size of restricted securities discounts according to the study. Earnings played the major part in establishing the ultimate discounts at which these stocks were sold from the current market price. Apparently earnings patterns, rather than sales patterns, determine the degree of risk of an investment. (b) Sales. The dollar amount of sales issuers' securities also has a major influence on the amount of discount at which restricted securities sell from the current market price. The results of the study generally indicate that the companies with the lowest dollar amount of sales during the test period accounted for most of the transactions involving the highest discount rates, while they accounted for only a small portion of all transactions involving the lowest discount rates. (c) Trading Market. The market in which publicly held securities are traded also reflects variances in the amount of discount that is applied to restricted securities purchases. According to the study, discount rates were greatest on restricted stocks with unrestricted counterparts traded over-the-counter, followed by those with unrestricted counterparts listed on the American Stock Exchange, while the discount rates for those stocks with unrestricted counterparts listed on the New York Stock Exchange were the smallest. (d) Resale Agreement Provisions. Resale agreement provisions often affect the size of the discount. The discount from the market price provides the main incentive for a potential buyer to acquire restricted securities. In judging the opportunity cost of freezing funds, the purchaser is analyzing two separate factors. The first factor is the risk that the underlying value of the stock will change in a way that, absent the restrictive provisions, would have prompted a decision to sell. The second factor is the risk that the contemplated means of legally disposing of the stock may not materialize. From the seller's point of view, a discount is justified where the seller is relieved of the expenses of registration and public distribution, as well as of the risk that the market will adversely change before the offering is completed. The ultimate agreement between buyer and seller is a reflection of these and other considerations. Relative bargaining strengths of the parties to the agreement are major considerations that influence the resale terms and consequently the size of discounts in restricted securities transactions. Certain provisions are often found in agreements between buyers and sellers that affect the size of discounts at which restricted stocks are sold. Several such provisions follow, all of which, other than number (3), would tend to reduce the size of the discount: (1) A provision giving the buyer an option to "piggyback," that is, to register restricted stock with the next registration statement, if any, filed by the issuer with the SEC; (2) A provision giving the buyer an option to require registration at the seller's expense; (3) A provision giving the buyer an option to require registration, but only at the buyer's own expense; (4) A provision giving the buyer a right to receive continuous disclosure of information about the issuer from the seller; (5) A provision giving the buyer a right to select one or more directors of the issuer; (6) A provision giving the buyer an option to purchase additional shares of the issuer's stock; and (7) A provision giving the buyer the right to have a greater voice in operations of the issuer, if the issuer does not meet previously agreed upon operating standards. Institutional buyers can and often do obtain many of these rights and options from the sellers of restricted securities, and naturally, the more rights the buyer can acquire, the lower the buyer's risk is going to be, thereby reducing the buyer's discount as well. Small buyers may not be able to negotiate the large discounts or the rights and options that volume buyers are able to negotiate. .03 Summary. A variety of methods have been used by the securities industry to value restricted securities. The SEC rejects all automatic or mechanical solutions to the valuation of restricted securities, and prefers, in the case of the Ovadya Funding Group International, Inc. Copyright 2007 59
  • 60. valuation of investment company portfolio stocks, to rely upon good faith valuations by the board of directors of each company. The study made by the SEC found that restricted securities generally are issued at a discount from the market value of freely tradable securities. SECTION 5. FACTS AND CIRCUMSTANCES MATERIAL TO VALUATION OF RESTRICTED SECURITIES. .01 Frequently, a company has a class of stock that cannot be traded publicly. The reason such stock cannot be traded may arise from the securities statutes, as in the case of an "investment letter" restriction; it may arise from a corporate charter restriction, or perhaps from a trust agreement restriction. In such cases, certain documents and facts should be obtained for analysis. .02 The following documents and facts, when used in conjunction with those discussed in Section 4 of Rev. Rul. 59-60, will be useful in the valuation of restricted securities: (a) A copy of any declaration of trust, trust agreement, and any other agreements relating to the shares of restricted stock; (b) A copy of any document showing any offers to buy or sell or indications of interest in buying or selling the restricted shares; (c) The latest prospectus of the company; (d) Annual reports of the company for 3 to 5 years preceding the valuation date; (e) The trading prices and trading volume of the related class of traded securities 1 month preceding the valuation date, if they are traded on a stock exchange (if traded over-the-counter, prices may be obtained from the National Quotations Bureau, the National Association of Securities Dealers Automated Quotations (NASDAQ), or sometimes from broker- dealers making markets in the shares); (f) The relationship of the parties to the agreements concerning the restricted stock, such as whether they are members of the immediate family or perhaps whether they are officers or directors of the company; and (g) Whether the interest being valued represents a majority or minority ownership. SECTION 6. WEIGHING FACTS AND CIRCUMSTANCES MATERIAL TO RESTRICTED STOCK VALUATION. All relevant facts and circumstances that bear upon the worth of restricted stock, including those set forth above in the preceding Sections 4 and 5, and those set forth in Section 4 of Rev. Rul. 59-60, must be taken into account in arriving at the fair market value of such securities. Depending on the circumstances of each case, certain factors may carry more weight than others. To illustrate: .01 Earnings, net assets, and net sales must be given primary consideration in arriving at an appropriate discount for restricted securities from the freely traded shares. These are the elements of value that are always used by investors in making investment decisions. In some cases, one element may be more important than in other cases. In the case of manufacturing, producing, or distributing companies, primary weight must be accorded earnings and net sales; but in the case of investment or holding companies, primary weight must be given to the net assets of the company underlying the stock. In the former type of companies, value is more closely linked to past, present, and future earnings while in the latter type of companies, value is more closely linked to the existing net assets of the company. See the discussion in Section 5 of Rev. Rul. 59-60. .02 Resale provisions found in the restriction agreements must be scrutinized and weighted to determine the amount of discount to apply to the preliminary fair market value of the company. The two elements of time and expense bear upon this discount; the longer the buyer of the shares must wait to liquidate the shares, the greater the discount. Moreover, if the provisions make it necessary for the buyer to bear the expense of registration, the greater the discount. However, if the provisions of the restricted stock agreement make it possible for the buyer to "piggyback" shares at the next offering, the discount would be smaller. .03 The relative negotiation strengths of the buyer and seller of restricted stock may have a profound effect on the amount of discount. For example, a tight money situation may cause the buyer to have the greater balance of negotiation strength in a transaction. However, in some cases the relative strengths may tend to cancel each other out. Ovadya Funding Group International, Inc. Copyright 2007 60
  • 61. .04 The market experience of freely tradable securities of the same class as the restricted securities is also significant in determining the amount of discount. Whether the shares are privately held or publicly traded affects the worth of the shares to the holder. Securities traded on a public market generally are worth more to investors than those that are not traded on a public market. Moreover, the type of public market in which the unrestricted securities are traded is to be given consideration. SECTION 7. EFFECT ON OTHER DOCUMENTS. Rev. Rul. 59-60, as modified by Rev. Rul. 65-193, is amplified. SOURCE: Rev. Rul. 77-287, 1977-2, C.B. 319. xxvi IRS Revenue Ruling 83-120 SECTION 1. PURPOSE. The purpose of this Revenue Ruling is to amplify Rev. Rul. 59-60, 1959-1 C.B. 237, by specifying additional factors to be considered in valuing common and preferred stock of a closely held corporation for gift tax and other purposes in a recapitalization of closely held businesses. This type of valuation problem frequently arises with respect to estate planning transactions wherein an individual receives preferred stock with a stated par value equal to all or a large portion of the fair market value of the individual's former stock interest in a corporation. The individual also receives common stock which is then transferred, usually as a gift, to a relative. SECTION 2. BACKGROUND .01 One of the frequent objectives of the type of transaction mentioned above is the transfer of the potential appreciation of an individual's stock interest in a corporation to relatives at a nominal or small gift tax cost. Achievement of this objective requires preferred stock having a fair market value equal to a large part of the fair market value of the individual's former stock interest and common stock having a nominal or small fair market value. The approach and factors described in this Revenue Ruling are directed toward ascertaining the true fair market value of the common and preferred stock and will usually result in the determination of a substantial fair market value for the common stock and a fair market value for the preferred stock which is substantially less than its par value. .02 The type of transaction referred to above can arise in many different contexts. Some examples are: (a) A owns 100% of the common stock (the only outstanding stock) of Z Corporation which has a fair market value of 10,500x. In a recapitalization described in section 368(a)(1)(E), A receives preferred stock with a par value of 10,000x and new common stock, which A then transfers to A's son B. (b) A owns some of the common stock of Z Corporation (or the stock of several corporations) the fair market value of which stock is 10,500x. A transfers this stock to a new corporation X in exchange for preferred stock of X corporation with a par value of 10,000x and common stock of corporation, which A then transfers to A's son B. (c) A owns 80 shares and his son B owns 20 shares of the common stock (the only stock outstanding) of Z Corporation. In a recapitalization described in section 368(a)(1)(E), A exchanges his 80 shares of common stock for 80 shares of new preferred stock of Z Corporation with a par value of 10,000x. A's common stock had a fair market value of 10,000x. SECTION 3. GENERAL APPROACH TO VALUATION Under section 25.2512-2(f)(2) of the Gift Tax Regulations, the fair market value of stock in a closely held corporation depends upon numerous factors, including the corporation's net worth, its prospective earning power, and its capacity to pay dividends. In addition, other relevant factors must be taken into account. See Rev. Rul. 59-60. The weight to be accorded any evidentiary factor depends on the circumstances of each case. See section 25.2512-2(f) of the Gift Tax Regulations. SECTION 4. APPROACH TO VALUATION PREFERRED STOCK .01 In general the most important factors to be considered in determining the value of preferred stock are its yield, dividend coverage and protection of its liquidation preference. Ovadya Funding Group International, Inc. Copyright 2007 61
  • 62. .02 Whether the yield of the preferred stock supports a valuation of the stock at par value depends in part on the adequacy of the dividend rate. The adequacy of the dividend rate should be determined by comparing its dividend rate with the dividend rate of high-grade publicly traded preferred stock. A lower yield than that of high-grade preferred stock indicates a preferred stock value of less than par. If the rate of interest charged by independent creditors to the corporation on loans is higher than the rate such independent creditors charge their most credit worthy borrowers, then the yield on the preferred stock should be correspondingly higher than the yield on high quality preferred stock. A yield which is not correspondingly higher reduces the value of the preferred stock. In addition, whether the preferred stock has a fixed dividend rate and is nonparticipating influences the value of the preferred stock. A publicly traded preferred stock for a company having a similar business and similar assets with similar liquidation preferences, voting rights and other similar terms would be the ideal comparable for determining yield required in arm's length transactions for closely held stock. Such ideal comparables will frequently not exist. In such circumstances, the most comparable publicly traded issues should be selected for comparison and appropriate adjustments made for differing factors. .03 The actual dividend rate on a preferred stock can be assumed to be its stated rate if the issuing corporation will be able to pay its stated dividends in a timely manner and will, in fact, pay such dividends. The risk that the corporation may be unable to timely pay the stated dividends on the preferred stock can be measured by the coverage of such stated dividends by the corporation's earnings. Coverage of the dividend is measured by the ratio of the sum of pre-tax and pre- interest earnings to the sum of the total interest to be paid and the pre-tax earnings needed to pay the after-tax dividends. Standard & Poor's Ratings Guide, 58 (1979). Inadequate coverage exists where a decline in corporate profits would be likely to jeopardize the corporation's ability to pay dividends on the preferred stock. The ratio for the preferred stock in question should be compared with the ratios for high quality preferred stock to determine whether the preferred stock has adequate coverage. Prior earnings history is important in this determination. Inadequate coverage indicates that the value of preferred stock is lower than its par value. Moreover, the absence of a provision that preferred dividends are cumulative raises substantial questions concerning whether the stated dividend rate will, in fact, be paid. Accordingly, preferred stock with noncumulative dividend features will normally have a value substantially lower than a cumulative preferred stock with the same yield, liquidation preference and dividend coverage. .04 Whether the issuing corporation will be able to pay the full liquidation preference at liquidation must be taken into account in determining fair market value. This risk can be measured by the protection afforded by the corporation's net assets. Such protection can be measured by the ratio of the excess of the current market value of the corporation's assets over its liabilities to the aggregate liquidation preference. The protection ratio should be compared with the ratios for high quality preferred stock to determine adequacy of coverage. Inadequate asset protection exists where any unforeseen business reverses would be likely to jeopardize the corporation's ability to pay the full liquidation preference to the holders of the preferred stock. .05 Another factor to be considered in valuing the preferred stock is whether it has voting rights and, if so, whether the preferred stock has voting control. See, however, Section 5.02 below. .06 Peculiar covenants or provisions of the preferred stock of a type not ordinarily found in publicly traded preferred stock should be carefully evaluated to determine the effects of such covenants on the value of the preferred stock. In general, if covenants would inhibit the marketability of the stock or the power of the holder to enforce dividend or liquidation rights, such provisions will reduce the value of the preferred stock by comparison to the value of preferred stock not containing such covenants or provisions. .07 Whether the preferred stock contains a redemption privilege is another factor to be considered in determining the value of the preferred stock. The value of a redemption privilege triggered by death of the preferred shareholder will not exceed the present value of the redemption premium payable at the preferred shareholder's death (i.e., the present value of the excess of the redemption price over the fair market value of the preferred stock upon its issuance). The value of the redemption privilege should be reduced to reflect any risk that the corporation may not possess sufficient assets to redeem its preferred stock at the stated redemption price. See Section .03 above. SECTION 5. APPROACH TO VALUATION of COMMON STOCK .01 If the preferred stock has a fixed rate of dividend and is nonparticipating, the common stock has the exclusive right to the benefits of future appreciation of the value of the corporation. This right is valuable and usually warrants a determination that the common stock has substantial value. The actual value of this right depends upon the corporation's past growth experience, the economic condition of the industry in which the corporation operates, and general economic conditions. The factor to be used in capitalizing the corporation's prospective earnings must be determined after an analysis of numerous factors concerning the corporation and the economy as a whole. See Rev. Rul. 59-60, at page 243. In addition, after-tax earnings of the corporation at the time the preferred stock is issued in excess of the stated dividends on the preferred stock will increase the value of the common stock. Furthermore, a corporate policy of reinvesting earnings will also increase the value of the common stock. Ovadya Funding Group International, Inc. Copyright 2007 62
  • 63. .02 A factor to be considered in determining the value of the common stock is whether the preferred stock also has voting rights. Voting rights of the preferred stock, especially if the preferred stock has voting control, could under certain circumstances increase the value of the preferred stock and reduce the value of common stock. This factor may be reduced in significance where the rights of common stockholders as a class are protected under state law from actions by another class of shareholders, see Singer v. Magnavox Co., 380 A.2d 969 (Del. 1977), particularly where the common shareholders, as a class, are given the power to disapprove a proposal to allow preferred stock to be converted into common stock. See ABA-ALI Model Bus. Corp. Act, Section 60 (1969). SECTION 6. EFFECT ON OTHER REVENUE RULINGS Rev. Rul. 59-60, as modified by Rev. Rul. 65-193, 1965-2 C.B. 370 and as amplified by Rev. Rul. 77-287, 1977-2 C.B. 319, and Rev. Rul. 80-213, 1980-2 C.B. 101, is further amplified. SOURCE: Rev. Rul. 83-120, 1983-2 C.B. 170 xxvii IRS Revenue Ruling 93-12 Issue If a donor transfers shares in a corporation to each of the donor's children, is the factor of corporate control in the family to be considered in valuing each transferred interest, for purposes of section 2512 of the Internal Revenue Code? Facts P owned all of the single outstanding class of stock of X corporation. P transferred all of P's shares by making simultaneous gifts of 20 percent of the shares to each of P's five children, A, B, C, D, and E. Law and Analysis Section 2512(a) of the Code provides that the value of the property at the date of the gift shall be considered the amount of the gift. Section 25.2512-1 of the Gift Tax Regulations provides that, if a gift is made in property, its value at the date of the gift shall be considered the amount of the gift. The value of the property is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. Section 25.2512-2(a) of the regulations provides that the value of stocks and bonds is the fair market value per share or bond on the date of the gift. Section 25.2512-2(f) provides that the degree of control of the business represented by the block of stock to be valued is among the factors to be considered in valuing stock where there are no sales prices or bona fide bid or asked prices. Rev. Rul. 81-253, 1981-1 C.B. 187, holds that, ordinarily, no minority shareholder discount is allowed with respect to transfers of shares of stock between family members if, based upon a composite of the family members' interest at the time of the transfer, control (either majority voting control or de facto control through family relationships) of the corporation exists in the family unit. The ruling also states that the Service will not follow the decision of the Fifth Circuit in Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981). In Bright, the decedent's undivided community property interest in shares of stock, together with the corresponding undivided community property interest of the decedent's surviving spouse, constituted a control block of 55 percent of the shares of a corporation. The court held that, because the community-held shares were subject to a right of partition, the decedent's own interest was equivalent to 27.5 percent of the outstanding shares and, therefore, should be valued as a minority interest, even though the shares were to be held by the decedent's surviving spouse as trustee of a testamentary trust. See also, Propstra v. United States, 680 F.2d 1248 (9th Cir. 1982). In addition, Estate of Andrews v. Commissioner, 79 T.C. 938 (1982), and Estate of Lee v. Commissioner, 69 T.C. 860 (1978), nonacq., 1980-2C.B. 2, held that the corporation shares owned by other family members cannot be attributed to an individual family member for determining whether the individual family member's share should be valued as the controlling interest of the corporation. After further consideration of the position taken in Rev. Rul. 81-253, and in light of the cases noted above, the Service has concluded that, in the case of a corporation with a single class of stock, notwithstanding the family relationship of the donor, the donee, and other shareholders, the shares of other family members will not be aggregated with the transferred shares to determine whether the transferred shares should be valued as part of a controlling interest. Ovadya Funding Group International, Inc. Copyright 2007 63
  • 64. In the present case, the minority interests transferred to A, B, C, D, and E should be valued for gift tax purposes without regard to the family relationship of the parties. Holding If a donor transfers shares in a corporation to each of the donor's children, the factor of corporate control in the family is not considered in valuing each transferred interest for purposes of section 2512 of the Code. For estate and gift tax valuation purposes, the Service will follow Bright, Propstra, Andrews, and Lee in not assuming that all voting power held by family members may be aggregated for purposes of determining whether the transferred shares should be valued as part of a controlling interest. Consequently, a minority discount will not be disallowed solely because a transferred interest, when aggregated with interest held by family members, would be a part of a controlling interest. This would be the case whether the donor held 100 percent or some lesser percentage of the stock immediately before the gift. Effect on Other Documents Rev. Rul. 81-253 is revoked. Acquiescence in issue one of Lee, 1980-2 C.B. 2. SOURCE: Rev. Rul. 93-12, 1993-1, C.B. 202. xxviii Revenue Procedure 79-24 SECTION 1. PURPOSE. The purpose of this Revenue Procedure is to provide the guidance necessary to properly utilize the market data approach in appraising unimproved real property for federal income, estate, and gift tax purposes. SEC. 2. DEFINITION OF UNIMPROVED REAL PROPERTY. Unimproved real property is defined as land without significant buildings, structures, or any other improvements that contribute to its value. SEC. 3. PROCEDURE. 01 The best indication of the value of property being appraised is the price paid for the property in an arm's-length transaction on or prior to the valuation date. When the property to be appraised has not recently been the subject of an arm's-length transaction, the best method of estimating the value of unimproved real property is by use of the market data or comparable sales approach. This approach uses arm's-length sales of properties that exhibit the most similar characteristics to the property being valued. The sales transactions used will adhere to the following definition of fair market value: The fair market value as defined in section 1.1 70A-1(c)(2) of the Income Tax Regulations, section 20.2031-1(b) of the Estate Tax Regulations and section 25.2512-1 of the Gift Tax Regulations is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. Fair market value is a definite amount paid in cash or its equivalent for a given property and is the same regardless of the purpose for which it is appraised. 02 Potentially comparable sales may be obtained from tax assessors, real estate brokers, appraisers, the recorder of deeds or other sources. The appraiser should first make a detailed inspection of the property being appraised and the potential comparable properties. During the inspection of the property to be appraised and each potential comparable property, the following factors or information should be considered: (a) Location, including proximity to roads, schools, shopping, transportation, and other amenities; (b) Configuration, topographic features, and total area; (c) Restrictions as to land use or zoning; (d) Road frontage and accessibility; (e) Available utilities and water rights; (f) Existing easements, rights of way, leases, etc.; (g) Soil characteristics; (h) Vegetative cover, such as: grass, brush, trees or timber; (i) Status of mineral rights; (j) Riparian rights; (k) Other factors affecting value. Ovadya Funding Group International, Inc. Copyright 2007 64
  • 65. Additional information necessary includes the name of the buyer, the name of the seller, the deed book and page number, the date of sale, sale price, property description, amount and terms of mortgages, property surveys, the assessed value, tax rate, and the assessor's appraised fair market value. Detailed analyses of the comparable property sales should include considerations of similarity of highest and best use legally permissible, the time interval between sale date and valuation date, economic similarities and trends affecting the neighborhoods. If any sale is a distress sale, a forced sale, or one negotiated with unusual terms provided by the seller, it should be discarded. Probative value is added to the use of comparable property sale when each sale price has been confirmed by either the purchaser, seller, real estate broker involved in the sale, or lawyer or title company handling the transaction. At this time, it may be determined whether there was any compulsion exercised by either party to the sale or if there were any motives affecting the purchase price. 03. Comparable property sales may be used only after the sales prices have been adjusted for differences between the properties. In making adjustments the appraiser should adjust to the property being appraised. Many property features are of equal value and require no adjustment of the sale price. Adjustments for time are necessary unless prices for real estate are static between the dates of sale and the valuation date. Adjustments are a judgmental conclusion of the appraiser and are usually shown as a percentage change. The results determined from the market data or comparable property sales approach will generally be an array of indicated values for the unimproved property being appraised; such values should not be merely averaged. A review should be made of the comparable sales and only those sales having the least adjustment in items and/or least total adjustments should be considered as comparable to the property being appraised. The adjustments should be reviewed to assure that adequate and meaningful data were used and that each adjustment was properly weighted. The appraiser should then conclude that two or three adjusted sales furnish the most reliable estimate of fair market value of unimproved real property by the market data or comparable sales approach. xxix Internal Revenue Manual 4350: Chapter 600 Valuation Of Real Property 610 (12-16-87) Introduction The appraisal of real estate is not an exact science. It is the estimate of value of property as of a certain date. Real estate is unique. There are no parcels of property really identical; they may be similar. The differences in opinion of value reflect the individual interpretation of appraisers. 620 (12-16-87) Basic Considerations (1) Unless special use valuation has been elected under IRC 2032A, the decedent's interest in real estate must be included in the estate at its fair market value. The regulations define fair market value as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. (2) Inherent in this definition is the requirement that the highest and best use of the property be considered. Highest and best use is defined as that reasonable and probable use that will support the highest present worth of the (improved) property as of the assessment date based on the highest net return that it can produce over a reasonably foreseeable period of time, such as the property's probable remaining useful life. Thus, use of the land for farming purposes might not be its highest and best use it were located within a good business area or within a substantial residential development area. All zoning, deed restrictions, or other physical, economic, legal-governmental, or locational restrictions preventing a higher income-producing use should be considered. (3) It is your job to recommend the fair market value of the property. Recognize that in the absence of actual sales the matter of valuation is one of opinion. Therefore, maintain a sense of proportion and exercise sound discretion and judgment in arriving at recommendation. Do not recommend extremes! If investigation shows that the returned value is essentially correct, recommend it. Slight differences based upon opinions of qualified experts should not be the basis for change. However, a sale, reflecting fair market value and made within a reasonable time of the valuation date, would be a proper basis for change even though the change might not be substantial. (4) Upon assignment of a return, determine the need for engineering or collateral assistance. Consult your manager regarding the proper referrals to be made. Your manager can guide you regarding district practice on size criteria and other requirements for referrals 630 (12-16-87) Precontact Analysis (1) When you make your precontact analysis of the estate tax return, note any real property interests returned. Real property interests occur where the decedent owned property individually or jointly and where the decedent had an interest Ovadya Funding Group International, Inc. Copyright 2007 65
  • 66. in a partnership, trust, or corporation which held property the valuation of which might affect the valuation of the decedent's interest in these enterprises. (2) Before you undertake any investigation as to the value of any realty interest in the estate, first determine whether the property has been sold. If the real property was sold within a reasonable time of the valuation date in a bona fide arm's- length transaction, then, in the absence of some unusual intervening event, the sale probably reflects the fair market value To determine whether the sale was arms-length examine the terms of the relationship between the buyer and seller. Of Course, if it is not arms-length, do the usual investigation. (3) If the realty has not been sold, examine any appraisal submitted If none, try to determine a range of values in the area. A consultation with a local real estate agent, a local Engineer familiar with the area, or a telephone call to an examiner in another district might give you an idea of whether the valuation should be accepted or not. Also check the local assessed valuation, which may or may not reflect fair market value, depending upon local conditions. (4) During the initial contact with the taxpayer's representative determine whether the property has been sold or is subject to a contract of sale. If so, obtain the details and a copy of either the contractor the closing statement. If not sold, request the basic information to value the parcel unless a formal appraisal with the following information as been submitted. For all types of real estate you should request the following: (a) taxpayer's basis for valuation (including comparable sales relied upon); (b) assessor's parcel number; (c) address or map showing exact location (if no street address); (d) copy of the most recent county tax bill; (e) dimensions or area and topography of the land; (f) size, age, condition and type of construction of all improvements; (g) written permission from the estate to examine the county assessor's files on the parcel, (some regions have pre- printed forms for this purpose.); (h) copies of all appraisals made within 5 years of valuation date; (i) copies of all listings on the properties and names of realtors handling within the past three years; (j) details of all offers made; (k) copy of the closing statement if the property was purchased within five years of valuation date; (l) any special conditions, restrictions, circumstances, etc., that would relate to valuation. (5) In addition to the above, further information about certain types of property should be considered. (a) Single family residence - number and types of rooms; special amenities such as pools, and quest homes. (b) Residential income property - size and type of units; actual and economic rent for each unit; actual expenses. (c) Commercial and industrial property copies of all leases; if not (eased, names of tenants and terms of occupancy; actual expenses. (d) Unimproved land - copies of any leases or options; actual usage; description of growing crops. (6) In the case of a married decedent it is a good idea to check the deed on each parcel (copies can be obtained from the taxpayer's representative) to determine how title was held at date of death. Prepares sometimes are not careful in distinguishing among tenancy in common, joint tenancy and community property. The exact form of title determines distribution and can affect the Net Federal Estate Tax. 640 (12-16-87) Professional Appraisal 641 (12-16-87) General (1) When a taxpayer submits a formal or "expert" appraisal to a returned valuation, you may have a valuable tool to aid in the audit, whether or not you agree with the appraiser's conclusion. If it is an acceptable conclusion, the issue may be closed. If not, it is usually a good source of data regarding the subject property, provides some comparables, and is a good beginning for your independent investigation, However, do not let it lead you into not looking at the subject property or at the appraiser's comparables, which sometimes are not as comparable as he/she claims they are. Analyze and use the appraisal carefully. (2) In going over the appraisal, consider the reliability of the appraiser and the approach he/she used, Consider the adjustments made for the differences between the subject property and the comparables, whether they are reasonable and have any basis in fact. Often it is a good idea to call the appraiser to explain parts of the appraisal and perhaps obtain additional information that would be helpful. Ovadya Funding Group International, Inc. Copyright 2007 66
  • 67. (3) For income properties request copies of the leases in effect and verify actual expenses, as sometimes the information summarized in the appraisal is inaccurate. The decedent's income tax returns may be used to verify rental income and expenses. (4) If the property is out of your area, call an examiner or Engineer in the area where the property is located, to get an idea whether a collateral should be requested. 642 (12-16-87) Outside Fee Appraisals (1) Appraisers may be needed for unique properties not subject to valuation by the usual methods. Contracting this work to experts takes considerable examination time. (2) Outside fee appraisals also may be necessary in unagreed cases in which a large deficiency is involved and the testimony of an expert witness will be needed for trial. It is an advantage to employ an appraiser who maintains an office or practice in the local area where the real estate to be appraised is Situated. 643 (12-16-87) Independent Appraisers In making an investigation to determine the valuation of real property it is generally advisable to seek the aid and advice of independent realtors, appraisers, or real estate agents who have some familiarity with the subject property. Ascertain the best qualified, with a good reputation for integrity, and contact them. Experience has shown that these persons are, for the most part, happy to be of assistance. When you confer with them, make available all the pertinent information you have received or developed during your investigation so that they may have the broadest basis in arriving at an opinion of value. 644 (12-16-87) Local Assessors Consult with local tax assessors who, in many cases, can give reliable valuations. Assessor records are good sources of information. Comparison of sales prices with assessment values in the area under consideration may give a factor which, when applied to the assessment of the property you are investigating, will furnish a valuation. Be careful that the actual sales are comparable (type, age, location, etc.) to the subject and that there are a number of sales to help establish the relationship between assessed value and sales price. Some local assessment values are based upon a percentage of fair market value. Application of this percentage to the local assessment value may give the assessors' opinion of the fair market value of the property. Most assessor's offices will disclose their records and worksheets if you obtain written permission from the executor, trustee, joint tenant, or other appropriate owner. This is a valuable, time-efficient source of information. 650 (12-16-87) Valuation 651 (12-16-87) General It is not the function of this handbook to explain the classical approaches to real estate valuation Rather, the discussion will relate to the appropriateness of certain approaches and suggest some specific techniques. 652 (12-I6-87) Market Data or Comparable Sales 652.1 (12-16-87) General (1) The main challenge in this approach is obtaining adequate data that is comparable enough to be useful. Sources of sales information include: (a) sales recorded in the public records of the County Assessor' Offices. (b) lists of sales published by local multiple listing organizations, realtor associations, and various commercial services (Locate the ones that cover your local.) (c) contacts with realtors and appraisers in the area. (d) inspection of the specific file on the subject property which is kept by the County Assessor. 652.2 (12-16-87) Adjustments of Comparable Sales (1) The greatest skill in this area is adjusting comparables, which are rarely, if ever, enough like the subject property to indicate fair market value without adjustments for significant differences. Ovadya Funding Group International, Inc. Copyright 2007 67
  • 68. (2) The comparables, as well as the subject property, need to be viewed by the person making the adjustments and the valuation. Adjustments should be specific and be defensible to the taxpayer. 652.3 (12-16-87) Income Multipliers (1) Gross rental multipliers are often used as a measure of value. These are only rough estimates. (2) Net income multipliers are more exact and are actually used more frequently by investors. The problem is obtaining and verifying the accurate data on expenses for the comparable sales, as well as for the subject property. 653 (12-16-87) Income Capitalization (1) Once net income has been determined for commercial or industrial property, the most difficult problem is the determination of the correct rate of capitalization to be applied. To obtain the correct rate of capitalization research the marketplace. Find out what investors were demanding as a net return on that particular type of property at the valuation date. Contact brokers, investors, etc. (2) Do not allow the taxpayer to convince you that the capitalization rate should be higher than the market would indicate by arguing that since Treasury Bonds were yielding % plus % for the risk, etc.. that a rate higher than the market is justified. Remember that potential appreciation and "tax shelter" aspects, such as depreciation, tax credits, etc., add value to the investment over and above the net income generated. 654 (12-16-87) Residual Methods of Valuation This type of valuation is rare. It is most appropriate when the value of either the land or the improvements are readily ascertainable and the net income is determinable. This approach is not of great value for ascertaining total value for inclusion in the gross estate, but is good for allocating value between land and improvements. 655 (12-16-87) Replacement Cost This method is viable only when the improvements are fairly new and the fair market value of the land is independently ascertainable. It does not result in a valid value if the improvements are more than several years old. 660 (12-16-87) Leases (1) When property is subject to a lease, obtain a copy of the lease. A taxpayer's brief synopsis is usually inadequate. (2) If it is a long term lease, the greatest amount of the value will be in the present value of the lease payments, with the residual value of the property itself being of little relative significance. (3) Whenever there are short or medium term leases on property, determine the value of the property without the leases and adjust for the positive or negative effects of the leases do this determine the difference between present value of the payments according leases and the present value of what the economic rent would have been for that same period of time, if there had been no lease. (4) Check the tenants on any lease to mine whether the terms are at arms length if the property is leased to a related person or entity, compare the terms with going terms at the valuation date. If the terms are not to market rental the value of the real estate an related close corporation, etc., should be adjusted accordingly. 670 (12-16-87) Leasehold Interests Leasehold interests owned by a decedent tenant should be returned as assets on Schedule F or debts on Schedule K. These items are often overlooked by preparers. The value is the difference between the present value of the payments according to the lease and the present value of the economic rent for that period of time. From Internal Revenue Manual 4350, Chapter 600 Ovadya Funding Group International, Inc. Copyright 2007 68
  • 69. xxx This suggested mineral valuation-appraisal reading/reference list is not intended to be a complete bibliography, but was designed to indicate to American Society of Appraiser's Candidates the general scope and level of knowledge that is being examined for advancement from Candidate to Accredited Member (AM) or Accredited Senior Appraiser (ASA) in the Mines & Quarries discipline. The mineral valuation reading list is divided into three parts: Technical Books and Articles; Standards and Guidelines; and, Periodicals Technical Books and Articles Aggregate Handbook, The, Richard D. Barksdale, Editor, 1991 Alluvial Mining -The Geology, Technology and Economics of Placers, Eoin H. MacDonald, 1983 American Law of Mining, Cheryl Outerbridge, Editor, 6 vols., 2nd Edition, 1984 Appraisal Manual for Centrally Valued Natural Resource Properties, Tax Year 1995, Arizona Department of Revenue Appraisal of Mineral Land, Ernest Oberbillig, The Appraisal Journal, October 1964 Appraisal of Mineral Properties, Ernest Oberbillig, Encyclopedia of Real Estate Appraising, 1978 Appraisal of Minerals Availability for 34 Commodities, An, Bulletin 692, US Bureau of Mines, 1987 Appraisal of Mines and Quarries, General Appraisal Manual, Texas State Property Tax Board, 1985 Appraisal of Real Estate, The, Appraisal Institute, 11th Edition, 1996 Appraisal Principles and Procedures, Henry A. Babcock, 1968 Appraisal Reviw - Income Properties, Seminar Workbook, Appraisal Institute, Rev. 7/12/93 Appraising Machinery and Equipment, John Alico, Editor, 1989 Appraising the Appraisal: The Art of Appraisal Review, Richard C. Sorenson, Appraisal Institute, 1998 Assessment of Mining Properties, Assessors' Handbook 560, California State Board of Equalization, 1997 Basic Real Estate Appraisal, Richard M. Betts and Silas J. Ely, 1990 Black’s Law Dictionary, 5th Edition, 1979 Communicating the Appraisal: The Narrative Report, William C. Himstreet, Appraisal Institute, Revised Edition, 1991 Computing Reserves of Mineral Deposits: Principles and Conventional Methods, Popoff, Constantine, C., USBM Information Circular 8283, 1966. Condemnation Practice in California, M. Reed Hunter, 1973 Construction Aggregates Demand in the New England States, New England Governors’ Conference, Inc., January 1992 Cost Estimation Handbook for the Australian Mining Industry, AusIMM, 1993 Dictionary of Mining, Mineral, and Related Terms, A, Thrush, Paul, W. and USBM Staff, United States Department of the Interior, 1968. (and on CD-ROM) Dictionary of Mining, Mineral, and Related Terms, A, compiled by the American Geological Institute, 1997 Ovadya Funding Group International, Inc. Copyright 2007 69
  • 70. Dictionary of Real Estate Appraisal, The, Appraisal Institute, 3rd edition, 1993 Economic Analysis of Construction Aggregates Markets and the Results of a Long-Term Forecasting Model for Oregon, An, Special Paper 27, Robert M. Whelan, Oregon Department of Geology and Mineral Industries, 1995 Economic Definition of Ore, The, Kenneth F. Lane, 1988 Economic Evaluation and Investment Decision Methods, Franklin J. Stermole, 1974-1993 Economic Evaluations in Exploration, Fredrich-Wilhelm Wellmer, 1989 Economic Evaluation of Mineral Property, Sam L. VanLandingham, Editor, 1983 Economic Principles for Property Valuation of Industrial Minerals, D. W. Gentry and M. J. Hrebar, SME/AIME Fall Meeting, 1976 Economics of Construction Mineral Aggregates with an Analysis of the Industry in Greater New York Metropolitan Area, The, Leonard Bronitsky, RPI, 1973 Economics of the Mineral Industries, William A. Vogely, Editor, 4th Edition, 1985 Engineer’s Valuing Assistant, The, Henry D. Hoskold, 1877, 1904 Evaluating Mineral Projects: Applications and Misconceptions, Thomas F. Torries, 1998. Finance for the Minerals Industry, Society of Mining Engineers, 1985 Financial Reporting and Tax Practices in Nonferrous Mining, various editions, Coopers & Lybrand Financial Reporting in the Extractive Industries, R. E. Field, AICPA Accounting Research Study No. 11, 1969 Fundamentals of Coal and Mineral Valuations, James W. Boyd, 1986 Glossary of Geology, Robert L. Bates & Julia A. Jackson, Editors, American Geological Institute, 3rd edition, 1987 Guide to Business Valuations, Jay E. Fishman, Shannon P. Pratt, J. Clifford Griffith, and D. Keith Wilson, Practioners Publishing Company, Fifth Edition, 1995 Guide to Federal Coal Property Appraisal, A, US Bureau of Land Management, 1985 Guide to the Evaluation of Gold Deposits, Marcel Vallee, 1992 Income Property Appraisal and Analysis, Jack P. Friedman and Nicholas Ordway, 1989 Income Property Valuation, Principles and Techniques of Appraising Income-Producing Real Estate, William N. Kinnard, Jr., 1971 Industrial Minerals A Technical Review, Richard Noetstaller, World Bank Technical Paper Number 76, 1988 Industrial Minerals and Rocks, Donald D. Carr, Senior Editor, 6th Edition, 1994 Industrial Minerals - Are They for You, Peter W. Harben, NWMA Short Course Book, North West Mining Association, 1986 Introductory Mining Engineering, Howard L. Hartman, 1987 Ovadya Funding Group International, Inc. Copyright 2007 70
  • 71. Investment Appraisal and Economic Evaluation of Mining Enterprise, Siegfried von Wahl, 1983 IRS Valuation Guide for Income, Estate and Gift Taxes, 1994 IRS Valuation Training for Appeals Officers, 1997 Market Analysis for Valuation Appraisals, S. F. Fanning, T. V. Grissom, and T. D. Pearson, 1994 Metal Prices in the United States Through 1991, USBM 1991 Mine Examination Reports and Valuation, James H. Pierce and Thomas F. Kennedy, 1960 Mine Investment Analysis, Donald W. Gentry and Thomas J. O’Neil, 1984 Mineral Deposit Evaluation, Alwyn E. Annels, 1991 Mineral Facts and Problems, Bulletin 675, US Bureau of Mines, 1985 Mineral Law, Terry S. Maley, 6th edition, 1996 Mineral Processing Technology, B. A. Wills, Sixth Edition, 1997 Mineral Properties - Exploration, Acquisition, Development and Disposition, Portfolio TM108, Tax Management, Inc., 1995 Mineral Properties Other Than Gas and Oil - Operation, Portfolio TM109, Tax Management, Inc., 1995 Mineral Resource Valuation for Public Policy, Colby, Donald, S., and David B. Brooks, USBM Information Circular 8422, 1969. Mineral Resources Appraisal, Deverle P. Harris, 1984 Mineral Resources, Economics and the Environment, Steven E. Kesler, 1994 Mineral Title Examination, Terry S. Maley, 1984 Mineral Valuation Methodologies 1994, Australasian Institute of Mining and Metallurgy, 1994 Mining and Petroleum Valuation 1989, Australasian Institute of Mining and Metallurgy, 1989 Mining Equities: Evaluation and Trading, Charles Kernot, 1991 Mining Exploration Agreements, Karl J. C. Harries, 1994 Mining of Mineral Aggregates in Urban Areas, Robert D. Thomson, UPitt, 1980 Natural Resources Appraisal Report, West Virginia Department of Tax and Revenue, 1994 Nichols’ The Law of Eminent Domain, 10 vols., Rev 3rd Edition, Julius L. Sackman, 1975 Planning for Future Construction in Developing Countries: The Estimation of Construction Demand Based on National and Sectoral Growth Patterns, Abdullah Al-Mufti Massood, Queens University Belfast, 1987 Practical Geostatistics, Isobel Clark, 1979 Price Behavior of Nonfuel Mineral Commodities, The, C. McCuiston, E. Battison, and A. M. Lago, USBM OFR 2-70, 1970 Ovadya Funding Group International, Inc. Copyright 2007 71
  • 72. Proceedings, Eastern Mineral Law Foundation, annually since 1980 Proceedings, Mineral Economics and Management Society, since 1992 Proceedings, Rocky Mountain Mineral Law Foundation, annually since 1955 Real Estate Value in Litigation, J. D. Eaton, 1982, 2nd edition 1995 Report of the Commission of Inquiry into Compensation for the Taking of Resource Interests (British Columbia), Richard Schwindt, 1992 Revised Guidelines for Fair Market Value Appraisal of Mineral Interests, James R. Evans, Bureau of Land Management Technical Bulletin, 1994 Section 2032A - Special Use Valuation, Estates, Gifts and Trusts Portfolio 445-2nd, Tax Management Inc, 1992 Small Business Valuation Book, Lawrence W. Tuller, 1994 South African Mine Valuation, C. D. Storrar, 1981 Taxation of Mining Operations, Peter C. Maxfield, annual updates, 1981 Theory of the Mining Firm, The, Brian W. MacKenzie, 1968 Uniform Appraisal Standards for Federal Land Acquisitions, Interagency Land Acquisition Conference, 1992 Uniform Standards of Professional Appraisal Practice, Appraisal Standards Board, 1998, updated semi-annually Using the Sales Comparison Approach to Value Precious Metal Minerals, William M. Wampler, MAI, in Viewpoints: A Collection of Papers Presented at the Appraisal Institute 1997 National Summer Conference, 1997 Valuation of Mines and Quarries, Assessors’ Handbook, California State Board of Equalization, 1973 (Replaced by Assessment of Mining Properties) Valuing a Business, Pratt, Reilly & Schweihs, 3rd edition, 1996 Valuation and Property Taxation of Extractive Resources: A Bibliography, Robert M. Clatanoff, IAAO, 1982 Valuation and Property Taxation of Non-Renewable Resources: An Annotated Bibliography, Robert M. Clatanoff, 1983 Valuation: General and Real Estate, Estates, Gifts, and Trusts Portfolio 132-3rd, Tax Management Inc, 1995 Valuation of Corporate Stock, Estates, Gifts, and Trusts Portfolio 831, Tax Management Inc, 1992 Valuation of Industrial Mineral Resources, Course Notes, 1991 Valuation of Oil and Mineral Rights, The, IAAO, 1971 Valuation Under the Law of Eminent Domain, Lewis Orgel, 1953 xxxi This suggested mineral valuation-appraisal reading/reference list is not intended to be a complete bibliography, but was designed to indicate to American Society of Appraiser's Candidates the general scope and level of knowledge that is being examined for advancement from Candidate to Accredited member (AM) or Accredited Senior Appraiser (ASA) in the Mines & Quarries discipline. The mineral valuation reading list is divided into three parts: Technical Books and Articles; Ovadya Funding Group International, Inc. Copyright 2007 72
  • 73. Standards and Guidelines; and, Periodicals. It is intended to update this list as new mineral industry and/or appraisal- valuation standards become known to the author or by suggestions from visitors to this site. Standards and Guidelines Securities and Exchange Commission and Other US Government Documents: SEC Reserve Definitions - Principles and Practice, David M. Abbott, Jr., 1985(?) Form S-18 Registration Statement under the Securities Act of 1933 Industry Guide 7: Description of Property by Issuers Engaged in Significant Mining Operations, Securities and Exchange Commission, 1992. Principles of the Mineral Resource Classification System of the U.S. Bureau of Mines and U.S. Geological Survey, USGS Bulletin 1450-A, 1976. Coal Resource Classification System of the U.S. Bureau of Mines and U.S. Geological Survey, USGS Bulletin 1450-B, 1976. Principles of a Resource/Reserve Classification for Minerals, U.S. Bureau of Mines and U.S. Geological Survey, USGS Circular 831, 1980. Mineral Resource/Reserve Classification: Categories, Definitions, and Guidelines, Standing Committee on Reserve Definitions, Canadian Institute of Mining, Metallurgy and Petroleum, 1996. Definitions of Reserves and Resources, British and IMM Standards, Minerals Industry International, May 1993. Performance Standards for Professional Engineers Advising on and Reporting on Oil, Gas and Mineral Properties, Association of Professional Engineers of Ontario, 1976. Australasian Code for Reporting of Identified Mineral Resources and Ore Reserves, JORC, 1996. Australasian Code for Reporting Identified Coal Resources and Reserves, JORC, 1986. Guidelines to the Australasian Code for Reporting of Identified Mineral Resources and Ore Reserves, Attachment to the 1996 Code, JORC, 1996. Code and Guidelines for Assessment and Valuation of Mineral Assets and Mineral Securities for Independent Expert Reports (The Valmin Code), AusIMM 1994. A Guideline for Reporting of Diamond Exploration Results, Identified Mineral Resources and Ore Reserves, 1995, The Association of Professional Engineers, Geologists and Geophysicists of the Northwest Territories. Uniform Format for Reporting Production Costs, 1996, The Gold Institute. Experts Reports in Prospectuses - A Regulator’s Views, Renato Sburlati, AusIMMBull, Jun 1996. Principles of Classification of Reserves and Resources in the CIS Countries, Serguei A. Diatchkov, Mining Engineering, March 1994. Classification of Ore Reserves Based on Geostatistical and Economic Parameters (Germany), F. W. Wellmer, CIM Bull, v86, No 972. Classification of the Deposit Resources of Solid Mineral Raw Materials of the German Democratic Republic, January 1962, Fettweis, 1979, p365. Uranium Resource Appraisal Group and Energy Mines and Resources, Canada, R. Sabourin, 1982. Proposed United Nations Resource Classification, J. J. Schanz, 1980. Ovadya Funding Group International, Inc. Copyright 2007 73
  • 74. A Guide for Reporting Exploration Information, Resources and Reserves, SME Working Party 79, Mining Engineering, April 1991. Defining Industrial Mineral Reserves: Common and Subtle Problems, D. A. Holmes and D. M. Abbott, Jr., 28th Forum of the Geology of Industrial Minerals, 1992. Uniform Standards of Professional Appraisal Practice, Appraisal Foundation, Updated Semiannually, 1998. ASA Business Valuation Standards, American Society of Appraisers, 1996. Valuation of Mineral Bearing Land and Other Wasting Assets, Royal Institution of Chartered Surveyors, SAVP 15:1, 3rd Edition, 8-90. Validity Examinations, BLM Manual 3891, Rel. 3-162, 7/8/87. Economic Evaluations for Validity on Mining Claims, J. R. Evans, SME Preprint 93-27. Mineral Material Appraisal Handbook, BLM Manual H-3630-1, Rel. 3-135, 8/26/86. Lands Prospectively Valuable for Leasable Minerals, BLM Manual 3021, Rel. 3-183, 9/10/87. Energy and Mineral Resource Assessment, BLM Manual 3031, Rel. 3-115, 6/19/85. Mineral Reports - Preparation and Review, BLM Manual 6060, Rel. 3-284, 4/07/94. Generic Mineral Appraisal Contract Specifications, National Park Service, no date. American Institute of Minerals Appraisers, Bylaws and Code of Ethics, 1996. Mines and Quarries Study Guide and Examination Outline, American Society of Appraisers, 1995. Principles of Appraisal Practice and Code of Ethics, American Society of Appraisers, 1994. Code of Ethics, Mineral Industry Consultants Association (Australia, New Zealand), 1992-3. Bylaws, Code of Ethics, Policies, and Procedures, American Institute of Professional Geologists, 1994. The Real Property Appraiser Qualification Criteria and Interpretations of the Criteria, Appraiser Qualifications Board, Appraisal Foundation, 1998. General Guidelines for Reviewing Geological Reports, State Mining and Geology Board, State of California, 1996 xxxii This suggested mineral valuation-appraisal reading/reference list is not intended to be a complete bibliography, but was designed to indicate to American Society of Appraiser's Candidates the general scope and level of knowledge that is being examined for advancement from Candidate to Accredited member (AM) or Accredited Senior Appraiser (ASA) in the Mines & Quarries discipline. The mineral valuation reading list is divided into three parts: Technical Books and Articles; Standards and Guidelines; and, Periodicals. This list is intended to be updated as necessary or as requested by visitors to this web site. Periodicals Aggregates Manager Appraisal Journal Ovadya Funding Group International, Inc. Copyright 2007 74
  • 75. AusIMM Bulletin Business Valuation Review Coal Age CIM Bulletin E&MJ Economic Geology Industrial Minerals Industrial Specialties News International California Mining Journal Machinery & Technical Specialties Journal Metal Bulletin Mineral Price Watch Miners News Mining Engineering Mining Journal Mining Magazine Mining Record Mining World News Northern Miner Paydirt Pit & Quarry Resources Policy Right of Way Rock Products Roskill Information Services Skillings Mining Review Transactions IMM Ovadya Funding Group International, Inc. Copyright 2007 75
  • 76. USGS/USBM monthly and annual mineral commodity reviews xxxiii The assumptions and limiting conditions described below are normally an integral part of every appraisal or valuation of a mineral property or mining business. Assumptions are necessary because appraisal is forward looking and must, of necessity, rely on certain assumptions about the future occurrence of events and/or conditions. Limiting conditions serve to notice the client and any intended and/or unintended readers of an appraisal report that the appraisal may have been performed under a set of defined conditions that would make it inappropriate to rely on it for other than its explicitly state purpose and use. This statement of general assumptions and limiting conditions is in addition to individual assumptions and limiting conditions which may be contained in particular sections of this appraisal report and/or within the special appendix section that is attached to and made a part of this appraisal report. These general assumptions and limiting conditions include but are not limited to: (a) that title to the subject mineral property is assumed to be merchantable; (b) that no responsibility is assumed by this minerals appraiser for legal matters, including those affecting title to the subject mineral property; (c) that the legal description given for the subject mineral property is assumed to be correct; (d) that all opinions, estimates, and/or other data furnished to this minerals appraiser by others are assumed to be correct; (e) that adequate rights exist for access, ingress, egress and/or passage across and/or through the subject mineral property for the intended mining and processing operations; (f) that adequate water rights exist on and/or for the subject mineral property for the intended mining and processing operations; (g) that any mining leases are valid; (h) that other, more specific assumptions and/or limiting conditions regarding the geology, mineability, processability, marketability, general and specific economics mentioned in subsequent sections of this report are those which a knowledgeable prudent prospective purchaser of mineral properties would consider reasonable; (i) that this appraisal has been performed for a single specific purpose and relies on a particular definition of value and that the resulting estimated value may not be valid for any other purpose; (j) that the subject mineral property is assumed to be free from any and all environmental hazards, whether on the subject mineral property or on surrounding properties; (k) the income approach to value has relied on current year constant dollars and real discount rates; (l) the subject mineral property has been appraised as if held in fee simple ownership, assuming all mineral and surface rights, except federal leaseable minerals, are also held by the owner, affected only by typical encumbrances such as mortgages, easements, and zoning ordinances; (m) the subject mineral property has been appraised as if it is and will remain under responsible ownership and competent management; (n) the term ‘reasonable probability’ and similar wordings are not used in a strictly mathematical or statistical sense, but are only intended to mean that the expected occurrences of events and conditions considered in an appraisal are appropriate and consistent with the purpose and intended use of the appraisal, and; the information contained in the report should be comprehensible to those who have a reasonable understanding of mining business and economic activities and are willing to study the information with reasonable diligence. Cautionary "Safe Harbor" Statement Under the Private Securities Litigation Reform Act of 1995. Appraisal is not an exact science and reasonable persons may differ in arriving at an estimate of fair market value. With the exception of historical data, the data and analyses discussed in this appraisal are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from estimated values. Such forward-looking statements include but are not limited to statements involving levels of exploration and development expense, plant, machinery, and equipment expenses, estimated mine life, timing of production, and other schedules of development. Factors that could cause actual results to differ materially include but are not limited to decisions and activities of property owners and/or managers, unanticipated geological, metallurgical, mining, processing, grade, quality and/or other engineering problems, conclusions of feasibility studies and/or market analyses, changes in project parameters, the timing of receipt of regulatory permits, the failure of plant, equipment, machinery, or processes to operate in accordance with specifications or expectations, results of exploration/development activities, accidents, acts of nature, delays in start-up dates, environmental costs and risks, changes in mineral product prices, as well as other factors. Most of these factors are beyond the appraiser’s and owner’s ability to predict or control. Client and other users of this appraisal report are cautioned not to put undue reliance on forward looking statements. An appraisal report cannot be a substitute for a client and other users who rely on it to perform the proper level of due diligence required in the performance of their usual business. SPECIFIC TO MINERAL PROPERTY AND MINING BUSINESS Legal Compliance: Unless otherwise stated in the report, Client and/or mining operator currently meet and will continue to meet all current and future federal, state and local laws, ordinances, regulations and rules governing the type of activities currently being performed or contemplated to be performed on the subject property. These activities include, but are not limited to, exploration, development, production, processing, waste and tailings transportation and storage, reclamation, mining or other business activities, insurance, bonding, or any other activity conducted on or associated with the property being appraised. Ovadya Funding Group International, Inc. Copyright 2007 76
  • 77. Mining Claims: Unless otherwise stated in the report, the status of any unpatented mining claim (lode, placer, association placer, mill site or tunnel site) or any mining claim in the process of being patented, is as represented by Client and/or mining operator; mining claim validity is assumed; Consultant has not made an examination of federal, state or county records for any required filings. Agreements: Unless otherwise stated in the report, any mineral rights, property leases, mineral production royalties and/or other payments, and/or mineral product sales contracts that are currently in effect and/or contemplated to be in effect are as represented by Client and/or mining operator. Mineral Resources or Reserves: Unless otherwise stated in the report, mineral resources and reserves are as represented by Client and/or mining operator. Consultant will endeavor to review relevant documents to gain some insight that any stated resource or reserve is in substantial compliance with the intent of relevant federal, state or local laws, regulations or rules concerning resource or reserve reporting. An audit of resource or reserve quantities is not a part of a normal appraisal. Production Plans and Mining and Processing Methods: Unless otherwise stated in the report, production plans and mining and processing methods and the expected rates of operation, plant capacity, availability and utilization and/or mineral product recoveries associated with these activities are as represented by Client and/or mining operator. Fixed and Mobile Machinery and Equipment: Unless otherwise stated in the report, any fixed and/or mobile machinery and equipment is sufficient in quantity, size and suitability for intended use for the current and/or expected mineral production from the property being appraised. Royalties, Working and Nonworking Interests: Unless otherwise stated in the report, the amounts, payment methods and schedules, divisions and/or apportionments, current and/or expected status of payments, accounting for and reporting of, or any other specified activities associated with these types of agreements are as represented by Client and/or mining operator. Mineral Product Market, Administered and/or Contract Prices, Hedging Activities and/or Commodity Loans: Unless otherwise stated in the report, actual or expected prices, whether market, administered or contract prices, for mineral products being sold or contemplated to be sold from the property being appraised, any hedging and/or commodity loans that are or are expected to be associated with the property being appraised and the current and/or expected status of payments, accounting for and reporting of, or any other specified activities associated with current or future mineral product sales are as represented by Client and/or mining operator. Mining, Processing and Administrative Costs: Unless otherwise stated in the report, actual or expected cash costs associated with the activities being performed or contemplated to be performed on the property being appraised are as represented by Client and/or mining operator. xxxiv This is a continuation of the previous assumptions and limiting conditions page and details some of the more common items normally contained in a real estate or real property appraisal or valuation report. Appraiser is legally regulated under federal and state law by the Uniform Standards of Professional Appraisal Practice (USPAP). This attachment is intended to supply Client with necessary information about Appraiser’s engagement performance and reporting assumptions and limiting conditions. This engagement and report are for no purpose other than property valuation and Appraiser is neither qualified nor attempting to go beyond that narrow scope. Client and other users of the report should be aware that there are also inherent limitations to the accuracy and reliability of the information, analyses and conclusions contained in this report. This appraiser assumes that readers of the report are knowledgeable of the relevant processes involved in the exploration, development, production and reclamation of mineral properties and have a working knowledge of the economics and commerce of the mineral products covered by the report. Before making any decision based on the information, analyses and conclusions contained in this report, it is critically important to read this entire section and to understand these limitations. Neither the processes used in this engagement nor the report can be used as a substitute for Client or third parties to perform the proper due diligence required in the performance of their business. Special/Extraordinary Assumptions and Limiting Conditions: Hypothetical Conditions: Ovadya Funding Group International, Inc. Copyright 2007 77
  • 78. Departures from USPAP: Appraiser may depart only from the following USPAP Standards. Performance: 1-2, 1-3, 1-4, 9-2 and 9-4. Reporting: 2-4, 10-2 and 10-4. Confidentiality(USPAP SMT-5): An appraiser must not disclose confidential factual data obtained from the client or the results of an engagement prepared for a client to anyone other than: 1) the client and persons specifically authorized by the client; 2) such third parties as may be authorized by due process of law, and 3) a duly authorized professional peer review committee. Under USPAP the obligation of the appraiser to protect the confidential nature of the appraiser-client relationship is neither absolute nor clearly understood. The appraiser-client relationship envisioned by USPAP is not comparable to the attorney-client relationship. With regard to factual data supplied to the appraiser by the client, the client is in the best position to decide what data must be considered confidential and to provide an explanation for such a determination. Data furnished by the client to other persons or entities without a confidentiality condition, or that is already in the public domain, do not become confidential when given to the appraiser. All other factual data obtained by the appraiser from any source are not recognized as confidential by USPAP, unless the appraiser has been advised of the confidential nature of the data. When the appraisal report is addressed to the client, any confidential factual data given to the appraiser by the client and relied upon in the appraiser’s analyses, opinions or conclusions may be specifically cited in the report without violation of the confidentiality rule. USPAP recognizes that such data are to be treated as confidential only when the client specifically instructs the appraiser that the factual data are confidential. Appraisal is made under conditions of uncertainty with limited data: Limitations result from a lack of certain areas of expertise by Appraiser (that go beyond the scope of ordinary knowledge of an appraiser), the inability to view certain portions of the property, the inherent limitations of relying on information provided by others and limitations imposed by the time constraints of this engagement. There is also an economic constraint in that the monetary budget did not contain unlimited funds for examination, inspection and acquisition of additional data. Appraiser used the available resources in the collection, verification and analysis stages of this engagement in those areas that Appraiser considers most relevant to the purpose and intended use but, there is a significant possibility that Appraiser does not possess all information relative to the property. Before relying on any statement made in this report interested parties should contact Appraiser for the exact extent of data collection and verification on any point they believe to be important to their decision making. This will enable such interested parties to determine whether they think the extent of data collection and verification were adequate for their individual needs or whether they would like to pursue additional data collection and verification for a higher level of certainty at an additional fee. Information, including projection of income and expenses, provided by informed sources, such as government agencies, financial institutions, accountants, attorneys, Client and others is assumed to be true, correct and reliable. No responsibility for the accuracy of such information is assumed by Appraiser. Any comparable sales data relied upon in the report is believed to be from reliable sources. It may have been impossible to examine all comparables due to monetary and time constraints. The value conclusions are subject to the accuracy of such information. Engineering analyses of the property were neither provided for use nor made as a part of this engagement. Any representation as to the suitability of the property for uses suggested in this analysis is therefore based only on a rudimentary examination by Appraiser and the value conclusions are subject to such limitations. All values shown in the report are projections based on Appraiser’s analysis as of the effective date of the appraisal. These values may not be valid in other time periods or as conditions change. Appraiser takes no responsibility for events, conditions or circumstances affecting the property’s value that take place subsequent to either the date of value noted in the report. Since mathematical models and other projections are based on estimates and assumptions which are inherently subject to uncertainty and variation depending upon evolving events, Appraiser does not represent them as results that will actually be achieved. The primary assumption underlying the discounted cash flow method of the income approach is a reasonable probability of occurrence of events and conditions that are expected to occur that may have a bearing on the subject mining operation. The term ‘reasonable probability’ and similar wordings are not used in a strictly mathematical or statistical sense, but are intended to mean that the expected occurrences of events and conditions considered in an appraisal are appropriate and consistent with the purpose and intended use of the appraisal. This report is an estimate of value based on an analysis of information known and available to Appraiser at the time of the engagement. Appraiser does not assume any responsibility for incorrect analysis because of incorrect or incomplete Ovadya Funding Group International, Inc. Copyright 2007 78
  • 79. information. If new information of significance becomes available the value given in the report is subject to change without notice. Opinions and estimates expressed in the report represent Appraiser’s best judgment but should not be construed as advice or recommendation to act. Any actions taken by Client or any others should be based on their own judgment and the decision process should consider many factors other than just the value estimate and information given in this report. Appraisal is not a survey: It is assumed that the utilization of the land and improvements is within the boundaries of the property lines of the property described and there is no encroachment or trespass unless noted in the report. No survey of the property has been made by Appraiser and no responsibility is assumed in connection with such matters. Any maps, plats, plans, sections or other drawings reproduced and included in the report are there only to assist readers with visualizing the property and are not necessarily to scale. The reliability of information contained on any such drawing is assumed by Appraiser and cannot be guaranteed to be correct. A qualified surveyor should be consulted if there is any concern on boundaries, setbacks, encroachments or other survey matters. xxxv This is a continuation of the previous assumptions and limiting conditions pages and details more of the common items normally contained in a real estate or real property appraisal or valuation report. Appraisal is not a legal opinion: No responsibility is assumed for matters of a legal nature that affect title to the property nor is an opinion of title rendered. The title is assumed to be good and marketable. The value estimate is given without regard to any question of title, boundaries, encumbrances or encroachments. We are not usually provided an abstract of title to the property being valued and we neither made a detailed examination of it nor do we give any legal opinion concerning it. It is assumed that there is full compliance with all applicable federal, state and local environmental laws and regulations unless noncompliance is stated, defined and considered in the report. A comprehensive examination of laws and regulations affecting the subject property was not a part of this engagement and was not performed. It is assumed that all applicable zoning and use regulations and restrictions have been complied with unless a nonconformity has stated, defined and considered in the report. Information and analyses shown in this report concerning these items are based only on a rudimentary examination. Any significant questions should be addressed to local zoning or land use officials, a qualified attorney and/or other qualified individuals. It is assumed that all required licenses, consents or other legislative or administrative authority from any federal, state or local government or private entity or organization have been or can be obtained or renewed for any use on which the value estimate in this report is based. Appraiser has not made a comprehensive examination of laws and regulations or private licensing terms affecting the property. Any significant questions should be addressed to appropriate government or private officials and/or an attorney. Appraisal is not an engineering, geology, environmental or property inspection report: The report should not be considered a report on the physical items that are a part of the property. Although the report may contain information about these physical items, including their adequacy and/or condition, it should be clearly understood that this information is only to be used as a general guide for property valuation and not as a complete or detailed physical. Appraiser is not a construction, engineering, environmental or legal expert and any statements given on these matters in the report should be considered preliminary in nature. The observed condition of foundations, roofs, exterior and interior walls, floors, HVAC systems, plumbing, electrical, insulation and all mechanicals and construction is based on a casual examination only and no detailed inspection was made. The structures were not checked for building code compliance and it is assumed that all structures meet applicable building codes unless so stated in the report. Some items such as conditions behind walls, above ceilings, behind locked doors or under the ground are not exposed to casual view and therefore were not examined. The existence of insulation, if any is mentioned, was found by conversation with others and/or circumstantial indications. Since it is not exposed to view the accuracy of any statements about insulation cannot be guaranteed. It is assumed that there are no hidden or unapparent conditions of the property, sub-soil or structures that would render it more or less valuable. No responsibility is assumed for such conditions nor for the engineering that may be required to discover such factors. Since no engineering nor percolation tests were made no liability is assumed for soil conditions. Ovadya Funding Group International, Inc. Copyright 2007 79
  • 80. Subsurface rights, including minerals, oil, gas and geothermal were considered only to the extent and detail stated in the report. Wells and septic systems, if any, are assumed to be in good working condition and of sufficient capacity for the stated highest and best use. Appraiser is not an environmental expert and does not have the expertise necessary to determine the existence of environmental hazards such as the presence of urea-formaldehyde foam insulation, asbestos, hazardous building materials, toxic waste or any other environmental hazards on the subject or surrounding properties. If Appraiser is aware of any problem of this nature which we believe would create a significant problem, it is stated in the report. Nondisclosure in the report should not be taken as an indication that no environmental problem exists. Any significant questions concerning environmental matters should be addressed to qualified experts. No chemical or scientific tests were performed by Appraiser on the property and it is assumed that the air, water, ground and general environment associated with the property present no physical or health hazard of any kind unless otherwise noted in the report. It is further assume that the property does not contain any type of dump site and that there are no underground storage tanks or other underground sources leaking hazardous or toxic substances into the groundwater or the environment unless otherwise noted in the report. The age of improvements on the property mentioned in the report should be considered only a rough estimate. Appraiser is not sufficiently skilled in the construction trades to be able to reliably estimate the age of improvements by simple observation. Appraiser has relied on circumstantial indications which may have come to our attention (such as dates on construction plans) or conversations with persons considered knowledgeable of the history of the property such as owners, onsite personnel or others. Any significant questions concerning the age of improvements should be addressed to qualified experts. Because no detailed inspection was made, nor was it a part of this engagement, and because such knowledge goes beyond the scope of this engagement, any observed condition or other comments given in this report should not be taken as a guarantee that a problem does not exist. Specifically, no guarantee is made as to the adequacy, condition, integrity and/or suitability of structures or buildings and their integral components. Any significant questions concerning these matters should be addressed to qualified experts. Appraisal Report limitations: Appraisal reports are technical documents addressed to the specific technical needs and requirements of Clients. Readers should understand that this report does not contain all of the information Appraiser has concerning the property or the relevant markets. While no factors Appraiser believes to be significant but unknown to Client have been knowingly withheld it is always possible that Appraiser has information of significance which may be important to others but which, with Appraiser’s limited knowledge of the property and limited expertise, does not seem to be important to Appraiser. Reports are made for Clients and are technical documents made to Client requirements. Other readers are cautioned about their limitations and cautioned against possible misinterpretation of the information contained in the report. Appraiser should be contacted with any questions before this report is relied on for decision making. This report was prepared at the request of and for the exclusive use of Client to whom the report is addressed. No third party shall have any right to use or rely upon this report for any purpose. There are no requirements, by reason of this engagement, to give testimony or appear in court or any pretrial conference or appearance required by subpoena with reference to the property in question, unless sufficient notice is given to allow adequate preparation and additional fees are paid by Client at Appraiser’s rates for such appearances and the preparation necessitated thereby. This report is made for the information and/or guidance of Client and possession of this report, or a copy thereof, does not carry with it a right of publication. Neither all nor any parts of this report shall be conveyed to the public through advertising, public relations, news, sales, or other media without the written consent and approval of Appraiser. Nor shall Appraiser, firm, or professional organization of which Appraiser is affiliated with be identified without the written consent of Appraiser. It is suggested that who possess this report should not give copies to others. Legal advice should be obtained on potential liability issues before this is done. Anyone who gives out an incomplete or altered copy of the report (including all attachments) does so at their own risk and assumes complete liability for any harm caused by giving out an incomplete or altered copy. Appraiser does not assume any liability for harm caused by reliance upon an incomplete or altered report of Ovadya Funding Group International, Inc. Copyright 2007 80
  • 81. the report given out by others. Anyone with a question on whether their copy of a report is incomplete or altered should contact Appraiser. Values and conclusions for various components of the property as contained within the report are valid only when making a summation: they are not to be used independently for any purpose and must be considered invalid if so used. The allocation of the total value in this report between land and improvements applies only under the reported highest and best use of the property. The separate valuations for land and buildings must not be used in conjunction with any other report and are invalid if so used. xxxvi The next step in the valuation process, after carefully defining the assignment, is to gather the data necessary to conduct the assignment. These data can be categorized into three groups: Company-specific data. Data about the company's industry and economic environment. Data about the subject property's market (market for ownership interests in the subject company). The company-specific data are gathered from the subject company in written form and during site visits and interviews with people knowledgeable about the company. The gathering of this information is the subject of this and the next chapter. The industry and economy data often can be provided by the subject company and can be gathered from publicly available sources. This is the subject of Chapter 6. Data about the market for ownership interests in the subject company include information about changes of ownership of competitors, about guideline company transactions, and about premiums and discounts that might apply to the subject property. These two categories of information gathering are covered in subsequent chapters in Part III. The manner and sequence in which the data are gathered are important only to the extent that the process be complete and efficient. For example, supporting analysts may be collecting industry, economic, rate of return, and guideline transaction information at the same time that the principal analyst is working directly with the management of the subject company. In any case, it is important to convey a sufficient overview of the company and the assignment to all valuation team members at an early meeting so that all the analysts will be in a position to recognize important data as they proceed on the project. If time allows, information gathered should be reviewed before the visit to the company so as to focus the interviewing process on the most essential factors that affect the value of the company, thereby minimizing the inconvenience of management interviews and also maximizing the productivity of the site visit. Some of the information necessary to conduct the business valuation will need to be obtained through interviews with company management. Sometimes, however, the analyst merely inspects voluminous or highly sensitive documents and gets copies only of the information necessary to perform the assignment. Written company-specific information that is generally used in business valuations is presented in Exhibit 4-1. This list is generic. Not every item on the list will be required for every appraisal, and in many circumstances, documents not listed must be reviewed. Working with this list, nevertheless, will assist the analyst in developing a subject-company-specific information request list. It will also be helpful to company officials and attorneys in the planning stages of a potential valuation engagement. Preliminary Documents and Information Checklist for the Business Valuation of a Typical Corporation Financial Statements for Typical Corporation Balance sheets, income statements, statements of changes in financial position, and statements of stockholders' equity for the last five fiscal years Income tax returns for the same years Latest interim statements and interim statements for comparable period(s) of previous year Other Financial Data Ovadya Funding Group International, Inc. Copyright 2007 81
  • 82. Summary property, plant, and equipment list and depreciation schedule Aged accounts receivable summary Aged accounts payable summary List of marketable securities and prepaid expenses Inventory summary, with any necessary information on inventory accounting policies Synopsis of leases for facilities or equipment Any other existing contracts (employment agreements, covenants not to compete, supplier agreements, customer agreements, royalty agreements, equipment lease or rental contracts, loan agreements, labor contracts, employee benefit plans, and so on) List of stockholders, with number of shares owned by each Schedule of insurance in force (key-person life, property and casualty, liability) Budgets or projections, for a minimum of five years List of subsidiaries and/or financial interests in other companies Key personnel compensation schedule, including benefits and personal expenses Company Documents Articles of incorporation, bylaws, and any amendments to either Any existing buy-sell agreements, options to purchase stock, or rights of first refusal Franchise or operating agreements, if any Other Information Brief history, including how long in business and details of any changes in ownership and/or bona fide offers recently received Brief description of the business, including position relative to competition and any factors that make the business unique Marketing literature (catalogs, brochures, advertisements, and so on) List of locations where company operates, with size and recent appraisals List of competitors, with location, relative size, and any relevant factors Organization chart Resumes of key personnel, with age, position, compensation, length of service, education, and prior experience Personnel profile: number of employees by functional groupings, such as production, sales, engineering/R&D, personnel and accounting, customer service/field support, and so forth Trade associations to which the company belongs or would be eligible for membership Ovadya Funding Group International, Inc. Copyright 2007 82
  • 83. Relevant trade or government publications (specially market forecasts) Any existing indicators of asset values, including latest property tax assessments and any appraisals that have been performed List of customer relationships, supplier relationships, contracts, patents, copyrights, trademarks, and other intangible assets Any contingent or off-balance-sheet liabilities (pending lawsuits, compliance requirements, warranty or other product liabilities, estimate of medical benefits for retirees, and so on) Any filings or correspondence with regulatory agencies Information on- prior transactions in the stock or any related party transactions When asking for historical financial statements on the subject property, one should endeavor to study statements during a relevant period. The most common period of such study is five years. However, conceptually, the relevant period covers the most recent time period immediately before the valuation date during which the statements represent the company's general operations. Ovadya Funding Group International, Inc. Copyright 2007 83