How are Discounts for Lack of Control Determined?

Joe OrlandoI recently penned a summary on valuation discounts for lack of marketability. As a follow-up, this post is about discounts for lack of control (DLOC) for the valuation of minority equity interests in operating businesses.

In the business valuation context, control refers to the ability to manage or control a business. A controlling shareholder enjoys many benefits that are not enjoyed by minority interest holders. Minority interests are therefore usually worth less, often considerably less, than a proportionate share of the value of the total entity.

Control Premiums

Conversely, a controlling interest in a company is more valuable than a non-controlling interest because the interest holder can control policy, strategic and operational aspects of the company. An investor will generally pay more per share for the rights and liberties afforded a controlling interest than for a non-controlling interest.

When a control premium is warranted, the size of the premium is often based on the controlling interest holder’s ability to:

  • Appoint or change members of the board of directors
  • Appoint management
  • Set management compensation and perquisites
  • Set operational and strategic policy and change the course of the business
  • Acquire, lease or liquidate business assets
  • Negotiate and consummate mergers, acquisitions and divestitures
  • Sell, liquidate, dissolve or recapitalize the company
  • Sell or acquire treasury shares
  • Register the company’s debt/equity for an initial or secondary public offering
  • Declare and pay cash dividends to shareholders
  • Change the articles of incorporation or bylaws of the company
  • Establish, revise or execute buy-sell agreements
  • Select joint venture partners or enter into such agreements
  • Decide product/service offerings, pricing, and markets to serve and not serve
  • Select suppliers, vendors and contractors to do business with
  • Enter into license or technology sharing agreements regarding intellectual property
  • Block any (or all) of the above actions

Evidence of Control Premiums in the Marketplace

A variety of studies have examined the premiums paid when public companies are bought out. One such source is the Mergerstat Control Premium Study. Mergerstat calculates buyout price premiums paid over market prices five business days prior to public announcement of the buyout.

We compiled the following table from Mergerstat Control Premium Study data:

It is impossible to know exactly how much of the premiums paid were due to gaining control versus the existence of synergistic benefits between the acquirer and the acquired. Some business appraisers argue that a significant portion of the premium relates to synergies (or other non-control factors), while others accept these studies at face value.

Lack of Control Discounts

When a valuation method result is on a controlling basis and we are valuing a non-controlling interest, a Discount for Lack of Control is usually applied. DLOC’s cannot be observed directly in the marketplace. Instead they are calculated from control premiums:

DLOC = 1 – (1 / (1 + Control Premium))

Business appraisers often select a baseline DLOC from studies of empirical data, then adjust up or down to fit the specific control attributes of the interest being valued. Key items to consider when evaluating a minority interest for a DLOC include the non-controlling interest holder’s inability to take the actions listed above, as well as other power attributes of the subject interest and economic attributes of the company.

How the IRS and Courts See Control Discounts

The IRS, valuation professionals and the courts recognize the appropriateness of DLOC’s. In a 1982 estate tax decision (Estate of Woodbury G. Andrews, 79 T.C. 938) the court distinguished this discount from a discount for lack of marketability, stating in part, “The minority shareholder discount is designed to reflect the decreased value of shares that do not convey control of a closely-held corporation.” The tax court continued in Harwood v. Commissioner, 82 T.C. 239, 267 (1984), “The minority discount is recognized because the holder of a minority interest lacks control over corporate policy, cannot direct the payment of dividends, and cannot compel a liquidation of corporate assets.”

In establishing a DLOC, IRS Revenue Ruling 93-12 should also be considered if the interest being transferred results in a control block of shares among family members in the subject entity. In brief, this ruling states that a minority discount will not be disallowed solely because a transferred interest, when aggregated with interest held by family members, would form a controlling interest.

Exceptions to the Rules

Users of business valuations should be aware that some valuation methods produce a non-controlling level of value, and no adjustment is needed when the subject being valued is a non-controlling interest (sometimes referred to as a minority interest, although they are not always the same). For the business valuation expert, it is critical to identify the level of control implied in a valuation method result before applying a DLOC. In some cases, a valuation method generates the same level of value needed for the valuation assignment, and no discount is required. In other cases, the levels don’t match.

It should also be noted that a minority interest usually does not have the benefit of control; however there are situations where a minority interest has control, such as an organization that has shareholders with limited voting rights. A minority owner without special rights cannot control the paying of dividends or selling of assets, or otherwise direct or manage a company’s activities.

Exit Strategies Group values control and minority (non-controlling) interests of private businesses for tax, financial reporting, strategic, buy-sell, ESOP and other purposes. If you’d like help in this regard or have any related questions, contact Joe Orlando, ASA, at 503-925-5510 or jorlando@exitstrategiesgroup.com.

Opportunity Zones: a Compelling Tax-Advantaged Investment for Business Sellers

Cashing in on the sale of your business is the final reward for many years of dedication and hard work. Then your CPA tells you how much you will owe in taxes. It’s a shock, but there’s a relatively new reinvestment opportunity that may help trim your tax bill …

In April 2018, The U.S. Department of the Treasury and the Internal Revenue Service (IRS) designated Opportunity Zones in 18 States. The Tax Cuts and Jobs Act created Opportunity Zones to spur investment in distressed communities throughout the country. New investments in Opportunity Zones can receive preferential tax treatment.

Under the Tax Cuts and Jobs Act, States, D.C., and U.S. possessions nominate low-income communities to be designated as Qualified Opportunity Zones, which are eligible for the tax benefit. Attracting needed private investment into these low-income communities will lead to their economic revitalization, and ensure economic growth is experienced throughout the nation,” said Secretary Steven T. Mnuchin. “The Administration will continue working with States and the private sector to encourage investment and development in Opportunity Zones and other economically disadvantaged areas and boost economic growth and job creation.”

Qualified Opportunity Zones retain this designation for 10 years. Investors can defer tax on any prior gains until no later than December 31, 2026, so long as the gain is reinvested in a Qualified Opportunity Fund, an investment vehicle organized to make investments in Qualified Opportunity Zones. In addition, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor would be eligible for an increase in its basis equal to the fair market value of the investment on the date that it is sold.

How Opportunity Zone Funds work

An investor who has triggered a capital gain by selling a business or real estate, can receive special tax benefits if they roll that gain into an Opportunity Fund within 180-days. Advantages are:

  • The payment of capital gains is deferred until December 31, 2026
  • It reduces the tax owed by up to 15% after 7-years
  • There is zero tax on gains earned from the Opportunity Zone Fund

If you’re planning to realize a sizeable capital gain or recently sold an asset where there is a capital gain (within the 180-day filing window), Opportunity Funds may help to keep more in your bank account and less in the federal treasury. It’s worth a look. Consult with your CPA or financial advisor.

Bob Altieri is a senior M&A advisor and business valuation expert with Exit Strategies Group. He can be reached at boba@exitstrategiesgroup.com.

How a Discount for Lack of Marketability (DLOM) is Determined

In a prior chapter of my professional career, I focused on equity security valuations for tax and financial reporting purposes. I led a team of valuation experts who determined the strike price of options granted to employees of up and coming technology companies on their way to IPO. For most, that strike price represents the basis (or cost) of an employee’s future wealth (and tax bill). In simple terms, the valuation of these shares in private companies are based on market multiples (or their value divided by a specific operating metric like sales or earnings) of public companies that are comparable. Once value is allocated to common shares, the per share price is a marketable value because it is based on the stock prices of marketable securities (the publicly traded companies we used to compare). Because private company shares are not as marketable (liquid) as public company shares, we need to adjust for this relative lack of marketability. But how?

Enter the Black-Scholes Model

One answer lies in the economic studies of the early 1970’s. In 1973, Fisher Black, Myron Scholes and Robert Merton published “The Pricing of Options and Corporate Liabilities” in the Journal of Political Economy introducing a simple model with five key inputs. While the formula truly has some high-level calculus, I will try to simplify the output and how it is used.

Here are some definitions you will need to understand before we start:

  • Current Price – The current per share value of the stock.
  • Dividend Yield – The annual return to an investor in the form of dividends as a % of the stock price.
  • Strike Price – The predetermined price.
  • Maturity – The amount of time in years until the option expires.
  • Risk-free Rate – The rate of a return for a risk-free investment, in this case a US Government debt instrument at the same maturity term of the put option
  • Volatility – The rate at which a security increases or decreases over a period of time.
  • Call Option – The option or right to buy (or call) a security at a predetermined price by a predetermined date.
  • Put Option – The option or right to sell (or put) a security at a predetermined price by a predetermined date.

How a Put Option Works

Before I dive into how a Discount for Lack of Marketability (DLOM) is determined, I want to examine a real-life example of what marketability is worth. For my example, I’m only going to look at buying a put option. The purchase of a put option assumes that the buyer is a long-term holder looking to protect his/her position in a security.  I chose a put option because it can be easily compared to an insurance policy.

Facts:

  • Stock Owned: Jane owns 100 shares of Microsoft currently priced at $138.90 as of the close of the financial markets on June 14, 2019. This price very close to its 52 week high of $139.22 per share.
  • Goal: Jane wants to lock in the current price (or close to it) for the next year and is willing to pay for the security of knowing that she can lock in that price.
  • Publicly Traded Options: Jane can buy an put option for one year (or with an exercise price of $140 in June 2020) at $12.20.
  • Options Purchased: Jane purchases 100 put options for $1,220.00 to lock in the sale of her shares when the option expires in June 2020 for $14,000.00.

What this Means for Jane

Jane just bought an insurance policy that lets her get the $140.00 per share for her stock. The put option ensures the marketability of her shares but it came at a cost of 8.7% of the value of her shares (or $1,220 divided by $14,000). While she can’t exercise the option until it expires (the terms of a standard put option) she can sell the options if they increase in value before it expires.

That option will increase in value as the price of Microsoft drops because it is worth more to someone to sell shares at a higher price in the future. An example of this concept is the fact that the put option for the same June 2020 date but at a price of $150.00 is selling at $19.40. In simple terms, the price is driven by the supply (people willing to bet that when the option expires in a year the price of Microsoft will be much higher than it is today) and demand (investors like Jane that simply want protection of believe that the price will be less in a year than it is today).

How this Relates to a DLOM in Valuing Private Company Shares

Let’s replace Jane with Jack and let’s assume that Jack’s investment is 100 shares in Software Widget, Inc., a private company with no publicly traded market for its shares.

Say Jack hires Exit Strategies to value his 100 shares. We value the shares based on market multiples of publicly traded (or “marketable”) companies comparable to Software Widget, Inc. and arrive at a price per share of $50.00 a share. But Jack’s shares aren’t marketable. He can’t call his broker to sell them and certainly can’t buy a put option to protect the value of his shares. Like Jane, he expects the shares to be marketable in a year but unlike Jane, he can’t buy a real insurance policy to lock in that price. Simply put he lacks marketability for the next year but what does this mean to the value we place on his shares?

The answer lies in the put option that we discussed above but instead of looking for the price of one on Google Finance, we need to go back to the formula Black and Scholes determined to build up and calculate a hypothetical one. Using the inputs below highlighted in gray, the hypothetical option asks a simple question; what would it cost to buy a hypothetical put option to lock in the price of a security at $1.00 for one year? In the case of the inputs below, the answer is $0.15 or 15.0% of the value of the security. Because it would cost $0.15 per share to lock in the price of $1.00 over a year, the lack of this marketability is the cost of not having this protection (or to Jane’s example, an insurance policy).

So back to Jack. His shares are worth $50.00 per share on a marketable basis but we need to value them on the non-marketable basis of a private company. Therefore, we apply a 15% discount to arrive at our concluded price of $42.50 as detailed below:

This is just one way to determine a DLOM

In determining discounts for lack of marketability, Exit Strategies also considers studies that map actual discounts of restricted stock. The uniqueness of the put option model approach above lies in the inputs and how the discounts change when one of the three key inputs (dividend yield, maturity and volatility) change. For example, if we change the term above to 5 years, the discount goes to 28%. That increase makes sense because an “insurance policy” to lock in a price would cost more for 5 years than it would for one.

If you have questions about discounts for lack of marketability or if you would like us to value your private business or an equity interest for any purpose, call or email Joe Orlando at 503-925-5510 or jorlando@exitstrategiesgroup.com.

How Would Your Company Survive Without You?

If you are like many business owners, you tend to get caught up in the daily demands of your business: managing sales and production, costs, and the bottom line. What about preservation and protection? Perish the thought, but what would happen to your company if it was unable to carry on due to your death or disability?

These concerns may seem like, and may in fact be, remote possibilities. However, by putting them off, you may be placing the future of your business, and its shareholders and their families, at risk. Once death or disability strikes, it will be too late to plan. Your company’s continuing operations could be severely damaged, permanently affecting your family, partners, employees, and others who may depend on it for their livelihood. If you’re like many business owners, you may assume that, if disaster struck, your family could simply sell the company. But, to whom would they sell and at what price? And what if otherwise capable buyers did not have sufficient cash for the purchase? A buy-sell agreement helps provide answers to these and many more questions.

What is a Buy-Sell Agreement?

Briefly, a buy-sell is a legal contract that guarantees a buyer for your business, and provides a means of funding the purchase. You typically negotiate a buy-sell with partners, shareholders, the management team, or key employees. The agreement commits them to buy out your share of the business if you die or become disabled. The process for valuing the company is agreed upon up-front, when the deal is struck. Life insurance and disability insurance are often used to provide the necessary funding.
Your family benefits by automatically having a cash buyer for the business. Your buyer benefits by being able to continue operations without fear of interference from outsiders who are unfamiliar with the business.

The Basics of Setting One Up

An insurance professional usually plays a key role in structuring a buy-sell. Ideally, your representative should have extensive experience in business succession planning. You may also require legal, tax, and accounting assistance, depending on the complexity of the agreement.
In many cases, funding a buy-sell agreement with both life and disability insurance may be the best way to proceed. The life insurance policy can either be term or have a cash value component. A term policy provides the largest death benefit for the least cost; however, it will only cover the buy-sell itself. If you want the insurance to provide other benefits, such as supplementing your pension or providing funds to buy out a partner, you will need a cash value policy. Disability insurance is particularly important, since the chances of becoming disabled are statistically greater than the chances of dying before age 65. However, insurability will depend on your occupation, health, and age.

One Company’s Approach

Consider the benefits of a buy-sell agreement, in the following hypothetical example. Barbara Smith, Mary Jones, and Tom Altuve are partners in a computer services company. Barbara owns the majority interest, while Mary and Tom are minority shareholders. Recognizing the importance of guaranteeing the company’s long-term survival, they consult an insurance professional, who, over the course of several months and with assistance from the company’s lawyers and accountants, develops a buy-sell agreement.

Twelve insurance policies are written to fund the buy-sell agreement, two life and two disability insurance policies per partner. Both life insurance policies are payable to the business. One policy will provide funds to buy out a deceased partner’s interest, while the other will pay the costs of recruiting a replacement. Of the two life policies, one is a term policy, while the other is a cash value policy. The cash value policy can be used to provide supplemental pension income in the event the partner retires. Of the two disability policies per partner, one is payable to the partner, while the other is payable to the company. The partner’s policy will provide him or her with income in the event of disability; the company’s policy will provide funds that can be used to buy out a disabled partner’s share.

Clearly, a buy-sell agreement can be complex and does not come cheaply, since it needs to be tailored to your company and your shareholders. However, it may help you sleep more easily at night, knowing that your family, and others who depend on your business, will continue to benefit from the company you worked so hard to build.

Jerry Matecun is based in Orange County, California. To contact Jerry for exit planning and business valuation services, Email jerry@exitstrategiesgroup.com or call (949) 287-8397.

 

Make No Mistake: The IRS is Serious About Qualified Appraisals and Appraisers

The IRS and the Tax Courts are serious about requiring taxpayers to properly determine the value of non-cash estate assets, gifts and charitable contributions. To avoid having the value of an inherited, gifted or donated privately-held business interest challenged or rejected by the IRS, obtain a qualified business appraisal (valuation) from a qualified business appraiser.
The IRS defines a qualified appraisal as one that:
  1. is performed in accordance with generally accepted appraisal standards;
  2. meets the relevant requirements of IRC Regulations section 1.170A-13(c)(3) and Notice 2006-96, 2006-46 I.R.B. 902;
  3. does not involve an appraisal fee based on a percentage of the appraised value of the property;
  4. includes specific information, such as a property description, terms of the sale agreement, appraiser identification information, date of valuation and valuation methods employed, among other requirements;
  5. in the case of a charitable donation, is made not earlier than 60 days before the property is donated, and in the case of gifted property is as of the date of gift; and
  6. is conducted, prepared, signed, and dated by a “qualified appraiser.” (see below)
Their definition of a qualified appraiser is an individual who:
  1. Has earned an appraisal designation from a recognized professional appraisal organization (such as the ASA, NACVA, IBA, or AICPA) or has met certain minimum education and experience requirements;
  2. Regularly prepares appraisals for which the individual is paid;
  3. Demonstrates verifiable education and experience in valuing the type of property being appraised;
  4. Has not been prohibited from practicing before the IRS under section 330(c) of Title 31 of the United States Code at any time during the three-year period ending on the date of the appraisal; and
  5. Is not an excluded individual (mainly, someone who is the donor or recipient of the property).

In-depth information on determining the fair market value of donated property can be found here, in IRS Publication 561 (Form 8283).  https://www.irs.gov/uac/about-publication-561

Taxpayers and tax practitioners need to pay very close attention to the credentials and experience of the business appraiser they hire, and be sure that the type of analysis and report that the appraiser intends to provide will fully comply with IRS requirements. When you need a business valuation or appraisal for a tax filing, Exit Strategies’ experienced valuation professionals would be happy to help. To discuss your particular business interest and valuation needs with a qualified expert, you can reach Al Statz, ASA, CBA, at 707-781-8580.

Case Study: How One Entrepreneur’s Advisors Enabled a Successful Estate Transfer

I recently had a client who wanted to transfer his medical distribution company to his son and retire with peace of mind — a common occurrence these days. Dad and his CPA requested an opinion of Fair Market Value to set the price for a transfer of stock. After I appraised the company (S corp.) stock at $2.0 million, Dad and Son asked me how to finance the transaction. Dad was reluctant to carry a long-term loan for his son — also a common occurrence! Here’s how a team of advisors helped the client make this happen …

The lenders that I approached wanted Son to inject a minimum of $500K (25% of the deal price). This turned out to be a lot more than the son had available. One creative lender suggested that Dad finance the sale for a short time until Son had paid down 25% of the principal on Dad’s note, then return to him for an SBA loan.

The lender proposed 3 seller notes totaling $2 million: Note1 for $500k (25% of the purchase price) for two years, fully amortized; Note2 for $750k with interest-only payments, due in 2 years; and Note3 also interest-only and due in 4 years. The plan was that as soon as Note1 was paid off, the lender would take out Note2 to Dad with a $750k 10-year term loan. Then, after that bank loan was seasoned for 2 years, the lender would lend the remaining $750k to take out Dad’s Note3. The result: Son can acquire the business with no money down, Dad can be completely paid off in 4 years, and Son will have the flexibility of a long-term loan.

When Dad and Son were ready to finalize their agreement, they called a meeting with me and their attorney and CPA. I discovered one significant problem. Under a stock sale, Son’s expected salary and distributions, after taxes, were not quite sufficient to cover his debt service (principal and interest payments) and living expenses in the first two years.  During the meeting, I suggested doing an asset sale-purchase instead of the planned stock deal. In an asset purchase, the Son’s net after-tax cash flow would be substantially increased by the stepped up basis of fixed assets and intangibles. After providing rough calculations, Dad and Son received definitive tax advice from their CPA.

Cash Flow Benefits

Let’s look at an example of the difference in cash flow in an asset sale versus a stock sale.  Assume a $2,000,000 price in both cases, with inventory and fixed assets as shown in the table below, as well as price allocations to covenant not-to-compete and goodwill under an asset sale.

Asset Sale – BuyerStock Sale – Buyer
Inventory$400,000 (not deductible)$400,000 (not deductible)
Fixed Assets$100,000 (new basis)$25,000 (existing basis)
Covenant not-to compete$50,000na
Goodwill$1,450,000na
Buyer’s total deductions against income$1,600,000$25,000
Depreciation of Fixed Assets$20,000 / year, 5 yrs*$5,000 /year, 5 yrs*
CNTC & goodwill combined$100,000 / year, 15 yrs$0
Total deductions, years 1-5$120,000$5,000

*Assume all fixed assets have 5-year depreciation

With an extra $115,000 per year in deductions, and assuming a combined state and federal tax rate of 40%, the Son’s after tax cash flow in an asset purchase would be $46,000 more. Under this structure, the Son’s cash flow would be sufficient to support the debt and enable the ownership transfer.

Dad and Son are now almost a year into their transition. Son is faithfully paying down Note1, the business is doing well, and Dad and Son are happy.

The first moral of this story is that business succession planning and estate planning are team sports, where entrepreneurs need a team of experts to guide them. No single professional is qualified to advise on the range of succession and estate issues that arise.

The planning process often begins with an appraisal of the business and real estate assets, so that tax, financial and legal professionals, lenders, insurers and other team members understand the assets to be transferred. The second moral is that when a business is part of an estate transfer, as in this case, selecting a business appraiser with experience in structuring and financing business sale transactions can be a big advantage!

For further information or to discuss a current need, contact Bob Altieri at ESGI.

Ten Exit Planning Benefits

Someone’s sitting in the shade today because someone planted a tree a long time ago. — Warren Buffett

Few would argue that a successful retirement takes more planning for a business owner than it does for other people.

Whether you intend to transfer your business to family, management or a third party, an exit plan is usually intended to produce a more successful exit and retirement. Here at Exit Strategies, an “Exit Plan” (or succession plan) means analyzing your business and planning how and when to exit ownership and employment, while maximizing value, reducing risk, and preserving wealth.

Ten Exit Planning Benefits

  1. Clarifies your best transfer option and timing
  2. Identifies value and marketability gaps
  3. Increases shareholder value
  4. Positions the company to attract more and better buyers
  5. Ensures business continuity
  6. More seamless leadership transfer
  7. Increases cash proceeds
  8. Minimizes taxes
  9. Minimizes financial risk
  10. Prevents costly mistakes

On a personal level, an exit plan re-energizes you and gives your work greater purpose. It clears and settles your mind, focuses your attention, and reduces your stress and anxiety.

In Exit Strategies’ experience, business owners rarely have the time or expertise to tackle this on their own. This is where we come in. To start with, we’ll objectively analyze your business and help you increase its value and marketability if gaps exist. We’ll coordinate with your tax, legal and estate planning advisors. Then, when the time is right for you and your family to sell, you’ll be ready, and the outcome will be successful. Ideally, we’ll start working together two, three or even five years before you’re ready to sell. The earlier we get involved the more impact we can have.

For more information on our exit planning services, and the approximate costs, timeframes and the typical return investment involved, Email or call Al Statz at alstatz@exitstrategiesgroup.com or 707-781-8580. Our discussion will remain confidential.

Don’t Forget the Net Investment Income Tax when Selling a Business

The Net Investment Income Tax, which our friends at the IRS put into effect in 2013, takes an extra toll on business owners who sell their businesses; and for that matter, on most higher income taxpayers and any moderate income taxpayer whose income increases suddenly in a given tax year.

What is the Net Investment Income Tax?

The Net Investment Income Tax (“NIIT”) is a 3.8 percent federal tax on certain income of individuals, estates and trusts whose modified adjusted gross income or “MAGI” exceeds certain threshold amounts. Common forms of investment income are interest, dividends, capital gains and passive business activities such as rental income or income derived from royalties. Generally, wages and income from an operating business are NOT considered net investment income.

For individuals, the MAGI threshold is $250,000 (married filing jointly) and $200,000 for single filers. Taxpayers with MAGI over the threshold are taxed at a flat rate of 3.8 percent on all net investment income, in addition to other taxes!

When you sell a business of any significant value, NIIT will likely affect your tax liability in the tax year(s) in which you receive payment. Individuals report (and pay) net investment income tax on IRS Form 1040; while estates and trusts use Form 1041.

So, what should business owners do?

If you are considering the sale of a business or business interest, it is important that you fully understand the tax implications of a sale beforehand. There are strategies that you can use to minimize your tax liability if you take action early enough and/or structure the sale in certain ways. Contact your tax advisor to estimate your tax liability and find out what can be done to maximize your after-tax proceeds.

 

Exit Strategies are not tax professionals, and we do not provide tax advice. However, tax issues arise in nearly all of our exit planning, valuation and M&A brokerage engagements, so we are well aware of them. If you are looking for an experienced CPA or tax advisor to analyze the various federal and state tax issues related to a business transaction and recommend appropriate tax minimization strategies, we can recommend one or two. Feel free to Email Al Statz or call him at 707-781-8580 for help.

Update on Estate and Gift Tax Changes Coming in 2016

Proposed rule changes would limit the practice of discounting the value of stakes in family businesses for estate and gift tax purposes—an update regarding IRS timeline.

The U.S. Treasury Department and the IRS are planning to introduce new regulations aimed at estate and gift transfers of closely held family businesses. The new rules would limit the practice of discounting minority stakes in closely held family owned businesses because of restrictions on an owner’s ability to sell their piece of the business.

The Wall Street Journal on August 19, 2016 reported that the IRS is accepting comments on the new proposals, and a hearing is scheduled for December 1, 2016, and some experts think the current administration will push to finish the proposed changes before a new president takes office.

A brief window of opportunity exists as the proposed changes will likely not take effect until 30 days after the rules are made final. Implementation of wealth transfers can easily take 2 to 4 months to complete, depending on the complexity of the entities and estates involved. Therefore, we urge you to talk with your estate, legal and tax advisors now to evaluate how the proposed regulations could impact your business succession and wealth transfer plans. Those who can take advantage of current rules will need to act immediately.

Exit Strategies performs valuations of family-owned operating businesses and holding companies for estate planning, gifting and other purposes. We value fractional interests using appropriate discounts.  If you have any business valuation questions or have a current need you can reach Louis Cionci at 707-781-8582.

Role of Business Appraisers and M&A Advisors in Estates and Trusts

I was recently asked about Exit Strategies’ role as business appraisers and M&A advisors in estates, estate planning and trust administration.  Here was my answer …

Business Valuation (a.k.a. Appraisal)

As business valuation experts, we provide fair market value appraisals of closely-held corporations, FLPs and LLCs for estate planning, gifting, estate tax, charitable donations, buy-sell transactions and succession planning. We value fractional interests in operating companies and asset holding companies using appropriate discounts. Our appraisers adhere to recognized professional standards, perform appropriate due diligence and meet or exceed accepted reporting requirements. And of course we are prepared to defend our work in the unlikely event of an IRS challenge.

For estates containing closely held business interests, we determine value of the decedent’s interest. We can provide input to the attorney on the effect of using the alternative valuation date.

With regard to trust administration, when a privately held business interest is placed in trust, our business valuation can help the fiduciary establish a baseline value and enhance their understanding of the asset. An independent business valuation can also avoid any potential for conflict of interest, since fees charged by trustees are often based upon the value of the assets managed. Subsequent valuations may be ordered by the fiduciary to assess the investment’s performance over time.

In estate planning where a family business is one of the owner’s major assets, a business valuation is often the starting point for estate planning professionals as they consider various estate planning techniques. Valuations provide a basis for the owner to evaluate potential ownership transfers and gifts; and can safeguard against future IRS challenges.

Landscape photo by Lance Kuehne

Landscape photo by Lance Kuehne

When drafting entity agreement and buy-sell agreement terms, attorneys have to balance flexibility and efficiency of operations with restricting control and marketability. During this stage, we can identify problem valuation situations or problem assets and identify the effects of gift and estate planning alternatives on valuation. We can also provide feedback and input on operating agreement terms that impact value.

When business owners gift ownership in their businesses, we determine value as of the date of gift. When closely held business interests are donated to a Charitable Remainder Trust (CRT), our business valuation can support the charitable deduction by the donor taxpayer.

Sometimes estate planning involves business succession planning. Like estate planning, real business succession planning is emotionally charged and often meets with resistance from clients.  A business valuation provides an objective look at many aspects of a business, including its management, marketability, inherent risks, and future prospects. The very act of going through the valuation process with an experienced and independent appraiser sometimes provides the catalyst that owners and their families need to fully engage in succession and wealth transfer planning.

M&A Advisors (a.k.a. business brokers, investment bankers, intermediaries, etc.)

There are many instances in which a generational transfer of a family-owned business is not the best option for a family. Often the children aren’t qualified to run the company or simply aren’t interested. Or the industry may be consolidating and an opportunity exists to sell the business for far more than fair market value and create substantial wealth and liquidity for the family.

Here, our firm regularly advises owners in the positioning, document preparation, strategic marketing and confidential selling process. We lead the M&A sale process for the client and work alongside their tax and legal advisors to maximize proceeds and preserve wealth.

Business valuations and M&A brokerage play a part in many estate and trust matters and succession planning for family owned businesses. For additional information or for advice on a current need, you can call Exit Strategies’ founder and president Al Statz at 707-781-8580.