Page 51 - Business Valuation for Estates & Gift Taxes

fair market value of cash or investment interests is usually done by referencing bank and investment ac-
count statements. The value of publicly traded investments can usually be determined as of a precise
date. The value of less liquid investments may not be determined as easily. The value of some invest-
ment funds may only provide valuations quarterly. FLPs that hold real estate or equipment may require
appraisals by specialists in those areas.

Under the income approach, the analyst can consider discounting the expected future cash flows for each
asset held by the FLP. For example, the current market value of an equity portfolio of $5 million with a
10-percent expected return would result in $500,000 of income. The valuation analyst might assume that
the future cash flows will include the distribution of all interest, dividends, and capital appreciation that
will accrue to the benefit of the interest owner even if not distributed currently. Alternatively, if using
only interest and dividends in the net cash flow forecast, growth in the equity portfolio for the undistrib-
uted capital appreciation should be factored in, with an assumption of a future liquidating event. The ap-
propriate rates of return can be derived using alternative rates of return from publicly traded stocks,
bonds, real estate investment trusts, and limited partnership interests.

Under the market approach, market-derived price/NAV (P/NAV) multiples can be used to directly de-
termine the non-controlling, marketable value of an FLP interest. Although not frequently used to direct-
ly value an interest, these multiples can be used to determine a discount for lack of control as discussed
in the following information.

Valuation Adjustments

Depending on the valuation methods used, discounts for lack of control and marketability will usually be
appropriate.

Once the value of the FLP has been determined (especially when the asset-based approach has been ap-
plied), the valuation analyst will then apply an appropriate discount for lack of control (DLOC) to con-
vert a controlling interest value into a minority interest value.

The most common method of determining this discount is by application of a market-derived P/NAV ra-
tio. This ratio captures the return on investment that a minority owner would expect. Because the in-
creased risk related to lack of control requires a higher rate of return, an investor discounts the price of
the minority interest to a level sufficient to produce a return that is commensurate with the risk of the in-
vestment.

Data from closed-end mutual funds or publicly registered real estate partnerships can provide P/NAV ra-
tios. The discounts reported in this data reflect the circumstances that affect the risk and reward (future
benefits) of the interests included in the data. Qualitative and quantitative comparisons should be made
between the data used to derive discounts and the subject interest.

The discount for lack of marketability appropriate for an FLP interest is determined using much the
same analysis that an analyst would use for any other interest in a closely held entity. An additional im-
portant factor when considering the DLOM to apply to an FLP interest is that there may be some lack of
marketability included in the market data used earlier in the analysis. Publicly registered real estate part-
nerships are traded on a secondary market which is not nearly as liquid as the market for publicly traded
stocks. Analysts should consider the likelihood that the reported P/NAV ratios also include a small dis-
count for the time it would take to convert these interests to cash.

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