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InKnowVision June 2012 HNW Technical Webinar 1 - Valuation Planning
 

InKnowVision June 2012 HNW Technical Webinar 1 - Valuation Planning

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InKnowVision June 2012 HNW Technical Webinar 1 - Valuation Planning InKnowVision June 2012 HNW Technical Webinar 1 - Valuation Planning Presentation Transcript

  • InKnowVision’s Monthly HNW Webinar Series Technical Webinar ©2012. InKnowVision LLC. All rights reserved. www.inknowvision.com
  • HIGH NET WORTH TECHNICAL EDUCATION Future Webinars On Vacation In July LinkedIn Email @ InKnowVision(630) 596-5090 www.InKnowVision.com All Content Copyright ©2012 InKnowVision, LLC InKnowVision TheC omplexEstate
  • InKnowVisionInstitute InKnowVision Institute Program “ What I like most about this program is not the typical stuff I get elsewhere.” Attendee 2 Days – Case Study/Technical/ Marketing/More October 25th and 26th – Chicago www.InKnowVision.com All Content Copyright ©2012
  • InKnowVisionInstitute $2500 if registered by July 20th Special Bonus $3000 – July 21st to August 14th Subject to availability $3500 – August 15 and after Subject to availability kim@ikvllc.com for registration form www.InKnowVision.com All Content Copyright ©2012
  • InKnowVision HNW Technical Webinar June 20, 2012“Valuation and Its Impact on the Succession Planning Process” presented by Mary Warmus, CPA, MBA, ASA Kensington Financial Consultants, Inc. 311 South Wacker Drive, #4950 Chicago, IL 60606 TEL (312)263-3874 mwarmus@kensingtonconsultants.com Kensington Financial Consultants, Inc. 7 Copryright 2012
  • Topics Covered in this Presentation:• Why valuations are necessary in effecting tax and other succession strategies• How the valuation expert fits in as part of the "Succession Team”• How valuations are used in long range strategic tax and business planning purposes and the importance of understanding the objectives of the client and his advisors• Overview of valuation methodologies• How the premise of value changes for different uses• Discussion of discounts for lack of marketability and minority interest• IRS tax case law and its impact on valuation• Case study discussing the difference between fair market value and investment value Kensington Financial Consultants, Inc. Copryright 2012 8
  • What’s the RushIn 2012 individuals can gift, or give away, asmuch as $5.12 million and pay no federal gifttaxes on the gifts, although this amount isreduced by the amount of any taxable giftsmade in prior years.In the absence of a Congressional change inthe law, however, the gift tax exemption will bereduced to $1 million on January 1, 2013.The result: many advisors are working withclients to race to the year end finish line. Kensington Financial Consultants, Inc. Copyright 2012 9
  • Other Compelling Factors• Low Marginal Estate and Gift Tax Rate – 35%• Low Applicable Federal Rates- the June 2012 long-term AFR (annual basis) is 2.60%.• The economic impact on the capital markets has depressed the value of taxpayers portfolios. Assuming capital recovery is on its way, gifting at the low point in the market is advantageous because future appreciation won’t be reflected in the taxpayers own portfolio.• Valuation Discounts – Revenue Ruling 93-12 acknowledged that stock interest transfers among family members, who in the aggregate own a controlling interest in the company, would not be valued as controlling interests solely due to the family relationship among the shareholders. This opened the door for FLP/LLC planning. Since that time the IRS has tried to slam the door shut with a string of tax court cases that have attacked the level of discounts taken, issues on formation, death bed transfers, and the lack of business purpose. It is critical that a business purpose be established for such structures. Kensington Financial Consultants, Inc. 10 Copryright 2012
  • AICPA urges Congress to act now on estate taxes The AICPA is calling on Congress to act quickly to pass new estate-tax legislation. "The uncertainty of the tax law impedes proper estate planning for taxpayers," the AICPA wrote in a letter to lawmakers. Moreover, "the necessity to revise estate-planning documents multiple times places an undue burden on taxpayers and their advisers.“ 6-19-2012 Kensington Financial Consultants, Inc. 11 Copryright 2012
  • The Succession TeamThe estate planning (succession) team has one or more of thefollowing professionals:Estate Planning Attorney/CPA/Financial Planners – • To propose and affect the proper tax vehicles that will maximize taxpayer benefits with respect to intergenerational transfers and succession planning strategies.Valuation Consultant – • To establish the value of a closely held business interests for sale, gift and estate tax purposes. • To determine the level of minority and marketability discounts relating to non-control transactions in closely held stock and/or securities.Insurance Agent – • To provide insurance products that will create liquidity in estate tax situations.Banker – • To provide loans to finance acquisitions or recapitalizations. Kensington Financial Consultants, Inc. 12 Copryright 2012
  • From the valuation standpoint:The valuation expert, as a member of thetransactional team must understand:1. The objective of the planning.2. The goals of the client.3. The risk tolerance of the parties involved.4. Have a clear understanding of the facts and circumstances of the case. Kensington Financial Consultants, Inc. 13 Copryright 2012
  • The Benefits of Proper Planning:“Always look out for Number 1 and be careful not to step in Number 2!” Kensington Financial Consultants, Inc. 14 Copryright 2012
  • The Four Most Important Objectives ofEstate Planning for Owners of Closely Held Businesses Include:1. Providing for sufficient liquidity for the estate to pay taxes and expenses2. Minimizing federal gift and estate taxes and state inheritance taxes3. Providing for the continuity of the business and thus avoid the unplanned, forced sale of the business or business interest4. Providing a way to allow the ownership of the business to end up in the hands of the appropriate heirs, while treating each beneficiary in a manner the owner desires (which may not always be viewed as “fair” treatment by each beneficiary) Kensington Financial Consultants, Inc. 15 Copryright 2012
  • What type of transactions require valuation?• Putting a price tag on any closely held entity for sale, succession, acquisition or merger• To price fractional interests in corporations, partnerships, Family Limited Partnerships (FLP) and Limited Liability Companies (LLC)• To convert from an S Corp from a C Corp (BIG Tax)• To set up a Grantor Retained Annuity Trusts (GRAT) or Intentionally Defective Grantor Trust (IDGT)• To sell a business to an Employee Stock Ownership Plan (ESOP)• To establish an arms length price for a related party sale• To create a Buy-Sell Agreement• To determine exchange ratios in a partnership or joint venture transaction• To establish the value of a marital estate for marital dissolution (divorce) purposes• To establish Damages in legal proceedings• To establish long range strategic planning benchmarks• Charitable Giving• ETC…. Kensington Financial Consultants, Inc. 16 Copryright 2012
  • Valuation OverviewYou must work with client/attorney to arrive at adefinition of value appropriate to the specific purpose ofthe engagement:• Fair Market Value (for all IRS/State & Ad Valorem Matters – discounts for lack of marketability and control are considered)• Market Value (Real Estate)• Fair Value (Minority Shareholder Oppression Suits – no discounts)• Investment Value (Control or Synergy Value- Acquisition Targets and/or Break-up Value)• Collateral Value (Insurance)• Ad Valorem Value (Property Taxes)• Other Standards of Value (Contractually Defined) Kensington Financial Consultants, Inc. 17 Copryright 2012
  • Why it is important for the TEAM to understand the Valuation Process• Set expectations• Get the client organized• Facilitate the data exchange flow• Be able to digest conclusions and their impact on the estate/gift tax planning strategy• Consider alternative strategies Kensington Financial Consultants, Inc. 18 Copryright 2012
  • Fair Market ValueThe price at which the property wouldchange hands between a willing buyer andwilling seller, neither being under anycompulsion to buy or sell, and both havingreasonable knowledge of the relevant facts.(Treas. Reg. 25.2512-1)IRC Revenue Ruling 59-60 serves as a guidelinefor business valuations for gift and estate taxpurposes and holds that the following factors,among others should be considered asinfluencing the value of a business or an equityinterest. Kensington Financial Consultants, Inc. 19 Copryright 2012
  • Revenue Ruling 59-60 (8 Factors)• The nature and history of the business enterprise;• The economic outlook in general and the condition and outlook of the specific industry of the business in particular;• The financial condition of the business and the book value of the business;• The earnings capacity of the business;• The dividend or cash flow generating capacity of the business;• Intangible values such as goodwill, patents, etc.;• Prior sales of stock and the relative size of the ownership interest to be appraised; and,• The market price of companies engaged in the same or similar lines of business having their stocks actively traded in a free and open market. Kensington Financial Consultants, Inc. 20 Copryright 2012
  • Premise of ValueFour alternative premises of value:1. Value as a going concern2. Value as an assemblage of assets : value in place3. Value as an orderly disposition: value in exchange, on a piecemeal basis premise contemplates that all of the assets of the business enterprise will be sold individually, and that they will enjoy normal exposure to their appropriate secondary market4. Value as a forced liquidation: value in exchange, on a piecemeal basis as part of a forced liquidation; this premise contemplates that the assets of the business enterprise will be sold individually and that they will experience less than normal exposure to their appropriate secondary market.Does this matter if the subject interest is a control vs. a minority interest position??? Kensington Financial Consultants, Inc. 21 Copryright 2012
  • Typical Data Request for a Valuation– 5 years of historical financial statements– Interim balance sheets and statements of income and cash flow as of the date of valuation– Segment financial information for separate business operations– Projections of income, cash flow, and capital expenses– Estimate of market share per country/marketing penetration– List of competitors/chief suppliers and customers– Supply/demand & pricing of products, including usage trends– Product brochures/Company catalogs and price lists.– Comprehensive fixed asset schedule including depreciation schedules for the next five years– Copies of real estate and equipment leases– If real estate is leased, is lessor an unrelated third party?– Are non-operating assets in the business such as land held for investment or an equity portfolio? Gain/Loss?– Condition of rolling stock?– Environmental concerns?– Request copies of fixed asset appraisals– Legal documents relative with impending litigation– Lawyer/Accountant name and contact number– Are there any buy sell agreements in place?– Other pertinent information required for analysis. Kensington Financial Consultants, Inc. 22 Copryright 2012
  • Valuation Approaches1. COST APPROACH - Value Indication of a business’s assets or equity interest using one or more methods based directly upon the value of the assets of the business less liabilities. In general, this approach is utilized for control transactions or in asset holding company scenarios.2. INCOME APPROACH - Based on the theory that the value of a business is equal to the present value of a company’s expected future benefits. These benefits are generally characterized as: cash flow, net income or dividends. Companies with strong, sustainable and growing cash flows yield higher values. Conversion of these benefits may be accomplished by either direct capitalization (single period model), or discounting (multi-period model).  A capitalized return method is most appropriate when a companys current operations are indicative of future operations, assuming a normal, stabilized growth rate.  Alternatively, a discounted future returns method tends to be more appropriate when future returns can be estimated with reasonable accuracy, but are expected to be substantially different from current operations.3. MARKET APPROACH - Estimates the value of a business based on prices obtained in market transactions of similar businesses or business interests. Two methods can be applied: – The Guideline Public Company Method, and – The Market Transaction Method Kensington Financial Consultants, Inc. 23 Copryright 2012
  • Valuation Approaches - continued3. MARKET APPROACH – Guideline Publicly Traded Company MethodInvestment ratios are applied to various income flows (Sales, EBIT, EBITDA, NI)and are adjusted for differences in capital structure, leverage, and assetownership between comparable companies and the subject company.In private market conditions, the dynamics of the market must be evaluated todetermine its adequacy in establishing a fair market value for the stock. Underthis method, the value of a company is determined by comparing the subjectcompany to similar Guideline Company (“G/L”) companies whose stocks areactively traded in a public market. Guideline companies are evaluated in lightof the subject company’s merits that include size, service capability, marketpenetration and target market. The value indication from that application fromthis approach is a freely traded one or a minority, marketable basis.MARKET APPROACH– The Market Transaction Method - ascertains the valuefor the subject company by identifying similar companies that have been sold inprivate transactions. It should be noted that the transaction multiplesobtained from sources such as Pratt Stats (http://www.bvmarketdata.com/Business ValuationsResources, Inc.) typically yield a control marketable transaction value. Thusdiscounts for lack of marketability and control would have to be applied todetermine the fair market value of a minority, closely held business interest. Kensington Financial Consultants, Inc. 24 Copryright 2012
  • Discounts for Lack of Control and MarketabilityUnlike the shares of the public companies that are freely traded on registeredexchanges or over-the-counter, these companies’ shares enjoy no suchprivilege. All else being equal, an interest in a business enterprise that isreadily marketable is worth more than one that is not because investors preferliquidity to lack of liquidity.Minority Interest DiscountControl Premiums are observed in the market by the value paid for publiccompanies in excess of their publicly traded stock price. The per share price ofa public company represents the minority value of a single share of stock, sowhen a company is acquired in a merger or acquisition the price paid over thequoted stock price represents the control premium. There are several studiesthat observe and record these premiums, and these studies can be used as aguide for determining the control premium to apply to a marketable minorityvalue determined by using the guideline public company method. When theincome approach is used in the discounted cash flow method the result is acontrol level value. This is also true when the cost or adjusted book valuemethod is applied. Therefore, in both of the preceding cases, discounts for bothlack of control and marketability must be applied. Kensington Financial Consultants, Inc. 25 Copryright 2012
  • Minority Discounts – Referenced Sources:1. Mergerstat DataThese transactions have been the subject of study in the Mergerstat Review.This data source reflects transactions occurring in 2011 in its 2012 edition.The current study reports the average control premium paid over the past 10years (2002-2011) approximates 31%. In order to calculate the minoritydiscount from the control premium (CP), the following formula is applied:Minority Discount = CP/(1 + CP).2. Closed-end mutual funds discounts to net asset value (“NAV”)Closed-end funds (investment companies which sell a limited number ofshares) generally do not buy their shares back from investors who wish tocash in their holdings. Instead, publicly traded shares of closed-end fundstrade on stock exchanges. The publicly traded price of closed-end funds canbe compared to the per share net asset value of their portfolios to determinethe discount (or premium) at which the funds are trading.3. Limited Partnership Studies: Partnership ProfilesAverage discounts (2000-2011) from Net Asset Value for distributingpartnerships with little or no debt was 19%, as compared to non-distributingpartnerships which had a discount to NAV of 37%. Kensington Financial Consultants, Inc. 26 Copryright 2012Mergerstat Review 2012, pg. 25 FactSet Mergerstat LLC
  • Minority Discounts – Referenced Sources:3. Limited Partnership Studies: Partnership Profiles - continuedThe Partnership Profiles, Inc. study notes that secondary market player’sreport that heavy price adjustments in the secondary market flow from thefollowing factors:1. The secondary market is relatively inactive with a limited number of buyers to support prices;2. Information on privately held limited partnerships is generally limited and difficult to obtain, which adds to the difficulty and risk of valuing limited partner Interest;3. Only general partners have the ability to control the disposition of assets and can continue to operate their partnerships well beyond their originally anticipated holding period;4. Historical roll-ups, restructurings and reorganizations of limited partnerships have had a detrimental effect on the value of limited partnership interests; and5. The fact that limited partnerships with positive earnings but no cash distributions can create a tax liability for limited partners without providing liquidity. Kensington Financial Consultants, Inc. 27 Copryright 2012
  • Marketability DiscountsThe adjustment for lack of liquidity reflects the marketabilitydifferences between closely held securities, such as the MemberInterest in a Limited Liability Company or LP interest or closely heldinvestment interest, and that of publicly traded securities. An ownerof publicly traded securities can know at all times the market value ofhis or her holding. The owner can sell that holding on virtually amoments notice and receive cash net of brokerage fees within threeworking days. Because closely held securities lack the inherentliquidity of traded securities and are less attractive for investmentpurposes, it is an accepted valuation practice to adjust the value toreflect this disparity.In determining the appropriate adjustments to apply to the subjectLLC Member Interest or LP or closely held investment interest,empirical evidence of observed adjustments in transactions involvingshares of publicly traded companies that are restricted from beingfreely traded in the markets were analyzed. Kensington Financial Consultants, Inc. 28 Copryright 2012
  • Marketability Discounts: Reference to Restricted Stock Studies Study *2 Years Covered in Study Number of Transactions Avg. Discount [a]SEC Institutional Investor [b] 1966-1969 398 25.8% Milton Gelman [c] 1968-1970 89 33.0% Robert E. Trout [d] 1968-1972 60 33.5% Robert E Moroney [e] 1969-1972 146 35.6% J. Michael Maher [f] 1969-1973 33 35.4% Standard Research 1978-1982 28 45.0% Consultants [g] Willamette Management 1981-1984 33 31.2% Associates [h] William L. Silber [i] 1981-1988 69 33.8% Management Planning [j] 1980-1996 49 27.1% FMV Opinions [k] 1980-1997 243 22.1% Bruce A. Johnson [l] 1991-1995 72 20.2%Columbia Financial Advisors 1997-1998 23 21.0% [m] Kensington Financial Consultants, Inc. 29 Copryright 2012
  • Marketability DiscountsFACT: Closely held equity interests, such as aminority Member Interest in an LLC generally hasno imminent prospect for marketability and istherefore, inherently less liquid. This wouldindicate that adjustments should be higher for aclosely held security that has no foreseeableprospect for marketability, all other things beingequal.Note: many of the private placements of restrictedstock mentioned provided registration rights givingthe purchasers the right to have their sharesregistered for public sale within a short period oftime after the sale. This effectively reduces the timefor stock to become freely traded, thus reducing theadjustment. Kensington Financial Consultants, Inc. 30 Copryright 2012
  • . VALUATION CONCLUSIONS MUST BE REASONABLE AND DEFENSIBLE!They must be able to sustain the scrutiny of the IRS agent who is reviewing the transaction and the Tax Court. This is a major contributing factor to bad case law! Kensington Financial Consultants, Inc. 31 Copryright 2012
  • Important Tax Cases and theirimpact on Business Valuations today• Is it appropriate to tax affect S Corporation earnings?• Can I consider the Built-in-Gains (BIG )tax when valuing a minority shareholder interest?• Are all death bed transfers disallowed?• Is it appropriate to cite case law in your report?• Is it appropriate to apply blanket discounts to assets like cash, marketable securities and real estate that are part of the underlying assets of a FLP? Kensington Financial Consultants, Inc. 32 Copryright 2012
  • 715 Enterprise DriveO ak Brook, IL 60523 Thank You!(630) 596-5090www.InKnowV ision.com Mary Warmus, CPA, MBA, ASA Kensington Financial Consultants, Inc. 311 South Wacker Drive, #4950 Chicago, IL 60606Info@ ikvllc.com TEL (312)263-3874 mwarmus@kensingtonconsultants.com @ InKnowVision InKnowVision, LLC InKnowVision TheComplexEstate All Content Copyright ©20112