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Valuation of Family Limited Partnership


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Valuation of Family Limited Partnership

  1. 1. Family Limited PartnershipsByKaran ShahMatt SmithYohei Matsumura
  2. 2. FLP Defined“A type of partnership designed to centralize familybusiness or investment accounts. FLPs pool togethera familys assets into one single family-ownedbusiness partnership that family members ownshares of. FLPs are frequently used as an estate taxminimization strategy, as shares in the FLP can betransferred between generations, at lower taxationrates than would be applied to the partnershipsholdings.”
  3. 3. FLP Explained Continued…“An FLP is different from a conventional trust, as familymembers actually own a share in a business. Shares canbe gifted to family members over years, thus takingadvantage of gift tax exemptions on an annual basis. Theassets held in an FLP impact the level of estate tax savingsthat can be realized by using an FLP. In general, the moreilliquid and complex the asset mix, the more difficult theFLP is to evaluate, and the larger the potential for estatetax savings.”
  4. 4. How it works?
  5. 5. How it works continued…1. Parents legally form FLP. Business and assets transferred to FLP.2. FLP issue GP and LP interests to parents3. Parents retain GP interests but gift LP interests to children onregular basis Value of gift may include discount for lack of marketability andminority interest4. FLP purchases life insurance on both parents. FLP is owner ofthe plan5. Upon death of parent the insurance proceeds are paid to FLP
  6. 6. When should one use an FLP? Want to transfer business to next gen without giving upcontrol immediately Need to shift income to another family member in lowerincome tax bracket Need to make it difficult for creditors to seize assets Want to protect assets transferred to children as a resultof a divorce
  7. 7. Important Points General Partners have unlimited personal liability forpartnership debts FLP must be formed for a valid operating business FLPs may own marketable securities, real estate,corporations, and insurance policies Each asset in the partnership should be valuedseparately
  8. 8. Primarily Marketable Securities Pro rate NAV Non voting shareholder Discount Decision making ability Marketability Closed end funds Discount Expenses to capital gain tax Performance
  9. 9. Important Consideration Professionally managed Stringent Regulations by SEC Diversification Investment objective Quality – Speculative vs Investment grade
  10. 10. FLP That own Primarily Real Estate Valuation Important Factor – cash flow Discount Lack of Control Lack of Marketability
  11. 11. Secondary Market 1980 - Secondary market for limited partnerships developed Three different types of participants Market Makers – over the counter dealers Exchanges Buyers and sellers Early years – limited information Bi-monthly publication – Partnership Spectrum Analysts able to calculate various valuation pricingparameters
  12. 12. Secondary Market Continued Secondary market serves as a reference pointfor the valuation of privately owned FLP’sSimilar to:Publicly traded common stock market –privately owned companiesMost of price-to-value discount in secondarymarket is due to lack of control
  13. 13. PricingEquityPartnershipDistributingNon-Distributing
  14. 14. Lack of Marketability Empirical analysis The liquidity and volatility Income potential and distribution policy Management Term of partnership agreement Quantitative analysis Primary Methodology Corroborative methodology
  15. 15.  Quantitative Marketability Discount Model (QMDM) Assumed growth rate Assumed income generation of the FLP’s assets Expected duration or holding period
  16. 16. The Needs of FLP(Agreement) 1Family businesses have longevity About 40% of U.S. family businesses turn into second-generationbusinesses, approximately 13% are passed down successfully to athird generation, and 3% to a forth or beyond. Due to the events: bankrupt, retirement, death, divorce etc. The average life span of a family business is 24 years.
  17. 17. Family business have issues about their sustainability 76% of small business owners did not have asuccession plan in place. 31% did not have any mechanism in place toresolve the dispute. Needs of FLP(Agreement) 2
  18. 18. The Role of FLP (Agreement)A family business agreement can Mitigate against the likelihood of a major disputescausing irreparable damage to the business Ease tensions between family members Make the transition from one generationto the next more successful.
  19. 19. Purpose: Family Business ValuationAllocating the value of the family business fortax reporting and financial statement purposesProviding values of assets to bankers and forinsurance purposesProviding correct values of assets for real andpersonal property taxesEstate and retirement planning purposesBuying /Selling all, or a part, of the familybusinessSource:
  20. 20. FLP Document Checklist(Just being formed) The final agreement (the written document) Documentation of the assets Valuation of the assets Balance sheet Pro forma / income statement The general partner’s policies
  21. 21. FLP Document Checklist(Ongoing) The same information of just being formed Partnership income tax returns The history of distributions made to partners Information about any transfer of partnershipinterests
  22. 22. Interpreting the PartnershipAgreement 1 Business Purpose- Description of the valid business purpose Contributions- Capitalization of the partnership Management Prerogatives- Management responsibilities and authority Distributions to the Partners- Discretion of the general partner
  23. 23. Interpreting the PartnershipAgreement 2 Control and Lack of Control- The percentage ownership of the company , right to control Transferability of Family Limited Partnership Interests- A provision restricting transfer of an FLP interest Dissolution / Liquidation- Several events will cause the dissolution of the partnership(the designated term, death, bankruptcy etc.)