The Challenges of Valuing Family Limited Partnership Interests
By: Steven J. Siefert, CFA, ASA, Senior Associate – Business Valuation, AccuVal Associates, Inc.
FLPs are popular as an effective way to transfer wealth between family members. These partnerships are established with two forms of partners: General and Limited. General Partners are responsible for managing the FLP and have significant influence over operations, such as buying and selling assets. The General Partners also help determine the size and timing of distributions. Limited Partners have no control over operations, which means they hold significantly less influence in Family Limited Partnerships.
Why do Limited Partnership interests need to be valued?
Limited Partnership interests, like other securities, must be valued for gift and estate tax purposes. The valuation date for Limited Partnership interests is the gifting date, for gift taxes, and the date of death, or the six month alternative date, for estate taxes.
How are Limited Partnership interests valued?
Valuing Limited Partnership interests in FLPs is very different from valuing privately held company stock. The asset mix of FLPs may be composed of several types of asset classes including marketable securities, real estate, private debt instruments, and equity interests in private companies.
Appraisers consider three commonly used methods to value.
- Market Approach: This method is based on the principle of substitution and compares the subject asset to sales of similar assets.
- Income Approach: Based on the principle of utility, this approach discounts the future economic benefits of the subject asset at a rate commensurate with the risk of the subject asset.
- Asset Approach: This method considers the principal of replication and quantifies the amount of money necessary to reproduce the benefits of the subject asset.
To come to the fair market value of the equity of the FLP, the adjusted balance sheet method is most commonly used. The underlying assets and liabilities owned by the FLP are adjusted to estimated fair market values.
Even if the assets held by FLPs are marketable, Limited Partnership interests themselves generally lack a marketplace. This lack of control and marketability of Limited Partnership interests leads to largely discounted values of Limited Partnership interests relative to the net asset value of FLPs. This is why, after determining the net asset value of the FLP, discounts for lack of control and marketability are applied to this value to arrive at the fair market value of the Limited Partnership interest.
Evidence of discounts for lack of control for Limited Partnership interests generally comes from three sources: FactSet Mergerstat control premium studies, closed-end fund studies and real estate discount studies. The applicability of these studies depends primarily on the assets held by the FLP. Evidence of discounts for lack of marketability often comes from restricted stock studies, pre-IPO studies and quantitative studies.
What are common challenges in valuing Limited Partnership interests?
In general, the biggest challenges in this area come from selecting discounts for lack of control and marketability. Some common items to review when selecting these discounts are:
- Asset mix of the FLP
- Volatility of its underlying assets
- Term of the FLP
- Historical distributions and expected distributions
- Restrictions on transferring Limited Partnership interests, such as rights of first refusal
If the primary asset of the FLP is privately held company stock, appraisers must be careful not to double count the effect of lack of control and marketability.
Summary
Limited Partnership interests need to be valued for gift and estate tax purposes like other assets need to be. Attorneys should hire qualified, experienced appraisers who deal in the area of Limited Partnership interests. AccuVal's appraisers have valued dozens of Limited Partnership interests that are subject to IRS scrutiny and carry a range of industry experience to help make the process more seamless.
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