Challenges of Valuing Family Limited Partnership Interests

Article

Family Limited Partnerships (“FLPs”) are popular as an effective way to transfer wealth between family members, often without ceding control, if desired. FLPs also help protect family assets from creditors and litigation. They also can help manage and reduce taxes. This type of corporate structure is most commonly established with two forms of partners: General Partners (GPs) and Limited Partners (LPs). 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 input concerning operations, which means they hold significantly less influence or control in Family Limited Partnerships.

Why do Limited Partnership interests need to be valued?
FLP interests, like other securities, must be valued for estate and gift tax purposes. The valuation date for FLP interests is the gifting date, for gift taxes, and the date of death, or the six month alternative date, for estate taxes. Valuation of FLP interests might also be desired to support other transactions or transfers.  FLP interests might be useful in dispute resolution/litigation as well.

How are Limited Partnership interests valued?
Valuing General or Limited Partnership interests in FLPs is very different from valuing privately held company stock. The asset mix of FLPs may consist of several types of asset classes including marketable securities, real estate, private debt instruments, and equity interests in private companies.
Appraisers must consider the following three approaches 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 considers the future economic benefits of the subject asset and the risk or uncertainty of the future economic benefits.
  • Asset Approach: This method considers the principal of replication and quantifies the amount of money necessary to replace or reproduce the benefits of the subject asset.

To develop an opinion of the fair market value of an FLP’s equity, the adjusted balance sheet method is most commonly applied.  This approach involves stating the underlying assets and liabilities owned by the FLP at their estimated fair market values.  This, the adjusted balance sheet method involves appraising all of the assets and liabilities held by the FLP.

Even if the assets held by FLPs are marketable, General and Limited Partnership interests themselves generally lack a marketplace and Limited Partnership interests lack control. This lack of control and marketability of Limited Partnership interests leads to largely discounted values 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 arrive at the fair market value of the Limited Partnership interest and to some degree to General Partnership interests as well.

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, although there are other sources as well. 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, but here again there are many other potential sources

What are common challenges in valuing General and Limited Partnership interests?
In general, the biggest challenges in valuing General and Limited Partnership interests come from selecting discounts for lack of control and marketability. Some common items to review when selecting these FLP discounts include the following:

  • Asset mix
  • Volatility of underlying assets
  • Term
  • Historical distributions and expected distributions
  • Restrictions on transferring interests, such as rights of first refusal
  • Other terms and conditions in the FLP governing documents

If the primary asset of the FLP is privately held company stock in a company that was essentially the FLP principal operating subsidiary, appraisers must be careful not to double count the impact of lack of control and marketability.  However, appraisers should consider tiered discounts when they are appropriate.

Summary
Limited Partnership interests need to be valued for gift and estate tax purposes, transaction support, and litigation support. Attorneys should hire qualified, experienced appraisers with prior experience in the area of General and Limited Partnership interests. Gordon Brothers’ appraisers have valued many Family Limited Partnerships and the respective General and Limited  interests. Gordon Brothers’ work has been subject to IRS scrutiny, audit review and court approval.  Gordon Brothers is well versed in  asset classes and industries.