175: The Valuation Puzzle: What Your Assets Are Really Worth: Part 2

In this episode of Absolute Trust Talk, host Kirsten Howe continues her valuation discussion with expert Alex Spaete from Bridge Forensic CPAs, exploring the intricacies of asset valuation. The discussion focuses on how privately held assets are valued, particularly examining discount factors applied to LLC interests based on control limitations and marketability constraints. Alex explains how family dynamics influence valuations, especially when implicit control exists despite limited ownership percentages. The conversation covers valuation approaches for unusual assets like promissory notes and accounts receivable, with Alex sharing real-world examples, including commercial rag manufacturing and Weather Derivatives. This show highlights why professional valuation expertise is essential when dealing with complex assets during estate planning, business transitions, or divorce settlements.

Time-stamped Show Notes:

0:00 Introduction

2:48 Diving back into the discussion, Alex breaks down the two main components of discounts: control factors and liquidity considerations that affect final valuations.

4:10 Here, we explore how operating agreements significantly impact valuation and what control considerations you should be aware of.

4:49 Gain insights on the fascinating impact of family dynamics on valuations, mainly how they come into play in divorce scenarios.

8:17 Find out whether the IRS requires taking discounts when available and the tax implications of valuation choices.

11:06 Alex explains the complexities of valuing promissory notes and how changing interest rates can dramatically affect their worth.

12:27 Before signing off, you must hear more about Alex’s most interesting case studies, including an unusual rag-making business and complex weather derivatives.

Get in touch with Alex!
Alex Spaete, Partner
Bridge Forensic CPA’s
(925) 203-5014
Alex@bridgeforensics.com
https://bridgeforensic.com/

Transcript:

Hello and welcome to Absolute Trust Talk. I am Kirsten Howe. Today, I’m here with a guest in our video podcast at Absolute Trust Counsel, and we’re going to be talking about valuations. Let me explain that a little bit. In my business, we spend a lot of time focused on our clients’ assets. That’s the nature of what we do as estate planners and administrators. The two most important questions that we have about any given asset when we’re working with our clients is, number one, who owns it? Number two, what is it worth?

Our regular podcast audience knows that we frequently discuss ownership and titling issues. We consistently emphasize the importance of owning your assets in a trust and the consequences of failing to do so. Fortunately for you today, we won’t focus on ownership and titling. Instead, we’ll explore the more enjoyable and intriguing aspect, which is valuation.

And to help us with that conversation is my colleague, Alex Beatty. Alex is a valuation expert. He’s a partner with Bridge Forensic CPAs, LLP, here in Walnut Creek. Alex has extensive experience in business valuation, family law forensics, private industry experience in healthcare and physician compensation, and we’ll talk a little bit about some of those things. He is a CPA. He’s accredited in business valuation and a Certified Information Technology Professional, which is a nice bonus that his firm gets by having him working there. He’s not just a numbers guy; he can handle the IT.

Alex has qualified and testified and been appointed as a court’s expert in pretty much all of the courts in the San Francisco Bay Area and Sacramento area. He’s worked on thousands of litigation matters. He works primarily in the family law area, but we work with him in estate planning as well. He’s commonly asked to perform post-separation accountings, analysis of real property interests, and we’ll talk quite a bit about that, equity compensation, just all the kinds of property issues and income issues, all of that stuff that happens in a divorce. He also works in what we call business divorces because a lot of those same issues come up. Alex, welcome. I’m so happy to have you here.

Yes, thank you so much for having me. A pleasure to be here today.

We aim to evaluate and compare this to other larger, publicly traded real estate holding partnerships and similar entities. We are examining comparable partnerships and conducting extensive market studies related to these issues in order to quantify the situation and understand how it pertains to the specific entity. I’ve observed that much of the core aspects tie back to the underlying LLC agreement, as that’s where the essence of control—what you can and cannot do—is defined. Some LLCs require a supermajority for any action, meaning that if you hold a 5% interest, your influence is quite limited. However, in certain scenarios, you may hold more power; for instance, if the other ownership stakes are around 30%, your 5% could be crucial, making you a potential tipping point. Thus, we must evaluate how the structure looks, understand the relative positions of each participant, and determine the requirements needed to sell, transact, or implement any changes. All of these factors are critical for us to consider as we assess the relative discounts.

Yeah, and one of the things that you and I talked about when we were preparing this episode—and yes, we do prepare—is maybe the dynamic among the owners might factor into it. A lot of times, this is a family situation, and maybe the parents set it up. Now, the children have become owners, and maybe the children own 49%. But they’re never going to vote contrary to their parents; you know, they’re always going to just be in lockstep.

It’s interesting how this can come into play. Certainly, we examine the relationship’s interplay, especially when considering the valuation in the context of all these other assets. For example, Dad might only have 10% ownership, while the two kids hold the remaining 90%. However, Dad may still influence all these other assets. I often see this scenario arise in divorce situations. If Dad is getting divorced and claims, “I only own 10% of this, and I can’t really control whether this distributes money to me,” he also has influence over the two kids, who are the controlling party. But is that truly control? Is it more of an implicit control?

There can be quasi-control narratives that are relevant for evaluation under gift and estate tax. The more explicit they become, the easier they are to quantify. This is particularly evident in litigated areas of dispute, where these issues become much more salient. We must address these potential concerns with attorneys and similar professionals. Untangling these closely-knit relationships can be quite complicated.

Yeah, you brought up an interesting point. Maybe Dad is only a 10% owner, and you could outvote him. You have the votes. You could override him, but Dad has 15 million other assets that, if he dies someday, you’re going to get if you’re a good boy. There’s all of that, all of the family dynamic.

Those are also implicit versus explicit control. And I guess sometimes, in the context of the valuation, we have to be a little bounded by having to look somewhat siloed. We’re looking at this entity, this 10% interest. Sometimes, it’s specific to this specific member interest. Sometimes, it’s more of a broader hypothetical 10% interest. It depends on the valuation structure, on whether we dive in, and on how far into that pool we dive.

But when I’m dealing with another state or a family dispute, it becomes extremely relevant due to the potential distributions that this LLC might provide. Surprisingly, those distributions often stop as soon as a dissolution is filed. It can get really complicated in their other contexts, especially in the estate world, where we’re not just valuing one interest. We have this LLC, but we’re also valuing LLCs A, B, C, and D, and the interplay of control between those entities can be crucial.

Right? Okay, I was going to ask you something I had been thinking about earlier today. Then you said something that made me think, oh, I should just ask that because I’ve never understood it. When we have these privately held entities with multiple owners and an operating agreement that could lead to discounts being taken, we want to pursue that if it benefits us. Usually, that’s related to tax matters, or in a divorce, which is a whole different issue. But does the IRS require us to take discounts when they’re available? Or can we just say, “Nope, it’s worth this much.”

I understand that the IRS does not require you to take them. If you prefer the prorated approach—pro rata, you know—you’re generally free and clear to do that. However, if you want to take the discounts, you need to provide the necessary backup and research specific to your subject and choice, which is really where we come in.

I find that if someone is on the cusp of the ever-changing estate tax and their business or interest isn’t really going to make a significant impact, then it’s probably not necessary for them to substantiate it to the point where we need to get involved. Almost always, when we discuss family real estate partnerships, there are times when it isn’t a real estate partnership, but rather an operating entity. For example, the family business might be a manufacturing company, making it challenging to just arrive at a number. A valuation is required, and because of that, we’ll also incorporate discounts and similar considerations.

Yeah, that’s an interesting point. If we have the option of not taking discounts, we’re kind of balancing the capital gains tax down the road. We could take the discount, but then we might be shooting ourselves in the foot if we ever sell this thing. That’s something I hadn’t really thought about, so we need your help to value this entity. It’s more than just a piece of real estate, right?

Some of it can be very simple, and you can almost get through without needing to go. I was telling my team when they said, “Oh, man, this whole thing is really complicated,” and I replied, “I know, that’s why we’re involved. If it were simple, we wouldn’t be here.”

There wouldn’t be this entire industry of valuation. Yeah, that’s why I wanted to have you on. I think a lot of people don’t really realize how complicated this stuff is and that I’m not trying to discourage anyone from setting up an LLC if that’s the right choice for them. Do it. There’s a lot of value in it, but you just need to understand that on the backside, you might have to do something like that.

And there are other, what I’ll call unusual assets—though they’re not truly weird—assets that people probably don’t consider much, which require valuation. These values aren’t ones you can simply glance at on a piece of paper and say, “Yeah, I know what that’s worth.” For instance, one of the things we’ve hired you to value is a promissory note. People often overlook that. If someone owes you money and has signed a promissory note, what is its value on any particular day?

And it can change based on its interest rates. It can have a significant impact on those assets. Ultimately, it really depends on what you mentioned. Because typically, we are both concerned about its worth. Not necessarily in a general investment sense, but rather, at this estate date or as an alternative, what is the worth of the alternate valuation date, if elected, at that specific moment? That’s truly the only date that matters. However, it is relevant because there can be impairment of that loan. The interest rate environment could have completely shifted regarding the loan, and it might not be worth as much as you thought when you initially made the loan.

Yeah, yeah. Other things like accounts receivable are assets, and that’s something you would also help value. It’s more than just saying how much money is owed to me; for instance, some money has been owed to me for a year and a half, while other amounts are just 30 days out. You know, there’s a whole art to it, and that’s also something you do for our clients.

Alex, we’re getting to the end. But before I let you go, maybe you could talk about the most unusual, challenging, weird, interesting asset or valuation situation you’ve been in without naming any names.

Of course. Two examples come to mind. One, because it stands out to me as something so basic, is a company that literally made rags. That’s what they did—they took tons of scraps of cloth and turned them into rags. It struck me because it’s like, that’s a business. How could I overlook this? They produce these big commercial blocks of rags that they distribute to auto mechanics, cleaning companies, and all kinds of places that need bulk rags.

That’s steady supplies, yeah, right.

And just one of those fascinating little things to me, that you just wouldn’t, you just shocked that you’re like, of course, someone makes that, but it just didn’t occur to me.

The other really strange one is that I had a company which dealt a lot with hedge funds and similar investments. They focused on alternative investments, and one area they were deeply involved in was Weather Derivatives, which I found to be a truly fascinating industry. Essentially, their strategy revolved around an insurance product that involved trading in Weather Derivatives. If a storm occurred on a certain day, there would be a payout, and so on. It’s a really intriguing model. I find the entire concept of converting various aspects into derivatives quite captivating, and the idea of turning weather into one is particularly interesting.

That’s interesting. There are so many legal ways to gamble on things that the average person would never dream of; and yet, there you go, Weather Derivatives. If you want to gamble on the weather, there’s a market for that.

Yeah, you know, are we gambling? Or is this, you know, more like a protective hedge? It’s a hedge, a really big event. And if it rains, that would crush me because of, you know, X, Y, and Z. But, you know, it’s a fascinating idea of how they’re modeling that and trying to predict the weather, which I thought was interesting.

Wow, yeah, that’s a very interesting and unusual asset.

Did it make you want to run out and purchase Weather Derivatives?

I think I’m going to avoid this. But whenever I’m looking at an insurance option for travel or something like that, it always reminds me of that, like someone is out there. That’s why I’m probably paying way too much to insure this trip or something like that. Fascinating.

Well, thank you so much, Alex. I really learned a lot talking to you, and I’m sure my audience did as well. My guest today has been Alex Spady with Bridge Forensics CPAs, LLP. I hope you all learned a lot, and I hope you’ll join us next time. I look forward to connecting with you then. Thanks so much for having me.

Resources Related to This Episode:

[AD] Estate planning addresses many vital factors about your future and legacy. Where do you get started if you don’t have an estate plan? If you do, how have new laws and life transitions changed? Will your plan still protect you? Regardless, you deserve control over your wants, needs, goals, and hopes for the future. We can help you understand your options and, legally, how you will best be protected at all touchpoints. Get started today by scheduling a free discovery call so we can discuss your needs. Visit https://absolutetrustcounsel.com/scheduling/ or call us at (925) 943-2740.

Asset ValuationBusiness PartnershipsDivorce PlanningEstate AdministrationFamily-Owned BusinessLLC ValuationPodcastsPrivate CompaniesReal Estate HoldingsTax ConsiderationsValuation Discounts
Kirsten Howe:
Related Post
  1. 174: Part 1: The Valuation Puzzle: What Your Assets Are Really Worth
  2. 5 Ways You Can Fill Out a Beneficiary Designation Form (and Who You Can Nominate!)
whatsapp
line