Highlights from the Panel Discussion on Making Gifts of Illiquid Assets

Sunday, May 03, 2015

On Friday, May 1, 2015, the California Community Foundation held a luncheon for advisors on Making Gifts of Illiquid Assets Work for Your Clients.  The panelists consisted of William Flumenbaum with Capital Group Private Client Services, David Newman with Mitchell Silberberg & Knupp, LLP and Melisa Silverman, President of Avenue M Advisors, Inc.

Below are some of the highlights on valuing illiquid assets from the panel discussion.

Question 1: Does it matter what the underlying illiquid asset is for the donation?

The type of asset that is being donated does matter.  In many instances it may be a partial interest in real estate or it may be a minority stock ownership interest in a company or a fund, or it may comprise intellectual property that is being donated, etc. 

If the asset consists of real estate or an interest in a fund (real estate, private equity, etc.) then in most instances we would be given the value of the underlying assets or would work to determine the value of the underlying assets.  The same is true with an interest in a business – where we would perform a valuation of the business to determine the enterprise asset value (or MVIC) of the business.  We would then determine if there is any discrete intangible asset value (IP) or non-discrete intangible asset value (goodwill) that is taken into consideration.  Once this is done, then in each type of valuation whether of real estate, a security interest in a fund, or a business interest, then a discount analysis is performed to determine what the discounted or FMV value of the interest is worth.

Question 2: Where do you start with a client who wants to make a donation of stock in a company or real estate, etc.?

For us, we start by providing a client with an Information Sheet that includes a list of documents we’ll need to review.  This list typically includes tax returns and financials going back at least 3 years, company or partnership agreements, real estate appraisal reports, private equity fund asset values, IP documents (such as patents, trademarks, copyrights, etc.).  There is also a list of questions about the asset being donated.  We need to know the date of the transfer – this is typically the Effective Date for the valuation.  We’ll need to know the intended users, the purpose and use of the valuation report.  We’ll also need to know what % interest or number of shares are being transferred.  And, there are a number of questions about the business or real estate or other type of asset that the client will provide.

Once we receive all of the information we’ll perform the valuation and provide a written report that meets USPAP (Uniform Standards of Professional Appraisal Practices) and NACVA (National Association of Certified Valuation Analysts) standards.  The report also meet the regulatory requirements of the IRS.

Once the valuation is completed and approved by the client, we will typically be provided with an IRS Form 8283 for us to sign.  Form 8283 is an IRS form for Donations of Property over $5,000.  By signing this form, we, as the appraiser, are certifying under penalty of perjury that we are not the donor, donee or a party to the transaction.  We are also certifying that we prepare valuations on a regular basis and that we have the qualifications to perform the valuation for the type of property that is being valued.  And, we may be subject to penalty for any false or fraudulent statements that we make in the valuation.

Question 3 – Ultimately, the reason for a transfer is very important for valuation purposes.  When there is a transfer of a minority interest, what role do discounts play and why?

When a gift or donation of a minority interest is made, the valuation in addition to valuing the underlying assets must consider discounts for lack of control and lack of marketability.  The reason for this is that we value the asset as if an investor were to acquire the asset and we have to view it from the perspective of what would a willing buyer pay for the asset from a willing seller.  In these situations, a willing buyer will never acquire a fractional or minority interest for full price.  They will want to receive a discounted value – FMV.

A discount for lack of control means that the minority owner does not have the right to make decisions for the company or the entity.  A discount for lack of marketability means that there is no available market for a person to easily and quickly sell the fractional or minority interest.  We perform an analysis using the corporate agreements and/or corporations code or partnership code to determine the applicable discounts that are applicable.  We will also utilize data from databases where applicable to provide support for the discounts taken.  And, we include court cases as support for the analysis that we perform that tells us what we, as analysts, are required to analyze as part of a discount analysis.  The flagship court case on discounts for tax purposes is Mandelbaum v. Commissioner.

Some of the discounts that might be considered include:

Lack of Control

  • Do the investors have the right to make management decisions?
  • Can investors call for the sale or dissolution of the business?
  • Are there conditional voting rights?
  • Are there contractual restrictions on distributions?
  • Is there a Buy Sell Agreement that gives an investor the right to purchase control?
  • Is there a Put Option that allows an investor to put their interest to the company?

Lack of Marketability

  • Is there a SH or Operating K with restrictions on an investors rights to transfer their interest or receive distributions?
  • Were distributions previously issued and are they contemplated in the future?
  • Are there restrictions on an investor’s right to transfer their interest to a third party?
  • Does the Company and/or other investors have a right of first refusal to purchase the interest?
  • Is the Company an S-Corporation with restrictions on investors to preserve the S-election?
  • Is the Company involved in serious adverse litigation?

These are some of the factors that we consider as part of a comprehensive discount analysis.  Once we’ve determined what the overall equity value is in the entity, then we will apply the cumulative discounted value to the ownership interests to arrive at the discounted value of the minority interests or FMV value of the interest.

The reason for this is that the person making the donation always wants to transfer the asset with the lowest value that can be justified.  After the donation is made, the charity would need to have the asset valued during the period of time it holds the asset.  This is a different valuation because the charity wants the highest value that it can possibly get for the asset.  Different purpose - different use.

One question that we received from the advisors was what does a client do if they are not happy with the valuation they received from the company they hired to perform the valuation?  The answer is it depends.  The first step is to discuss your concerns with the valuation company and see if they understand your position and if there is anything that can be done to modify the report to everyone's satisfaction.  

If this is not an option, then the client might want to contact another reputable valuation firm with experience valuing the type of asset that is at issue and discuss having them perform a peer review on the valuation that was originally performed.  In this situation, the second appraiser will review the valuation that was performed to determine if the right approaches to value were applied and whether the methodologies that were used were correctly applied.  

A third option is to have another qualified valuation firm perform a valuation of the asset.  An issue that can arise is what happens if there are two valuations and you rely upon one of them but not the other report and then you are audited.  This is a situation that should be discussed with your legal advisor prior to having a second valuation done so that you understand the ramifications that could later occur or determine if there is a way to minimize who would have access to the valuation report(s).

If you would like to learn more about valuations for gifts of illiquid assets, please send us a request