Do Partnership Profile Discounts Include Lack of Control and Marketability?

Partnership profile discounts can be a complex topic, but let's break it down.

In a partnership, the value of a partner's interest is typically determined by their share of the business's profits and losses. However, this value can be affected by factors such as lack of control over the business.

Lack of control can significantly impact a partner's ability to influence the business's decisions, which can, in turn, affect the value of their interest.

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Several factors increase or decrease discounts from pro rata NAV at which non-controlling interests trade. These factors can significantly impact the value of an investment.

Control is a key element that can increase the value of an investment. When determining the fair market value of an ownership interest that doesn't unilaterally control key aspects of the business, a discount for lack of control is warranted.

Experts often rely on the Survey of Re-Sale Discounts published by Partnership Profiles Inc. (PPI) to determine discounts for lack of control applicable to real estate holding companies.

The NAVs of secondary market partnerships reflect the value of real property owned by the partnership, determined by an independent appraiser or estimated internally.

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A qualified business appraiser or skilled valuation analyst is needed to determine an appropriate discount based on an analysis of the assets held by the entity and their condition.

The size of the interest being gifted and restrictions outlined in the operating agreement are also key factors to consider.

Many factors enter into a business valuation, and specific facts surrounding the transfer will weigh heavily into the discount.

Experts recommend undertaking a valuation with each gift, as closely to the time of transfer as possible.

Discounts for lack of control and marketability are typically applied to a partnership's net asset value (NAV) to determine the value of a minority limited partner's interest.

The discount for lack of control (DLOC) is applicable because a minority limited partner is generally unable to control the cash flow, investment of assets, or liquidation of the partnership.

A discount for lack of marketability (DLOM) is also applicable because the partnership interest is not readily marketable, as a publicly traded security would be.

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To determine an appropriate discount, experts often rely on the Survey of Re-Sale Discounts published by Partnership Profiles Inc. (PPI).

This annual survey reports the discounts from net asset value (NAV) at which non-controlling interests in non-publicly traded real estate limited partnerships and real estate investment trusts (REITs) have been purchased in the secondary market.

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A discount for lack of control is warranted when determining the fair market value of an ownership interest that does not unilaterally control key aspects of a business.

The IRS stance on discounts to Partnership Profiles data has been refuted by experts, who argue that the data already reflects both minority and marketability discounts.

Experts recommend undertaking a valuation with each gift, as closely to the time of transfer as possible, especially if gifts are being made over a period of years.

The value of a minority interest in a privately held company may be negatively impacted by marketability, liquidity, and control issues.

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A discount for lack of control represents an amount or percentage deducted from a pro-rata share of the value of 100 percent of an equity interest in a business, to reflect the absence of some or all of the powers of control.

The lack of control (minority interest) discount is attributable to the fact that a holder of a Member Interest generally does not have the power to appoint or change operational management or members of the board of directors, among other things.

Here are some examples of powers of control that a holder of a Member Interest may not have:

The size of the interest being appraised, restrictions laid out in the family limited partnership or LLC operating agreement, the historical dividends paid, and the future outlook of the enterprise are among the variables that can affect the value of a majority or minority interest in an entity.

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Discounts for lack of control and marketability are crucial factors in determining the value of a partnership interest. These discounts are typically applied to the partnership's net asset value (NAV).

A discount for lack of control (DLOC) is applicable because a minority limited partner is generally unable to control the cash flow, investment of assets, or liquidation of the partnership. This discount represents the absence of some or all of the powers of control.

A discount for lack of marketability (DLOM) is applicable because the partnership interest is not readily marketable, as a publicly traded security would be. This discount is an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability.

Marketability is defined as the ability to quickly convert property to cash at minimal cost. A publicly-traded stock on the New York Stock Exchange, where the owner can order the sale and the proceeds are deposited in a bank account in three days or less, is an example of a highly marketable asset.

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A lesser price is expected for the business interest that cannot be quickly sold and converted to cash. This is because the final sale price becomes less certain and with it a decline in value is quite possible.

The Business Valuation Committee of the American Society of Appraisers states that a discount for lack of control represents an amount or percentage deducted from a pro-rata share of the value of 100 percent of an equity interest in a business, to reflect the absence of some or all of the powers of control.

Here is a list of the powers of control that a minority limited partner typically does not have:

Discounts for lack of control in real estate holding entities are primarily affected by distributions, not debt or overall market conditions.

Distributions play a significant role in valuing these entities, as emphasized by PPI.

Debt, while a consideration, is not the most important factor in determining discounts for lack of control in real estate holding entities.

A nuanced understanding of distributions and debt is essential for accurately valuing these entities that hold real property.

The pandemic has led to increased discounts, but its impact on distributions and debt is secondary to the entity's distributions.

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The IRS stance on discounts can be a bit confusing, but let's break it down. The IRS suggests that minority and marketability discounts are already reflected in Partnership Profiles data, so appraisers shouldn't add a marketability discount.

This is based on the IRS's Discount for Lack of Marketability Job Aid, which was written by Mike Gregory, a former IRS employee with 28 years of experience. Gregory argues that adding a marketability discount can distort the effective rate of return for an investment.

Partnership Profiles, on the other hand, has a different view. They point out that their data shows that discounts are warranted for non-controlling interests, and that these discounts can vary depending on the specific circumstances. For example, the Survey of Re-Sale Discounts published by Partnership Profiles shows that non-controlling interests in non-publicly traded real estate limited partnerships and REITs have been purchased at discounts ranging from 10% to 40% of net asset value.

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Experts recommend that individuals seeking to determine an appropriate discount for a specific interest should consider the impact of the discount on the rate of return, rather than simply applying a fixed discount. This can involve a detailed analysis of the assets held by the entity, their condition, and the restrictions outlined in the operating agreement.

DLOM determination is not as straightforward as one might think. Investors prefer liquidity to illiquidity, and a discount is applied to compensate for the absence of a ready market.

The IRS has argued that cash held by a partnership is not subject to any discount for lack of control. However, our response has been that cash is just as locked-up from a control standpoint as any other asset held.

Cash is discounted in the public marketplace, and at least that portion of cash held by the partnership that represents a percentage of the portfolio in proportion to the comparable closed-end funds' percentage of cash ought to be discountable at whatever rate is applied to the rest of the partnership's assets.

A Discount for Lack of Marketability (DLOM) is an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability. This is a primary concern driving the price reduction for a business interest that cannot be quickly sold and converted to cash.

A prudent buyer would want a discount for acquiring such an interest to protect against value loss in a future sale scenario. This is because the final sale price becomes less certain and with it a decline in value is quite possible over the uncertain time frame required to complete the sale.

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In a partnership, discounts are often offered to attract investors and increase capital.

These discounts can take the form of a reduction in the purchase price of a partnership interest.

A 10% discount on a $100,000 partnership interest would be $10,000.

Cash contributions can also be made to a partnership in exchange for a percentage of ownership.

For example, an investor might contribute $50,000 in cash and receive 5% of the partnership's ownership in return.

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