One of the first items we ask for when engaged to value a holding company interest is the governing agreement of that entity. This could be either an Operating or Partnership Agreement (with all amendments). Sometimes we are asked why we need the governing agreement to prepare a valuation. In the valuation of holding company entities, such as partnerships or limited liability companies, which own real property or marketable securities, consideration of the operating or partnership agreement is very important.
Many times, we have been engaged to value a noncontrolling interest for a limited liability company (LLC) or a partnership. We are told that the interest, despite being greater than 50%, is a noncontrolling interest. This is typically because the entity is managed by a Manager or a General Partner. The Manager/General Partner often has day-to-day control of the entity, as well as the ability to:
- Buy and sell property,
- Incumber property,
- Invest funds,
- Make loans,
- Refinance debt,
- Enter into contracts,
- Issue distributions, or
- Take other actions which are deemed necessary for the operations or purpose of the entity
By having the Manager/General Partner in place, the other Members/Partners cannot exercise control of the entity. Therefore, a noncontrolling interest exists and certain discounts may be applied.
An issue we have run into more than once for interests greater than 50%, which are believed to be noncontrolling due to the appointment of a Manager or General Partner, is the ability to remove and replace the Manager or General Partner. We have seen agreements which state that a Manager/General Partner can be removed with or without cause by a majority in interest of the Members. Suddenly, the 50%+ Member who didn’t think they could do anything, can remove the Manager/General Partner and potentially appoint him or herself, or another related party, to that position. This could be considered control. Or, at the very least, a mitigating factor in the amount of control discount to be applied to the interest.
Sometimes certain actions, such as the sale of all or substantially all the assets, requires consent of the Partners or Members. This could be consent of the majority in interest of the Partners/Members or unanimous consent. Depending on the type and number of actions which require consent of the Members, the 50% or more interest may be considered to have significant blocking power. While unable to completely control the entity, the subject interest may be able to stop significant actions from happening. Significant blocking power held by an interest may mitigate the control discount to be applied to that interest.
These are a couple of examples of how the language contained within governing agreements can have a significant effect on the valuation of a holding company.
Melissa E. Loughlin-Sines, CPA, CFE, CVA, CFF, ABV