The Valuation Method for a Limited Partnership

You can obtain numeous publications summarizing empirical studies on illiquidity discounts.
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Investors set up limited partnerships for numerous reasons. Wealthy individuals use them as investment vehicle and for estate and gift tax planning. Large companies commonly have complex business structures consisting of a parent company and numerous subsidiary partnerships for purposes ranging from administrative to operations. Small companies may also register as limited partnerships as their main operating entities. If you are valuing a limited partnership, determine the purpose of the limited partnership and if any related parties exist.


Review Partnership Agreement

Limited partnerships are formed at the state level, and often must submit valid limited partnership agreements as part of the registration process. Closely review the partnership agreement, which provides a detailed framework of the administration of the partnership and should contain many provisions that are relevant to the valuation. These include restrictions on transfers, capital contribution requirements, procedures for calculating and scheduling distributions to partners and the level of control held by all partners.

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Net Asset Value

Subtract the fair market values of liabilities from the fair market value of total assets to arrive at adjusted net asset value. In most instances you will need to adjust the balances of capitalized costs and other intangible assets to zero, because in the case of a hypothetical liquidation of the partnership you would not be able to obtain any proceeds from the sale of these assets. Often, these assets represent accounting measures with no relationship with fair market value. If the partnership operates as an actual business, calculate the fair market value of the business and use the fair market value to mark the balance sheet to market.


Apply Valuation Discounts

Limited partnerships typically are privately held, with no secondary market existing for potential buyers to purchase limited partnership interests. This reflects liquidity risk, especially in the case of small minority interests. If you are valuing a minority interest, apply an appropriate discount for lack of liquidity. Even if the limited partnership's underlying assets consist solely of liquid securities, the limited partnership interests themselves are illiquid. It is common for partnerships to be created with a structure consisting of passive limited partners and the general partner. The general partner is in charge of the day-to-day operations of the partnership. However, many limited partnerships allocate voting rights to partners, who can impact operations by pooling votes. In some instances you will need to apply a discount for lack of control to the partnership interest being valued. Estate planners often set up partnerships as a method for reducing the value of the client's taxable estate by transferring ownership of the client's assets to illiquid investment vehicles to which valuation discounts apply. Look to empirical studies and relevant Tax Court decisions for guidance in calculating valuation discounts.



Tax Considerations

Limited partnerships are pass-through entities which are not required to pay federal income taxes. Instead, the investors in the partnership pay taxes at the individual level. In instances where the partnership is an operating entity, apply an appropriate income tax rate to the partnership's pretax income stream to reflect this. In other cases you may find that the partnership owns assets for which the fair market value is substantially higher than their cost bases, reflecting unrealized capital gains tax liabilities. If the general partner intends to sell off certain holdings and trigger the capital gains tax, adjust liabilities to reflect this. In some cases uncertainty as to when the underlying assets may be liquidated make it necessary to adjust liabilities upward for a portion of the tax liability.



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