Regardless of whether a business is structured as an LLC or some other type of entity, its valuation is a matter of ascertaining a fair market value. The value of an LLC interest is proportional to the LLC member’s ownership percentage. The overall fair market value of the LLC is established first. The Uniform Standards of Professional Appraisal Practice is an accreditation organization setting standards for appraisals such as business valuations.
An LLC is a business structure created under a state charter that provides similar legal protections as a corporation. However, an LLC has the financial flexibility to operate like a partnership. That is, the income passes through to the individual owners of an LLC. The owners are called members. The valuation of a member’s interest in an LLC is determined like a partnership interest. It is the fair market value of the member’s portion of ownership in the LLC.
Fair Market Value
The term applied to business valuations is “fair market value.” Although definitions vary slightly among several sources, the concept is generally consistent. Fair market value is the price at which willing parties are expected to transfer property. There is a presumption that fair market value is determined based upon neither the buyer nor the seller acting under any force or compulsion. A most important factor in fair market value is that both buyer and seller have reasonable knowledge of the facts.
The USPAP requires consideration of three approaches to appraising business values. These are the Asset Approach, the Market Approach, and the Income Approach. The Asset Approach values a business for its assets only. Liabilities transferred with acquisition of assets are subtracted to determine a net asset value. The Market Approach compares benchmark financial rations of similar companies that recently changed hands. The Income Approach values a business interest based upon earning projected income from investing in the business.
The value of a minority interest in an LLC is discounted from its valuation as a percentage of the entire LLC. The discount for a minority interest is affected by a range of considerations reflecting the degree of influence for the minority interest owner. For example, when there are many LLC members that all possess minority interests, there is lesser discount than an LLC with one member possessing substantial ownership.