Valuing Pass-Through Entities - Are They More Valuable?
The majority of businesses in the United States are privately-held entities. Many of these entities have elected S corporation status or have chosen to be non-taxable entities such as limited liability companies or limited liability partnerships. These entities are often referred to as pass-through entities. Valuing them can be a challenge.
The challenge arises because the data used to value a privately held company may often be derived from comparable publicly-traded companies. Using this data to value pass-through entities may not be entirely accurate because pass-through entities have different benefits. One of the advantages of operating as a pass-through entity is the tax benefits available to the owners. The income stream of a regular (C) corporation for tax purposes is subject to double taxation1. An investor in a pass-through entity has an advantage over an investor in a C corporation because the pass-through entity only bears a single level tax at the pass-through individual level. Pass-through entities avoid the second level of tax the C corporation shareholder has to deal with; a tax on corporate dividends. This avoidance of double tax provides pass-through entities additional value.
Valuation analysts capture this additional value by the use of several models. These models adjust the overall value of an entity to reflect the additional economic benefit an owner receives because of the entity's pass-through status. Even though these models are accepted by the valuation community, there is no one preferred model. Valuation analysts should address each valuation of pass-through entities on a case-by-case basis to determine whether additional value exists.
Please contact me, John Maloney, CPA, CFF, CVA, at 215-675-8364 for assistance with business valuation or forensic accounting needs.
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