Coronavirus and the Value of Your Family Business

Special Topics Valuation

As family business leaders continue to make hard decisions in real-time against the ever-changing backdrop of the pandemic, their legal and tax advisors would do well to consider whether this is an opportune time for intra-family ownership transfers.  For many family businesses, the current economic uncertainty presents a unique, and perhaps fleeting, opportunity for more tax-efficient estate planning.

Wall Street vs. Main Street

Investors value the shares of public companies on a (nearly) continuous basis.  It should not be too surprising that these “real-time” valuations are subject to a good bit of volatility.

Is the value of your family business that volatile?

Unlike public companies, private family businesses are not subject to continuous public valuation.  Reliable valuation data points for family businesses exist only when a competent business valuation is prepared or when there is an arm’s-length transaction with a third party.  As a result, whatever day-to-day volatility exists in the value of your family business is not visible.  However, just because you can’t see it doesn’t mean it’s not there.  Instead, what is often assumed to be limited volatility in the value of a family business is more likely a function of the limited frequency with which value is observed.

The same fundamental factors that influence public stock prices – risk assessments, growth expectations, and cash flow projections – also influence the value of private family businesses.

We say all that to say this: unless you are a grocer or the like, the value of your family business is likely lower today than it was two months ago.

The (Potential) Silver Lining In All of This

At this point, you may be thinking that, even if the value of your family business is currently depressed, you have no intention of selling today.  But even for families that have no intention of selling in the current environment, the fact that the value of your family business has declined should not be ignored.

One of the cornerstones of estate planning is the concept of fair market value (“FMV”).  Fair market value is the price at which shares in family businesses can be gifted or otherwise transferred when executing estate planning.  In general, the lower FMV is, the more efficiently shares can be transferred in pursuit of estate planning goals.

IRS regulations (Revenue Ruling 59-60) define fair market value as:

“The price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.  Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.”

Fair market value does not depend on whether you are willing to sell your family business today.  What does matter is the price that would be received, were a transaction to occur today.  And if a transaction were to occur today, the price would reflect the same uncertainty that we see manifest in public markets.  In case there was any doubt about this, Revenue Ruling 59-60 offers the following additional guidance, which seems almost prophetic with regard to where we find ourselves today:

“The fair market value of specific shares of stock will vary as general economic conditions change form ‘normal’ to ‘boom’ to ‘depression,’ that is, according to the degree of optimism or pessimism with which the investing public regards the future at the required date of appraisal.  Uncertainty as to the stability or continuity of the future income from a property decreases its value by increasing the risk of loss of earnings and value in the future.”

As the number of confirmed coronavirus cases across the globe grows, we do not yet have a clear sense of what the long-term economic toll will be.  Large-scale restrictions on social gatherings are having an immediate effect on the dining, entertainment and other service industries.  The size of the economic ripples on other sectors is hard to forecast.  However, the real-time impact of the uncertainty on public securities market can be measured.

Family business directors are currently facing many pressing issues.  Amid all of the chaos, however, directors should know that the estate planning opportunities triggered by lower valuations may not last.  Schedule a quick call with your estate planning advisors to see if there are steps you can take to help reduce the burden of future estate taxes on your family business.