Partnership Valuation
Tops tips if instructing an expert valuation of an interest in a partnership
In this blog I share my tips on what family lawyers should consider when instructing a Single Joint Expert to value an interest in a partnership (whether a general partnership or a Limited Liability Partnership “LLP”).
There are key differences in the approach to valuing a partnership interest as opposed to a shareholding in a limited company. In my experience these are not always understood and I have reviewed several valuers’ reports that simply adopt the typical approach for company share valuation without appreciating the nuanced differences. This can result in a flawed valuation.
Legal framework
My first key observation is that valuing a partnership interest must start with an understanding of the legal framework of the partnership. The starting point should be to consider if there is a partnership agreement or, for an LLP, a Members Agreement. If not, and if the entity is a general partnership, the valuer needs to understand the implications of the Partnership Act 1890. If it is an LLP, then the Limited Liability Partnerships Act is relevant.
In any event, even if a written agreement exists, it is still necessary to understand the legal framework, the mechanics of partnership accounting and the application of income and capital gains tax to partners.
Valuation of an interest in a partnership
The starting point to assess the value of a partnership interest is to establish the balance on the partner’s capital and current accounts (including any tax reserve). The balance on these accounts represents profits already earned and due to the partner.
The second point is to consider is whether there is any value to be attributed to goodwill (i.e. the ability to generate future profits from the partner’s interest).
The partnership agreement or LLP Members Agreement may include provisions regarding how a partner can exit the partnership agreement and how their interest in goodwill should be valued. It is typical in professional partnerships for an exiting partner to be precluded from realising any goodwill. Alternatively, the agreement may specify how any goodwill is to be valued.
Once the legal and commercial framework is understood, the valuer can determine if there is any value attributable to the partner’s interest beyond their capital and current accounts. Any value that is attributable to goodwill will be liable to capital gains tax.
To decide how to value goodwill, the valuer must ascertain the operation of the partnership. Partnerships often trade from property that is not owned by the partnership and there may not be formal agreements as to the ongoing right of the partnership to use these assets. The ownership of key assets may impact the actual influence and control of the partnership.
The valuer should also understand the sector and current trends. For example, in the accountancy sector there is considerable consolidation at present and opportunities to sell practices to consolidators or private equity. An understanding of the likely valuation parameters is vital.
Tax considerations
The taxation of partnerships is also very different to the taxation of company shareholder directors.
Equity partners receive a profit share which is then taxed as income through self assessment. In addition, they are liable to national insurance contributions, albeit at a favourable rate compared to employees. In most cases the partner is responsible for paying their income tax from their own bank account. However, in some cases the partnership retains a tax reserve for each partner.
A further tax consideration is the taxation of any partnership property that is chargeable to capital gains tax and any property held personally but which is used by the partnership.
Future sustainable income and liquidity
Future sustainable income should be considered in the context of historic profits and the drawings policy (if one exists). The starting point is to consider a weighted average of the profit share of the partner in recent years. There may be a monthly fixed draw which is topped up annually with a “bonus” which is calculated in accordance with a formula in the partnership agreement or it may be discretionary.
Extraction of liquidity should be considered in the context of the legal framework. In larger partnerships it is unlikely an individual partner can extract any additional sum outside the normal drawings.
Conclusion
The valuation of a partnership interest should not be estimated by following the standard approach to company valuation. I recommend family lawyers ensure the single joint expert has experience in advising and valuing partnerships (both in terms of the accounting and tax).
Getting in Touch
Fee estimates and CVs are readily available. Quotes can typically be provided within two working days.
Email: fiona@fhmforensic.co.uk
Telephone +44 (0)7770 642491
