How to value an LLC in the event of death/divorce

[FCharlie]

Hello.

 

If anyone out there has any experience owning rental property with partners inside of an LLC or a corporation, how do you value the business in the event that one partner wants to exit, dies, or is forced to exit due to divorce?

 

I am setting up an LLC with two other people and we need to create language in the operating agreement to handle this possibility.

 

Obviously it could be valued at cost in the beginning, and perhaps for a few years. Going forward, the two scenarios that come to mind are

 

1) Paying for BPO's (Broker Price Opinions) on properties to account for market value of property instead of cost of property.

 

2) Having a predetermined valuation, such as X times cash flow or net operating income.

 

Any thoughts would be appreciated here.

 

Thanks

 

 

[Hielko]

Do you want to give partners the option to exit easily? Imagine what happens if the two other partners want out? Do you have the cash to just buy them out laying around? And especially being able to exit at a predetermined valuation is problematic, because what if they can exit at 20x cash flow and the market is trading at 10x cash flow?? If you do a build-in exit mechanism I think you should do something like 95% of appraised value or something like that. Don't offer liquidity for free, since it will have a real cost for the partner(s) remaining.

[SharperDingaan]

Offer a predetermined valuation, but make it vest over different periods. 1/3 year over 3 years for <25%, 1/5 year over 5 years for 25-49%, etc. It averages out the gaming possibilities, and reduces the liquidity drain on the business/remaining partners. It also permits partners to buy out future vests at a market discount (without rancor) - if they have the additional liquidity available.

 

SD

 

[oddballstocks]

Do you want to give partners the option to exit easily? Imagine what happens if the two other partners want out? Do you have the cash to just buy them out laying around? And especially being able to exit at a predetermined valuation is problematic, because what if they can exit at 20x cash flow and the market is trading at 10x cash flow?? If you do a build-in exit mechanism I think you should do something like 95% of appraised value or something like that. Don't offer liquidity for free, since it will have a real cost for the partner(s) remaining.

 

This is key, if you're offering an out at any time then you need to have the cash laying around.  That isn't ideal.

 

Talk to your accountant.  There are tax implications as well for the remaining partners.

 

Typically in small business transactions like this the remaining partners buy out the seller over time.