There are times in our lives when we look back and speculate “if only I had.” For many of us those regrets seem to focus on timing-related opportunities such as “if only I had invested in Microsoft in 1992” or “if only I had sold my business last year.” While the M&A activity is healthy, in terms of estate planning, owners of privately held companies may have an wealth transfer opportunities at lower values using low interest rates, and avoid looking back and seeing the “if only” moment.
The value of a company is determined by its financial performance combined with the perception of the company in the marketplace. That is, value is equal to some measure of financial performance times some observed multiple of that measure which mirrors market conditions. Of the two, the multiple typically tends to have a greater impact on total value and is dictated by the actual transactions. Therefore the owner’s primary impact on value is the company’s financial performance.
In recent years, market multiples steadily increased for companies in most industries as private equity groups (PEGs) became more active and increasingly aggressive market participants. The vast availability of inexpensive credit contributed greatly to the ability of PEGs to acquire companies. The combination of PEG dollars plus cheap credit created a situation in which multiples rose rather quickly and remained at relatively high levels for a fairly long period. A change has occurred.
Because of the current credit crisis, buyers of companies are not able to apply as much leverage as in the recent past. The result is that multiples have dropped. The effect on the value of companies is obvious – lower multiples means lower values. Even companies whose fundamental financial performance has not changed could be affected by the lower multiples.
Applicable Federal Rates
As the economy has begun to experience a downturn, key interest rates have dipped. One of the benefits of declining interest rates is lower Applicable Federal Rates (AFRs). The AFRs are the minimum rates of interest that must be charged on loans for the IRS to classify the loans as true debt. Many estate planning transfers are made at AFRs.AFRs have been falling for some months and are currently at levels unseen for several years. If one considers the lower-than-normal.
AFRs alongside the potentially lower company valuations, we may be experiencing the perfect storm for estate planning transfers. Because these transfers generally take the form of non-controlling interests, there may even be additional valuation considerations such as discounts that may be appropriate for the transfers of minority interests.
Conditions are perfect for estate planning utilizing transfers of minority interests with installment notes at the current AFRs. Take Action Now. Don’t let this be an “If only I had” instance for you or your client.