Do Profits Interests Have Any Value When Granted?
David Howell
Expert in valuation for private equity. I simplify financial reporting and GAAP | IFRS compliance for CFOs and accountants. Passionate about making complex fair value requirements easy to understand.
>>> 5 Things to Know
What are profits interests worth??
CFOs and accountants in private equity need to understand the value of profits interests for financial reporting, tax, and planning.
Features of profits interests can lead to thinking there’s no value when granted.
That’s not the whole picture.
Here are five things to consider.
One: Tax
Profits interests are typically not taxed at grant and have a $0 basis for any 83(b) election. ?However, future distributions are taxable and may qualify for capital gains treatment.
*** Not taxable at grant does not mean worthless.
Two: Financial Reporting (GAAP)
Fair value requirements recognize value in the potential payout from future income, distributions, or an exit.
*** The possibility of a payout creates value.
Three: Cash Basis
There is no cash investment with the chance for a payout.?That’s an attractive ROI.
*** No one would give that opportunity away for nothing.
Four: Business Economics
Grants are an incentive to attract, retain, and reward employees.? Value to the employee increases as the business grows.
*** The right to share in success is meaningful.
Five: The Future is Uncertain
Business performance and value could change. Vesting requirements might not be achieved.? An exit might not result in a payout.
*** Why issue units if success is not possible? All equity interests have risk. ?The potential reward makes it worthwhile.
Bottom Line
The inherent value in profits interests helps drive value creation in private equity.
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