Security Sales & Integration

September2013

SSI serves security installing contractors providing systems and services; surveillance, access control, biometrics, fire alarm and home control/automation. Coverage in commercial and residential product applications, designs, techniques, operations.

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HOW TO REAP GAINS FROM ESTATE AND GIFT TAX EXEMPTIONS Building Your Business by Kevin Moore Kevin Moore is a Senior Valuation Analyst at Pennington, N.J.-based BCG Valuations. kmoore@bcgvaluations.com L ate in 2010, Congress passed legislation that increased the lifetime estate, gift and generation-skipping transfer (GST) tax exemption to $5 million per individual or $10 million combined, including spouses. Te exemption was indexed for infation and increased the tax rates on such transfers from 35% to 40%. In 2013, the exemption amount increased to $5.25 million. While these provisions and rates cannot automatically expire and revert to a less favorable law, future legislation could reduce the lifetime exemption or further increase the applicable tax rates. In fact, President Obama's proposed federal budget for fscal year 2014 recommends reducing the lifetime estate, gift and GST tax exemption to $3.5 million per individual and increasing the efective tax rates to 45%. Given the uncertainty surrounding the estate tax, many owners of closely held companies may look to transfer noncontrolling or minority interests in their family business to the next generation or key employees in order to take advantage of the current favorable federal estate and gift tax exemptions. With the lifetime exemption for 2013 set at $5.25 million, business owners are able to signifcantly reduce, or eliminate altogether, the tax burden imposed on transfers of ownership interests made to or for the beneft of the next generation or key employees. Tis is especially relevant within the security alarm services industry, of which more than 90% of participants are closely held businesses with fewer than 20 employees. Let's take a look at how applying proper valuations of minority interests can help business owners allocate the wealth of an entity in the most judicious manner. PARTICULARS OF FAIR MARKET VALUE It has been well established that the value of a security alarm services business in an acquisition by a third party is primarily a function of recurring monthly revenue (RMR). However, due to factors such as lack of marketability and lack 144 / SECURITYSALES.COM / SEPTEMBER 2013 PHOTO: ©ISTOCKPHOTO.COM Owners of small companies may want to act to transfer minority interests in their business to take advantage of current federal estate and gift tax law. Understanding and applying proper valuation protocols is key. of control, discounts from the total (or enterprise) value of such businesses are available when valuing the company in the context of fair market value for estate planning purposes. For tax purposes, fair market value is the price at which interests would trade in a transaction between a hypothetical willing buyer and willing seller, each having full knowledge of all relevant facts and neither being under any compulsion to buy or sell. Te buyer and seller are unspecifed parties, operating at arm's length, who agree upon a price. In the case of most intergenerational transfers, the price being paid is for a noncontrolling illiquid (not easily converted into cash), minority interest. By way of example, consider a fctional security alarm services provider, K&M; Alarm Co. LLC, which generates RMR of $200,000. Taking into account the implicit RMR multiples of recent public acquisitions — including Tyco Int'l Ltd.'s acquisition of Brink's Home Security, GTCR's buyout of Protection 1 and Ascent Capital Group's purchase of Monitronics — the prospective acquirer might value K&M; Alarm at an RMR multiple between 25x and 45x. Tis range in multiple would also consider other relevant factors, such as company size, local market share, customer attrition rate, etc. Applying the midpoint of this range (35x) to K&M;'s RMR results in an enterprise value of $7 million, above the taxable threshold for an unmarried owner. Tis enterprise value is the marketable, controlling interest value of the entity assuming all of its shares are sold in a single block. In order to convert this value to a minority interest basis, an allowance for lack of control is applied in order to remove the implicit control premium. Control premiums refect the relative attractiveness of an

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