Evaluating Loan Terms For Charitable Donations

May 2013       Download PDF      Print

Situation

The National Christian Foundation (NCF) operates a donor-advised fund that accepts contributions of minority business interests. Minority business interests are illiquid assets, and as such, donors who gift shares of their privately held company, often purchase them back to provide the liquid gift of cash.

In one instance, two shareholders of an engineering company located in Texas desired to purchase back a minority interest that was previously donated to NCF by two other minority owners in the company. In cases such as these, NCF often issues a seller note to facilitate the transaction. NCF engages an outside expert to confirm that the terms of the note represent the fair market value being paid for the interest.

Engagement

NCF hired Allied Business Group to assess the seller note and determine its reasonableness as a mechanism for NCF to obtain the fair market value purchase price for the interest at stake. Allied first reviewed the buyers' (that is, the original donors') credit history and personal financial statements to assess the buyers' creditworthiness. We then developed hypothetical scenarios illustrating cash flows that would be available to NCF by executing the transaction. These hypothetical cash flows varied depending upon different duration calculations and reinvestment assumptions. We also evaluated the reasonableness of the terms of the note by comparing them to traditional and expected loan terms and market data.

Result

Our business valuation professionals determined that the terms of the seller note could not be regarded as being fair market value because the interest rate on the note was not appropriate considering the amount of risk inherent in the transaction. After discussions with Allied, NCF agreed to raise the note's interest rate by 1.5%, to a level more reasonable given the buyers' risk profile.