If a person says they are worth $10 billion but they own a US company that is privately held, (making it a pass-through entity) and that company owes $20 billion, how is that person allowed to say they are a billionaire? Thank you. Btw: this is an ACCOUNTING question, not a POLITICS question.
In: Economics
I believe corporations and LLCs are different entities from sole ownerships and partnerships. If the company is a corporation or an LLC then I think their financials are separate from the owner’s. Something like that.
A company can be a pass-through entity and still expose its owners only to limited liability (for what it’s worth, a company can also be privately held without being a pass-through entity). Something like an LLC allows the owner to treat the profits of the company solely as personal income (so they don’t also have to pay any corporate taxes on it), but they’re still protected against creditors if the company declares bankruptcy. This system works fine so long as you can ensure that the owner is only directing *profits* towards themselves and not generating a bunch of debt for the company by declaring all its revenue to be profits.
That said, usually when someone is “worth $10 billion,” or some similarly large number, it’s because they have an ownership stake in a large company, not because they have a lot of personal money just sitting in a bank somewhere. If the long run net value of that company is actually -$20 billion, then they are lying. More likely is that the company indeed has $20 billion in debts, but its assets and/or projected future revenues are even higher, so its net value is positive.
A persons net worth is calculated by subtracting their total liabilities (debt) from their total assets. If, for instance, you have $20,000 in savings, a house with a fair market value of $500,000 and a mortgage balance of $100,000, you would have a net worth of $420,000. $20,000+$500,000-$100,000.
Just because your business is privately held does not mean you share the liability of the corporation, it just means that you earn the profit as the shareholder, you own 100% of the stock instead of a pool of people, so you get 100% of the dividends. If a company with 1000 publicly traded stockholders has debt, those stockholders don’t carry the liability if the company. The whole purpose of creating a legal company is to keep the business liabilities separate, so you aren’t on the hook if the company goes under. The exception to this would be if you, as owner, personally guaranty the debt. This allows creditors to sue and seize assets of the guarantor if the company fails to pay. Those personally guaranteed debts are factored against your personal net worth in credit decisions.
It’s a division of personal and business. The business has separate liabilities and assets as the person, even though the business itself is an asset for the person. This is because if the business is an LLC, an s-Corp, or c-Corp, it is a separate entity from the person who owns it.
Determining a person’s net worth is simple, it’s just assets minus liabilities.
Determining the value of a business is more complex than figuring out a person’s net worth. For a business, it’s not as simple as assets minus liabilities (equity), though it is a factor in determining what the business is worth.
Furthermore, not all debt is bad. Infact, in terms of business, almost all debt is good, especially for real estate. It’s a concept called leverage, and it’s very powerful. It’s actually very normal for businesses to carry a large amount if debt because it helps them make more money than if they operate strictly with cash.
Many people see debt as something bad because of the debt they’ve experienced. If you max out a credit card or take out a loan to buy expensive yard equipment for your house and had to pay $250 a month to pay it all off, that’s bad debt if you’re not making any money off that. But if you used that lawn equipment to start a landscaping business that makes $1200 a month, then it becomes good debt because now you’re using that debt to make a profit. It gets more complicated that that the bigger you get, but that’s the general concept of leverage.
Now let’s get a little more technical. Every company has what’s called a Balance Sheet. A balance sheet is a financial statement that lists all the companies assets and all of the company’s liabilities. If a company owns theme parks, the loans taken out to buy the land and build the rides go under liabilities. The value of the park goes under assets. And when we subtract the total of liabilities from assets, we get equity which is a factor for what the company that owns the theme parks is worth.
Individuals have balance sheets too, you can even make one for yourself. If you have a car loan, it would go under liabilities and the value of the car would go under assets. Same thing if you own a house, the mortgage goes under liabilities and the value of the house goes under assets. You bank account also goes under assets, and so does any retirement accounts or brokerage accounts.
The person who owns the theme park business has their own balance sheet, and their theme park business goes under assets on their balance sheet because it makes them money even though the company has debt exceeding the person’s net worth. The company’s liabilities are the company’s, not the individual’s.
Net worth or personal net worth claims are simply that. It isn’t regulated or bound in some legal definition.
If some independent person or group wants to estimate (and it is always an estimate) someone’s net worth, it is usual to have a separate valuation for their private assets – which may include a private company.
For the most part, there are many ways of valuing a company and for a private company, it isn’t bound by any accounting requirement. Going by accounting methods, the simplest method is the net book value (assets – liabilities) or owner’s equity. This is somewhat crude and not particularly useful for many knowledge based companies. Other methods could include earnings multiples, discounted cash flow etc etc. These will give a range of results any of which one can claim to be a valuation.
Net worth claims are simply that, statements that can have as many interpretations as there are people. They aren’t written in stone.
Thank you very much. I appreciate the in depth answer. This was great!
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