BVWire Issue #175-4 | April 26, 2017


Surprising estimates of private-company cost of equity

Over half (59%) of privately held business owners believe their cost of equity is less than or equal to 12%, according to the “2017 Private Capital Markets Report" from Pepperdine University Graziadio School of Business and Management. What’s more, half (50%) of the 1,034 respondents say it is no higher than 10% and almost a third (31%) say it is less than or equal to 8%. These results may be a little surprising to some appraisers.

Private view: The survey was released in January 2017, and it represents the hard work of Pepperdine researchers in developing a private cost of capital method as a legitimate alternative to looking to the public markets. Their method is refreshingly simple: They ask private capital market players what returns they project. The players are divided into six segments aligned with the major institutional arms of the private investment world, each with different return, investment, and research characteristics. The segments are: bank lenders, asset-based lenders, mezzanine lenders, private equity groups, venture capital, and angel investors.

We note that the majority of private firms that responded had 20 employees or fewer, with 55% having no more than five employees. Also, approximately 58% of the respondent firms had annual revenues less than $1 million.

Extra: BVR is a research sponsor in Pepperdine’s efforts, which started back in 2007. Dr. Craig Everett, who runs the program, will give a presentation at the ASA/USC 12th Annual Fair Value Conference in Los Angeles on June 1.

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ESOP trustee’s ‘passive and blind’ adoption of valuation spells liability

Close on the heels of the Brundle case, in which the court ruled the ESOP trustee was liable for a $28 million overpayment, comes a second decision finding trustee liability. In tandem, these cases drive home the point that an ESOP trustee is ultimately accountable for determining fair market value. Both courts get down to the nitty-gritty of valuation and identify similar deficiencies in the valuation analyses, making the decisions instructive for all valuation professionals.

The instant case concerned a New Jersey site preparation construction company that was primarily active in homebuilding. At the relevant time, most of its top customers were residential homebuilders. In April 2007, the ESOP bought 38% of company stock from the company’s majority shareholder for $16 million. The price was based on the seller’s initial offer. The ESOP was represented by a professional trustee, which worked with an experienced ESOP valuation firm. Eventually, the Department of Labor sued, claiming the trustee had breached various fiduciary duties and engaged in a prohibited transaction.

Expert ‘is not a shield’: After an exhaustive probe into the trustee’s and valuator’s actions, the court concluded the trustee’s failure to explore the “glaring errors” and “myriad of red flags” related to the ESOP valuation “led to a passive and blind adoption of the seller’s optimistic valuation.”

Just as in the Brundle case, the court here found the problem started with the projections. The trustee knew the cash flow projections were the driver of the value conclusions, and it knew the valuator was relying on information from the seller and the company without independently verifying the data, the court noted. Therefore, the onus was on the trustee to perform its own due diligence and, if necessary, recast the projections based on its findings. The trustee failed to do so.

A critical omission in the draft report was an industry analysis. Only the post-transaction valuation report included a discussion of the economy and acknowledged the state’s housing market “will not pull out of its slump in 2007.” Considering construction is a cyclical industry and given to volatility, questioning how the valuator accounted for that cyclicality was critical, the court noted. The trustee did not do so. What’s more, the trustee did not challenge the valuator’s using 2006, a record year for the company, as a baseline for its projections, thus forecasting peak performance into the future. At the same time, available data on residential building permits showed the housing market was on a downward trend toward the end of 2006, the court noted. Also, the company’s interim financials for January 2007 through March 2007 indicated a significant decrease in revenue, but neither the valuator nor the trustee gave proper consideration to them.

Another issue that came up in Brundle and in the instant case was the failure to account for the risk of customer concentration. Here, the company’s top customer announced in its 2006 annual report it was going to manage the business as if the industry was in a prolonged downturn. Neither the trustee nor the valuator read that report, and both seemed to assume a 19.25% discount rate would sufficiently account for the risk. Also, the trustee and the valuator blindly trusted company statements that it had in place a diversification strategy even though another major customer declared bankruptcy in fall 2006.

Reliance on experts “is not a shield,” the court noted in finding the trustee failed to “make an honest, objective effort” to review the valuation report and question any assumptions and methods that did not make sense.

The case is Perez v. First Bankers Trust Servs., 2017 U.S. Dist. LEXIS 52117 (March 31, 2017). A digest and the court’s opinion will be available at BVLaw.

Extra: The court’s opinion is 158 pages long. Readers who want to get a head start on their study of the decision can find it here.

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New white paper denounces brand valuation rankings

BVWire has been given an advance look at a white paper that calls for the end of public brand value rankings. The paper explains why the rankings are “nonsense” and also points out that they can come back to haunt a company that was proud to be high on the list. It mentions the recent case in which Amazon transferred a bundle of IP assets including various European trademarks from the U.S. to a subsidiary in Luxembourg. The IRS challenged the valuations, claiming Amazon transferred the assets too cheaply and improperly avoided taxes. The IRS pointed to Amazon’s high brand value rankings by Interbrand, Millward Brown, and Brand Finance. In fact, the IRS hired Brand Finance, which valued the transferred brands at $3.125 billion. Amazon’s experts, Willamette Management Associates, concluded a value of $282 million. After a long and expensive battle, the Tax Court’s opinion resulted in a value of around $500 million—and the values from the public brand rankings ended up being meaningless.

The white paper, which has not yet been released, is titled “We Have Had Enough. Ten Reasons to Stop the Brand Value Rankings” and is from Markables, a firm that maintains a database of global trademark valuations.

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D&P’s empirical review of 3,000 fairness opinions

Duff & Phelps has reviewed and analyzed more than 3,000 fairness opinions filed with the SEC during the period 2006 to 2016 to address the criticisms that they generally provide valuation ranges too wide to be useful and that they are too reliant on “mechanical” discounted cash flow (DCF) analyses. The analysis found that “the vast majority of fairness opinions offer valuation indications that fall within 15 percentage points on either side of a midpoint—a clear indication of a widespread industry standard with robust methodologies and highly calibrated valuation analyses.” The report is “In Defense of Fairness Opinions: An Empirical Review of Ten Years of Data."

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FASB meets on liabilities and equity

At its April 19, 2017, meeting, the FASB discussed its project liabilities and equity and tentatively decided that:

  • A “down-round” feature should not preclude equity classification for an instrument that contains the feature; and
  • Public business entities should recognize the effect of the trigger of a down-round feature as an adjustment to earnings per share.

The FASB staff was asked to perform additional research.

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Questions a judge will ask about your valuation opinion

Does the expert have a thorough understanding of the business and has he or she considered the eight factors of Revenue Ruling 59-60? Why does the expert believe his or her determination of the normalized income to capitalize best represents the expected future performance of the company? Under the DCF method, can revenues realistically grow at the projected rates and do the expenses support the revenues?

These are just a few of the many questions a judge will ask about your opinion of value. You’ll find a lot more in a new book, The Business Valuation Bench Book, by William J. Morrison (WithumSmith+Brown) and Jay E. Fishman (Financial Research Associates), two well-known valuation specialists. The book is designed to give judges and attorneys a reference guide of fundamental business valuation concepts. For valuation experts, it will help you prepare for court and give you insights into how to review and critique the work of other experts.

Extra: For a more in-depth look at the role of the financial expert, see the newly released Litigation Services Handbook: The Role of the Financial Expert, 6th edition, which gets into the fine points of trial preparation, deposition, and testimony.

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Please help with academic research on Big Data and forensic accounting

Researchers at the University of Memphis are conducting a survey to gather and analyze insights regarding the use of Big Data in forensic accounting in preventing and detecting fraud. It’s a short, five-minute survey, and the findings will have educational, policy, and practical implications. Businesses lose about 5% of their revenues to fraud each year, and there’s a need to integrate Big Data and forensic accounting topics into business and accounting curricula to train the most competent and ethical future forensic accountants. Click on this survey link, which is designed to assure that responses are completely anonymous and confidential.

If you have any questions, please do not hesitate to contact Dr. Zabihollah Rezaee at or Dr. Jim Wang at Dr. Rezaee is Thompson-Hill Chair of Excellence at the University of Memphis Fogelman College of Business & Economics. Dr.Wang is an assistant professor at the Hong Kong Polytechnic University School of Accounting and Finance.

Thank you for your help!

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New edition of Hitchner’s valuation book released

Top valuation experts all have Jim Hitchner’s valuation book on their shelves, and the new edition is now available: Financial Valuation: Applications and Models, 4th edition,as well as its companion, Financial Valuation Workbook: Step-by-Step Exercises and Tests to Help You Master Financial Valuation, 4th edition. What’s new in this edition includes:

  • Thinking and research on risk premiums, beta, and data sources related to cost of capital/rates of return;
  • Data sources for valuing companies outside the United States;
  • Presentation of a complete valuation report that is compliant with the business valuation standards of the AICPA (SSVS), ASA, IBA, NACVA, and USPAP;
  • Quantitative models for determining a discount for lack of marketability and using restricted stock transaction data;
  • Guidance on calculating fair market compensation in the healthcare industry and other industries; and
  • New thoughts and applications for valuing pass-through entities.

The book includes contributions from over 30 nationally recognized names in the valuation industry with specialties in accounting, forensics, business valuation, and financial analysis. We especially like the practical “ValTips” for getting to the bottom of controversial issues.

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Sorting out DLOM methods at New York City BV confab

We’ve lost count of how many methods there are for determining a discount for lack of marketability (DLOM). And they all have "warts," according to Jim Alerding (Alerding Consulting LLC) and Pat Rafanelli (Grassi & Co.). Knowing what they are is key to supporting your opinion, they advise. Alerding and Rafanelli will present a session on DLOMs at the New York State Society of CPAs Business Valuation Conference on May 15 in New York City. Other sessions include valuing PTEs, fair value, the Section 2704 regs, and a discussion by Baruch Lev (New York University Stern School of Business) of The End of Accounting, a book he co-wrote with Feng Gu (SUNY Buffalo).

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Global BV News

Malaysia sets up new board for IP valuation

The Malaysian government has announced that it will set up a board to prepare a comprehensive framework for IP valuation by the end of 2017. The Valuation and Property Services Department and the Intellectual Property Corporation of Malaysia are collaborating in this effort.

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Key differences between U.S. GAAP and IFRS on goodwill and other intangibles

Deloitte has published a detailed comparison of key differences between ASC 350, Intangibles—Goodwill and Other, and both IAS 36, Impairment of Assets, and IAS 38, Intangible Assets.

Under U.S. GAAP and IFRSs, ASC 350, IAS 36, and IAS 38 are the primary sources of guidance on the recognition, measurement, amortization, and impairment of goodwill and other intangible assets.

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BV movers . . .

People: Annapolis, Md.-based C.W. Rains & Associates announced the addition of William Egge as director … Michael Crain is now the director of the new Center for Forensic Accounting at Florida Atlantic University’s College of Business in Boca Raton.

Firms: Philadelphia-based Drucker & Scaccetti completed an expansion of its headquarters and redesigned its website and logo … Porte Brown of Elk Grove Village, Ill., was named one of the 2017 Best Places to Work in Illinois, its fifth consecutive year receiving this award … Weaver expanded its forensics and litigation services practice by adding six new executives to its Dallas and Houston offices from Charles River Associates.

Please send your professional and firm news to us at

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CPE events

Advanced Bankruptcy Valuation (April 27), with Robert Reilly (Willamette Management Associates).

Purchase Price Allocations for Banks (May 3), with Rick Childs (Crowe Horwath LLP) and Charles Clow (Crowe Horwath LLP). This is Part 5 of BVR's Special Series on Banking and Financial Services.

Courtroom Confidential: Solutions to Real World Valuation Problems (May 10), with Pasquale Rafanelli (Grassi & Co.) and Jennifer Rosenkrantz (Schlissel Ostrow Karabatos PLLC).

Current Trends in Ambulatory Surgery Center Valuations (May 16), with Robert Mundy (Ankura Consulting) and Angie Smith (Ankura Consulting). This is Part 9 of BVR's Special Series presented by the BVR/AHLA Guide to Healthcare Industry Finance and Valuation.

Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist

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New and Trending LinkedIn Discussions

Why Does the Standard of Value Matter in Business Valuation?

Four Questions to Ask New Business Valuation Clients

BV Outsourcing to India Stirs Strong Feelings

Your discussion could be featured here—BVR's LinkedIn group is a place for valuation professionals to share, discuss, and learn about compelling BV topics. If you're not already a member, request to join:

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We welcome your feedback and comments. Contact Andy Dzamba (Executive Editor) or Sylvia Golden (Executive Legal Editor) at:
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In this issue:

Private COE

More ESOP woes

Brand values

Fairness opinions

FASB meets

Court queries

Big Data survey

Must-have book

BV NYC event

Global BV news

BV movers . . .

CPE events

LinkedIn discussions

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