August 3, 2011 | Issue #107-1  

What happens to the risk-free rate if (when) U.S. debt is downgraded?

A BVWire reader recently asked us this question, and we turned to Roger Grabowski (Duff & Phelps) for one answer:

During these episodes of flight to quality [securities and assets], one needs to reevaluate simply using the quoted risk-free rate as the basic building block in estimating the cost of equity capital. One needs to identify whether the flight to quality has influenced the market interest rate. On a monthly basis, analysts could follow changes in the market interest rates relative to a rolling average of prior months interest rates and various economic indicators, for example, the flow of funds, the implied volatility derived from options, changes in estimates of inflation, etc. Once analysts suspect that the market interest rates are abnormally low, they could use a build-up approach to estimate a normalized risk-free rate looking at the real rate of interest and inflation estimates.

Look for Grabowski’s detailed response in the September Business Valuation Update.

Minority premium model may not apply to all properties

Last week’s item ’Minority premium’ model may not comply with FMV standard,” drew a response from James B. Lurie (CapVal-American Business Appraisers, LLC):

Depending on the type of property, and assuming that the holder of the 1% interest has an undivided right to use the $2 million property that Mills-Mazer presents as an example, it might be unreasonable for the holder to sell the fractional interest at anything other than a substantial premium. 

For example, if the subject property is a house on the beach, the utility of the undivided 1% interest would be far greater than $20,000, and the potential for impairing the 99% interest utility could be far greater than 30% (if, for instance, the 1% interest holder habitually sits in his underwear in the living room smoking cigars). By the same token, if the property is timberland that can be subdivided without impairing the value, maybe not. 

As always, it depends on the facts and circumstances, and neither IRS engineers nor independent appraisers can establish hard and fast policies that apply to all situations.

Majority rule on goodwill in divorce is ‘mistaken’

Nearly a year ago, the Wisconsin Court of Appeals broke new ground in divorce law when it held that all the saleable personal goodwill in a professional practice, as evidenced by a non-compete agreement, is a divisible marital asset. (See BVWire #96-2) The husband appealed, and in McReath v. McReath, 2011 WL 2706249 (July 12, 2011), the state Supreme Court affirmed, ruling that a trial court “shall” include saleable professional goodwill in the divisible marital estate. It specifically rejected the current majority rule, reasoning that “some courts” follow that rule, but the “premise on which the distinction is grounded—that enterprise goodwill is saleable and personal goodwill is not saleable—is mistaken.”

The court also held that any rule against “double-dipping” did not apply to the salable goodwill in the professional practice, which—like an income-producing asset—has value separate from the income it generates. The Supreme Court appeared more concerned with this issue during oral arguments, according to Stephen Beilke (Murphy Desmond SC), counsel for the wife at trial and during the first appeal. When the justices did focus on goodwill, “there were various questions related to what type of goodwill can be sold since there have been obvious problems with different classifications in previous case law,” Beilke reports. In the end, he believes that the opinion appropriately addresses both issues of goodwill value and the “double dip” (although a number of his peers disagree). The decision does not create a new “formula” for determining goodwill, Beilke adds, but confirms that “trial judges will have to analyze each business evaluation on its own merit to determine what type of goodwill is saleable.”

The S. Ct. also notes what made the valuation by the wife’s expert more credible than the husband’s, as detailed in the trial court’s opinion. “Underneath all of this is a message to those valuators who take extreme positions,” says Dennis Kleinheinz (Meicher & Associates LLP), the wife’s income expert at trial. A close read of all three court opinions “might help educate our profession on things NOT to do when valuing dental practices (or any other professional service business),” Klenheinz adds. Look for his further insights in a future BVUpdate; the complete case digest will appear in the September 2011 issue, and the S. Ct. opinion will be posted soon at BVLaw.

Download update. Lastly, we’ve also updated one of our most popular downloads, Goodwill Hunting in Divorce, to reflect the new Wisconsin ruling: get your copy here.

Two sources for comparable ‘useful life’ transactions

CFOs and valuation analysts performing purchase price allocation analyses (ASC 805) need to assess the useful lives of the intangibles in the acquired company. Pratt’s Stats subscribers already have access to nearly 2,000 purchase price allocations (from official filings), complete with “living” data. Here’s a random sample from one Pratt’s Stats transaction:

Allocation of the Purchase Price:

  • Cash and cash equivalents, $26,000,000
  • Accounts receivable, net $22,000,000
  • Intangible assets, $120,000,000
  • Deferred tax assets, $53,000,000
  • Other assets, $10,000,000
  • Deferred revenue, ($25,000,000)
  • Other liabilities, ($8,000,000)

Intangible Assets Acquired:

  • Customer relationships – subscription, hosting & maintenance, and perpetual software: $37,000,000 (10-year useful life)
  • Customer relationships – professional services: $13,000,000 (4 years); Developed technology: $60,000,000 (7 years)
  • Trademarks/trade names: $10,000,000 (10 years)

Identifying and valuing those intangibles is the next important step in the process, and Mark Zyla (Acuitas) will present a comprehensive overview in his Advanced Workshop on Valuation Issues under ASC 805 and Business Combinations, coming this November 3rd.

Tax, family law matters are still the top revenue generators

Tax and family law matters continue to contribute significant revenues to practitioners and their firms, according to the new 2011/2012 BV Firm Economics & Best Practices Guide (see table below). In fact, during the past two years, valuations for tax purposes have surpassed divorce valuations as the top source of revenues for BV firms, perhaps due to the reported “boom” in business transfers as Baby Boomers begin to exit their enterprises and plan their estates.

Percent of total business valuation revenue comes from the following
specialty areas (average for firms reporting any revenue in each specialty):

Practice Specialty



Tax, Gifts and Estates






Transactional (Including brokerage, mergers and acquisitions)



Fair Value for Financial Reporting (ASC 820, ASC 805 purchase price allocations, etc.)



Shareholder/Corporate (buy/sell agreements, shareholder disputes, etc.)



Incentive compensation arrangements






Bankruptcy and Restructuring



Transfer Pricing



Other revenue sources not listed above



Will tax matters stay on top, following BV-related litigation trends? Members of LinkedIn’s Business Valuation & Advisory Network recently responded to Gary Schurman’s (Applied Business Economics) query regarding the current (and future) hot beds of BV-related litigation. Some answers:

  • Discounts for lack of marketability (DLOMs)
  • Effect on value of pass-through entity tax status
  • Prices paid for pass-through entities
  • Control premiums
  • Earnouts  

Average deal termination fees at 3.5%

The just-released 2010 Transactions Termination Fee Study by Houlihan Lokey (HLHZ)—which summarizes key metrics for 2008-2010 M&A transactions—shows termination fees as a percentage of transaction value ranged from 0.9% to 30.4% in 2010, with a mean of 3.5% and a median of 3.3%–slightly higher than the mean in 2008.

“Properly crafted, a termination fee provision can facilitate the sale of a company by ensuring that the bidder will receive a material ‘consolation prize’ to defray its investment—in time, out-of-pocket expense and opportunity cost—if the transaction is not consummated,” the report says. “On the other hand, termination fees protect the acquirer by effectively increasing the price that a third-party bidder will need to pay to consummate a competing transaction.”

One of the best books of deal data: BVR’s partner PitchBook has just pushed its deal count over 50,000 domestic and international transactions (representing over $6.24 trillion of invested capital) in private equity and venture capital. Also available on the PitchBook Platform: data on deal sizes, transaction multiples, investors, sellers, lenders, service providers, company financials, and more. Over 41,000 companies, 14,000 investors, 14,000 funds, 158,000 people, 6,000 service providers, and 5,000 limited partners in the PE/VC universe are included in the database.

Contact BVR’s Lexie Gross about the PitchBook Platform, or click to the PitchBook/BVR Guideline Public Company Comps Tool.

New FTC report recommends 35 ways to improve IP value

The FTC, better known for its anti-trust and consumer protection oversight than IP matters, issued a new report: “The Evolving IP Market Place: Aligning Patent Notice and Remedies with Competition.” The report focuses on how well the patent system and competition policy could work together if there were:

  • More clearly defined patent rights and notice. Unclear patent notice undermines discovery of, and investment in, emerging IP. Competition is weakened as businesses are forced to design products with incomplete knowledge of costs and other potentially relevant technologies.
  • Patent remedies that replicate the reward the patent holder would have earned absent infringement. Effective remedies that boost the patent system’s incentives to innovate are essential, according to the report. The FTC wants remedies (such as injunctions and compensatory damages) to stop and/or deter infringement, thus protecting a patentee’s ability to earn returns. On the other hand, remedies that under- or over-compensate patentees for infringement, as compared to the market, can adversely affect innovation and competition.

Those wishing to wade through all 300+ pages will find 35 recommendations directed to Congress, the USPTO, and the courts.

Defined value transactions: what will (almost) certainly work

In his recently updated article, “Defined Value Gifts and Sales Under the Microscope: What’s Possible and What’s Not? – Revisited,” attorney L. Paul Hood analyzes “defined value transactions in isolation of the ‘factual baggage’ that too often has muddied the waters” when the courts and the IRS consider these “difficult” transactions. Hood’s 23-page article, also appearing in the July 2011 Tax Management Estates, Gifts, and Trusts Journal (BNA), notes “What we are (virtually) certain still will not work” as well as “What should still work.”

Best, brightest CPE opportunities from BVR

This Friday, August 5th, the Online Symposium on Healthcare Valuation continues with “Lost Profits Damages in Medical Practices.”  Part 7 of BVR’s Symposium features expert James Lloyd (PYA) and series curator Mark Dietrich dissecting the more difficult and delicate aspects of combining appraisals for lost profits damages with medical practice valuations.

On Thursday, August 11th, BVR welcomes attorney L. Paul Hood Jr. and appraiser Timothy Lee (Mercer Capital) for “Business Appraisal Reports: Perfecting the Art,” a 100-minute presentation that will address best practices and common pitfalls in the most critical step in the valuation process: the appraisal report. 

And for an estimated two CPE and CLE credits per program: join Timothy Devlin (Fish & Richardson) and William Marsden (Fish & Richardson) for BVR’s new Litigation and Economic Damages Series beginning September 13th with “Working with Financial Experts.” The two attorneys will examine and explain the key considerations that lawyers use when selecting and developing a case with financial experts—as well as tips for defending aggressive challenges in court. For more information on the Symposium—including a full list of programs, and a preview of Litigation Desktop Learning Center, an online multimedia library available to Symposium subscribers—click here.


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Copyright © 2011 by Business Valuation Resources, LLC
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Lost Profits Damages in Medical Practices
Part 7 of BVR's Online Symposium on Healthcare Valuation
August 5, 2011
10:00am - 11:40am PT
Featuring: Mark Dietrich
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The Business Appraisal Report: Perfecting the Art
August 11, 2011
10:00am - 11:40am PT
Featuring: L. Paul Hood Jr. and Tim Lee


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