BVWire Issue #155-3 | August 19, 2015


New Chancellor’s first words on tax affecting in fair value case

Tax affecting is alive and well in the Delaware Court of Chancery, as new Chancellor Bouchard’s recent decision in a joint fiduciary duty and appraisal action makes clear. As part of the discussion, the court addressed the issue of whether or not a valuation based on the controlling Kessler model should consider the company’s earnings distribution policy.

‘Blitzkrieg-style’ merger: A company’s former president sued his partners—and the company—alleging they orchestrated a “boom, done, Blitzkrieg style” merger in which he was cashed out for a mere $26.3 million. At the same time, he petitioned the court to determine the fair value of his shares. The company was organized as a Subchapter S corporation.

Both of the opposing valuation experts performed DCF analyses but arrived at spectacularly different conclusions. According to the petitioner’s expert, the stock’s value was $52.65 million. In contrast, the company’s expert said it was worth $21.5 million. Tax affecting was one of the major disagreements shaping the results. The petitioner’s expert concluded it was appropriate to tax affect the company’s earnings using a 21.5% tax rate to account for its S corp status. The company’s expert rejected tax affecting and applied a 44.8% tax rate. But he said that, if the court were to tax affect, it should use a 34.1% tax rate. This rate was based on the premise that the petitioner should only receive the value of being an S corp stockholder for the actual distributed earnings (76.7%), not for earnings the company retained and reinvested in the company (23.3%).

The court found this rationale problematic. At the start of its analysis, it noted that the petitioner had a right to that which had been taken from him. “A critical component of what was ‘taken’ … in the Merger was the tax advantage of being a stockholder in a Subchapter S corporation.” It said that adequate compensation for the petitioner’s loss required tax affecting the company’s earnings as part of a DCF valuation.

Operative metric: In terms of how much of the earnings should be subject to tax affecting, “the operative metric under the Kessler-based valuation method is not the actual distribution made by a Subchapter S corporation, but the amount of funds that are available for distribution to stockholders.” To conclude otherwise would deprive the petitioner of “his proportionate interest” in the company as a “going concern,” the court said. Also, here, the company did not actually reinvest significant amounts of its undistributed earnings in the business. Instead, it kept the earnings as cash on its balance sheet. And it did not need to reinvest earnings to grow. Both experts testified that the relevant projections included all of the capital expenditures necessary to enable the company to generate the projected future cash flows.

Using the Kessler model, the court determined the appropriate tax rate was 22.71%. Under its own DCF analysis, it valued the petitioner’s shares at $42.16 million.

Takeaway: Experts using a DCF analysis in a fair value proceeding must treat company earnings in a way that accounts for the tax advantages of being an S corp stockholder, i.e., tax affect. What matters is the amount available for distribution to stockholders, not the company’s decisions of how much to distribute.

Find an extended discussion of Owen v. Cannon, 2015 Del. Ch. LEXIS 165 (June 17, 2015) in the October issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.

Extra: The recent book, Taxes and Value: The Ongoing Research and Analysis Relating to the S Corporation Valuation Puzzle, is a major advance in thinking about tax affecting with respect to pass-through entities. The book, authored by Nancy J. Fannon (Meyers, Harrison and Pia LLC) and Keith Sellers (University of Denver) is available from BVR. For more details, click here.

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Key nuances of valuing wineries

When valuing a winery, experts should generally approach it as they would any other manufacturing process—with a few key differences, explains Keith Meyers (Perkins & Co.), who conducted a recent webinar on valuing wineries.

Proper aging: First of all, the process of turning grapes into wine has a long lead time—about two years—according to Meyers. “Because of this long process, inventory turnover is very slow,” he says. Also, it takes a number of years for inventory to “stabilize,” which means you need to extend your forecasts past the stabilization period. “You may have to forecast out up to 10 years to develop a reasonable value,” he says.

Another factor to consider is that the inputs to the process are not typical raw materials—they are agricultural products that can be volatile due to the effects of Mother Nature. “The quantity and quality of the inputs—the grapes in this case—can change materially from year to year, so you need to take that additional risk into account,” he advises. In some cases, wineries have had to scrap as much as a year’s production because of problems with the grapes or the quality of the wine.

Bitter taste: There’s one issue that can have a major downward impact on valuation—and it has nothing to do with the grapes. If the owner has plopped a million-dollar mansion onto the property and uses it as a primary residence, the value of the winery will be negatively impacted, Meyers points out. Potential buyers will then be limited to “lifestyle” buyers—those looking to live and work on the property in grand style. Better to have a modest structure on the property that the new owner can possibly convert to other purposes, such as housing for the vineyard manager or winemaker.

To access a recording to the webinar, Special Considerations in Valuing Wineries, click here (purchase required).

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Hospital M&A market held steady in 2Q15

During the second quarter of 2015, the hospital acquisition market remained steady, with 23 transactions announced. This is the same number of deals announced in the first quarter of this year, according to the Health Care M&A Report. The number of deals is up one compared from the 22 deals done in the second quarter of 2014.

“Hospital transactions have become trickier to track in recent years, as some hospitals and health systems have formed strategic partnerships, joint ventures, or clinical collaborations. The 23 announced in the second quarter are true mergers or acquisitions,” says Lisa E. Phillips, editor of the report. With a total of 56 hospital deals recorded in the first half of 2015, M&A activity in this sector could surpass the 100 hospital transactions announced in 2014.

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Complimentary list of links to sources of state economic data

There is a great deal of state and territory economic information available online—at absolutely no cost. BVR is happy to provide an updated list of links to these sources, and you can download the document, entitled Sources for State-by-State Summary of Economic Information, 2015 if you click here.

This list is updated regularly and is made available to subscribers of BVR’s Economic Outlook Update, a one-of-a kind review and forecast of the national economy.

Help us out: If you use any free sources that don’t appear on the list, please share them with us, and we will add them. Please send state economic source contributions to

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Global BV news:

Recent events put the focus on your international valuation toolbox

Valuation professionals cannot afford to ignore what is happening in the global economy, especially in light of recent events. Last week’s devaluation of the Chinese Yuan has triggered a debate on the potential impact on American businesses. Then there’s the Fed’s decision on whether or not to raise interest rates—a decision that will be made at its upcoming September meeting.

In today’s economy, it is rare for a U.S. company to be completely insulated from the rest of the world. It could be as simple as having to deal with suppliers, competitors and/or customers located abroad, but it could also extend to having physical operations in foreign countries. Exposure to other countries typically creates new sources of risk that need to be incorporated in valuations.

One of the first decisions a valuation analyst needs to make is whether to reflect country risk in the projected cash flows or in the discount rate (or a mixture of both). “While ideally one would prefer to incorporate the incremental country risks directly in the projected cash flows, the reality is that it can be very difficult to develop truly “expected” projections (i.e., probability-adjusted) in an international setting, especially when dealing with countries where lack of reliable data prevails” says Carla Nunes, a senior director at Duff & Phelps. 

Most analysts end up adjusting the discount rate when attempting to capture country risk. Several international cost of capital models are available, but it can be challenging for practitioners to find the appropriate underlying inputs. Developing robust inputs can be time-consuming and cost prohibitive for many valuation practitioners, but simply selecting a subjective country risk premium is not likely to be a defensible alternative. “We live in an environment where adding an ad-hoc country risk premium to the discount rate is no longer acceptable,” says Duff & Phelps director Jim Harrington. Practitioners see their valuations scrutinized by auditors, the SEC, the IRS, foreign tax authorities, courts, and other regulatory bodies. “Your valuation conclusions will be more defensible if you can corroborate your estimated country risk premium with third-party sources,” he adds.

Fortunately, there are some readily-available resources, all with their own pros and cons, of course. For example, Professor Aswath Damodaran (New York University Stern School of Business) publishes country risk-adjusted equity risk premia on his website for a variety of countries. However, there are a number of caveats posted on his website about the usage of his data, and he explicitly indicates that it was never his intent for it to be used in the legal arena. 

The Duff & Phelps 2015 International Valuation Handbook – Guide to Cost of Capital is a new resource providing country-level country risk premia, relative volatility factors, and equity risk premia, which can be used to estimate country-level cost of equity capital globally, for up to 188 countries, from the perspective of investors based in up to 56 countries. BVR has a webinar on how to use this annual publication, and you can access it—at no charge—if you click here.

Also look for an early-2016 Business Valuation Update article by Jim Harrington and Carla Nunes for a more detailed discussion of country risk rating sources, as well as how they can be converted into usable country risk premia information.

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How do you handle the size premium?

There's no consensus in the valuation profession about the application of the size premium. Does it still exist? Is it already included in other measures? Is it the same for all industries and time periods? Help us examine this issue by taking a short survey on how you apply—or not apply—the size premium. Your responses will be confidential and we’ll report the results in a future BVWire. In exchange for your response, you will be given access to an exclusive interview with Pablo Fernandez (University of Navarra) in which he gives his views on the subject. Thank you in advance for your help! To take the survey, click here.

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Preview of the September issue of Business Valuation Update

Here’s what you’ll see:

  • The Misuse of Bid Premium Data to Determine Minority Discounts (Andrew Strickland and Robert Dohmeyer). The concepts surrounding the use of bid premium data in valuing private companies are like “guests who have outstayed their welcome.” The authors explain how these data have historically been misused.
  • Authors Respond to Comments on Their New S Corp Book (BVR Editor). BVR has received comments on the new book, Taxes and Value:  The Ongoing Research and Analysis Relating to the S Corporation Valuation Puzzle, by Nancy Fannon and Keith Sellers. The authors respond to what some say is an omission of certain studies they feel are relevant and should have been included in the book.
  • Why Valuation Experts Should Not Use the Term ‘Non-Marketable’ (Ronald D. Rudich). The author puts forth a new paradigm describing levels of value that moves away from the use of a negative term when informing clients of the value of their control or minority interest.
  • BVU PROFILE: A Perspective on Business Valuation From South of the Border. An interview with Adriana Berrocal, the founder and managing director of BValue Consulting, a firm based in Mexico City.
  • IPCPL and Margin Reversion: Implications for the Valuation of Small Privately Held Companies (Igor Gorshunov). The author describes an empirical test he conducted of the implied private company pricing line (IPCPL), which is a new method designed to eliminate the inherent problems in comparing public and private data. IPCPL adds another approach in estimating the cost of capital for a privately held business.
  • Pros and Cons of Models for Estimating the Cost of Equity in a Global Setting (BVR Editor). At the 2015 International Valuation Forum in Atlanta, sponsored by the International Association of Consultants, Valuators and Analysts (IACVA), James Harrington (Duff & Phelps) gave a rundown of the models for developing the equity component of international cost of capital using the capital asset pricing model (CAPM).
  • Valuators Are Now Entering the M&A Picture Sooner (Raymond Weisner). The author, who is with Valuation Research Corporation, sees that more and more companies are performing pre-acquisition valuations, and valuators are being called in earlier in the process. He explains the valuation issues they are focusing on during this time.
  • New Features: Ask the Experts and Tip of the Month. Valuation experts answer puzzling questions and give some practical advice on a wide variety of topics.

To read these articles—as well as digests of the latest court cases—see the September issue of Business Valuation Update (subscription required).

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New regional NACVA events kick off in Pittsburgh Sept. 14-16

The National Association of Certified Valuators and Analysts (NACVA) has introduced four regional “specialty conferences” this year, with the first one taking place in Pittsburgh Sept. 14-16. This conference will focus on business valuation, including valuing family limited partnerships, BV foundations, and BV leading-edge topics. There will be two keynotes: one on growing your practice (Lee Fredericksen) and one covering updates of industry standards (Robert Grossman and Mark Kucik). For more information, click here.

NACVA’s other regional specialty conferences will be held in Houston (Oct. 18-20), San Diego (Nov. 16-18) and Ft. Lauderdale (Dec. 6-9).

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BV movers …

People: Andrew Burczyk was elected president of Mayer Hoffman McCann (MHM) and succeeds Bill Hancock, current CEO of the firm who will remain chairman of the board of directors. Jay Webber, based in the firm’s Boston office, Linda Lauer in Memphis, Bruce Murphy in Tampa Bay, and Laurie Hopkins in St. Louis are the recently elected members of the MHM Board … Stephen Chipman, senior vice chairman of Grant Thornton LLP, announced his early retirement effective October 31, 2015 after 34 years in various roles across the firm’s global network including U.S. CEO and leadership positions in Europe, North America, and Asia … Daniel Golish, principal in the valuation and litigation advisory services at Skoda Minotti in Columbus, Ohio, was honored as a “40 Under 40” recipient” by the National Association of Certified Valuators and Analysts (NACVA) … Daniel Rahill, current chairman of the Illinois CPA Society, has joined Alvarez & Marsal’s Chicago office as managing director … Michael Stachowski, of Kansas City, Mo., was recognized as a “Professional of the Year” for his outstanding contributions and achievements in the field of financial planning by Strathmore’sannual Who’s Who … Renee Andrews-Tushinski was elected to director at the Chicago firm Ostrow Reisin Berk & Abrams, Ltd., where she focuses on trusts, estates, and high net worth clientele. 

Firms: Bergan Paulsen (Iowa), Kern Dewenter Viere (KDV) (Minnesota), and Networking Solutions (Iowa) have merged and are rebranded as BerganKDV … BKR International has accepted TRI-S-Audit of Tashkent, Uzbekistan into its global membership organization … The Brenner Group, a professional services firm based in Silicon Valley, will join the Armanino company effective September 1 … The Montreal-based Crowe BGK LLP merged with the Ottawa accounting practice, Connolly & McNamara,  and has nearly  doubled the size of its Ottawa division to 30 employees and four partners … Templeton & Company, a South Florida-based firm, has merged with the Wellington, Fla., firm Cocuy, Burns & Co, growing the firm to over 60 professionals … Weiss & Company, based in Glenview, Ill., merged with Allen C. Berg, CPA and his staff, adding extensive experience with high net worth clientele and family office services to the firm’s portfolio of services.

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August winds down with some great CPE events

Unconventional Drilling and the Impact on Valuing Oil & Natural Gas Rights (August 25), with Joshua Lefcowitz.

Valuing Beer, Wine, and Alcohol Distributors (August 27), with Timothy Lee (Mercer Capital).

Valuation of Customer-Related Intangible Assets (August 28), with Robert Reilly and John Elmore  (both Willamette Management Associates). This is Part 6 of BVR's 2015 Special Series on Intellectual Property

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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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963 ext. 133
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In this issue:

New Chancellor's ruling

Nuances of wineries

Hospital M&A

State economic data

Global BV news

Size premium

September BVU preview

Steel City BV event

BV movers

CPE events












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