Pulse of the BV profession: tax affecting is OUT, specialization is IN
When we first polled BV appraisers five years ago, their dominant concern was “the continuing debate on tax affecting,” which nearly half (42.1%) of those surveyed believed was the most “impactful” issue in 2006. The following year, the number had slid to roughly 28%; and this year, none of the respondents (0%) ticked off tax affecting from the list of practice- and profession-shaping issues.
The IRS has followed a similar slide: in 2006, over 31% of respondents picked “all things IRS” as having the greatest professional impact that year. (Remember, that’s when the Pension Protection Act came out, with its provision for appraiser penalties.) By 2007, only 16% of respondents believed that IRS issues had the greatest influence on their BV practices. This year, only 10% still do.
Fair value for financial reporting may have also peaked: in 2006, only 10.5% of those polled believed it was the most impactful issue, but that number more than doubled to 25.6% in 2007. This year, a mere 3.3% of respondents believe that FASB pronouncements are shaping the BV profession.
What issue has had the greatest impact in 2011? Why, the global economy of course, which nearly a third of respondents (30%) picked over any BV-specific issue. The same percentage (30%) picked the increasing specialization of the BV profession. Slightly fewer (20%) say that the day-to-day practice of determining discounts, cap rates, and other analytical inputs had the greatest influence this year; in fact, this percentage has slowly trended upward since 2006 and 2007, when 5.3% and then 11.6% of respondents, respectively, picked discounts as their primary concern.
Will the macro-economic crisis continue to dominate your practice in 2012? Or will it focus the BV profession on micro-specialties? We’ll cover the prospective aspect of our poll in our next issue (the last of 2011). There’s still time to participate: we’ve kept our online survey open. Its two questions will only take two minutes—and will help take the pulse of the profession now and in the years to come.
Taxpayer loses to bad facts in latest FLP case
In what’s likely to be this year’s last case concerning the taxable assets of a family limited partnership (FLP), the estate was buried by the following “bad facts” concerning formation and funding:
- Although the founder transferred roughly $6 million worth of real property to the FLP in 1997, he kept reporting the properties’ income on his 1997 and 1998 personal tax returns, and didn’t set up a separate bank account for the FLP until 1999.
- More importantly, the founder (and his advisors) “ignored” a formal appraisal of the FLP interests, choosing their own values for the partnership’s units by “unclear” methods, according to the court.
- They also ignored partnership formalities, failing to hold meetings, keep proper books and accounts, and execute a management agreement with the founder’s son.
- Finally, the founder commingled personal and FLP funds; and the FLP paid many of his personal expenses, including his debts, tuition for his grandchildren, and—later—his estate taxes.
The estate tried to argue that protection against partition of the properties (along with general protection against creditors) were the FLP’s legitimate, non-tax purpose, sufficient to except its assets from the reach of IRC Sec. 2036(a). But the Tax Court disagreed, finding under the “totality” of bad facts that the FLP served primarily as the founder’s “testamentary device,” such that the full, fair market value of its assets was taxable. Read the complete digest of Estate of Liljestrand v. Commissioner, T.C. Memo 2011-259; 2011 Tax Ct. Memo LEXIS 251 (Nov. 2, 2011) in the January 2011 Business Valuation Update; the Tax Court’s opinion will be posted soon at BVLaw.
DLOM—still a ‘controversial’ aspect of valuing PE interests
“Can I still apply a marketability discount for an unquoted company after calculating its Attributable Enterprise Value to determine its current Fair Value?” That’s one of the frequently asked questions regarding application of the International Private Equity and Venture Capital Valuation guidelines (IPEV). The answer:
The IPEV Guidelines suggest when comparator multiples are used from quoted companies, that an adjustment may be needed to reflect the difference between the liquidity of the shares being valued and those of the comparables. However, an adjustment for marketability should be applied to the multiple instead of the Enterprise Value in determining Fair Value. . . . A further marketability discount would not be appropriate because the concept of fair value assumes a hypothetical sale at the Reporting Date.
“I think in the past, there was double dipping with regard to the DLOM,” comments Jamie Buress (Duff & Phelps), who answered BVWire’s query on the topic. “The IPEV guidelines wanted to make sure this did not happen, so they suggest [discounting for DLOM] at the enterprise level—for example, by adjusting the multiple downward, instead of taking the discount at the end, at the entity level.” This is the aspect of the IPEV guidelines that Buress still sees as “controversial.” The reason: “Most of the empirical evidence on discounts has been done at the equity level, [but] in practice, I think most valuation analysts take the DLOM at the end, at the equity level.” Should practitioners adapt their approach to PE and VC valuations—or should the IPEV amend its current guidelines? Email your comments to the editor.
Updated USPAP now available for e-readers
The Appraisal Foundation has just released the 2012-13 Uniform Standards of Professional Appraisal Practice (USPAP); the new edition will be valid through December 31, 2013. As with prior years, this latest version includes the standards of professional practice as well as guidance from the Appraisal Standards Board (ASB) in USPAP Advisory Opinions and USPAP Frequently Asked Questions (FAQs). Among the new updates:
- Revisions to definitions of “Client,” “Extraordinary Assumptions,” “Hypothetical Condition,” and “Exposure Time”;
- Creation of a new Record Keeping Rule and related edits to the “Conduct” section of the Ethics Rule;
- Revisions to Advisory Opinion 21, USPAP Compliance; and
- Revisions to Standards 7&8: Personal Property, Appraisal, Development, and Reporting.
Of greater interest, perhaps: the TAF is making this and future USPAP editions available as e-books—specifically, for the Amazon Kindle and the iPad, Nook, and Sony Reader. For more information on purchasing the updated USPAP in all formats, visit the TAF Store.
Pratt’s Stats’ top five industries in 2011
Restaurants continue to top the list of transactions added to the Pratt’s Stats database in 2011, as sorted by SIC codes, followed by business services (not classified elsewhere) and software companies:
“There were no remarkable changes this year as compared to last,” says Adam Manson, BVR’s manager of financial research. Barring any atypical trends, such as the consolidation of automobile dealerships during the 1990s and the tech “bubble” of 2000-2001, the industry sectors that traditionally see the most business sales are the ones that have the most businesses. “There are a lot of restaurants,” Manson says, “so you will see many restaurant sales.” Sales from these top five business sectors helped add 1,637 transactions to the Pratt’s Stats database this year, bringing total transactions to 17,751.
Mean vs. Median? Notably, the current data reveal the differences between (1) pricing multiples in the various industries; and (2) the median and harmonic mean. “It’s interesting that many appraisers use median figures,” Manson says, “when, more often than not, the median may overstate the multiple.”
Proposed estate tax reform would do away with discounts
The latest tax reform proposal, which Rep. Jim McDermott (D-Wash.) introduced last month as the “Sensible Estate Tax Act of 2011,” would raise the maximum estate and gift tax rate to 55% and lower the applicable exclusion amount to $1 million. It would also eliminate valuation discounts on investment assets, such that:
the value of any nonbusiness assets held by the [passive] entity shall be determined as if the transferor had transferred such assets directly to the transferee (and no valuation discount shall be allowed with respect to such nonbusiness assets).
Few authorities predict that H.R. 3467 will pass as currently drafted. However, most pundits agree that tax reform in 2012 is as certain as—well—taxes, and that any proposal will attempt to capture the enormous wealth transfer of aging baby boomers. Stay tuned ...
Bankruptcy court says BPC is ‘Daubert-proof’
The debtor planned to build a southwest Texas urban development in 2006—but by 2010, it defaulted on over $32 million in notes and filed for bankruptcy. A real estate equity group purchased the notes at an auction (and at a discount) and then objected to the debtor’s proposed reorganization plan in favor of its own ownership. To assess the debtor’s plan, the U.S. Bankruptcy court heard from several appraisal experts, including Paul French (Lain Faulkner & Co.), who estimated the required interest rate to return the present value of the equity investors’ claims.
Starting with the five-year T-bill rate of 1.71% as his risk-free rate, French adjusted it to account for specific risk factors associated with the debtor, the property, and the loan agreements, and then adjusted it further for each tranche (senior, junior, and equity) to reach “final” rates, as applied to two different appraisals of the property, of 6.25% and 7.75%. Without detailing the data from which French derived his numbers, “suffice it to say that his research was extensive and well-planned,” the court noted, adding that “his opinions are defensible under the most rigorous Daubert analysis.”
To reach his opinions, French used the Butler Pinkerton Calculator—Total Risk Calculator (BPC). In addition to the court’s approving his methodology, his “BPC calculations, along with all of my work, were entered into evidence without objections,” French tells the ’Wire. After making its own adjustments for some of French’s assumptions, the court ultimately concluded that it would accept a “cramdown” rate between 6.27% and 6.59%. We’ll have the complete digest of In re Village at Camp Bowie I, No. 10-45097 (Bankr. N.D. Tex.)(August 4, 2011) in a future Business Valuation Update; the court’s opinion will be available soon at BVLaw.
PCAOB on accounting for risk in today’s economy
Last week the Public Company Accounting Oversight Board (PCAOB) published Staff Audit Practice Alert No. 9: Assessing and Responding to Risk in the Current Economic Environment (Dec. 6, 2011).
"This practice alert discusses issues posed by the current economic situation and highlights certain requirements in the new risk assessment standards,” says Martin Baumann, PCAOB chief auditor and director of professional standards. “Auditors should be alert to the new requirements . . . and how those requirements relate to audits performed in the current economic climate."
"Today's volatile economic environment may affect companies' operations and financial reporting, which has implications for audits," adds PCAOB chairman James R. Doty. "The alert reminds auditors of their responsibilities under these conditions." The alert also analyzes the auditor’s risk assessment by reference to four categories: 1) the impact of economic conditions; 2) fair value measurements and estimates; 3) a company's ability to continue as a going concern; and 4) financial statement disclosures.
IVSC issues new ethical and competency codes
Following two published exposure drafts and analysis of the comments received, the professional board of the International Valuation Standards Council (IVSC) approved the Code of Ethical Principles for Professional Valuers at its recent annual meeting in Hong Kong.
The new code has two main functions, according to an IVSC release. The first is to establish “five fundamental principles” that all IVSC members should have in their respective codes of conduct. The second is to provide a comprehensive code that members can adopt or adapt to their own.
Two months left to comment on competency framework. The IVSC has also issued a second exposure draft of A Competency Framework for Professional Valuers, which clarifies the paper’s purpose and proffered guidelines. “The intention is to establish a high level framework describing the competencies that the public could reasonably expect from a professional valuer,” the introduction notes. “This has been done by attempting to identify the essential characteristics of a professional valuer based on criteria that are common to [IVSC member organizations]. It is not intended to either endorse or criticize any Valuation Professional Organisation’s qualification or accreditation criteria.” Comments are due by Feb. 28, 2012.
Still need 2011 CPE? Try our new self-study program
Did you know that BVR now offers self-study programs in continuing professional education (CPE)? From the comfort of office or home, business appraisers can now receive up to 2.5 CPE credits by listening to programs carefully selected from BVR’s vast archive of valuation webinars and taking a simple online exam. Hear from top experts in the valuation and legal professions and tick “CPE” off your end-of-the-year “to do” list. For eligible courses and a complete description of how the process works, visit BVR’s Self Study CPE web page.
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