| Trial court relies on just cash flows (but not gross sales) to value a high-revenue restaurant A couple owned a 60% interest in a successful Ohio restaurant. During their divorce, the wife’s expert valued the restaurant at $650,893. Interestingly—the husband’s first expert used a “blended” approach (percentage of average cash flow and gross sales) to find the restaurant was worth $691,000—or nearly $40,000 more than the wife’s. Perhaps that’s why the husband retained a second expert, who reduced the first valuation to take into account cash, deposits, accounts and notes payable, and reached an “adjusted value estimate” of $279,494. The trial court started with the husband’s first valuation—but it may have misheard the expert’s testimony, because it found that a restaurant valuation could be based on a percentage of gross sales or a percentage of cash flow; and in this case, the profitable restaurant would likely sell for 2.5x cash flow. This resulted in a value of nearly $795,000—which exceeded the expert’s blended average by roughly $104,000, so the court added this amount to the second expert’s value, to reach a final determination of nearly $385,000, allocated to the husband. On appeal in Foppe v. Foppe (Oh. App., Dec. 30, 2009), the husband argued that the trial court should have relied on both portions of his expert’s value—but the appellate court disagreed. On closer examination, the first expert used a range of values from both cash flows and gross sales, and he testified the former would likely determine the sales price. Although the trial court may have “misstated” the expert’s valuation methods, its decision was based on competent evidence, including the restaurant’s steady revenue growth. To ensure clear, comprehensive, credible values, take a look at the just-published, BVR’s Guide to Restaurant Valuation by Ed Moran (along with industry professionals.) The Guide includes a fascinating overview of the industry—including an inside look at “winning kitchens”—and provides details on site visits, market research, fixed asset values, financing, using projections, the market approach, franchises, and more. Check out the table of contents for a “complete smorgasbord” of all this Guide offers: You’ll be impressed by the variety and by its winning style. Damodaran sees "back-filling" after surprisingly quick ERP rebound “I must confess that I was surprised at how quickly the market has come back from the crisis, though the economies seem to be lagging,” admits Professor Aswath Damodaran (NYU Stern School of Business), in his latest e-newsletter (Feb. 5, 2010) (available at his website). “During the year, the equity risk premium dropped from 6.43% to 4.36% and default spreads also narrowed dramatically; we are effectively back to where we were on Sept 12, 2008. Emerging markets bounced back particularly well and the gap between developed and emerging markets narrowed substantially.” There may be some “back-filling” this year, the Professor adds, as the market tries to consolidate its gains. “Much will depend on whether we see more shocks to the system (Greece default?) and how strong the economic recovery is.” Busy as always, Damodaran has just finished updating The Dark Side of Valuation—Valuing Young, Distressed, and Complex Companies, and the third edition of his applied corporate finance text (in which he expands the analysis of Disney, Aracruz, and Deutsche Bank and adds Tata Chemicals to the mix), should be in bookstores in a couple of weeks. “I hope to finish a third project this year,” he says: a book on the lessons learned from the economic crisis. “It is a work in process, since I keep learning new lessons.” Download Delaware Chancery case digest on size premiums, S Corp values, CSRP, and more Our item on In re Sunbelt Beverage Corp. Litigation, 2010 WL 92519 (Jan. 5, 2010) in last week’s BVWire™ provoked a slew of inquiries and comments. The case “has got all kinds of tidbits,” writes Nancy Fannon, including the Delaware Chancery Court’s views on size premia, company-specific risk premia, and the exclusion of a post-merger S Corp conversion from its valuation. (“Don’t get me started!” Fannon says.) “Boy, what a fascinating case,” agrees Neil Beaton, after plowing through the lengthy opinion, which pits a well-known appraiser against a Harvard Business School corporate finance professor. (Hint: “Courts like teachers,” Fannon observes, “they teach.”) Don’t try a CSR in Delaware. The court did not like the “rush job” on the fairness opinion, provided by a financial firm just one week prior to the merger. As Jeffrey Tarbell notes, “the criticism of a financial advisor ‘rushing’ their analysis at their client's demand is nothing new. But it illustrates the need for fairness opinion issuers to be familiar with relevant case law and what the Chancellors like and don't like. Appraisers and investment bankers should also take heed, if they don’t already, that company-specific risk premiums won't fly in Delaware.” We’ve just posted the case digest as our latest free download. Comments welcome. Does the selection of the size premium from Ibbotson data really pose a problem in circularity? And what about the company-specific risk premium: Does it have a future in Delaware—or any other major forum? Are the judges really looking for better, empirically based data—or do they essentially believe the CSRP adjustment is redundant? Email the editor and we’ll continue the discussion… Last chance to register for free Duff & Phelps COC webinar The 2010 Duff & Phelps Risk Premium Report (D&P) webinar is tomorrow…Thursday. Co-authored by Roger Grabowski and David King, this year’s D&P Report expands the best available (and defensible) cost of capital measures—and adds two free bonuses from BVR: the Cost of Capital Reader, a supplemental collection of articles and presentations on all things cost of capital; and “Duff & Phelps Report 2010: Learn from the Master,” this 100-minute teleconference taking place February 18th, featuring Grabowski and a “hands-on” application of the D&P data, including time for “live” (by email) Q & A. Attendance to the teleconference can also be purchased separately—and if attendees like what they hear, they can apply the entry fee to their later purchase of the complete 2010 Duff & Phelps Risk Premium Report. A ‘too good to be true’ FLP case? Samuel Black Jr. was born into poverty in 1902, began peddling bread and newspapers in his Pennsylvania hometown when he was 11; started with the Erie Indemnity Co. in 1925 when it just insured automobiles, and stayed until he was senior vice president and a director—and the company was a national, multiline insurer. Bullish on the company but a conservative “buy and hold” investor, Black bought Erie shares at every chance, until his holdings were worth nearly $80 million in 1993. Wanting to pool, protect, and preserve the family’s wealth for his son and grandsons, Black formed a family limited partnership (FLP). He contributed all his Erie stock and maintaining a 1% GP interest, disbursing LP interests among his son and grandsons’ trusts. When he died in 2001(and his wife of nearly seventy years followed in 2002), the Erie stock was worth over $318 million. The IRS challenged the FLP transfers under Sec. 2036(a), claiming its full, fair market value should be brought back into the estate for taxation. The estate claimed only the FMV of the LP interests should be taxed—and the Tax Court agreed, finding a host of factors to support the FLP’s formation for a bona fide, business (non-tax) purpose at adequate consideration, even though the assets consisted entirely of marketable securities donated from primarily one person. As Owen Fiore observes in his newsletter, “Were the facts in Black...so good that most, if not all, of our clients will not be able to match them?” Read our digest of Black v. Comm’r (T.C. Memo, Dec. 2010) in the next (March 2010) Business Valuation Update™. The full-text of the court’s opinion will be available soon at BVLaw™. IVSC taking applications for three new working groups The International Valuation Profession Board (IVPB) is currently developing best practice guidance in four critical areas:
Work is already underway in the first area. In the meantime, the IVPB is creating three work groups in the three remaining areas. Anyone interested in joining any group should send a CV to the IVSC Executive Director, mtissier@ivsc.org, by February 28, 2010. The groups will not meet in person but conduct most of their work by email and conference calls under the guidance of a Chair (to be selected from the IVSB). In further news, the International Standards Valuation Board (ISVB) plans to rewrite and update the current edition of International Valuation Standards (8th edition, 2007). The improvements will fall into three broad categories: to remove any bias toward a single asset type; to improve the structure of the book and the focus of the standards; and to remove material that purports to dictate valuator behavior. The ISVB wants to release an exposure draft in May 2010 with publication to follow by the year. BPC adds German Stock Exchange data The Butler Pinkerton Calculator™ recently added data from the Canadian Exchange, and now appraisers can access the German stock index. Jim Catty (Chair of the International Association of Consultants Valuators and Analysts, IACVA) encouraged the addition, indicating that IACVA will soon be updating their instructional materials for Germany (and the U.K. may not be far behind…) Step 1 of the BPC provides a full description of the new data source: “The Composite DAX, or CDAX, is a performance index of the Deutsche Börse AG, covering some 750 companies listed in the top segments, capital weighted and adjusted for capital changes, subscription rights, and gross dividends without corporate income tax.” In Step 2, appraisers can add the extension of .DE or .F to any entered German stock symbol and pull data from the German Exchange.
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