February 29, 2012 | Issue #113-5 | Printer Friendly Version - Click Here  

Take a larger view of tax affecting, says new paper from Fannon, Sellers

Nancy Fannon (Fannon Valuation Group) and Prof. Keith Sellers (University of Denver) have just published their new paper, “Valuation of Pass-Through Entities: Looking at the Bigger Picture” on SSRN. In the article abstract, the authors first note the “critical and ongoing controversy” regarding the relative valuation of closely held, pass-through entities vis-à-vis traditional corporations in the valuation community. Then they add:

This paper documents a wealth of empirical research that demonstrates that the Tax Court, the IRS, and indeed the valuation profession are missing the larger issue. Cost of capital estimates based on publicly traded markets impound shareholder-level taxes, but at varying rates across firms and over time. Fortunately, research may also provide a means of removing the effects of shareholder-level taxes, yielding an untainted and defensible cost of equity capital appropriate for the valuation of closely held companies.

“Whether you agree or not, this paper adds to the body of knowledge regarding how we choose to treat pass-through entities that are the subject of an appraisal,” comments Rick Warner, editor of the ASA’s BV E-Letter. Fannon and Sellers just presented their new paper this past week in New Orleans at the mid-year 2012 meeting of the American Tax Association, held in conjunction with the annual Journal of Legal Tax Research Conference. Afterwards, their paper was ranked among the top ten SSRN downloads.

‘Step Zero’ of goodwill impairment is no ‘slam dunk’ 

In providing “Step Zero” to assessing goodwill impairment, the FASB’s ASU 2010-28 now permits companies to use an optional, qualitative approach to determine whether it is “more likely than not that” the fair value of a reporting unit is less than its carrying amount. (If so, then Step 1 is required.)  But, "Step Zero is not a slam dunk,” according to Mark Zyla (Acuitas), one of several experts to address the NACVA/CTI 2012 Congress on Fair Value in Seattle this week. “Companies who say, 'we've got a break,' are being overly simplistic,” Zyla said. “They still have to be audited." 

Bruce S. Koch (Seattle University) asked:  “Do you know of any studies that indicate how many companies have employed Step Zero?”  In response, Alfred King (Marshall & Stevens), a member of the Appraisal Issues Task Force, described a recent meeting in which members asked each other how many of their clients were using Step Zero. “The answer was very few,” King reported.

In another conference session, Jason W. Woon (KPMG) told attendees that in the recent 2011 Goodwill Impairment Study (from Duff and Phelps and the Financial Executives Research Foundation) the majority of respondents—69% of private companies and 81% of public companies—expected to employ the qualitative assessment for some or all of their reporting units. “Whether they actually go ahead and employ Step Zero is another question,” several attendees added.  For those who couldn’t make the 2-day conference this week, NACVA has made the materials available here.

No empirical basis for S corp premium in control transactions

First—our sincere apologies to Josh Angell, who’s not an intern (as last week’s issue incorrectly stated), but who has worked in the BV department of Moore, Ellrich, & Neal for the past three years. Angell is also the author of the recent article on the FMV Restricted Stock Study that fed the flames of another ongoing controversy within the BV profession on deriving the discount for lack of marketability. (For various views on Angell’s article, see the item below.)

Showing that he’s not afraid to take on tough topics, Angell has just posted a new article, “Empirical Research Generally Does Not Support S Corp Premium in Control Transactions.” Starting with the 18,000-plus private market transactions in the Pratt’s Stats database and then filtering the data for nine different variables—including buyer-type, industry affiliation, and year of sale—Angell ultimately concludes that there is “no empirical evidence to support the existence of an S corp premium in stock transactions in the market for control. Other valuators may find this information useful,” he adds.

Pratt’s Stats adds new Analyzer tool

Pratt’s Stats has just added a new, enhanced functionality. For no additional cost, current as well as new subscribers and single-search users can now take advantage of the Pratt’s Stats Analyzer, a new Excel-based tool that greatly improves a user’s ability to analyze selected transactions. Although users have always had the option of downloading their data into Excel, the Pratt’s Stats Analyzer takes that functionality to the next level by offering built-in tools to select and deselect transactions, create scatter graphs with the data, calculate regression formulas, and compute and apply median, mean, and harmonic mean valuation multiples. After completing their analysis, searchers can export any or all of their worksheets to a new Excel workbook. To sum up its key highlights, the new Analyzer enables analysts to:

  • Use search tools to easily select and deselect transactions from their analysis;
  • Use scatter graphs to quickly determine outliers;
  • Quickly compute valuable statistics from the selected sample of comps;
  • Calculate and then apply various regression formulas and valuation multiples to the subject company; and
  • Export selected sheets into their custom reports.

“The new Pratt’s Stats Analyzer provides the user with analysis tools that go beyond the web site’s search capabilities and should add immeasurably to the usability of Pratt’s Stats,” says Doug Twitchell, Publisher of BVMarketdata. For more information, visit Pratt’s Stats or contact Doug.

New distributor model for valuing customer relationships to be featured in TAF best practice aid, due in March

Traditional valuation approaches tend to treat customer relationships as a company’s primary asset and thus may overstate their value, particularly when an IP asset (such as a brand or technology) is the key business driver. In these instances, analysts at Valuation Research Corporation (VRC) determined that using market observations of both wholesalers and distributors as inputs in a multiperiod excess earnings method may be an appropriate approach to valuing certain types of customer relationships.

“The method assumes, and is best used when, the relationships held by a distributor with its customers are similar to those held by a company whose primary asset is something other than customer relationships, i.e. brands, technology, capital assets,” explain P.J. Patel and Ed Hamilton (both of VRC). “Distributors and the subject company have the same key driver: the ability to provide the desired product or service in a timely manner. As such, distributor inputs are a reasonable proxy when valuing the relationships of the target company.”

Patel and Hamilton are currently working on a case study of the DM for the Business Valuation Update. In the meantime, the DM will be part of The Appraisal Foundation’s (TAF) best practice guidance for valuing customer relationships, says Patel; look for the working draft to be released by the end of March.

Private COC database—scorched earth or valuation oasis?

John Paglia (Pepperdine Private Capital Markets Project) recently put out a “call for action to expand the thought leadership on private cost of capital by performing rigorous research on relevant topics such as minority interests, DLOMs, using private cost of capital (PCOC) for fair value engagements, case studies, etc.,” he says, in a posting at LinkedIn’s BV Professional’s forum (membership required).

In the lively debate that followed, commentators such as Pete Butler (Valtrend) and Rick Warner (Great Lakes Valuation) believe that the PCOC is an important tool in the valuation analyst’s tool box, but not to the exclusion of an analyst’s traditional reliance on data from Ibbotson’s, Duff & Phelps, etc. “Be very careful with the scorched-earth mantra,” Butler tells Paglia. “While I like what you are attempting to do, I could never rely upon your surveys as my only cost of capital reference source.”

“I certainly understand the importance to have many tools,” Paglia responds, “but having a hammer or a Phillips head screwdriver to apply to a flat head screw is completely inappropriate. The same is true with public and private data. Privately held companies don't get their funding from public markets. They get their capital from banks, asset-backed lenders, factors, mezzanine funds, venture capital, private equity, hedge funds, angels, etc.,” the very sources that the Pepperdine PCOC database tracks.

Listen to both sides. Don’t miss Point/Counterpoint: Debating the Private Capital Markets Project, BVR’s webinar on March 15, when Paglia will discuss all aspects of the Pepperdine project and PCOC database with Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos).

Competition for BV talent returning to prerecession levels

“It’s not a stretch to say that, so far in 2012, demand for qualified BV professionals is on a pace to return us to the days of talent shortage that preceded the recession,” says John Borrowman (Borrowman Baker). In fact, he wrote an article back in 2009 on this potential. “Retention has becomes more critical. Smart practice leaders will want to make sure they’re operating with up-to-date compensation information to retain top BV talent.”

And, of course, the best way to ensure that they are paying market value is to participate in the 2012 Borrowman Baker/BVR BV Salary Survey. “Business valuation is a specialized profession,” Borrowman observes. “Compensation studies from public accounting and/or corporate finance just can’t deliver the same precision and validity.” By reporting data in the 10th, 25th, 50th, 75th, and 90th percentiles (instead of just an average or a range), the BB/BVR survey also permits more precise calibration of pay plans. Additional features include:

  • Confidentiality (no data will be reported in any way that would identify the source);
  • The final report will include analysis of billing rates and chargeable hours; and
  • The report will be available in August, in time for 2013 planning.

What are you waiting for? If you start now, you can always download the survey and then complete it offline as time permits (in hardcopy). Then all you have to do is log back in and enter the data. “And, yes, if you just want to enter the data on the hardcopy form and fax or mail it to Borrowman Baker, we’ll even do the data entry for you!” Borrowman says. Don’t wait a minute longer; participate here.

2012 D&P data available now through Risk Premium Calculator

The 2012 Duff & Phelps Risk Premium Report, which includes data through Dec. 31, 2011, is now available via the online Duff & Phelps Risk Premium Calculator. The 2012 Risk Premium Report will be published at the beginning of March.

“The online Duff & Phelps Risk Premium Calculator enhances the usability of the Risk Premium Report by calculating cost of equity estimates (COE) based on user-provided inputs,” says James Harrington (Duff & Phelps). “The Calculator quickly delivers four COE estimates using the capital asset pricing model (CAPM) and the buildup method as well as contextual information in a variety of formats. In addition, the Calculator instantly delivers a fully customizable executive summary in Microsoft Word that includes sourcing, key inputs, and a range of COE estimates. The Calculator also exports a detailed record of all inputs, outputs, and calculations to a ‘Support and Detail’ Microsoft Excel workbook.”

Get a ‘live’ demo. On Tuesday March 13, join Harrington for a demonstration of the new Calculator and a complete discussion of the 2012 data in: Introducing the 2012 Duff & Phelps Risk Premium Report & Calculator. Free registration is available to subscribers to the Calculator or purchasers of the Report.

Judge, in approving MUM, also credits an expert’s explanations

Just last year, Judge Carl P. Funderburk denied a Daubert-type challenge to the multiattribute utility model (MUM) in Lieberman v. Lieberman, No. FD-2008-956 (Tulsa, Okla.). Developed by BV appraiser David Wood (Wood Valuation), MUM permits an expert to allocate the goodwill value of a business between its enterprise and personal or professional components.

“What I liked about MUM is that it allows the expert to take two, eight, six, or 12 attributes that describe a business and weight the attributes to challenge and confirm the expert’s conclusions,” says Judge Funderburk. “While MUM is subjective, it provides experts with the means to explain rationally the attributes they used and the weights they assigned.” In coming to an ultimate conclusion of goodwill value, the judge agreed with the expert’s selected attributes, but added an additional element to account for the brand names sold by the business. “The valuator needs to be able to see the multiple layers of goods and services that make up the business to better assess the factors and benefits of MUM.”

Words of advice for all BV experts: “When I have valuation or CPA experts on the stand, sometimes it is difficult to follow their assumptions,” says Judge Funderburk. “Their ability to explain the rationale they used in each step goes a long way, at least with me.” Read the complete interview with the judge—as well as the expert, Don B. DeSelms (Sullivan & Associates), who presented the MUM analysis at trial, in the current Business Valuation Update.

Using restricted stock data: the debate continues

“When members of the business-valuation community use restricted-stock evidence, they engage in financial economics, albeit bad financial economics,” says Robert Comment, Ph.D., in response to our continuing report on the FMV Restricted Stock Study. “The valuation world is not entitled to its own version of financial economics.” Look for a new article by Comment, "Revisiting the Illiquidity Discount for Private Companies: A New (and ‘Skeptical’) Restricted-Stock Study," in the Journal of Applied Corporate Finance, Vol. 24, No.1 (Winter 2012), which should be out in a few weeks.

On the other side, Terry Lloyd (FSG) points out numerous “failures” in the critique of the restricted stock data. “Intelligent users will always take guidance from where appropriate to assist them in measuring certain features of illiquid interests,” Lloyd says. “Unless and until there is a larger database with transactions specific to my particular situation (industry, size, etc.), I will use the best tool available to me to help estimate that feature of the interest I am appraising. That sometimes includes the FMV database, and sometimes it does not. As in so many areas, the tool is no more useful than the skill of the practitioner applying it,” Lloyd adds. “Judgment is an attribute of any profession, including [business] appraisal. I have found the FMV database to be useful to me on more than one occasion. The information taken from there is not dispositive but can provide guidance not found in other sources,” particularly in its feature that allows the data to be sorted by industry, size, and date.

As for the allegations that “risky firms” in the dataset make it inapplicable for measuring illiquidity, Lloyd has two comments. “First, this is a straw man argument. The valuation of the enterprise would include the riskiness of the specific firm and its industry. The FMV data are used to measure illiquidity using the relative pricing of liquid-versus-illiquid shares and are not used (to my knowledge) for other things,” Lloyd says. Second, “most appraisers deal with risk separately, but confusing the two (risk factors and liquidity) would be the appraiser’s mistake and not a limitation of the data in the study.”

IVSC takes on the valuation of derivatives

“The valuations placed on the portfolios of derivative instruments held by financial institutions have been the subject of extensive scrutiny by financial regulators following the 2008 financial crisis,” says a new release from the International Valuation Standards Council (IVSC). “It is therefore the IVSC’s objective to provide greater transparency around the valuation process in order to assist management, investors, and other stakeholders in understanding the valuations.”

To advise it on the project, the IVSC Standards Board has formed an expert working group from representatives of major banks, including UBS, Deutsche Bank, and HSBC, as well as independent consultants and buy-side investors. The IVSC anticipates a public exposure draft by the third quarter, 2012.

Three more CPE options in March

Just before Spring Break, three more ways to expand your BV professional education:


In last week’s BVWire, we should have noted that Jeff Harwell is a principal with his own firm, Harwell & Co., in Fort Worth, Texas. We apologize for any confusion.


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