February 27, 2013 | Issue #125-4  

Lack of time, talent may be holding back BV
firm growth

Like the valuation practice itself, growing a BV firm may involve as much art as science. Or at least, that’s what our most recent online survey seems to suggest. When asked to list their firm’s top three competencies, respondents either took an esoteric (art) or practical (science) approach.

For instance, one participant described the firm’s core competencies as “people, knowledge, and experience.” Similarly, another answered, “Experience, knowledge, and connections.” Compare these to responses that listed particular practices, most common among them tax, fair value for financial reporting, and M&A consulting.

When asked what core competencies they would like to add to the firm, respondents were similarly split between the practical (“more fair value” or “transfer pricing, stock option, and distressed debt valuation”) and the esoteric (“more experience, thought leadership, better people.”) Notably, several participants didn’t want to add anything to the firm. “We are making a comfortable amount with our existing competencies,” said one. Likewise, another combined art and practicality by quoting a “Dirty Harry” movie for the observation: “A man’s got to know his limitations.”

What ‘magnum force’ may be imposing those limits? Of those who wanted to grow the firm’s practice beyond the core, the majority (61%) checked off “not enough time” as one reason they couldn’t. Another 50% checked off “not enough BV talent,” both within the firm and without. More than a quarter (28%) said they lack the money to grow, and roughly the same number (22%) said they lack viable merger or acquisition options. At least one participant advises practitioners to focus on being “strong and knowledgeable in a few areas, rather than trying to be everything to everyone,” while another would like to see more CPE courses addressing these esoteric yet very practical questions.

The most influential resource on BV firm management & economics

Which practices are generating the most revenues—and will BV firm revenues increase (or decrease) this year compared to last? How much are BV firms paying to obtain (and retain) hard-to-get talent? Which BV credentials are drawing top pay? BV practitioners and firm owners will find the answer to these questions and more in BVR's 2013 Business Valuation Firm Economics & Best Practices Survey, which will cover nine topics, including all the critical compensation and performance indicators as well as marketing and practice development, hiring trends, and a new area on practice acquisitions and partner defections.

The ‘World According to BV.’ As in past years, our biennial survey—the fourth in a series—will present the most comprehensive overview of the BV profession from a financial and administrative perspective. (In its last incarnation, almost 600 BV firms representing over 4,000 appraisers responded.) But first you have to participate—and this year, those who do will also save money. Respondents to the 2013 survey can receive the complete results for only $79 (or $250 less than the post-publication price). Completing the questionnaire is easy and convenient; if you’re interrupted at any point, you can save the results and return later. Deadline for responses is April 1, 2013. Get started by clicking here now.

A lawyer-director is worth 10% of company value?

A new working paper by a trio of finance and law academics argues that the benefits of appointing a company’s lawyer to its board of directors far outweigh the costs, not only because the lawyer-directors lower certain enterprise risks, but also because they boost the overall value of a company by nearly 10%. “Our results tell us that, on average, a lawyer-director increases firm value by 9.5 percent, an increase that rises to 10.2 percent when the lawyer-director is also a corporate officer,” say the authors of Lawyers and Fools: Lawyer-Directors in Public Corporations. By managing litigation, regulation, and management compensation, the on-board lawyers take firm risk-taking down to more efficient levels. Perhaps this explains why, over the period the paper studied (2000 to 2009), the percentage of public companies with attorneys on board nearly doubled.

The authors’ findings “fly in the face” of conventional corporate wisdom that only “foolish” boards would accept their attorneys as members, for fear of any conflict of interest or loss of independence. In fact, their results suggest that, overall, an “ideal” board should reflect external circumstances particular to each firm and fill any substantive gaps in management. “Our intuition is that a lawyer-director brings a special perspective based on her training and experience with the law and legal issues and an appreciation of doing things ‘by the book’ that likely comes with it.” The result is greater firm value, based not on a director’s independence, but on his or her specific skillset and experience.

Yet another bankruptcy decision discredits the DCF—and the expert who ‘forced’ its value

Adding to what seems to be an unfortunate trend in current case law—first appearing in an article on the future of valuation litigation and continuing as a “cautionary tale” for BV experts—a new bankruptcy decision considers how to value a subsidiary during its 2006 spinoff from Verizon. At the time, the subsidiary’s public trading price produced an implied enterprise value of $12.8 billion.

To support claims that Verizon loaded the business with debt prior to the spinoff and drove it into bankruptcy, the trustee’s expert gave no weight to its trading price because she believed Verizon withheld “material information from the market.” But even after her market multiple and comparable transactions approaches produced values ranging from $11.7 billion to $15.8 billion, she declined to assign them much weight. Instead, she applied a DCF analysis—including a discount rate of nearly 10% and a 2% company-specific risk premium (CSRP)—to yield a value of $5.85 billion. After assigning this a 70% weight, she ultimately valued the subsidiary at $8.15 billion—or more than $4 billion under its publicly traded value—enough, after including its spinoff debt, to render it insolvent.

Rebuttal experts sharply critiqued the cash flow projections, terminal value assumptions, discount rate, and CSRP that went into the expert’s DCF. Simply correcting for these errors would have boosted her DCF value by $4.8 billion, they said—and the federal district court agreed:

At nearly every step in the DCF analysis, [the expert] selected inputs that forced [the subsidiary’s] value lower. From her selection of only the most pessimistic projections of [the subsidiary’s] future performance, to her reliance on a “commercially unreasonable” terminal value projection …, to her selection of a remarkably high discount rate, the method produced a valuation that is low in the extreme and that implied an incredibly low trading multiple for [the subsidiary].

After rejecting all three of the expert’s approaches as unreliable, the court ultimately found the subsidiary was worth “no less than” $12 billion on the spinoff date, based on its publicly traded price. Read the complete digest of U.S. Bank, N.A. v. Verizon Communications, Inc., 2013 U.S. Dist. LEXIS 8521 (Jan. 22, 2013) in the April Business Valuation Update; the court’s decision will be posted soon at BVLaw.

Get early access to the 2013 D&P Risk Premium Report

The 2013 Duff & Phelps Risk Premium Report—which includes data through Dec. 31, 2012—is now available via the online Duff & Phelps Risk Premium Calculator.

“The online Duff & Phelps Risk Premium Calculator enhances the usability of the current 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, and also provides contextual information in a variety of formats,” including an executive summary in Microsoft Word that lists 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.

New this year: The 2013 Risk Premium Report expands the section on how to use the data for valuing very small companies. For example, it lists the smallest and largest companies in “Portfolio 25” (the smallest category) for each of the eight size measures, thereby giving the appraiser a greater capability to gauge the comparative size characteristics of his or her subject company and support any subsequent adjustments. Get instant access to the 2013 Duff & Phelps Report by ordering the updated Calculator (that now also includes all of the historical Duff & Phelps Reports back to 1996) by clicking here or order only the 2013 Report here (available mid-March).

Country-specific COC is ‘by far’ Damodaran’s most popular download

In addition to his general data update for 2013, Prof. Aswath Damodaran (NYU Stern School of Business) provides a list of country default spreads and risk premiums. “This is actually the most downloaded page by far,” the professor told a packed house during last week’s meeting of the CalCPA Business Valuation Section in Los Angeles. “The other pages don’t even come close.”

Damodaran’s data “get used in the strangest places,” he added, during his day-long session on the “dark side” of valuation. He even got an email from the New Zealand Milk Board and one from a businessman in Lebanon “who blamed me for his country’s problems.” But as BV analysts know—particularly when valuing companies with substantial foreign operations—the country-specific input can be critical. “You must attach a risk premium incorporating that country risk, by either adjusting the cash flows or changing the discount rate,” Damodaran told CalCPA attendees. “It’s not just emerging companies you have to worry about.” To aid in the exercise, the professor has also posted his article, “Country Risk and Company Exposure: Theory and Practice,” on his website.

Two new standards updates from the FASB

Last week, the Financial Accounting Standards Board (FASB) released two new proposed Accounting Standards Updates (ASUs):

  • Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes; and
  • Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward or Tax Credit Carryforward Exists.

Both ASUs are a consensus of the FASB Emerging Issues Task Force, and both request written comments by April 22, 2013. To access the complete list of the board’s current exposure drafts and proposed ASUs, click here.

BizEquity makes the case for its online valuation tool

Responding to a recent New York Times article, “Do You Know What Your Business Is Worth? You Should,” the VP of valuation services at BizEquity, Scott Gabehart, admits there “is an art to valuation” and “many instances” in which business owners would benefit from a “real person, trained at valuation” to assess their companies’ worth.

That said, even “reasonable” BV appraisers would agree that a company’s value can “easily” range up or down by 10% to 15% around some “hypothetical average or probable value,” Gabehart adds in a new blog post. Although a wide variety of online applications—from the simple to the “staggeringly” complex—are currently available, “none can truly help the typical small business owner determine value or understand what truly determines business value.”

None except for the BizEquity tool (of course), which has worked all of the “key valuation elements” into its algorithm, including size, expected growth rate and profit margins, customer concentration, financial statement ratios, and importance of the owner/operator. BizEquity will continue to plug its tool in a future series of blog posts, Gabehart promises, and also a new book, Valuation 2.0, geared to users of the online tool as well as business owners seeking to maximize value.

Last chance for February CPE

On February 28, the Online Symposium on Economic Damages begins with the Advanced Workshop on Lost Profits Calculations, featuring Robert Gray and James O’Brien (both ParenteBeard). This intensive, four-hour workshop is free to subscribers of the full Symposium and will cover the process of calculating lost profits from start to finish, using case studies and “live” examples.

For more information on the 10-part, year-long Symposium, including sessions, speakers, and subscriber benefits, click here.


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