|New cost of capital model gets kudos from NACVA
The implied private company pricing line, a new model for estimating the cost of capital for small private companies, “is an exciting development and contribution to the cost of capital determination,” says an article in QuickRead, a publication of the National Association of Certified Valuators and Analysts (NACVA).
IPCPL aggregates 500 Pratt’s Stats private company transactions and directly estimates the aggregate IRR on free cash flows. By using fair market value prices paid for small privately held companies, all of the public security return extrapolation issues are rendered moot. Effects of liquidity, unsystematic and systematic risk, and taxes are already reflected in (i.e. “baked-in”) the market clearing prices.
“Based on the current work, results, and communication between the developers and the valuation community, the IPCPL Model will gain credibility and acceptance by valuators and users of business valuation in the near future,” writes Jeff Harwell (Harwell & Co.) who currently serves on NACVA’s Standards Committee. “Any valuator who appreciates the market approach or has operational or transactional experience will be drawn to the Implied Private Company Pricing Line like comfort food. While the cost of capital debate continues and one resource transitions, many of us can look forward to future developments, advancements, and another helping of IPCPL.”
The IPCPL model was featured in the September 2013 issue of Business Valuation Update, and the article is now available as a free download. In addition, you can learn more about IPCPL at BVR’s Cost of Capital Resource Center and receive monthly updates on the back page of the Business Valuation Update in the Cost of Capital Center section.
Different slant on issue of valuation as art or science
We’ve all heard it: “Valuation is more of an art than a science.” But one valuation analyst puts it differently. Serena Morones (Morones Analytics) says it’s an “iterative” process. Speaking at a recent BV expert seminar attended mostly by attorneys with little prior exposure to business valuation, she explained that, upon engagement, the appraiser starts gathering information and outlining the issues. As she learns more, she has to keep circling back to tweak assumptions and calculations—and even course-correct. It’s also important to keep the big picture in mind and not get lost in complexities, or risk being “precisely wrong.”
The seminar was conducted by the Multnomah Bar Association of Portland, Ore., and Morones’ presentation also featured two local attorneys, Kim McGair (Farleigh Wada Witt) and Keith Ketterling (Stoll Berne).
Close collaboration: All three panelists agreed that close collaboration among the attorney, expert, and the client was key to getting the most out of the appraiser’s work. A lawyer should attend any interview the appraiser has with the client’s management because his or her knowledge of the case and the legal issues augments the expert’s questioning. “Inform yourself” about all the factors that may figure into the valuation in order to be able to “push” the expert, one attorney exhorted the audience.
Two is better than one: One of the attorneys said he preferred hiring both a testifying and a consulting expert, assuming the purse allowed for it. The consulting expert can bring a different perspective with which to challenge the testifying expert’s methodology and assumptions before the opposing side does so in deposition or at trial.
Know your weaknesses: All speakers agreed that preparing the expert for deposition and trial was crucial. A deposition serves to gather facts and assumptions; it pins the expert down to a position. It’s not wise to subject an expert to cross-examination at that point, one of the attorneys said.
Preparation means asking the expert to identify vulnerabilities in his or her report and force him or her to formulate a cogent response to any potential questions. Morones said that role-playing was a great way to experience the adversarial process ahead of time and feel more at ease in the real situation.
One of the attorneys said he liked to create a spreadsheet to simulate the opposing expert’s analysis and play around with the variables to understand the key assumptions. He also uses his document as a guide to questioning the expert at deposition or in cross-examination.
The second attorney cautioned against fighting over every variable. The key for the expert is to know which variables matter most to the conclusion of value and defend those. Morones did say that an expert’s grasp of detail and her ability to point out inaccuracies to the court are an instant boost to the expert’s credibility.
Avail yourself of translation aids: Morones agreed that experts operate on a different level of communication. Visual aids that make the expert’s testimony comprehensible to jury members are invaluable, as are trial consultants who can take valuation concepts and formulate them in a way laypeople can understand.
Mystery: Why are patent cases dwindling?
A recent report on patent filings confirms what we have observed in our own research on valuation cases: There are fewer patent cases on which to report. But why?
According to data from the legal analytics company Lex Machina, total monthly filings of new patent cases in United States district courts have reached their lowest level in more than two years. Also, the number of filings in January 2014 is significantly lower than it was in December 2013 and drastically lower than it was in January 2013. Specifically, in January 2014, plaintiffs filed 322 new patent cases, compared to 427 in December 2013. In contrast, in January 2013, there were 490 new patent suits.
Lex Machina said that January historically was a slow month for patent suit filings (going back to 2007), but it's not clear what is at the root of this pronounced decline. The company, which started as a nonprofit at Stanford, said it would further analyze the numbers. “We will try to disentangle the impact of the AIA [American Invents Act] misjoinder provisions (one defendant per suit) from the rise of the non-practicing entity business model, as well as identify trends (if any) in operating company v. operating company patent case filings,” it said.
PCC delves into identifiable intangibles
The Private Company Council (PCC) directed the FASB staff to conduct further research and analysis on an alternative, or a variation thereof, to recognize and measure separately from goodwill only those intangible assets in a business combination that are capable of being sold or licensed independently from other assets of the business. This is part of the PCC’s project Accounting for Identifiable Intangible Assets in a Business Combination (Issue No. 13-01A).
ESOP market outlook is positive for 2014
ESOP companies proved to be resilient during the Great Recession and have since attracted new entrants into the ESOP financing market, according to William Stewart of PCE Companies, who gave the firm’s yearly market update in a recent webinar. Capital availability, valuations, and demand will drive new ESOP formations. Stewart reports ESOP companies are still attractive exit opportunities because of tax advantages and employee ownership. “Desire for diversification, capital gains tax deferral (1042), and partial liquidity options are driving demand,” he said.
Appraisal Foundation seeks board candidates
The Appraisal Foundation (TAF) is soliciting candidates to serve on its board of trustees. Trustees provide oversight to the Appraisal Practices Board (APB), Appraiser Qualifications Board (AQB), and Appraisal Standards Board (ASB). Three at-large trustee seats are available, with two of them earmarked for a representative from academia and a licensed/certified real estate appraiser.
Completed applications must be received no later than March 14. The individuals selected for the board of trustees will serve three-year terms beginning Jan. 1, 2015. Click here for an application package.
What’s in the February issue of Business Valuation Update
Here’s what you’ll see:
- Alternative Model Uses Corporate Bond Yields to Measure a Size Premium (Michael Dobner). Measuring a size premium through historical data has been criticized for being flawed and static and lacking a credible fundamental or economic basis. The author proposes the use of prospective data (using corporate bond yields) to measure a size premium.
- Recent Case Points Out Confusion Over Calculation Reports Under the SSVS (R. James Alerding, CPA/ABV, ASA). Buried deep in a densely worded opinion in a recent divorce case are references by the court to a preliminary appraisal of a business. The expert gave a calculated value instead of a conclusion of value.
- Is the Lingering Criticism of Using Pre-IPO Studies for DLOM Justified? The use of pre-IPO studies to measure a discount for lack of marketability has gained acceptance although the method continues to be a target of some criticism. The trouble is, this criticism can sometimes be based on “old” facts, which can lead to misinformation.
- Determining a Distressed Debtor Company Discount Rate (Part 2) (Michael D. Pakter). The second part of a two-part article on how to derive the cost of capital for a distressed debtor company.
- Impact of Recent Developments on Employee Stock Ownership Plans (ESOPs) (Scott D. Miller, CPA/ABV, CVA). The American Taxpayer Relief Act of 2012, S corp eligibility for ESOPs, and proposed DOL regulations all have had an impact on ESOPs.
To read these articles—plus a digest of the latest court cases—see the February issue of Business Valuation Update (subscription required).
BV Movers . . .
People: Cherry Bekaert LLP announced the addition of Peter Gampel as a litigation support principal based in their South Florida office. Gampel will assume leadership of the firm's Commercial Litigation Practice and will provide consulting services in the areas of commercial litigation, fraud, and forensics, including business valuation and litigation matters … Daniel Boarder has joined Whitley Penn as a transaction advisory services senior manager in the firm's Dallas office … Bennett Thrasher LLP has appointed five to partners throughout the firm: Christopher Benner, Matthew Grosvenor, Timothy Oberst, Rick Rosell, and Timothy Watt … Herbein Wealth Management LLC has promoted Scott Worley to partner …Dixon Hughes Goodman LLP recently selected Tripp Bacon to join its Risk Advisory Services practice as a director in the firm’s Atlanta office … Achin Khanna, director, HVS Consulting & Valuation team’s New Delhi office, has been promoted to managing director, HVS South Asia … Bryan Grunewald, Brian Gunderson, and Andy Mugerauer have recently been named shareholders at Schenck SC.
Professional recognition: Steven Buller, managing director and former chief financial officer of BlackRock Inc., has been appointed chairman of the Financial Accounting Standards Advisory Council …Michael S. Stachowski, CPA, of Kansas City, Mo., has been honored with a recognition by KC Magazine in its selection of “Top Accounting and Estate Planning Professionals in Kansas City.”
Firms: Porte Brown LLC acquired the Crystal Lake, Ill.-based firm LHW & Associates on Jan. 1, 2014 … Honkamp Krueger & Co. in Dubuque, Iowa, has joined CPAmerica International … Walter J. Kero and Mark Byington have formed Kero, Byington and Associates in Missoula, Mont. … Corporate Finance Associates (CFA) announced the opening of an office in Mexico City, Mexico, which will be managed by Miguel Alonzo.
Report & Testimony for Litigation & Deposition (February 14), featuring Rebekah Smith (GBQ Consulting LLC). Part 2 of BVR’s Advanced Webinar Series on Reporting & Testimony focuses on how best to present and defend valuation work in litigation, deposition, and cross-examination.
Join us for the remaining installments of the Advanced Webinar Series on Reporting & Testimony:
Valuation Handbook - Guide to Cost of Capital and the Risk Premium Calculator (February 20), featuring Roger Grabowski (Duff & Phelps). Join us for this free first look at the 2014 Valuation Handbook (available with any subscription to the Risk Premium Calculator or on its own) to learn how Grabowski and the brain-trust at Duff & Phelps have combined their long-running, annual publication, the Risk Premium Report, with the data previously available in the now-discontinued SBBI Valuation Yearbook to create a critical single resource for all year-end data for cost of capital determination.
Demystifying Compensation for Hospital Call Coverage: New Data Sources and Methods for Valuing On-Call Pay (February 25), featuring Timothy Smith (American Appraisal) and Gregory Anderson (Horne). Part 2 of BVR’s 2014 Online Symposium on Healthcare Valuation addresses the proper methodology for implementing the new tools and resources that seek to clarify hospital call coverage valuation.
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