January 3, 2013 | Issue #124-1  

NY court affirms DLOM for statutory fair value
of real estate holding company

Business appraisers may recall Giaimo v. Vitale, a dissenting shareholder case that affirmed the application of a discount for lack of marketability (DLOM) to the statutory fair value of a company that owned 19 apartment buildings. Importantly, the lower court did not distinguish between the discount that might apply to a partnership versus a corporation that holds real estate, denying a DLOM based on a “control level of value” for the company shares. It also adopted a present-value discount for taxes on built-in gains (BIG), and the parties appealed.

In the most recent decision, the New York appellate court agreed that DLOM applies to the statutory value of a close corporation, but found that the marketability of a corporation’s real property assets was not the same as the marketability of its shares. Although the common factors might affect both the liquidity of corporate stock and real estate, the effects “are not the same,” the court held:

There are increased costs and risks associated with corporate ownership of the real estate in this case that would not be present if the real estate was owned outright. These costs and risks have a negative impact on how quickly and with what degree of certainty the corporations can be liquidated, which should be accounted for by way of a discount.

After reviewing the entire record—including evidence from the company’s expert estimating a DLOM from 8% to 30%, based on the build-up method as well as restricted stock and other studies, and applying a 20% DLOM—the court agreed the build-up method “best captured” the DLOM in this case, which should be 16%, it held (without much discussion). As for the BIG discount, the court rejected the parties’ respective arguments—that it should be dollar-for-dollar (the company) or zero (the dissenting shareholder)—and, like the prior court, affirmed the present value approach. Read the complete digest of Giaimo v. Vitale, 2012 N.Y. App. Div. LEXIS 8706 (Dec. 20, 2012), in the February 2013 Business Valuation Update; the court’s decision will be posted soon at BVLaw.

Don’t miss the latest on the BIG discount: On Jan. 8, 2013, BVR will host part four of its 5th Annual Online Symposium on Estate & Gift Tax with “Pass-Through Entity Discounts for Built-In Capital Gains Taxes,” featuring Mel Abraham (Mel Abraham Inc.) and William Frazier (Stout Risius Ross). Their program will focus on the current status of accounting for built-in gains tax liability when appraising pass-through entities (such as S corporations and LLCs) that hold highly appreciated assets. Learn which jurisdictions have accepted a dollar-for-dollar discount and why the IRS (and a substantial number of BV appraisers) continues to favor a present value accounting for the BIG discount.

You asked for it: New download on the ‘pitfalls
of beta’

Prompted by a subscriber’s request, we asked the editor of the Journal of Applied Corporate Finance to republish an article from its current issue, “The Pitfalls of Levering and Unlevering Beta and Cost of Capital Estimates in DCF Valuations,” that was cited in the most recent BVWire.

As you’ll recall, the article, by Robert Holthausen (University of Pennsylvania) and Mark Zmijewski (University of Chicago), reviews the “routine steps” of quantifying beta in common cost of capital models and concludes that the “levering and unlevering formulas … are not appropriate for valuing many companies.” In fact, the authors say, substantial valuation errors can result from assuming the betas of debt and other preferred securities are equal to zero and/or ignoring the effects of equity-linked securities, such as employee stock options.

The editors and authors graciously agreed to our request, and the complete article is currently available at our free downloads page. By the way, the authors will have a new release of their book Corporate Valuation: Theory, Practice and Evidence (Cambridge Publishers) coming in February 2013. We’ll feature more information and a link to the hardcover edition soon.

Five simple BV marketing resolutions that put the year—and life—into perspective

“Let me share with you a secret that is not really that secret,” writes Barbara Price, director of marketing for Mercer Capital, in the ASA’s e-letter published just before the holidays. “Marketing is not that difficult.” And making New Year’s resolutions—particularly in the face of events that are truly difficult or tragic, such as those that left their sad mark on last year (Hurricane Sandy, Newtown) may seem relatively “unimportant” she says, particularly when studies suggest that our January resolutions won’t last the month.

But marketing is not about promoting business or brands so much as making “personal connections,” Price says. She suggests keeping this important list in mind when making your 2013 marketing plans:

  1. Invest what you have to invest (both in time and money) to get good at what you do;

  2. Pay attention to your clients;
  3. Put helpful content on your website;
  4. Network—get to know your peers, learn from them, and then educate them, too; and
  1. Figure out what development techniques you are good at and do those. 

Consider your legacy. To put these five resolutions in proper perspective, Price reminds BV appraisers to “focus on what’s important. Our careers can give us great enjoyment and a sense of purpose—or they can be a weight around our neck.” Remember to give back, slow down, and deepen your most valuable relationships, particularly with something greater than yourself. “You are not your career, or the clothes you wear, or the car you drive. Your LinkedIn profile is not the sum of who you are,” Price says. “The length of time we're on earth is but a breath. What will your legacy be? Spend more time thinking about this question and then do something about it.”

Audit firms still struggling with fair value measurements, say PCAOB’s latest reports

Just before the close of the year, the Public Company Accounting Oversight Board released 2011 inspection reports for three of the largest audit and accounting firms: Deloitte, Grant Thornton, and Ernst & Young. From the reports, it appears the audit firms are still having trouble in testing for fair value measurements and/or disclosure related to hard-to-value assets and goodwill.

For example, in the Deloitte inspection report, the PCAOB cites one particular audit in which the firm failed to identify when an issuer inappropriately allocated a portion of the purchase price of a group of assets to goodwill rather than to a definite-lived asset.

In its inspection of Grant Thornton, the board cites an audit for five major deficiencies, including the firm’s failure to test the issuer’s assumptions underlying its projections regarding the value of certain deferred tax assets; it also failed to challenge the issuer’s use of dated financial information to support its forecast when more current, available data would have contradicted the projected growth rate.

Similarly, its Ernst & Young report cites failures to audit the valuation of certain long-lived assets as well as leases and derivative contracts; it also consistently faulted the firm for sufficiently testing an issuer’s internal controls as well as its management projections and fair value measurements.

New edition of Trugman’s perennial bestseller

It’s now available from BVR: Understanding Business Valuation: A Practical Guide to Valuing Small- to Medium-Sized Businesses, fourth edition, by author, speaker, and BV hall-of-famer Gary Trugman. In addition to analyzing valuation standards, theory, approaches, and methods—including discounts and capitalization rates—this new, expanded edition contains content on:

  • Forecasting techniques for business valuation and economic damages;
  • Valuing pass-through entities, including a discussion of all the leading models; and
  • Quantifying discounts with the latest techniques, such as the Black-Scholes and other empirical models.

Plus, an accompanying CD-ROM presents new sample reports and one of the most comprehensive bibliographies in BV literature. Trugman's informal, easy-to-read style covers all the bases in BV; Trugman posts “author’s notes” throughout that draw on his experience as well as “real-life” examples to explain critical points in the content and its application.

Is the ‘the illusion of accuracy’at all tempting?

The temptation for many business appraisals in this highly technical and analytical field is to “present a number that is less accurate but looks more accurate,” says David Wanetick (IncreMental Advantage). For example, he just recently valued a client’s patent portfolio at $5.0 million, a number that might not “look right,” he says. “The concern is, when people see the cover of the report, they will reflexively believe that this is a generic number.” As a result, the temptation is to present a number that perpetuates “the illusion” of greater accuracy, such as $4.85 million or $5.125 million. Had he done so in this case, Wanetick says, he would have been wrong. “According to my analysis, the value was $5.0 million and the number I published was $5.0 million.”

Similarly, when developing a decision tree, he will find that some of the various scenarios equate to a flat 50% risk, which might look like an uneducated “guess” compared to 45% or 52.5%. Repetition of a number within an analysis presents another temptation; if a reasonable royalty rate is 6% but so is the premium to the discount rate, then it might appear more accurate to change one of the numbers. However, if 50% or 6% or any other number “best reflects the analysis and can be supported,” Wanetick says, then that is the number the analyst should use.

FASB proposes standard for measuring credit losses on loans and other financial instruments

Just before the holidays, the Financial Accounting Standards Board (FASB) proposed Accounting Standards Update—Financial Instruments—Credit Losses (Subtopic 825-15) for public comment.

The proposed ASU presents “a new accounting model intended to require more timely recognition of credit losses” on loans and other financial assets held by banks, financial institutions, and other public and private organizations, says the FASB release. It should also provide additional transparency about credit risk. Stakeholders are asked to review and provide comments by April 30, 2013.

January CPE takes on more ‘big’ topics

In addition to the webinar on the BIG discount at the beginning of the month, BVR’s January 2013 programming will take on such substantial topics as marketability discounts and the size effect:

The Advanced Series on Discounts for Lack of Marketability, a weekly, four-part program, starts Thursday, January 10, with “Restricted Stocks: A Review of Studies and the Market,” featuring John J. Stockdale (John Stockdale Business Valuations). Additional weekly programs include “How to Quantify and Support Your DLOM using Rates of Return,” featuring Bruce Johnson (Munroe, Park & Johnson Inc.), “What Business Valuators Need to Know When Preparing a DLOM for the IRS,” with Michael Gregory (Michael Gregory Consulting LLC), and “A Review of DLOM Volatility and Option Models,” again with Stockdale.

On Tuesday, January 15, Ashok Abbot (West Virginia University) and Robert Schlegel (Houlihan Valuation Advisors) will address “Size and Liquidity Premiums: Proportional Roles” and discuss the latest research on the relationship between size, liquidity, and risk in valuing private companies.


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