January 23, 2013 | Issue #124-4  

DLOM methods: Is the use of benchmark studies declining?

“It’s great that the area receives so much attention but also daunting that there are so many opinions on how to address the issues,” says one participant to our latest survey on the discount for lack of marketability (DLOM). It’s also notable that, when compared to our 2009 survey, opinions seem to have shifted. Consider:

  • This year, nearly three-quarters (74.4%) of respondents say they apply the Mandelbaum factors when determining DLOM, down from four years ago, when nearly 83% did.
  • Four years ago, the vast majority—over 90%—used the restricted stock studies (RSS), but this year that number slid to 74%.
  • Reliance on pre-IPO studies is also down, from 52% who checked off this method in 2009 to 45% in the current poll.

Admittedly, this year’s survey is much more comprehensive, offering over 20 specific DLOM methods to choose from (compared to just five in 2009). The current survey also distinguishes between general RSS as well as restricted stock equivalent studies (some 5% checked this off) and the FMV Restricted Stock database (47% use it). Finally, the results don’t immediately reveal whether any particular method has absorbed the possible decline in reliance on RSS. Usage of the QMDM has held steady, at 17% in 2009 and 18.5% this year, as have quantitative option pricing models (about 10% in each year), although several respondents specifically added the Asian put model to this year’s “other” category.

Desperately seeking consensus? Survey comments also suggest the plurality of DLOM methods has multiplied their complexity and cost. “It seems like there is too much disagreement about methodology, which makes me never feel really comfortable with any method selected,” says one participant. Similarly, others believe this “is the complex area and one which now commands more time and attention than in the past to arrive at a sensible and defensible answer.”

Some believe BV appraisers have “over-engineered” the DLOM analysis at the expense of its credibility. Still others assert that the fact-specific nature of the determination makes the complexity and cost all but unavoidable. We will have more results next week, particularly on the use of partnership and the new Pluris data. The online survey is still ongoing; to add your comments, click here now.

Author of IRS DLOM Job Aid provides complete overview. Don’t miss the webinar tomorrow, January 24, when Michael Gregory, former IRS engineering manager and one of the chief authors of its DLOM Job Aid, discusses how to create credible DLOM determinations in “What Business Valuators Need to Know When Preparing a DLOM for the IRS,” Part 3 of our current DLOM series.

ASB contemplates ‘radical change’ to USPAP

As a reminder, comments to the Appraisal Standards Board’s third exposure draft to the 2014-2015 USPAP are due this Friday, Jan. 25, 2013. The ASA BV Committee is currently preparing its response, says chair Linda Trugman, in her most recent weekly missive to members, “but it never hurts for there to be more than one voice from the BV community.” Trugman also reports the ASB has withdrawn its change to the definition of “report,” stating:

As a result of the concerns expressed with both the current and the proposed definitions of report, and the fact that these concerns are largely a function of the appraiser’s type of practice, the ASB has decided to investigate the possibility of having different report and workfile requirements based on the intended use and intended users of the assignment. The Board recognizes that this would be a radical change to USPAP and would affect many stakeholders. For that reason, such a change must be thoroughly investigated and vetted. Rather than rush to adopt changes for the 2014-15 edition, the ASB plans to follow up on this issue after the 2014-15 USPAP has been adopted. This will allow the Board to proceed judiciously and allow for the necessary level of consideration and deliberation on this important topic.

“Maybe they’ll consider a litigation exception when they do this?” Trugman asks, somewhat rhetorically. “We can hope!”

ASA FV conference is next week in New York. In the meantime, the ASA is hosting its annual one-day conference on fair value topics. Sessions include determining DLOM with put-option models, by John Finnerty, and a Big Four panel discussion on the state of the audit. For more information, click here. 

Difficulty of determining patent damages is no defense against Daubert

Under today’s tighter evidentiary standards for proving reasonable royalty damages, IP experts can expect challenges to any use of the entire market value of the accused product as well as any reliance on prior licenses. For instance, a new decision from the federal district court (Delaware) considers $300 million in damages claims against the Intel Corp. and a Daubert challenge against the plaintiff’s expert for violating the entire market value rule (EMVR) as well as his reliance on portfolio (rather than single patent) licenses. In response, the plaintiff argued that Intel processors were the “smallest practicable unit” that contained the patented circuitry and “at least one” of the prior licenses concerned a single patent.

But “difficulty in determining a royalty base … is not a reason to accept an unreliable method,” the court held. Even if the patented circuits were the single most important feature, the expert’s report provided “little, if any, basis” for concluding they drove demand for the entire Intel processor. Further, “this is a single patent case,” the court said. “No reasonable juror could consider … broad portfolio license agreements to be comparable in scope.” The one single-patent license resulted from litigation, and the expert’s report failed to analyze its comparable benefits and technological value. Although the court leaned toward excluding his entire opinion, it granted the expert a last chance to give “live” testimony at a hearing. Read the complete digest of AVM Technologies LLC. v. Intel Corp.,2013 U.S. Dist. LEXIS 1165 (Jan. 4, 2013) in the March 2013 Business Valuation Update; the district court’s decision will be posted soon at BVLaw.

Accuracy is not the illusion in BV, says Pellegrino, precision is

The recent item on the "Illusion of Accuracy" may have resurrected a frequent discussion among BV professionals—whether a rounded number in a value conclusion is perceived as more accurate than a nonrounded number—but Mike Pellegrino (Pellegrino & Associates) would like to take it to a new level.

“First, no appraiser can guarantee accuracy,” he says, “even in an ex-post analysis,” which contains “embedded conditional probabilities” that are beyond anyone’s abilities to predict (particularly with Excel). Further, the hypothetical precondition of the fair market value standard virtually “guarantees that a valuation conclusion will never be accurate, unless by accident or coincidence.” In fact, the only thing an appraiser can guarantee is precision. “Consider shooting at a target. Hitting the bull's eye once out of 100 shots shows an accuracy of 1%, but no precision. Hitting a single number 99 times out of 100 shows remarkable precision (99%), but no accuracy.”

Even an “illusion of precision” is easy to audit, Pellegrino says. “Is the math correct? What is the confidence interval on the value conclusion after running through 10,000 simulations of the valuation model? Did the analyst account for uncertainties in all material value drivers, and if so, how?” A competent valuation analyst can answer those questions authoritatively.

For what it is worth, Pellegrino has had “remarkable debates with fellow practitioners and attorneys on the topic of rounding.” He’s also done extensive research, ultimately failing to find any deals that didn’t close because they depended on nonrounded numbers or court cases that were lost based on unrounded value conclusions. At the same time, “how many judges have excluded BV appraisers for using rules of thumb and other undocumented, unproven theories in litigation?” Pellegrino asks. Perhaps that is the discussion that BV appraisers should continue having.

Get it while it lasts: updated state-by-state economic summary

One of our most popular free downloads of 2012, the State-by-State Summary of Economic Information, is once again available for a limited time—and it’s newly updated, with added links to additional state resources and confirmation that all links are current. To access the 2013 state economic summary, click here now.

Help us keep it current and complimentary. To make this free resource as comprehensive as possible, we will keep updating it during the year. If you run across any additional state economic sources, please pass your suggestions along to Adam Manson, BVR’s manager of financial research, at adamm@bvresources.com.

FASB proposes improvements to accounting for repurchase agreements

Last week, the Financial Accounting Standards Board (FASB) released for public comment its Proposed Accounting Standards Update, Transfers and Servicing (Topic 860)—Effective Control for Transfers with Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings

The proposed ASU “would clarify the guidance for distinguishing these transactions as either sales or secured borrowings and improve disclosures about them,” according to the accompanying release. Stakeholders are asked to review and provide comments by March 29, 2013.

Your team didn’t make it to the Super Bowl? Our CPE will help

If you were heartbroken by the Denver Broncos’ last minute loss to the Baltimore Ravens (okay, so we admit an editorial bias) or even if you can’t wait for the Ravens to take on the 49ers on Super Bowl Sunday, here are some great ways to earn CPE up to and after the big game:

  • On January 29, kick off Part 1 of BVR’s Online Symposium on Healthcare Valuation with Mark Dietrich and Frank Cohen (Frank Cohen Group) for “Healthcare Coding for the Non Coder,” which will discuss the federally mandated updates to Medicare/Medicaid coding so vital to the analysis of revenues in the healthcare sector.


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