BV wrap-up for 2014, and what’s in store for 2015?
What were the most significant BV developments in 2014? What can we expect for 2015? We posed these questions to the editorial advisory board of BVR’s Business Valuation Update.
Here are a few comments.
Looking back: “2014 witnessed a growing skepticism of the capital asset pricing model in academia and elsewhere,” says Ted Israel (Eckhoff Accountancy Corp.). “It’s as if CAPM is cowering in the castle while the villagers assemble outside with torches and pitchforks.” However, he says nothing better has come along—yet. “Dohmeyer, Butler, et al. have offered up the implied private company pricing line, which is interesting but needs more vetting (and they invite it). All of this leaves the practitioner in a quandary over what to do.”
Speaking of cost of capital, the introduction of Duff & Phelps’s Valuation Handbook – Guide to Cost of Capital was major, according to Ron Seigneur (Seigneur Gustafson LLP CPAs). “While many thought we would have a gap with respect to cost of capital information, Duff & Phelps has more than filled that gap. It provides solid information and is very well organized.”
Seigneur also points out that the changes in estate tax limits have “resulted in less than 1% of U.S. taxpayers being exposed to estate tax.” As a result, he says the need for estate tax-related planning valuations has subsided, especially after the surge BV practitioners witnessed at the end of 2012 and into 2013. “Those who focus on this work see softness in their work flows.”
On the court scene, R. James Alerding (Alerding Consulting) tells us: “The number of new cases dealing with personal goodwill during 2014 shows the growing importance of this concept, especially in divorce cases, but also in tax cases.” Alerding says an important advance in 2014 was the memorandum of understanding (MOU) with the International Valuation Standards Council (IVSC) that was signed by the ASA, the CICBV, The China Appraisal Society, and the Royal Institution of Chartered Surveyors (RICS), which represents a commitment to comply with a single global set of standards. However, he pointed out the absence of the AICPA. “It is disappointing that the IVSC and these other organizations could not work out wording that is acceptable to the AICPA.”
Looking forward: “I see continued growth in the area of divorce valuation,” says Alerding. “An area of valuation and litigation that was for years looked on as a poor cousin is now front and center in the development of precedents in valuation.” He also sees the further development of new BV talent. “As more and more long-time BV experts reach retirement age, I see a continuation of firms trying to develop younger BV professionals for both valuation and litigation in order to service those needs in the future.”
Seigneur sees 2015 as busier than ever with litigation work and M&A engagements. “As long as the current ‘irrational exuberance’ in the stock market lasts, we will all be busy—or should be."
Israel advises: “I think we better arrive at some consensus about the cost of capital.”
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Goodwill ownership dominated 2014 Tax Court valuation cases, says Bogdanski
The drought is over, at least with regard to valuation cases in the U.S. Tax Court. This was the message Prof. John A. Bogdanski (Lewis & Clark Law School) delivered during a recent BVR webinar, "Business Valuation in the Federal Tax System in 2014." The court had been bogged down with other matters, but BV is now back on its calendar.
Bogdanski, an authority on the Tax Court, also detected a theme linking several of the most noteworthy 2014 valuation cases: ownership of goodwill or similar intangibles.
Goodwill doctrine: This is not a new issue, Bogdanski says, but the court has not spent much time on it since the 1998 Martin Ice Cream Co. case involving the shareholder of a company introducing Häagen-Dazs to New Jersey. When the corporation spun off its supermarket distribution rights to a subsidiary wholly owned by the company’s sole shareholder, he transferred them to Häagen-Dazs along with the subsidiary's business records, customer records, and associated goodwill. The IRS argued that the ice cream company was liable for the gain from the sale of the subsidiary, but the court said the shareholder personally owned the customer relationships and distribution rights. The company could not distribute assets it did not own.
Possible push back: Fast-forward to 2014 and the Adell estate tax case. In valuing the decedent’s 100% interest in a for-profit satellite company providing uplinking services to a nonprofit religious network the decedent’s son had built, the court (J. Paris) found the IRS’s expert significantly undervalued the pivotal role the son played in operating both companies as well as the critical relationships he built with contributors to the religious network. The son, the court said, owned the asset of goodwill and, since he never transferred it by way of a noncompete, he could compete directly with the company.
Not quite so, Bogdanski says. The court ignores black-letter corporate law under which the son, as a director of the subject company, had a fiduciary duty of loyalty to the company, regardless of whether he had a contractual obligation to the company. A hypothetical buyer would have challenged the son in state court from competing directly with the acquired company. The IRS expert’s valuation actually may have reflected the son’s role more accurately, Bogdanski concludes.
Cavallaro was a gift tax case with a similar story line but a very different outcome. Here, too, a father built a successful business, along with his sons, and achieved great financial success. Much of it was due to a machine the owners conceived together but built with the resources of the father’s company. To facilitate a structured merger between the two companies that was to transfer most of the wealth to the younger generation with minimal tax consequences, tax advisors concocted a narrative in which the sons’ company owned the technology prior to the merger. The IRS claimed the transfer was a huge gift, and the Tax Court, although highly sympathetic to the taxpayer, agreed.
This case, Bogdanski says, is a clear win for the IRS. The service got its hands on very damning evidence related to the tax advisors. Perhaps counsel for the taxpayer should have emphasized the goodwill the younger generation created around the technology and machine. It was real.
Bross Trucking combined corporate income tax and gift tax issues. The father built a road construction empire that included a trucking company, which the taxpayer owned 100%. When it ran into serious trouble with regulators, father and sons decided to form a new company, ostensibly to ensure a clean regulatory slate. The IRS claimed the company had distributed an appreciated intangible asset to the taxpayer, who then transferred it to his sons and was liable for gift tax. The Tax Court (J. Paris again) disagreed. What the old company had was “the antithesis of goodwill.” The family built a new company precisely to avoid losing customers.
Bogdanski points out that the court seems to ignore that the customer base was made up almost entirely of other family entities, all of which were linked to the road construction business. There were no arm’s-length transactions, and it is conceivable that indirect gifts were being made regularly under the contracts existing among the various business entities. Maybe the real gift the father made was taking himself out of the trucking business, Bogdanski says.
All of the above cases are available at BVLaw. Stay tuned for a discussion of some of the other cases Bogdanski mentioned. Also, a full audio version of the webinar is available here.
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Academic research is flying under
In a recent interview, Michael A. Crain (The Financial Valuation Group) says he sees a gap between the financial research being published by the academic community and what BV professionals know about. One of the reasons is that there’s little incentive for academics to translate this complicated research for practitioners, “who find it extremely difficult to understand,” says Crain.
Example: Crain says a good example of this hidden research is in a working paper from Fama and French on their five-factor model. “This is one recent line of research that hasn’t received much attention in the BV community,” he says. Of course, the duo is famous for its three-factor model. Their new research “shows that the degree of a firm’s profitability and reinvestment are two additional factors that have an effect on equity returns,” says Crain. “The implication is that these two factors have a role in explaining cost of capital.”
During the interview, Crain also shows how data about the size premium contradict conventional wisdom. The interview will appear in the February issue of Business Valuation Update.
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Underlying economic conditions
The U.S. economy posted its strongest growth in 11 years during the third quarter of 2014, expanding at a 5.0% rate. The growth was fueled by robust consumer spending and business investment. The Associated Press reported that the acceleration in U.S. growth is a key reason the global economy is also expected to grow faster in 2015, at about 3.0%, up from 2.5% in 2014, according to economists at JPMorgan Chase and IHS Global Insight. Meanwhile, Gallup's U.S. Economic Confidence Index moved into positive territory at the end of December for the first time since before the Great Recession. Gallup found that this was a possible sign that Americans are feeling the accelerating economic recovery. The Conference Board’s Leading Economic Index also displayed optimism, indicating that the U.S. economy will continue to grow through the winter season and that the underlying conditions remain strong.
Stay current: Receive comprehensive and timely economic data and text for your valuation reports—along with forecasts—delivered to you monthly and quarterly. A subscription to the Economic Outlook Update provides you with the economic information you need in Word, Excel, and PDF formats, as well as access to all historical reports dating back to 2003. Learn more here.
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OIV BV conference in Italy
On January 19, the Organismo Italiano di Valutazione (OIV), the Italian business valuation standard setter, will hold the III OIV Business Valuation International Conference at Bocconi University (Aula Magna) in Milan, Italy. Interestingly, all of the speakers, except one, are from the United States. For a copy of the program, click here. For more information, go to the OIV’s website.
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BV movers …
People: Joseph Bondi, after a quarter-century tenure at Alvarez & Marsal Holding LLC, has left his role as managing partner to become new operating partner at the New York City private equity firm Turnspire Capital Partners … Michael DeSiato joins the Coral Gables, Fla., office of Cherry Bekaert LLP as tax partner … Dennis Gallagher joins Haynes Boone LLC’s Orange County, Calif., office as counsel in the intellectual property transactional practice … Ray Harrison joins Honkamp Krueger & Co. of Dubuque, Iowa, as general services partner … John Johnson, managing partner of SaxBST’s Valuation, Forensic and Litigation group in Tampa, Fla., recently was admitted as a charter member of the American Academy of Matrimonial Lawyers (AAML) Foundation’s Forensic & Business Valuation Division, an elite group selected on the basis of their national reputation and achievements in business valuation, litigation support, and forensic accounting in the context of divorce proceedings … Jacob Kaufman, lead member of the business valuation team at Smith Elliott Kearns & Co. in Pennsylvania, was awarded the Greater Chambersburg Chamber of Commerce’s 2014 Business Person of the Year … John Levitske joins the Chicago office of Houlihan Lokey as a managing director in its Dispute Resolution & Financial Expert Opinions … Jason MacMorran, a director with P&N Consulting Services Group in Baton Rouge, La., has been awarded the AICPA’s 2014 Business Valuation Volunteer of the Year award for his continuous efforts to improve and support the business valuation profession … Joe Musto is the new managing director of MG Valuation’s New York City practice. He brings over 25 years’ experience with American Appraisal and Deloitte in New York, New Jersey, and Pennsylvania … Stephanie Peters, president and CEO of the Virginia Society of CPAs, was awarded the CEO Award of Excellence by the Virginia Society of Association Executives … Gary Van House joins the financial advisory firm Alvarez & Marsal Holding LLC as a senior director in the Dallas office and will advise in healthcare strategy and performance improvement … Kathy Weaver was promoted to senior vice president at the Dallas firm Ryan LLC.
Firms: The Lansing, Mich., firms Gallagher & Associates CPAs PLC and Flintoff & Klein PC merged on January 1 and will rebrand as Gallagher, Flintoff & Klein … Gallina LLP and the Utah-based accounting firm Leverich Group merged on January 1 … Glass Jacobson, a financial services and wealth management firm in Maryland, was named one of the Top Workplaces by The Baltimore Sun … The Colorado firms Jim Marty and Associates LLC and Brock and Co. have announced their merger … The Washington firms Newhouse & Associates and Alegria & Co. merged on January 1 and will operate under the Alegria & Co. brand … Assurance & Services Auditores y Consultores CIA., LTDA., based in Ecuador, is the newest member firm to join the global accountancy network of UHY LLP.
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CPE events to ring in the new year
Valuing Architecture and Engineering Firms (January 8), with Ian C. Rusk (Rusk O’Brien Gido + Partners LLC). Firms in the architecture, engineering, and environmental consulting field (A/E industry) have special elements of risk, irregular income streams, a lack of tangible assets, and specialized markets. Rusk is one of the foremost experts on valuation in this industry. His firm compiles the A/E Business Valuation and M&A Transaction Study. Join him for an examination of how appraisers can best overcome the obstacles these unique businesses pose.
How Courts View Cost of Capital in Appraisal and Fairness Cases (January 13), with Gilbert E. Matthews (Sutter Securities Inc.). One of the country’s leading experts reveals what judicial proceedings and decisions can tell us about how cost of capital determinations should be performed for trial and deposition. Matthews will cover what can be gleaned from appraisal and fairness cases in the courts.
Free webinar: International Valuation Handbook: The Final Installment of the Duff & Phelps Trilogy (January 15), featuring James Harrington (Duff & Phelps). Get an in-depth look at what's included in the new 2014 International Valuation Handbook – Guide to Cost of Capital and how appraisers can put it to work.
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