July 13, 2011 | Issue #106-1 Forward to a Friend

Tax-affecting imposes an ‘unjustified fictitious corporate tax rate’ on future earnings, says new Tax Court case

The most recent “must-read” decision from the U.S. Tax Court, Estate of Gallagher v. Commissioner, T.C. Memo.  2011-148 (June 28, 2011), takes on nearly every aspect of private company appraisal—from discounts to the DCF, the applicability of the guideline public company method to the proper calculation of WACC. A digest of the court’s exhaustive opinion (by Judge Halpern) will be in the next Business Valuation Update; because this is such a dense, detailed decision, we’ve made it available as the latest among BVR’s free downloads. Some highlights of the case, which valued a decedent’s 15% interest in a privately held newspaper publishing company:

  • The IRS expert applied a 17% minority discount, based on the inverse of control premium data; the taxpayer’s appraiser applied none, reasoning that his DCF analysis already accounted for minority-based cash flows. The court applied a 23% minority discount, based on the low-end of the control premium range.
  • The IRS expert applied a 30% marketability discount based on restricted stock studies; the taxpayer’s expert applied a 31% DLOM based on the same plus pre-IPO studies. “We have previously disregarded expert’s conclusions as to marketability discounts for stock with holding periods of more than 2 years when based upon the above-referenced studies,” the court said. But since both appraisers relied on them, it accepted the studies as a “benchmark” to apply a 31% DLOM.
  • The IRS valued the company at $40.9 million, the taxpayer at $28.2 million. After crafting its own, item-by-item DCF analysis, the court valued the company at $32.6 million.
  • Judge Halpern recently warned appraisers that he failed to see the justification for tax-affecting (see BVWire # 104-4). Sure enough—in rejecting tax-affected adjustments by the taxpayer’s expert—“we will not impose an unjustified fictitious corporate tax rate burden on [the company’s] future earnings,” he ruled.
  • Overall, the court found the IRS appraiser’s approaches and adjustments more persuasive, faulting the taxpayer’s expert numerous times (we counted at least 14) for failing to adequately explain his methods and conclusions.

Predictably, the case is also creating some buzz in the BV blogosphere. Attorney Paul Hood’s post takes the Tax Court to task on several issues, including its resistance to tax-affecting. Peter J. Reilly focuses more on the professionals in Forbes.com, saying the taxpayer’s appraiser “could have used more words, less math.”

New PitchBook report: have private equity acquisitions altered the FMV standard of value?

BVWire has cautiously commented that so much of the observed recent increase in deal activity comes from PE firms selling assets to other PE firms. Appraisers might question whether the prices paid and deal structures have much in common with “fair market value” as we know it from Rev. Ruling 59-60, USPAP, and SSVS-1.  Or does the domination of our transactional economy by secondary buyouts somehow alter the typical fair market value approaches and conclusions?

A new report by PitchBook confirms what most appraisers have suspected about the middle and upper-middle market.  In the last year and a half, 182 U.S.-headquartered companies have been sold by one PE investor to another, according to the PitchBook Platform. Eight of those secondary buyouts have been billion-dollar deals. So far this year, 49 secondary buyouts have been completed, putting 2011 behind last year’s deal pace. During 2010, 133 secondary buyouts were closed. The B2B (business-to-business) industry has accounted for 36% of the secondary buyout activity, making it the most active in this sector. The second most active is the B2C (business-to-consumer) sector, which posted a 31% share.

BVR is PitchBook’s marketing partner on the Guideline Public Company Comps Tool.

Most agree with FASB’s recommendations on private company financial statement use

The FEI Financial Reporting Blog just reported FASB’s preliminary findings on potential improvements to standard setting for private companies. “The FAF has thus far received over 1,100 comment letters on this subject,” says Edith Orenstein (FEI). Although a large portion of the comment letters agree to the Blue Ribbon Panel's recommendation to form a new standards-setting board for private companies, others do not support “the wholesale creation of a new standards board for private companies, preferring instead other approaches, including formation of a new advisory group to FASB regarding private company accounting,” Orenstein remarks.

FASB published its preliminary findings in FASB in Focus: Private Companies: The Path to a Differential Standard-Setting Framework.

Nevada adopts ‘Delaware’ approach to fair value

A new dissenting shareholder case from Nevada poses several immediate questions. For instance, why did the dissenting shareholder (an institutional investor holding nearly 600,000 shares of preferred stock), object to the merger price at $3.00 per share when, just one year before, that was the price it paid for the shares—and a year later, during trial, that was what it claimed as “fair value”? Of more interest to appraisers, why didn’t either of the (well-funded) parties obtain an accredited appraisal? During oral argument, counsel for the company maintained that the appraiser it hired could not perform such an “extraordinarily difficult endeavor” because of the nature of the private company stock, its lack of marketability and minority factors. Hmmmm…

At the same time, the company argued that the trial court erred by adopting the merger price as statutory fair value, because it failed to consider such factors as the pre- and post-merger enterprise value of the company stock, including illiquidity. The Nevada Supreme Court rejected these arguments, finding (in a case of first impression) that in a dissenting shareholder case, both sides have the burden of proving their respective valuation positions by a preponderance of the evidence, with the trial court making the final, independent determination. The court adopted this approach from Delaware law and affirmed the lower court’s finding that the $3.00 offering price represented fair value. Read the complete digest of American Ethanol, Inc. v. Cordillera Fund, LP, 2011 WL 1706823 (Nev.)(May 5, 2011) in the August 2011 Business Valuation Update; the court’s opinion will be posted soon at BVLaw.

Keep current on statutory fair value. The 2011 update of BVR’s Guide to Fair Value in Shareholder Dissent, Oppression and Marital Dissolution ships late next week, providing online access to real-time updates of recently published court opinions, case abstracts, new articles, conference presentations, podcasts, news and blog feeds, and more. The Guide also comes in digital format for any eBook reader. The 2011 edition features new articles from leading experts such as Shannon Pratt, Jay Fishman, and Gil Matthews, and an updated, state-by-state chart of shareholder dissent/oppression statutes and FV standards (including discounts). Check out this and all the online resources now available at BVR.

Ten ways to convince corporate boards to value brands

James Gregory (CoreBrand, LLC)wrote in BOARDMEMBER.com ten reasons why brand valuation matters for boards of directors.  Brand valuation:

  1. legitimizes investment
  2. provides an objective measure of effort
  3. creates accountability
  4. aligns leadership
  5. identifies growth opportunities
  6. predicts market shifts
  7. identifies competitive opportunity and advantage
  8. informs M&A or strategic alliances
  9. creates licensing opportunities
  10. helps define the value of other intangibles

Seller financing and earnouts (SFE) influence control premiums

In middle-market M&A transactions there are significant and consistent premiums in valuation multiples of transactions that did not include SFE's, reports Andy Greenberg (GF Data) in a recent Private Equity Professional Digest (subscription required). SFE's are used more frequently in smaller transactions and in years when deal flow is reduced. 

GF Data, which collects lower-middle market transaction information from over 175 contributing PE firms, will be providing metrics on SFE's along with valuation, leverage, and key deal term data when they release their Q2 report. The Q1 report showed "the size premium in private equity-sponsored middle market deals had never been wider than in the first quarter of 2011," according to Greenberg. For more information on GF Data contact Bob Wegbreit.

BVR now offers self-study CPE

Beginning this summer, practitioners can receive CPE credits for viewing selected archived webinars and training events. Watch the recorded program, study with the enclosed review materials, pass our online, self-grading exam and receive your CPE electronically–all for only a $50 processing fee. Current archived programs offering self-study CPE include:

  • Valuing Banks
  • Lost Profits Calculations: Methods & Procedures
  • ESOP Valuation: Repurchase Obligations
  • The Use and Application of Option Pricing Modeling
  • Valuing Internet-Based Companies, and more…

BVR is approved by the National Association of State Boards of Accountancy (NASBA) for self-study CPE delivery.  For more information on eligibility by state, please consult NASBA’s  website or your state board of accountancy. For more information on BVR’s self-study CPE, eligible programs, or to suggest one of our archived programs for self-study CPE, contact BVR or visit our self-study CPE home page.

Are you current in goodwill and lost profits analysis?

For the most current overview of goodwill valuation, join expert James Alerding (Clifton Gunderson) and attorney Andrew Soshnick (Baker Daniels) for “Goodwill in Divorce” on Thursday, July 14. This 100-minute webinar addresses one of the most difficult parts of valuing a professional practice in divorce: the allocation of personal versus entity goodwill.

On Wednesday, July 20 BVR’s Online Symposium on Healthcare Valuation continues with “Lost Profits Damages in Medical Practices.”  Hosted by James Lloyd (Pershing Yoakley & Associates) and Symposium curator Mark Dietrich, this program applies the already tricky analysis of lost profits calculations to the challenges of valuing medical practices.

Call for presentations on fair value topics

Here’s an opportunity to market your expertise in fair value for financial reporting:  NACVA, IBA, and Seattle University have issued a call for presentations for the 2012 Congress on Fair Value: Fair Value Measurements and Recognition. Check out the Request for Proposal.

Two BV committees post a changing of the guard

BVWire would like to congratulate the new members of the American Society of Appraisers’ Business Valuation Committee: 

  • Chair: Linda B. Trugman (Trugman Valuation Associates)
  • Robert B. Morrison (RSM McGladrey)
  • Raymond D. Rath (PricewaterhouseCoopers)
  • William A. Johnston (Empire Valuation Consultants)
  • John C. Faunce (Gorfine, Schiller & Gardyn)
  • Erin D. Hollis  (AIW)
  • Bruce A. Johnson (Munroe, Park & Johnson)
  • Lee C. Russell (Ernst & Young)
  • David Smith (Hill Schwartz Spilker Keller)
  • Jeffrey S. Tarbell (Houlihan Lokey Howard & Zukin)

Scott A. Nammacher (Empire Valuation Consultants) is the newly elected Business Valuation Discipline Governor.

We’d also like to congratulate the new members to the International Institute of Business Valuers:

  • Chair: Carl Merton (Reko International Group)
  • Vice Chair: William Quackenbush (Advent Valuation Advisors)
  • Secretary/Treasurer: Farley Cohen (Cohen Hamilton Steger & Co.)
  • Vice President: Lee Hackett (American Appraisal Associates)



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Goodwill in Divorce
July 14, 2011
10:00am - 11:40am PT
Featuring: Jim Alerding and Drew Soshnick

Lost Profits Damages in Medical Practices
Part 7 of BVR's Online Symposium on Healthcare Valuation
July 20, 2011
10:00am - 11:40am PT
Featuring: Mark Dietrich and Jim Lloyd


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