June 8, 2011 | Issue #105-2  

The ‘one size fits all’ company-specific risk doesn’t exist

At the CalCPA conference in San Francisco last week, Ted Israel (Eckhoff Forensic & Valuation Services) joined James Harrington (Duff and Phelps) to discuss the issues surrounding company-specific risk (CSR). Many valuation analysts may be double-counting CSR, Israel said, because they are not aware of the risk already embedded in the companies in Ibbotson’s lower tenth deciles and Duff & Phelps Portfolio 25. The subject company’s earnings may already manifest many of the ills normally associated with small private companies. “We’re spending too much time obsessing over the denominator [the discount rate] and ignoring the effects on the numerator [earnings],” he said. Some analysts might also be blurring the line between risk of the investment (the proper focus of the CSR analysis) and the investor’s risk. Through a Fama-French analysis, Harrington demonstrated that although greater CSR may indeed be associated with the non-diversified holdings, the market did not necessarily compensate them with greater returns. As for the “total beta” model, he believes that a “one size fits all, ‘silver bullet’” for estimating CSR does not exist. The more important question: How does the subject company compare to those in the selected peer group from, e.g., the SBBI 10z or Duff & Phelps Portfolio 25 companies?

For more on this complex, always controversial topic, Israel’s paper, “Risky Business” is in the current BVUpdate (June 2011) and is now available as a free download here.

Income approach may be the dominant, but not exclusive method to value an S Corp going concern in divorce

A joint expert valued the husband’s 33% interest in a successful grocery store/ S corporation at $557,000, based on net assets and including 20% marketability and minority discounts. At the 2007 trial, the wife’s attorney questioned the expert about a just-released decision from the Massachusetts Supreme Judicial Court, Bernier v. Bernier, which also concerned a closely held grocery store/ S Corp (and which has since become familiar to most appraisers for its holdings on tax-affecting as well as discounts; see BVWire #60-3). Valuation professionals were still “wrestling” with Bernier, the expert conceded, but in light of its holding, he testified that discounts were no longer applicable, and adjusted his valuation to roughly $870,000. With leave from the  court, the husband presented a rebuttal expert, who criticized the asset approach for improperly equating the net book value of an ongoing business to fair market value, and used the “more appropriate” income approach to value the business at $534,000, without discounts.

The trial court adopted the $870,000 value by the joint expert and the husband appealed—but he couldn’t persuade the appellate court, which found that Bernier clearly bars discounts, except in “extraordinary” circumstances (liquidation or imminent sale). Moreover, “while the income approach has emerged as the dominant approach in business valuation, the weight of authority does not support…that it is the only appropriate measure of [the store’s] value or that the use of any other methodology is clearly erroneous,” the court held, citing Pratt & Niculita, The Lawyer’s Business Valuation Handbook, (2d ed. 2010). Notably, the decision does not discuss tax-affecting, leaving appraisers and attorneys to keep wrestling with the issue. The complete digest of Palmerino v. Palmerino, 2011 WL 1450359 (Mass. App.Ct.)(April 15, 2011) will appear in the July 2011 BVUpdate; the court’s unpublished opinion will be posted soon at BVLaw.

Keep current on divorce case law. These decisions illustrate why it’s so important for appraisers to know, understand, and apply the most recent court decisions to business values in divorce. To do just that, consider BVR’s comprehensive, just-updated Divorce Case Law Compendium.

Too late to cure the ‘disconnect’ between DOL and appraisers?

Not surprisingly, the new proposal from the Department of Labor (DOL) to make appraisers “fiduciaries” under ERISA (Sec. 3(21)) dominated the discussion on ESOP valuations at last week’s 25th annual meeting of the Valuation Roundtable of San Francisco in Orinda, CA. (For background on the reg., see BVWire #s 101-2 and 102-1.) “There is a disconnect between the DOL and the appraisal community,” said attorney Larry Goldberg (Sheppard Mullin), who testified at the DOL hearings last March as Chair of the ESOP Association’s Advisory Committee on Legislative and Regulatory Issues. If the DOL purports to make appraisers fiduciaries—then how can they maintain their objectivity and independence?

The DOL says they are after “rogue” appraisers who perform “incorrect” valuations, but when pressed for clarification (incorrect standard of value? incorrect multiples?), “the DOL couldn’t or didn’t say,” Goldberg reported. Since they can’t win lawsuits under the current rules, the DOL wants a direct cause of action against appraisers, he added. Some VRT members believed that a robust peer-review process would be a better solution, and Goldberg said the idea of an IRS-type appraiser penalty came up at the hearings. “All the appraiser groups said they’d vote for that,” and some are continuing to lobby the point—along with the DOL's failure to assess the impact of its proposed regulations on business in general, but ultimately, the DOL is “very focused on getting this finalized and passed,” Goldberg said, with an internal deadline by year’s end.

What’s behind the attack? Some VRT attendees believe the union-friendly DOL is generally opposed to ESOPs (and have been since the 70s). Others, including the latest  ESOP Ownership Foundation blog, say the DOL is targeting the specific valuation practice of discounts/control premiums. Whatever the reason, “I’m upset, and I want someone to take DOL to task on this issue,” said Scott Miller (Enterprise Services, Inc.), a VRT co-presenter. “Go to your elected representatives,” he advised appraisers. “Champion employee-owned companies, how they tend to grow faster, create more jobs, more profits than non-ESOP firms—and don’t ship jobs overseas.” Hammer the point home: Why is the DOL attacking what is working so well? “Consider your direct involvement,” Miller added, who’d already “hammered” his local reps with some success: “It does work.”

Porter: Expert ‘disasters’ I have seen (and how to avoid them)

“Most lawyers will not take on your analysis directly,” John Porter (Baker Botts LLP, Houston) told VRT attendees in California last week. “Instead, they will nibble around the edges to find some ‘gotchyas’ to impeach your credibility.”  And just how will they gnaw at your testimony? Porter, one of the most experienced trial and appellate attorneys in the valuation arena, lists the ways:

  • Prior opinions. If what you say in this case differs from prior testimony or published articles, be prepared to explain your current stance. “In this day of larger valuation firms,” Porter said, “you should also search out prior testimony or articles by anyone in the firm.”
  • Incomplete references.  Porter recently reviewed an appraiser’s report that excerpted the companion study to The FMV Restricted Stock Study without providing its full context. “I was able to cross-examine him and say you ‘cherry-picked’ the companion guide, which caused you to overstate the discount,” Porter said. So if you’re going to cite authoritative materials, “make sure nothing can come back to bite you.”
  • The uninformed testifier. If junior colleagues performed the “spade work,” make sure the senior appraiser (who ultimately signs off on the report), becomes “intimately familiar” with its content. Porter just attended a deposition in which the senior appraiser kept looking to his junior associate for help answering questions, “which made him look like he needed a lifeline.”
  • Friendly fire. When the client is relying on another expert in the case, the two should stay apart until they’ve each filed a report—but then they should read and discuss the other’s work. “Serious damage could be done by one expert simply agreeing to a seemingly unimportant statement,” Porter said, which could unintentionally impeach the other expert.

Rights of first refusal restrict marketability

“Rights of first refusal (ROFRs) are not the same as buy-sell agreements,” explains Chris Mercer (Mercer Capital) on his blog Valuation Speak. “The bottom line about rights of first refusal is that they restrict marketability. Buy-sell agreements provide for marketability under specified terms and conditions upon the occurrence of specified trigger events.” Click here to read more.

Tap into your inner Columbo during site visits

In his presentation,The Cause-and-Effect Approach to Gauging Unsystematic Risk” at the CalCPA conference last week, Warren Miller (Beckmill Research) emphasized the importance of the site visit in a valuation engagement. “Many appraisers give the on-site interview short shrift,” says Miller. “This is not a social call, folks. The site visit is your chance to connect the dots…to discover the metrics and relationships that account for the major differences between the company’s relative performance and its financial condition.”  Valuation practitioners should act like Columbo during the interviews, Miller joked, such as introducing a difficult question with a self-deprecating comment. An example:

“You know, you’re probably going to think this is a really dumb question, but I need to ask it because I’m trying to understand this particular area.” And then ask the question again, using ”weasel words” (adverbs, lots of “uhhs” and “uhms”) and “weasel” facial expressions (scratch head if confused; scratch head even if not confused but the answer you just got was, well, jarring, and you’re going to repeat the question to make sure that you heard it right); and so on...

Get Miller’s detailed tips for successful site visits on BVR’s Free Downloads page.

Have the last six months changed the BV profession?

John Paglia (Pepperdine University), Robert Slee (Robertson & Foley), and the Graziadio School of Business and Management at Pepperdine Univ. just published the latest results from their ongoing Pepperdine Private Capital Markets Project, a  survey of privately held companies and their capital markets. Of particular interest, the majority of BV participants expect business confidence, business conditionsand BV engagements to increase over the next 12 months.

Compare those future expectations to the following snapshot of key practice indicators for the BV profession, excerpted from Slee and Paglia’s Private Capital Markets: Valuation, Capitalization, and Transfer of Private Business Interests, 2nd Edition:   

Comparison: Today versus Six Months Ago



About same


Number of engagements




Fees for services




Time to receive payment for services




Size of your BV department




Cost of capital




Market (equity) risk premiums








Company specific risk premiums




In last week’s ASA E-Letter, John Borrowman (Borrowman Baker LLC) also provided insights on the current state of the BV profession:

  • “Of all the service areas, litigation support has probably remained the strongest.”
  • “Congress has reintroduced certainty into the world of estate planning, and brought clients back onto the playing field.”
  • “Valuation work driven by the return of merger and acquisition activity is another factor contributing to the return of confidence.”

Two new reports on current M&A activity

Grant Thornton International Ltd (GTI) just published its annual International Business Report (IBR) and the U.S. M&A activity update: Q1 2011.

  • The IBR, based on the results of a survey of 6,000 privately held businesses (PHBs) across 39 economies, indicates 34% of respondents are planning to make an acquisition this year, up from 26% last year. Access to new geographic markets and building scale are the two most important drivers. Approximately 32% of those PHBs are planning to grow through a cross-border transaction, up from 28% last year.
  • Deal volume in the U.S. during the 1st quarter 2011 was lighter than in the 4th quarter 2010, but “deal conditions remain generally favorable with increasingly active lenders, a renewed interest in M&A as a mechanism to accelerate growth, and abundant private equity capital and corporate cash.” GT analysts expect “the robust pace of deal activity will likely continue through the rest of the year.”

Access both reports in the current (Spring 2011) Deal Maker.

Does this remind any one of Cuba in 1959?

The infamous Trugmans are moving into leadership roles as of July 1 (either showing great wisdom or what Gary refers to as “suicidal tendencies.”) Linda is taking over as Chair of the ASA’s Business Valuation Committee (BVC), and Gary is becoming the ASA’s BV Education Chair. Congratulations to both—and to all the other BV volunteers whose terms start or continue next month. It’s great to know the ASA’s BVC and education efforts will continue in great hands. ...Junta, anyone?

Two opportunities to earn CPE next week in BVR webinars:

BVR’s Online Symposium on Healthcare Valuation continues on June 14 with “Valuing Clinical Co-Management Agreements,” featuring Gregory Anderson (Horne LLP) and Ann Brandt (HealthCare Appraisers).  Focusing on a fast-growing arrangement in the American healthcare system, part 6 of our Symposium will discuss considerations such as operational characteristics of co-management agreements and methods of valuation, including income-, incentive-, and cost-based approaches.

Thursday, June 16 marks the return of BVR’s Industry Spotlight Series with “Valuing Alternative Investment Management Companies: Private Equity and Hedge Funds,” featuring Jay Fishman (Financial Research Associates) and Scott Nammacher (Empire Valuation Consultants). Though proliferating during good times, alternative investment vehicles are often stripped bare during down economic cycles, revealing flaws in strategy, management, and objective.  In their 100-minute webinar, Fishman and Nammacher will discuss the challenges inherent in valuing the companies that produce and manage these increasingly popular (and problematic) investment vehicles.


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Valuing Clinical Co-Management Arrangements
June 14, 2011
10:00am - 11:40 am PT
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Valuing Alternative Investment Management Companies: Private Equity and Hedge Funds
June 16, 2011
10:00am - 11:40 am PT
Featuring: Jay Fishman and Scott Nammacher


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