FAF tightens FASB oversight, reduces Board

Effective July 1, 2008, the Financial Accounting Standards Board (FASB) will be reduced from seven to five members, according to resolutions that the Financial Accounting Foundation (FAF) adopted last week.  Reacting in part to the recent Progress Report by the SEC’s Advisory Committee on Improvements to Financial Reporting (see last week’s BVWire™), the FAF Board of Trustees also modified FASB member qualifications, which must now include “knowledge of and experience in investing and accounting education and research, and appreciation of the needs of participants in capital markets.”  Further, FAF will “assume a more active role in the oversight of FASB…standard setting processes.”

…While FAF will not insert itself into standard setters’ substantive deliberations or standards promulgation, it will provide and perform more active oversight as to the efficiency and effectiveness of certain important elements of standard setting such as due process, agenda setting solicitation of public comment, consideration of comments, and the post-implementation evaluation of the effectiveness and efficiency of standards.

To meet these goals, the FAF will formalize its evaluation procedures and post-implementation standards reviews, and FAF Trustees will devote more time to both policy and strategy related to independent standard setting.  The FASB agenda-setting process will also become a “leadership agenda” process by which “the FASB Chair shall be vested with the authority, following appropriate consultation, to set the FASB’s project plans, agenda, and project priorities.”  To read the full Recitals and Resolutions (February 27, 2008), click here.

New S Corp article analyzes embedded tax rates

“When analysts use a public market cost of equity capital to value an S corporation, they apply the S Corp valuation models to account for the different returns that a public market investor realizes compared to an S corporation investor,” says Nancy Fannon, author of Fannon’s Guide to the Valuation of Subchapter S Corporations (BVResources, 2007).  “They do this primarily by measuring the dividend and capital gains taxes that the S corporation investor avoids.”  But just when you might have thought that the S corporation debate was about to settle down around these simple concepts, Fannon says, “we have more to talk about than ever.”  

In her new article, “The Real S Corp Debate: Impact of Embedded Tax Rates from Public Markets” (Business Valuation Update™, March 2008), Fannon explains the problem: 

Typically, analysts have measured the benefit to the S corporation shareholder, relative to the public C corporation shareholder, at the current statutory dividend and capital gains tax rates.  Thus far, the [S Corp valuation] models have been silent as to the distinction between the current dividend and capital gains tax rates, and the rates embedded in the public market equity return which analysts use to value the S corporation.  The distinction is notable.  This article examines the most recent and relevant academic studies that have researched the impact of personal taxes (dividend and capital gains) on value. 

Those who’ve already subscribed to Fannon’s Guide will automatically receive a free copy of the new article, plus a Telephone Conference Pack that includes the transcript, audio file, presentation, and ancillary reading materials from Fannon’s recent BVR teleconference (Nov. 13, 2007) on “S Corporations” (a $249 value).  New subscribers to her Guide will also receive the article and the TC pack; to order, click here.

VCs still view valuation as ‘necessary evil’

During last week’s meeting of Venture Capital in the Rockies (VCiR), attendees from Arcstone Partners (Denver, CO) reported on the content and conversational tone of the meetings.  Overall attendance at the event, held at the Beaver Creek ski resort, was at record levels, with 326 pre-registrants and a number of “walk-ins” paying cash at the door. The hallway “chatter” or tone was good, says Chuck Reed, Arcstone’s director of valuation services.  If there is any impact from the ongoing credit crunch in public markets, venture capitalists either aren’t feeling it yet—“or they are excellent actors,” he says.  “There are also no hints that portfolios are being reviewed for underperforming assets with any greater vigor than has been exercised in the past.”

However, in general, the VC community still views valuation as a “necessary evil that they are reluctant to pay for,” Reed observes.  Those in the Rocky Mountain region complain that Silicon Valley VCs are driving valuation prices higher.  At lunch, the topic of greatest interest was “Valuation Doesn’t Matter”—a tongue-in-cheek presentation on why a higher valuation is actually desirable in many instances.  Views on valuation also depend on whom you ask, according to Arcstone managing director, Bo Brustkern.  “More to the point, it depends on the auditor you ask.  At VCiR we heard a range of perspectives (relating to common stock valuations, purchase [delete the d!] price allocations and portfolio valuations), from ‘you're a bunch of bloodsucking leeches’ to ‘we take this stuff seriously and act in full compliance wherever required.’" 

Notably, the interpretation of "wherever required" may vary significantly based on how hard certain auditors are pushing regulatory compliance.  One private equity CFO offered an illustrative anecdote.  Last November, his auditors made it clear that his portfolio could be valued using the old-school PEIGG standards of value.  “Business as usual,” Brustkern says, “no surprises.”  Then just this past February, the very same auditors said the PE firm's portfolio would have to be valued according to the Fair Value standard.  “Needless to say, this caused our friend a tremendous amount of heartburn, and he is [right now] working through the issues.”  Brustkern would be surprised if this was an isolated incident.  “It’s very clear that strict adherence to Fair Value standards is not at all uniform across the PE, VC and tech industries.  It all comes down to the auditor at this point, and adherence is all over the road.”

Adding to the positive notes, “Judging from the number of potential investors speaking with management teams after presentations,” Reed says, “the private equity segment of the economy continues to be healthy and should ensure continued work for valuation professionals.”  Visit the VCiR website for more details on this year’s conference.

Butler/Pinkerton update questions on comparables

The FAQ for the Butler/Pinkerton Model Total Cost of Equity and Public Company-Specific Risk Calculator™ (BPM) stays current on all user questions, thanks to constant attention and updating by co-developers Pete Butler and Keith Pinkerton.  Recently, a user asked whether he “must have” good public company comparables for using the BPM in an engagement involving a $40 million subject company (when the opposing expert had valued the same company at $90 million).  “I believe the key word is ‘must’” Butler responds, adding these points:

  1. Alternatives to quantify company-specific risk (CSR) lack any empirical data.  The BPM supplies empirical data.  So, the choice is to use the BPM with maybe ‘not-so great’ guidelines or to use the component observation method, for example, which does not have any empirical data.
  2. Any time appraisers use the income approach, we generally get our discount rate inputs (beta, equity risk premium, size premium, and industry premium) from publicly traded stock data.  We do not throw out the income approach because there are no good guideline companies.  Thus in our opinion, we should not throw out the BPM if there are no ‘good’ guideline companies.  We calculate CSR from the same publicly-traded data.

Of course, “I do want ‘good’ guidelines with the BPM,” Butler adds.  What constitutes “good” will vary from one engagement to the next.  For the complete FAQ, click here.

The authors answer more questions tomorrow:  Butler and Pinkerton will discuss their model and take questions from attendees tomorrow, March 6, 2008, during BVR’s teleconference on “Using the BPM Total Cost of Equity (TCOE) and Public Company-Specific Risk Calculator.”  To register, click here.

Seeking Senior Business Valuation Analyst

Shannon Pratt Valuations is seeking a Senior Business Valuation Analyst with testimony experience for its Portland office.  Qualified candidates please respond with resume to Shannon Pratt at:

or phone Paul Anthony at (503) 459-4700 ext. 1.

BVMarketdata: better, faster, stronger

In response to subscriber requests, over the last few days we’ve made a series of changes to BVMarketData.com that will make search and data retrieval even more efficient.  Key improvements include:

  • We’ve modified certain pages that bots (web crawlers) could get stuck on and potentially bog down the server.
  • We’ve decreased the output size of the Pratt’s Stats® search results and Excel downloads.
  • Users now receive compressed data.

This last point significantly reduces the size of transferred data and accelerates search results. For example, a Pratt’s Stats search that resulted in 1500 transactions used to take approximately 58 seconds to download and display. Now, with the compressed data, the same search takes only five seconds.  Downloading the Excel file takes only one second now, compared to 50 seconds before.  Subscribers can enjoy the new improvements at BVMarketData. 

IBA responds to critics of database, DMDM

“Flaws in the IBA Transaction Database and the Direct Market Data Method have…come to the attention of some vociferously articulate members of the appraisal profession,” writes director Ray Miles in the latest newsletter from the Institute of Business Appraisers (IBA).  “Some of these critics are, shall we say, not enthusiastic supporters of the concepts behind the IBA Transaction Database and the Direct Market Data Method (DMDM).  Like many of us, they are resistant to change, no matter how necessary.”

In this Part XLVII of his series on the IBA database and the DMDM, “Responding to Criticisms,” Miles says that critics often target the lack of mathematical rigor in DMDM methods and the presence of duplicates in the database.  “No method of valuing a business is perfect,” he writes.  “Many of these criticisms, while technically valid, are irrelevant in the real world in which businesses are appraised.  They reflect a vain search for precision that is inconsistent with achievable accuracy.”

But the critics help create “an active forum for discussion and debate,” Miles adds, before addressing their points.  “This is how the system is supposed to work, and the discussions are both healthy and useful.”  To access the article and the complete IBA newsletter, click here.

PCAOB may tighten auditor review requirements

More oversight pressure on auditors: The Public Company Accounting Oversight Board (PCAOB) last week announced its proposed new auditing standard on engagement quality review.  Pursuant to Section 103 of Sarbanes-Oxley, the new proposal would require all registered public accounting firms to provide a concurring or second partner review (also known as an Engagement Quality Review) for all audit reports conducted in compliance with PCAOB standards.  “By focusing the review on higher risks, the proposed standard would increase the likelihood of identifying and correcting deficiencies in the audit prior to the issuance of the auditor’s report,” says the PCAOB release.  The Board is requesting comments on the proposal prior to May 12, 2008.  For more information, visit PCAOB.org.

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