Has the debut of IPCPM sounded the death knell for the buildup method?
“I feel like using the IPCPM and abandoning BUM and not referring to BUM at all in my report.” This startling comment summed up one BV professional’s feeling after listening to the debut presentation of the new implied private company pricing model (IPCPM). This is the first income approach method to valuing private companies that relies on private company data—eliminating the need to make lots of adjustments to public company data.
IPCPM’s developers, Robert Dohmeyer (Dohmeyer Valuation Corp.), Peter Butler (Valtrend), and Rod Burkert (Burkert Valuation Advisors), conducted a recent webinar to explain how this new model estimates cost of capital for companies with revenues of less than $150 million. They also authored an article explaining IPCPM that was featured in the March issue of Business Valuation Update. That article is now being made available by BVR as a free download.
Builds on IPCPL: Last year, the IPCPM developers introduced the implied private company pricing line (IPCPL) as a new tool for estimating the cost of capital for small private companies. IPCPL uses two sets of data: (1) transaction prices of 500 small private businesses from the Pratt’s Stats transaction database (the “IPCPL 500”); and (2) the cost of capital, adjusted for the cost of going and staying public, of micro-cap publicly traded companies that are in the range of $150 million in revenues.
Feedback from the BV community was positive, but some commenters pointed out that, while IPCPL is fine for average companies, what if the subject company is not average—and what if it’s not in the same industry? How do you adjust for these factors? The new IPCPM model facilitates adjustments from the IPCPL size-based indication for comparable differences in: (1) systematic risk (i.e., beta); (2) diversifiable and total risk (i.e., total beta); (3) liquidity; and (4) debt capacity.
BUM’s rush? The build-up model would not probably be used by appraisers today if it had just been invented—not that it hasn't been the core of methods to achieve a cost of capital conclusion. Various experts, including Prof. Aswath Damodaran (Stern School of Business, New York University), have expressed concerns. During their webinar presentation, the IPCPM developers presented some notable outside comments about the flaws of the build-up method, such as Damodaran’s observation: “The build-up approach is a recipe for disaster.”
One valuation expert in the audience took issue with the mere mention of these disparaging comments. “I certainly hope lawyers for cases in which I have testified do not quote (in future cases) these melodramatic comments in an attempt to discredit my work for all the years I've been using a build-up method,” he says. “These comments sound like a total indictment against the majority of business valuation professionals. I wish we could exclude these comments from CPE programs.”
Burkert pointed out that these comments (from Damodaran and Dr. John Paglia, one of the authors of the Pepperdine Private Capital Markets Project) are out there in public, so lawyers can come across them just as easily as they did. "It's better to know that attacks on BUM are coming, and prepare for them, rather than to be surprised," he says. "The more information the better."
To listen to the archive of the webinar, “Utilizing the Implied Private Company Pricing Model: The Cost of Capital Wizard,” click here.
IRS stance on discounts to Partnership Profiles data refuted
At the recent Partnership Profiles’ “Appraising Family Limited Partnerships” course in Dallas, a participant asked the speakers to comment on the IRS’s Discount for Lack of Marketability Job Aid for IRS Professionals. In the Aid, the IRS indicates both minority and marketability discounts are already reflected in the Partnership Profiles data, and therefore appraisers shouldn’t add a marketability discount.
IRS distortions: Speaker Spencer Jefferies (Partnership Profiles) responded that some appraisers add small marketability discounts because the partnerships covered in his study were traded in the secondary market. “There is a lot of misinformation in the Job Aid and Mike Gregory is addressing the concerns in the Discounts for Lack of Marketability and the IRS,” said presenter Bruce Johnson (Munroe, Park & Johnson). Gregory was with the IRS for 28 years and put together the DLOM Job Aid back in 2009. Now a private consultant and mediator, BVWire contacted him for his comments.
Gregory provides several pages of commentary on Partnership Profiles in his book. “By discounting the value of a limited partnership interest or the value of a minority interest in an operation company, the effective rate of return for the interest increases. Practitioners often make the error of applying a fixed discount for lack of marketability without any regard to the resulting rate of return,” he writes. “I would add that this approach works well for market data when market data is appropriate for the valuation,” he says. Partnership Profiles now has over 340 real estate limited partnerships, for example.
In addition, the fourth edition of Partnership Profiles’ "Comprehensive Guide for the Valuation of Family Limited Partnerships" addresses the concerns raised in the 2009 Job Aid and presents commentary indicating that applying the appropriate discount for a specific interest should be based on the impact that the discount has on the rate of return.
Look for an article on often-overlooked steps when valuing FLPs in a future issue of Business Valuation Update.
Some sanity returning to Daubert analysis?
A business interruption case that was appealed at the 7th Circuit Court of Appeals for review of the district court’s Daubert decision may restore some sanity to the Daubert review process, according to R. James Alerding (Alerding Consulting LLC). The plaintiff had claimed losses for the collapse of its office building in Paris. The defendant’s insurance company contested the claims, and the case found its way into federal court.
Too far: The district court excluded the plaintiff’s expert under Daubert even though it approved of his methodology; it simply disapproved of the data he relied on in his analysis. The 7th Circuit found that it went too far. Even though the court as a gatekeeper has some leeway in determining reliability, it is not unlimited. “Reliability, however, is a primary question of the validity of the methodology employed by an expert, not the quality of the data used in applying the methodology or the conclusions produced,” the appellate court said.
“I could not have said it any better,” says Alerding. “That is exactly what it should be.” He adds: “I think this decision is not so much a victory for expert witnesses as it is for reason and boundaries of the application of Daubert.” He is concerned that the more a court injects its own opinion as to the data an expert uses, the greater the risk of protracted litigation. The lower court excludes proper expert testimony, and one party has to appeal to stay in the litigation.
Alerding and BVR’s legal editor and attorney Sylvia Golden conduct a regular webinar update of significant business valuation cases. To listen to an archived version of their latest webinar, click here.
The case discussed above, Manpower, Inc. v. Ins. Co. of Pa., LLC, 2013 U.S. App. LEXIS 20959 (Oct. 16, 2013), is available at BVLaw.
Common error in post-M&A damages valuation
In post-M&A purchase price disputes, the valuation analyst is often called in to measure damages due to misrepresentations by the seller. These typically involve financial statements and projections, information about key customers, existing or impending litigation, regulatory compliance, and the like.
Typical mistake: According to Jeff Litvak (FTI Consulting), a common error valuation analysts make is that they approach an M&A damages assignment as a revaluation of the company. “Some valuation experts get confused and think that you need to revalue the business on an impaired basis,” says Litvak. “That is not the right approach. You need to value the misstatement.”
Damages due to seller misrepresentations are measured on a “benefit of the bargain” basis. This is the difference between what the buyer bargained for and what was actually received due to the misrepresentation. If a misrepresentation results in a one-time, nonrecurring charge that does not impact future earnings, the value of the damage is measured on a dollar-for-dollar basis. On the other hand, if the misrepresentation does impact future earnings, the damage is measured “at the multiple,” based on the decrease in value due to the misrepresentation.
For example, assume Target Co. does not disclose a contingent liability relating to some environmental damage and Buyer Co. ends up having to pay a one-time $10 million cleanup charge because of it. Since there is no impact on future earnings, the damage is valued at $10 million. However, if Target does not disclose that it knows that a major customer will jump to a competitor, the damage is calculated based on the impact to earnings. For instance, if Buyer paid a multiple of five times EBITDA and the lost customer contributed $5 million to EBITDA, Buyer could claim that the value of the damage is $25 million ($5 million of lost EBITDA times the multiple of five).
Good case: In the upcoming April issue of Business Valuation Update, Litvak discusses a very good case in which he testified in the Delaware Court of Chancery. The case was settled before the court could render a verdict, but Litvak gives us an inside look at how it did the valuation of the M&A damage claim.
BV movers . . .
People: Timothy Adams was named to the Board of Directors at Maner Costerisan PC of Lansing, Mich. … Jarred Berman joined Gettry Marcus’s Business Valuation and Litigation Group in Woodbury, N.Y. … Steven Egna, director at Teal, Becker & Chiaramonte CPAs of Albany, N.Y., was appointed the new managing member of the American Business Appraisers … Grossman Yanak & Ford of Pittsburgh, Penn. announced the addition of two new managers: Brett Fulesday in the Business Valuation and Litigation Support Services Group and Christen Wisinski in the Tax Services Group … Decosimo, based in Chattanooga, Tenn., added Nicole Gossett as a valuation services manager in its advisory services practice group … Linda Koerselman was appointed chair and Kevin Doyle named the vice chair of the 2014 Eide Bailly Board of Directors … Rob Nance joined Inovautus Consulting of Boulder, Colo., as director of content marketing & consulting services … Sandy Purcell, senior managing director at Houlihan Lokey, joined the Board of Directors of AudioEye, a publicly traded Tucson-based content publication and distribution software company … Mark A. Schmidt was promoted to partner at Sirchia & Cuomo LLP of Syracuse, N.Y. … Allen Global Hospitality (Allen Global), announced that John Stockdale, Sr. joined its valuation team as senior consultant, business valuation … Ph.D. economist and financial professional Nancy Voth became the new director of WTP Advisors’ Minneapolis office.
Firms: Cortland Valuation Group Inc. of Washington, D.C., announced its merger with the San Diego-based The Windward Group Inc. and will offer a compelling full breadth of valuation services … Gettry Marcus of Woodbury, N.Y., became the first North American firm to join as well as hold a position on the executive board of the new global organization TGS Global … Mountjoy Chilton Medley LLP, headquartered in Louisville, Ky., was featured in early March on the television show “World’s Greatest.” MCM’s distinctive, employee-led culture, broad range of expertise and dedication to community betterment was highlighted on the program … Perkins & Co. of Portland, Ore., opened a downtown office in Vancouver, Wash.
Latest CPE events KO old saying
They say March comes in like a lion but goes out like a lamb. Not so, judging from these strong CPE events that take us to the end of the month.
Omissions & Commissions: Errors, Challenges & Solutions in Business Appraisal Reports (March 12), featuring L. Paul Hood Jr. (The University of Toledo Foundation) and Timothy Lee (Mercer Capital). The Advanced Webinar Series on Reporting & Testimony concludes with a look at the all-too-common errors and mistakes that can sink a business appraisal report. Join attorney Hood and appraisal expert Lee to learn how to avoid these mistakes and safeguard the defensibility of the appraisal.
Valuing Ambulatory Surgery Centers (March 25), featuring Todd Sorensen and Kevin McDonough (both VMG Health). Over the past decade or so, ambulatory surgery centers (ASCs) have been featured prominently in major trends within the healthcare industry. In Part 3 of BVR’s 2014 Online Symposium on Healthcare Valuation, experts Sorensen and McDonough examine the ongoing and emerging trends and valuation challenges that make ASCs both ripe for appraisal and fraught with peril for the analyst accepting the assignment.
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