Should you add basis points to adjust risk-free rates for volatility?
BVWire's™ inquiries—confirmed by BVR's teleconference last week on Developing Discount and Cap Rates in a Troubled Economy—indicate that the consensus answer is “no.” Don DeGrazia suggests that business appraisers should “not throw out the methods and empirical support we've tested over the many years.” It may be hard to justify breaking from these empirical methods to substitute some other long term proxy in the 4.5% range until the RFR returns to more historical norms, he believes.
Twenty-year Treasury notes, the most common proxy for the risk-free rate (RFR) in North America, are currently 200 basis points lower than historical levels (historical RFRs are available free from BVR). This factor by itself generates higher values, obviously, at a time when “reality” suggests values should be lower.
How should appraisers compensate for the fact that this key and trusted data source is currently producing counterintuitive valuations—by adding basis points? Co-presenter Stacy Preston Collins says, “We may become more dependent on industry research to help us justify lower earnings streams in the numerator of the value equation,” and because the industry-based elements of the discount rates may need to be adjusted upwards to compensate for higher risk.
DeGrazia, Collins, and Ron Seigneur agree that appraisers also need to pay more attention to measuring future income streams. “We're not only talking about the denominator [the discount rate], but also the numerator—the income stream—which is much less certain than it was in the past,” confirms DeGrazia.
“Every element of creating a discount rate is under examination now more closely than before,” says Collins. “A cookie-cutter approach to calculating discount rates won't stand up to scrutiny any longer.” Seigneur agrees: “We used to take the risk-free rate for granted, but now even that number is being questioned.”
More on BizMiner research reports—now available at BVMarketData
Our recent mention of new improvements at BVMarketData and BVResources’ exclusive agreement to offer reports from BizMiner prompted several inquiries from readers for more details. BVR now distributes BizMiner products for site licenses, subscription sales, and one-time purchases for BizMiner’s:
- Industry Financial Profile—3 and 5 year;
- Sole Proprietor Profit & Loss Profile—3 and 5 year;
- Startup Profit and Loss—3 and 5 Year;
- US Market Research Report—3 year;
- Local Market Research Profile—3 year; and
- Regional Business Profile—3 year and
- Competitive Market Analysis.
View sample reports of each and learn about subscription and site license pricing at www.bvmarketdata.com/bizminer or contact firstname.lastname@example.org for additional information.
May is a great month for business valuation CPE in New York City
First, the NYC Chapter of the American Society of Appraiser's 17th annual "Current Topics in Business Valuation" conference kicks off this Friday, May 8. Scott Nammacher, who is chairing the event, points out that "the current market environment is causing technical valuation issues in bank valuations, corporate debt values, equity option pricing/repricing, and impairment testing," so leading experts like Stamos Nicholas, Cindy Ma, and Jeff Dunn will be addressing these topics. Call Annie Bell at 212-714-0122 to register or get additional information on the program.
Then, on May 18-19, BVR teams up with the New York State Society of Certified Public Accountant’s Foundation for Accounting Education (FAE) to present their two-day 11th Annual FAE/BVR Business Valuation Conference, featuring Darrell Dorrell, Ashok Abbott, Jim Hitchner, Michael Kaplan, and other professional leaders. Click here for registration and further information.
Restaurant valuations decline to their lowest levels in four years
Restaurant valuations declined to their lowest levels in four years and cap rates continued to rise to their highest levels in recent history. This turn of events reflects a perfect storm of deteriorating sales and store profit margins (driven by increasing commodity and labor costs), falling real estate prices, tighter credit markets and fewer lenders, data from Restaurant Research LLC’s 6th Annual Restaurant Valuation Trends Industry Data Report show. The report—which outlines EBITDA multiple estimates on 30 restaurant chains based on data provided by seven appraisal firms, responsible for approximately 5,500 store valuations over the last 12 months—show that the casual dining segment, not surprisingly, was hardest hit and has the worst outlook. Indeed, the outlook over the next 12 months remains bearish as rising food and fuel costs continue to weigh on operators and consumers alike while credit market tightness continues.
Interested in finding out more about the restaurant marketplace? Log on to Pratt’s Stats® for transaction data relating to SIC 5812 (Eating Places) to glean invaluable insights on this industry. In addition, BVR will also host a 100-minute teleconference on restaurant valuation on Thursday, August 6, featuring Edward Moran and Kevin Yeanoplos. More information can be found here.
Valuing dental practices: the latest in BVR’s Industry Spotlight Series
As part of its new ‘In the Industry Spotlight Series,’ BVR is hosting teleconferences focused on the valuation of specific industries, businesses, and business models. With each new edition, top BV experts and thought-leaders will guide listeners through the characteristics of the target industry and offer insights on how to deal with the complications they present to the appraisal process.
On Thursday, May 14, BVR will host Valuing Dental Practices—the latest installment of the Industry Spotlight Series. This 100-minute teleconference will provide clarity on the complex world of dental practice valuation.
Joining expert appraisers Jim Andersen and Ron Seigneur is Dr. Stephen Persichetti, a practicing dentist, MBA, and professor of dental practice management. The trio will provide insights into valuation challenges presented by practice types, operating requirements, and the changing landscape that all dentists now face (and all business appraisers must account for). With changes to the professions of valuation and dentistry, this teleseminar is not to be missed!
Valuing Dental Practices begins at 10:00am PT/1:00pm ET. Two CPE credits are available for listeners. To register, learn more, and hear Jim Andersen describe the program in his own words, click here.
Terrible FLP facts preclude consideration of discounts
Through a combination of hard work, savings, and investments, an army colonel and his wife amassed a tidy portfolio of marketable securities worth roughly $2 million. When it came time to preserve and pass on their wealth, the couple established two family limited partnerships, one before his death in 1996 and one afterward. When the widow died in 2002, the IRS assessed roughly $800,000 in deficiencies against her estate.
At trial, the U.S. Tax Court (J. Haines) considered the following non-tax, business reasons for forming and funding the FLP, which the taxpayer argued pursuant to I.R.C. Sec. 2036(a)(1) demonstrated that it was a “bona fide sale for adequate consideration,” sufficient to keep the asset’s discounted value out of the widow’s gross estate:
- Management succession. The colonel’s widow specifically deferred any responsibility for choosing or investing the securities to her grown children, the FLP’s limited partners. However, they deferred most decisions to their investment advisors, failing to take an “active or efficient” management role, enough to fulfill this purpose.
- Financial education and family unity. There was little evidence that the colonel actually taught his two children about investing, and promotion of unity was “no more than a theoretical purpose,” the court said.
- Perpetuation of investment philosophy. Under these facts, the “perpetuation of a ‘buy and hold’ strategy is not a legitimate or significant nontax reason for transferring the bulk of one’s assets to a partnership.”
- Pooling and gifting of assets. Although pooling the assets might have cut expenses when it came to gift-giving, the donees could have received the investment accounts directly without adding any costs, especially in light of the expense of forming the FLPs in the first place. Finally, gift giving, alone, does not constitute a significant business purpose.
Even though the colonel and his wife had not discounted the value of any transfers during his lifetime, the Tax Court found that the widow and her children failed to treat the FLPs as formal, independent partnership entities, and pulled their full value back into the estate in Estate of Jorgensen v. Commissioner, T.C. Memo. 2009-66 (March 26, 2009).
Some believe that the court may have gone too far in Jorgensen v. Commissioner. At least one commentator, Owen Fiore, says that the court “in reality is taking IRC Sec. 2036(a) to the extreme, making it virtually impossible to have a passive investment, asset-holding FLP or LLC qualify as having the prerequisite real and significant non-tax purpose(s) to avoid treating [the] transfer of assets into the entity followed by gifts, etc. as testamentary in nature and [avoided] for estate tax purposes!”
For more of Fiore’s comments, see his current newsletter; and for a full write-up—including all of the facts and the court’s findings—see the forthcoming (July 2009) Business Valuation Update™. The full text of the Tax Court’s decision will be available at BVLaw™.