AICPA BV conference buzz
At the time of this writing, BVWire is at the AICPA Forensic & Valuation Services Conference 2013 in Las Vegas. Nearly 1,000 attendees are in Sin City hitting the jackpot with some great sessions. Here are a few golden nuggets we’ve picked up.
Shorter valuation reports are now in vogue, it was explained in one session. A show of hands of session attendees found that 50 pages was the average length. The big valuation firms seem to be producing the shorter reports, and the small firms are turning out the 150-page tomes.
Automatic IRS audits can be triggered when the same firm does tax and valuation work. For example, IRS agents in some areas will pull an estate and gift tax return prepared by the same firm that does an attached valuation. Session members were polled, and 60% said their firm does both. Rethink this strategy as it adds risk to clients.
More calculation reports are being ordered and used for purposes not intended by the standards. For instance, attorneys are ordering them to be attached to estate and gift tax returns because they’re cheaper than full reports. BV standards envision their use in limited circumstances, but not litigation. If a calculation report ends up in court or in an IRS audit, you could have a disaster.
There is a lot of chatter about the final AICPA Goodwill Impairment Guide that has just been released in e-book format (print version coming in December). Some of the guide’s Task Force members will conduct a webinar on November 19.
See next week’s BVWire for more takeaways from the AICPA conference.
Where will I get my 2014 SBBI Valuation Edition? A further update on this evolving resource
More news is now available on replacement products for the valuation edition that was discontinued by Morningstar in October.
Duff & Phelps is now moving ahead to combine the most critical components of the Ibbotson reports into its existing Duff & Phelps Risk Premium Report. The working title of the new book, scheduled to be released by Wiley in March (coinciding with the annual release of the old valuation edition from Morningstar), is currently the Duff & Phelps Valuation Handbook/Guide to Cost of Capital.
The Valuation Handbook will include industry risk and new size premia calculations that had been available from Ibbotson—but had not been included in the existing DP Risk Premium Report. And this book will be available from BVR, NACVA, and perhaps the AICPA, as well as from Wiley, BVR has confirmed.
The Risk Premium Calculator, which also includes historic cost of capital data, will continue to be available from BVR, and also to NACVA members. Users of the Calculator will receive the new Valuation Handbook.
BVR is also working to re-create the missing Morningstar beta “tear sheets” and calculator as well as to provide a new international cost of capital study. More news on these remaining missing items will be published here as soon as they’re available and also will be posted to the BVR Cost of Capital Resource Center.
Ibbotson and the ERP take spotlight in divorce case
It is no mystery that financial experts rely on the Ibbotson SBBI Valuation Yearbook for their valuations, but what makes a recent divorce case intriguing is how two experts used the same authority to argue for a vastly different equity risk premium (ERP).
Cap rate gaps: The parties contested the value of a small, agriculture-based business that the husband owned and operated during the marriage. Three experts appeared in front of the court: the spouses’ appraisers and a third-party valuator whom the court appointed because it found the parties’ valuations “not convincing.” The experts used a capitalization of net income approach, with vastly different capitalization rates. The wife’s expert applied an 18% capitalization rate, including a 5.7% ERP and a 5% company-specific risk premium. It reflected a low-risk business, he said, because the agriculture industry was relatively stable and healthy. The husband’s expert used a 26.6% capitalization rate, noting the industry was “relatively unstable”; also, the company relied on only a few customers, and the loss of any one client put its profitability at grave risk, he said. The third-party appraiser determined a 13.1% capitalization rate, including a 5.2% equity risk premium from the 2010 Ibbotson Valuation Yearbook. He also believed a 10% size premium and a 4% company-specific risk premium were reasonable. The trial court adopted his valuation in its entirety, finding that the business risk was less than the risk the husband’s expert claimed.
The husband appealed the decision, arguing the appointed expert used an improperly low capitalization rate. As to the ERP component, he said, the expert falsely claimed to use the 5.2% ERP appearing in the 2010 Ibbotson Valuation Yearbook, when in reality Ibbotson showed a 6.6% value.
The appellate court dismissed that argument quickly. “Presumably [Ibbotson] is a manual used to value businesses, but it is not included in the lower court’s record,” it said. Without evidence, the court could not determine whether the trial court had erred in accepting the valuation. But, the appellate court added, the 5.2% rate was comparable to the 5.7% rate the wife’s expert had applied. At the same time, no expert had argued for an ERP as high as 6.6%.
Mystery of two ERPs: Business valuator Dan Gilbert (Gilbert Valuations LLC) confirms that the 2010 Ibbotson Yearbook lists a 5.2% supply-side ERP and a 6.7% historical ERP. In short, the historical ERP derives the premium using historical market returns. The yearbook calculates the historical ERP using the simple average of returns since 1926. The supply-side ERP relies on basic information, including earnings, dividends, or general economic productivity figures in determining the expected ERP. “Most appraisers I know use the supply-side ERP, which attempts to eliminate investor bias in price-to-earnings multiples,” Gilbert says. He also points out that, in 2010, the differential between the supply-side and historical ERPs was the highest in the past five years (2008-2013).
It seems that in this case the husband’s reference to a 6.6% ERP was to the historical rate, which his expert may have used (although the opinion does not expressly say so). This choice would result in the highest cost of equity and the lowest overall valuation—which his expert achieved and the court discredited.
Find a discussion of Alexander v. Alexander, 2013 Mich. App. LEXIS 1490 (Sept. 10, 2013) (slip op.) in the December issue of Business Valuation Update; the court opinion will be available soon at BVLaw.
Get third-party review of valuation reports, urges former IRS manager
Since leaving the IRS and opening his own firm, Michael Gregory (Michael Gregory Consulting LLC) has reviewed many business valuation reports. He finds enough errors to typically generate a four- to six-page paper of significant comments followed up by a discussion of the documentation provided.
“What does this tell me?” he writes in his recent book Business Appraisals and the IRS.“It tells me that you should have a third party conduct a real review of your work.” And this should not just be an afterthought, he says. It should be made a formal part of the work flow. The review should cover readability as well as technical competency, including math in spreadsheets. This will help prevent many of the more common errors Gregory saw during his stint with the IRS and, since then, in scores of reports by business valuation expert witnesses in the private sector.
Fall harvest of CPE events
Goodwill in Physician Practice Valuations (November 19). Unravel the challenges posed by the combination of goodwill determination and medical practice revenue streams. Featuring Stacey Udell (Gold Gerstein Group) and Stacy Collins (Financial Research Associates). Part 11 of BVR’s 2013 Online Symposium on Healthcare Valuation.
Valuing Synergies (November 21). Colloquially, business synergies are said to result in “one plus one equals three.” Find out how the math actually works with Jeff Litvak and Brent Miller (both FTI Consulting).
Advanced Workshop on Fractional Interest Valuation (December 12). Mark your calendar for the last Advanced Workshop of 2013. Learn how to value a fractional interest in any asset through this intensive four-hour presentation. Featuring Dennis Webb (Primus Valuations)
BizMiner: A Guided Tour of New Offerings (November 15). Join BizMiner founder Jon Brandow for a free one-hour tour of new tools and resources available in the BizMiner Suite.
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