BVWire Issue #146-1 | November 5, 2014


Takeaways from the ASA-CICBV confab in Toronto

BVWire was on the scene last week in Toronto as over 600 attendees enjoyed three days of excellent sessions at the ASA-CICBV Business Valuation Conference jointly hosted by the American Society of Appraisers and the Canadian Institute of Chartered Business Valuators. The great thing about attending a conference such as this is the chance to collect valuable information, not only in the sessions, but also at the many networking opportunities the event offers. Below are just a few of the insights we collected both in the sessions and during the breaks.

John Paglia, Ph.D. (Pepperdine University), founder of the Pepperdine Private Capital Markets project, reveals that in five years appraisers of private companies say they will be putting more weight on sources from private markets than public markets to determine the cost of capital, a “huge change” for the profession.

The biggest BV problem in litigation is company-specific risk, says Roger Grabowski (Duff & Phelps). Judges are totally skeptical of it. With this challenge in mind, Chapter 16 of the 5th edition of his Cost of Capital: Applications and Examples book (co-authored with Shannon Pratt) is devoted to this topic.

Justice Donald Bowman, former chief justice of the Tax Court of Canada, discloses that Canadian judges review U.S. Tax Court rulings and find them “very useful.” Also, expert witnesses should not try to be funny or they'll compete with judges who already believe they are.

John Stockdale, a sole practitioner and author of BVR's DLOM guide, asks for feedback on his new paper on volatility.

Business valuation engagements with real estate and machinery and equipment in the mix are prone to errors, Alex Ruden (Southeast Appraisal) tells us. Coordination between the valuation disciplines is sorely needed.

A key trend affecting oil and gas valuations is that by 2018 the U.S. will shift from being a natural gas importer to being an exporter, according to Kristopher Zack and Justin Bouchard (both with Desjardins Securities Inc.). This will put pressure on producers to find new markets.

Michael Badham (International Institute of Business Valuers) announces that the Saudi Arabia Institute of Business Valuation is a new member of the IIBV—a very positive development. The IIBV is a leader in BV education and provides ongoing training in locations such as the United Kingdom, Russia, Hungary, Australia, and South America.

New case buzz: During a cocktail reception, there was a lot of talk about a newly released court decision in New York involving the valuation of a 50% interest in the company that makes AriZona Iced Tea. The ruling is chock full of BV issues, including the court’s relying solely on a DCF analysis despite “expressions of interest” from potential company buyers. It also involves DLOM, valuation of synergies, key man discount, EBITDA adjustments, a tax amortization benefit, discount rate, and more. Stay tuned for more coverage here and in Business Valuation Update (subscription required).

We’ll have more from the ASA-CICBV conference in next week’s BVWire.

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Shannon Pratt receives ASA’s
highest honor

Congratulations to Shannon Pratt (Shannon Pratt Valuations), who received the ASA Lifetime Achievement Award at the 2014 ASA-CICBV Business Valuation Conference in Toronto. The ASA honored Pratt for his legendary leadership, commitment, and dedication to excellence in advancing the business valuation profession.

Pratt, the developer of Pratt’s Stats, has authored and co-authored numerous books on business valuation, including Valuing a Business: The Analysis and Appraisal of Closely Held Companies, 5th edition; Cost of Capital: Applications and Examples (co-author with Roger Grabowski); Standards of Value (co-author with Jay Fishman and William Morrison); Business Valuation and Taxes: Procedure, Law and Perspective (co-author with the Honorable David Laro); The Lawyer's Business Valuation Handbook; and more.

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Harsh ruling due to faulty value allocation in a merger

So much for professional help! Hardworking taxpayers who built a successful business relied on estate planning professionals to effect a transfer of wealth that would minimize their tax liability. The resulting merger of two family businesses led to an IRS deficiency notice alleging the couple was liable for making a $46 million gift to their sons.

‘A few embarrassing facts.’ In 1979, the taxpayer husband and wife founded a company, Knight, which built custom tools and machines. Eventually, the husband and a son used Knight resources to develop a unique machine, CAM/ALOT, and formed another company, Camelot, to take the product to market. The taxpayers’ three sons owned Camelot in equal parts. No contemporaneous documents showed a transfer of the rights to the machines from Knight to Camelot. Knight built the machines and financed the operations of both businesses. The two companies worked out of the same building and shared payroll and accounting services. When the taxpayers hired a major accounting firm for tax advice, the latter prepared tax returns that claimed R&D tax credits for Knight, based on work Knight engineers had done.

In 1994, the taxpayers also retained a well-known law firm for estate planning purposes. Initially, the accountants and the lawyer had differing ideas as to which entity owned the technology and how to pass that value down to the three sons. The attorney set out to construct a narrative in which the value transfer from Knight to Camelot started at the time Camelot was incorporated. When told that real events did not bear out this story, the attorney said that in any history one had “to squeeze a few embarrassing facts into the suitcase by force.” Eventually, the accountants fell in line and the professionals structured a merger based on the premise that no gift tax was due because, on the merger date, Camelot already owned the CAM/ALOT technology. In 1995, the petitioners accepted a 19% interest in the new entity, while the three sons claimed the remaining 81% in equal measure. Effectively, Camelot was valued at four times the value of Knight. Six months later, the merged company was sold for $57 million in cash.

Fifteen years later, the IRS issued a deficiency notice claiming the premerger Camelot had zero value and the merger resulted in a roughly $23 million gift from each parent to the sons.

Faulty key assumption: The issue in Tax Court was whether the petitioners agreed to an unduly low interest in the merged company and the sons received an unduly high interest. The court considered valuation testimony from three experts. The taxpayer’s two experts arrived at similar conclusions. Both appraisers relied on the assumption that, at the time of the merger, Camelot owned the value of the technology. They both used a market approach and valued the merged entity between $70 million and $75 million and Knight’s portion of that value between $13 million and $15 million. Both said they were unable to perform a stand-alone valuation for Camelot. In contrast, the IRS’s trial expert assumed Knight owned the technology. He based his valuation on a discounted cash flow analysis and concluded the merged entity was worth $64.5 million—less than the taxpayers’ experts stated. He determined that 65% of that value belonged to Knight, that is, $41.9 million. As a result, the IRS conceded some ground and lowered the gift amount to $29.6 million.

The court found that Knight owned the technology and the merger was not an arm’s-length transaction. Because the taxpayers’ valuations were based on the wrong assumption, there was no evidence to counter the IRS valuation. The court also said the petitioners had a reasonable-cause defense and were not subject to an accuracy-related penalty. Since they had no formal legal or accounting background, they in good faith and to their detriment hired professionals. “The fault in the positions [the taxpayers] took was attributable not to them but to the professionals who advised them,” the court noted.

Takeaway: The conduct of the estate planning professionals raises serious ethical issues. The court noted there was “doctoring” of documents and filing of amended tax returns to “accommodate” the idea that Camelot was the technology’s owner. Ultimately, the IRS was able to gain access to the damaging material and the taxpayers, who played no role in formulating or executing the strategy, paid the price.

Find an extended discussion of Cavallaro v. Commissioner, 2014 Tax Ct. Memo LEXIS 189 (Sept. 17, 2014), in the January issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.

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New reference tool for BV-related cases from the Delaware Court of Chancery

Rigorous analysis of and insight into the Delaware Court of Chancery’s view of BV methodologies and techniques is available in a new special report, Valuation Cases From the Delaware Court of Chancery Show How to Excel. Business appraisers and attorneys recognize this court as the source of many of the decisions and guidelines that govern the valuation process across the country.

Highlights of the special report include:

  • A collection of articles covering the Chancery’s stance on various valuation methods, as well as strategies for how to be an effective expert witness in the court;
  • A summary table, which presents cases by type of action such as breach of fiduciary duty, contract, dissenting shareholder, evidence, judicial dissolution, and securities;
  • A keyword index to help find cases that address particular valuation issues, such as CAPM, control premiums, cost of debt, preferred stock, and normalization adjustments; and
  • Over 70 digests of cases heard by the Chancery from 2000 to the present.

To preview an excerpt from this special report, click here.

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Free webinar on new resource for industry cost of capital

On November 13, a free one-hour webinar will be presented, Guide to Industry Cost of Capital: The Latest in the Duff & Phelps Trilogy, featuring James Harrington (Duff & Phelps). Harrington will give an in-depth look at what's included in the new 2014 Valuation Handbook - Industry Cost of Capital and how appraisers can put it to work.

In a recent interview in the November issue of Business Valuation Update (subscription required), Harrington was asked: If one has the Valuation Handbook - Guide to Cost of Capital to develop company-level cost of equity estimates, why is there a need for a second book on industry cost of capital? “Several reasons,” he says. “First of all, valuation is an inherently comparative process—just about any analysis boils down to trying to compare one thing to another. For example, if you’ve developed a cost of equity estimate for the subject company, a natural first question you might get is: ‘How does my own analysis of the subject company compare to the subject company’s peers, or industry?’ A normal and prudent step in any analysis is to perform some benchmarking as a ‘reasonableness’ test.”

He continues: “The valuation analyst will likely find the statistics presented in the new book to be a very useful indicator for benchmarking, augmenting, and providing additional support for his or her own custom analyses of the industry in which a subject business, business ownership interest, security, or intangible asset resides. Also, the original guide does not have betas for CAPM. The industry handbook has industry-level betas that can be used in a CAPM analysis. Those betas can also be used in the online Risk Premium Calculator.”

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BV movers . . .

People: Robert Allen joins as senior manager at CBIZ Valuation Group LLC in the Dallas office … Russ and Russell Barone, formerly of Barone, Siciliano & Co., have joined the Rochester, N.Y., firm Mengel Metzger Barr & Co. … Patricia Cummings and Michael DeVito will be co-managing partners in charge of all operations at Citrin Cooperman’s New York City headquarters and will report to Joel Cooperman, who is transitioning from managing partner to CEO of the firm … Grant Thornton LLP names CEO Stephen Chipman senior vice chair, and he will lead the firm’s international and public policy operations effective January 1.

Firms: ACERTIS S.à r.l. of Windhof, Luxembourg, joins BKR International member firms … Elliott Davis and Decosimo, two of the leading accounting firms headquartered in the Southeast, will merge effective January 1 and will rebrand as Elliott Davis Decosimo to become the region’s fifth largest accounting firm with $108 million total annual revenues and more than 800 professionals and specialists in 17 offices across seven states … Schenck SC of Wisconsin has been accepted as the exclusive Appleton, Wis., member of the National CPA Health Care Advisors Association … The Harrison, N.Y.-based firm O’Connor Davies LLP will merge with Perl & Asch CPAs PC of Purchase, N.Y., effective on January 1 … The Cleveland-based firm Libman, Goldstine, Kopperman & Wolf merges with Bober, Markey, Fedorovich effective November 1.

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CPE events

Preferred Stock: Valuing Multiple Layers of Equity Securities in Venture-Backed Companies (November 4), featuring Joel Johnson (Orchard Partners Inc.). Expert Johnson dissects the determinants to equity value in venture-backed companies to show how to properly assess the value of both preferred and common shares. His presentation addresses equity values and their valuations, including a discussion of which valuation techniques are most appropriate for this unique setting.

The Stark Law & Anti-Kickback Statute: Implications on Healthcare Valuations (November 18), featuring James Pinna and Matthew Jenkins (both Hunton & Williams). In Part 11 of BVR's 2014 Online Symposium on Healthcare Valuation, attorneys Pinna and Jenkins discuss how the long-standing Stark and AKS fit with the new healthcare economy and what every appraiser should know before their next healthcare assignment.

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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963
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In this issue:

ASA-CICBV coverage

Shannon Pratt honored

Valuation scheme KO'd

Delaware case resource

Industry cost of capital

BV movers

CPE events








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