BVWire Issue #182-3 | November 15, 2017


Fair value audit deficiencies still too high despite dip

The number of audit deficiencies tied to fair value measurements (FVM) declined for the second year in a row, but they’re still high, according to the “2017 Survey of Fair Value Audit Deficiencies.” The analysis, done by the valuation and litigation consultancy firm Acuitas Inc., examines seven years of Public Company Accounting Oversight Board (PCAOB) inspection reports on auditing firms. Here are the key findings:

  • The percentage of audit deficiencies has dropped since its dramatic peak in 2013—but remains quite high, at 31.6% of audits and other engagements examined.
  • FVM audit deficiencies are increasingly attributable to a surge in business combination engagements. Fair value deficiencies cited related to business combinations increased to 68% in 2015, up from 56% in 2014. The PCAOB considers the robust pace of merger and acquisition activity to be an economic risk escalating the prospect of material misstatements.
  • Based on the analysis by Acuitas, failures to assess audit risks as well as test internal controls and assumptions underlying prospective financial information are the root causes of most FVM and impairment audit deficiencies. The PCAOB links improvements to factors such as heightened responsiveness from management and the increased use of quality control aids.
  • The June 2017 release of proposed auditing standard, Auditing Accounting Estimates, Including Fair Value Measurements, reinforces the PCAOB's commitment to seeing improvements in these areas.

"It's apparent that the number of audit deficiencies remains high, owing to a surge in deal-making activity," says Mark Zyla, a managing director of Acuitas. "But we are seeing industry and accounting firm leaders committing to more quality control measures and ensuring due professional care, hence the decline."

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Appeals court approves of use of IPO valuation in fair value proceeding

Pity the trial court that recently was asked to value a pharmaceutical startup that, during the relevant period, was in serious debt but had high hopes for two drugs that could (and ultimately did) make the company very profitable. Moreover, the court confronted expert value determinations that resulted in a one-billion-dollar discrepancy. When the court devised its own valuation solution, neither party was satisfied, and both sides appealed.

Limited objective valuation data: The plaintiff and the defendant in this shareholder dispute founded a company that developed and marketed a form of fentanyl and different versions of dronabinol. The plaintiff, a minority shareholder, initially was in charge of the company’s operations and science. The defendant, who had controlling interest, was responsible for the financing. In early 2007, the company prepared for an initial public offering (IPO), acknowledging in SEC filings that its own success was “highly dependent” on the success of the two drugs in development. As the company underwent a change in corporate structure, the plaintiff’s role and standing diminished. In late 2007, various underwriters valued the company between $150 million and $200 million. The company abandoned the IPO in the fall of 2008.

As a result of two contested transactions that took place in 2008 and 2009, the controlling shareholder came to own the company in its entirety in exchange for his continuing funding. At the same time, the 2009 transaction effectively eliminated the plaintiff’s ownership interest. The plaintiff sued the company, the controlling shareholder, and the company’s directors, alleging breach of fiduciary duty and fraud. During the litigation, the company obtained FDA approval for the drugs. It went public in March 2013, and a March 2014 estimate put its value at almost $1.7 billion.

The trial court reviewed both transactions under the highest standard of review, entire fairness, and found the defendants liable as to the 2009 transaction. As a remedy, the court awarded the plaintiff the value of his proportionate share of the company at the time of the 2009 transaction. It noted, however, that determining a per-share value was difficult. There was “very limited objective data available for valuation” in this case, which meant any expert valuation risked being based “almost entirely upon subjective assumptions and predictions, now tainted by hindsight bias.” Here, the plaintiff expert’s adjusted book value method generated a $41.46-per-share price, whereas the defense expert’s discounted cash flow analysis produced a $0.07-per-share price. The court found it was impossible to produce a reliable fair value based on traditional valuation methods. It, therefore, looked to 2007 IPO valuations and decided the company then was worth $151.5 million, which resulted in a $7.3 million fair value for the plaintiff’s then ownership interest.

On appeal, the defendants claimed use of IPO valuations to determine fair value was improper. The Court of Appeals found there was no authority for this proposition. It also rejected the plaintiff’s claim that the trial court erred when it failed to award him rescissory damages in lieu of the fair value of his shares. The trial court “coped admirably with the evidence that was presented,” the appeals court concluded.

A digest for Kottayil v. Insys Therapeutics, Inc., 2017 Ariz. App. Unpub. LEXIS 1179 (Aug. 29, 2017), and the court’s opinion, are available at BVLaw.

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Damodaran on the effects of corporate scandal

The corporate world is getting battered every day with new revelations of scandal. Of course, the first thoughts are with the victims of this misconduct. From a financial and valuation standpoint, there are consequences at many levels, explains Professor Aswath Damodaran (New York University Stern School of Business). Management distraction, lawsuits, fines, and penalties can all work to derail a company in the short term, but there are long-term effects as well.

Lasting damage: If the “corporate narrative changes as a consequence of the misconduct,” a company can have serious long-term damage, Damodaran writes in his most recent book, Narrative and Numbers: The Value of Stories in Business. “This is due to several reasons. The first is that the scandal can unalterably change the reputation of the company and, to the extent that its narrative was built on that reputation, its story as well. Thus, the news in 2015 that Volkswagen, a company that built its reputation on German efficiency and reliability, had cheated on emissions controls for its diesel cars in the United States could have altered your story line for the company and had large consequences for value. The second is that a key component or components of the company’s business model may have been built on questionable business practices, which, once exposed, can no longer be continued. The third is that large scandals often result in management turnover, with the new management perhaps bringing a different perspective to the company.”

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U.S. Leading Economic Index decreased in September

The Leading Economic Index decreased 0.2% in September—the first time the index declined in 12 months—bringing the index to a reading of 128.6, according to BVR's latest Economic Outlook Update (September 2017 issue). Negative contributions from initial claims for unemployment insurance, building permits, and the average weekly manufacturing hours more than offset the positive contributions from ISM new orders and the financial components. In addition, the strengths of the leading indicators became somewhat less widespread. Still, the reading suggests continued solid growth for the U.S. economy through the second half of 2017.

Other highlights:

  • Total retail sales surged 1.6%, recording the largest gain in two and a half years;
  • The unemployment rate improved 0.2%, reporting at a 16-year low of 4.2%;
  • September marked the first month of job losses in seven years, with a decline of 33,000 jobs;
  • Hourly wages climbed 12 cents, recording the largest increase in more than eight years; and
  • Existing-home sales experienced their first year-over-year decline, falling 2.2% from September 2016.

Also, the S&P 500 increased for the 11th consecutive month in September, rising nearly 2.1%.

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D&P issues Valuation Insights for 4Q17

The newest edition of Valuation Insights from Duff & Phelps discusses the recent change in its recommended U.S. equity risk premium (ERP). The firm decreased its recommendation from 5.5% to 5.0% for use as of Sept. 5, 2017, and thereafter, until further guidance is issued. This new rate, used in conjunction with a normalized risk-free rate of 3.5% (reaffirmed), implies a “base” U.S. cost of equity capital estimate of 8.5% (5.0% + 3.5%). Other topics in the issue include industry market multiples for North America and Europe, recent changes in unclaimed property programs in certain states, what to know about arbitration clauses, and preparing for the new IFRS 16—Leases.

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Get inside the mind of the IRS re: BV

How does the IRS examine business valuations? Find out from a former IRS manager in its valuation area who worked on several agency job aids, including ones for DLOM and reasonable compensation. He’s Michael Gregory (Michael Gregory Consulting LLC), now a consultant in private practice. His new book, Business Valuations and the IRS: Five Books in One, is now available for preorder (will ship in December). It will give you practical advice on how to avoid common errors and includes case studies and real-world examples right from the horse’s mouth. It’s a rare look at what makes the IRS tick in terms of reviewing business valuations.

Extra: Mark your calendar for Jan. 25, 2018, when Gregory will conduct a BVR webinar, What You Need to Know About DLOMs and the IRS.

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New paper examines shareholder conflicts and dividends

A new study reveals that controlling shareholders use dividends to mitigate conflicts with other shareholders, which may increase the access to new equity and reduce the cost of capital. The study is explained in an article, which is forthcoming in the Review of Finance, by Janis Berzins, Øyvind Bøhren, and Bogdan Stacescu of the BI Norwegian Business School. The authors analyzed 10,000 private Norwegian firms.

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Global BV News

U.K. wants to promote IP valuations

Last week’s BVWire reported on a study from the United Kingdom Intellectual Property Office (UKIPO) that shows a low awareness of IP valuation within U.K. businesses. The UKIPO has now published an “Intellectual Property Call for Views” as it seeks to find ways to stimulate collaborative innovation and increase licensing opportunities for intellectual property (IP) rights. The goal is to identify the valuation market’s structure, behavioral drivers, and whether barriers could be overcome to encourage more businesses to carry out valuations of their IP with a view toward being able to trade, protect, and invest in it more effectively. The UKIPO notes that other countries around the world are also looking at this issue, and some have arrived at commonly accepted, government-regulated standard valuation methods. The call for views requests comments on whether and how the U.K. should consider similar activities and what the benefits would be.

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Valuation conference in China December 2-3

The 7th International Forum on New Development of Valuation will be held in Beijing December 2-3. Capital University of Economics and Business (CUEB) will be the sponsor of this year’s forum in cooperation with the International Association of Consultants, Valuators and Analysts (IACVA), the American Society of Appraisers (ASA), Business Value Research Center of Zhongnan University of Economics and Law (ZUEL), and the Economic School of Xiamen University. The forum is supported by China Appraisal Society (CAS) and other institutions.

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What’s in the November 2017 issue of Business Valuation Update

Here’s what you’ll see:

The issue also includes:

  • Regular features: “BV News At-a-Glance/Global Perspective,” “Ask the Experts,” and “Tip of the Month.”
  • BV data spotlight: “Pratt’s Stats MVIC/EBITDA Trends,” “ktMINE Royalty Rate Data,” “Economic Outlook for the Month,” and “Cost of Capital Center.”
  • BVLaw Case Update: The latest court cases that involve business valuation issues.

To stay current on business valuation, check out the November issue of Business Valuation Update.

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BV movers . . .

People: Jim Hirt, CEO of the American Society of Appraisers, leaves his post on November 15 to pursue other career opportunities; a search committee will look for someone to fill his shoes; Lee P. Hackett will be the ASA’s transition team leader … Jeffrey Buchakjian has been named a partner in the Forensic, Litigation and Valuation Services group at EisnerAmper; he’s in the Philadelphia office … Timothy L. Christen is the new chairman of the board of Baker Tilly International, a network of independent accountancy and business services firms; he’s the past chairman of the AICPAStout promoted John Baumgartner to a managing director in the Dispute Consulting group in the Houston office; he’s a CDBV, certified in distressed business valuation … Patrick Emmet has joined Business Valuation Inc. (Winter Park, Fla.) as a managing director after 29 years in finance, sales, operations, and leadership roles.

Firms: Cherry Bekaert LLP enters the Nashville, Tenn., market with the acquisition of Frasier, Dean & Howard PLLC, one of the city’s largest CPA firms that has 11 partners and more than 50 associates … HBK CPAs & Consultants acquired Sally Frizzell Coleman, CPA, expanding its presence in the Fort Myers, Fla., region … Denver-based Compensation & Benefit Solutions is now part of Alvarez & Marsal Taxand LLC The Bonadio Group LLP (Rochester, N.Y.) has purchased the nursing home practice of EFPR Group LLP, also in Rochester; four EFPR partners and 16 staffers join Bonadio A new Philadelphia accounting and advisory firm, Horsey, Buckner & Heffler LLP, is the first midsized CPA firm in the area to have an ownership interest in a minority controlled accounting practice; the firm is affiliated with Heffler, Radetich & Saitta LLP, also in Philadelphia … Baltimore-based SC&H Group has a brand new website … York, Pa.-based Stambaugh Ness has acquired nearby Artisan Value Advisors; Artisan’s founder Glenn Spinello will be a principal and lead the new Value Advisory practice … Veriti Consulting LLC opened a new office in Flagstaff, Ariz., to complement its headquarters in Scottsdale; other offices are in Las Vegas and Charlotte, N.C.

Please send your professional and firm news to us at

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CPE events

Hospital Valuations: Issues and Perspectives (November 16), with G. Don Barbo (VMG Health) and John Meindl (VMG Health). This is Part 11 of BVR's Special Series presented by the BVR/AHLA Guide to Healthcare Industry Finance and Valuation.

An extensive overview of recent hospital transaction activity, reimbursement trends, and hospital valuation metrics.

Small Businesses, Big Challenges: Navigating Main Street Valuations (November 28), with Pasquale Rafanelli (Grassi & Co.).

Get insights on working with limited financial information, key person issues, discounts, fee pressures, and other challenges in working with small businesses.

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New and Trending
LinkedIn Discussions

The Times They Are A-Changin' (Even in 409a Business!)

Proposed Sec. 2704 Regs Have Been Officially Withdrawn Per Treasury

Integrating Excel Data Into Microsoft Word

Your discussion could be featured here—BVR's LinkedIn group is a place for valuation professionals to share, discuss, and learn about compelling BV topics. If you're not already a member, request to join:

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Holiday Break

BVWire will be taking a break to enjoy the U.S. Thanksgiving holiday next week. We will resume publication on Wednesday, November 29. We wish you a very happy holiday!

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We welcome your feedback and comments. Contact Andy Dzamba (Executive Editor) or Sylvia Golden (Executive Legal Editor) at:
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In this issue:

FV audit flaws

IPO value as FV

Biz scandals

Econ update

D&P Insights

Inside the IRS

Shareholder conflicts

Global news

BVU November

BV movers . . .

CPE events

LinkedIn discussions


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