Facing the challenge of rolling out new BV methodology
The business valuation profession does not always welcome new methodology with open arms. In a recent interview with Business Valuation Update, Peter J. Butler (Valtrend) talked about the challenges of bringing new methodology into acceptance. Butler championed a more quantitative and empirical approach to developing the cost of capital, which is embodied in the Butler Pinkerton Calculator (BPC), a model that he invented and co-developed. The BPC passed a Daubert challenge in 2010.
Butler is now on the team that has developed the implied private company pricing line (IPCPL) and the implied private company pricing model (IPCPM), a calibrator for developing the cost of capital for small private companies. His experience with introducing the BPC is reflected in the way IPCPL/IPCPM is being rolled out.
Taking their time: “We are taking more time to allow the masses to become acquainted with it before we commercialize it, if that is in its future,” says Butler. “We have given out hundreds of free trials through our LinkedIn discussions. I should mention that the Butler Pinkerton Calculator is also available for a free trial run.”
Looking back, he says that some people may have misconstrued their enthusiasm for total beta (TB) and the BPC as an attack on the status quo. And of course, to a certain extent, it was. “Thus, we are being less ‘confrontational’ in rolling out IPCPM,” he says. “We call it a ‘Calibrator.’ It can run completely behind the scenes. As you can see, we are not asking the BV community to abandon the BUM, or whatever other publicly traded stock method they are using, such as MCAPM or TB/BPC for example. Rather, we are asking that they calibrate those indications of the appropriate cost of equity with the IPCPL/IPCPM. In summary, appraisers may feel less ‘threatened’ by its arrival than they might have with TB/BPC.”
The full interview with Butler is in the November issue of Business Valuation Update (subscription required). For more details on IPCPL/IPCPM, click here.
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‘Stunning’ personal goodwill amount triggers lawsuit
How do you rationalize a $12 million personal goodwill claim when you already receive compensation for signing a consulting and noncompete agreement? This was the issue explored in a recent ruling in a dissenting shareholder case.
Valuation follows price: An advertising company was embroiled in a five-year litigation with a competitor over the legality of the competitor’s business practices, which threatened to ruin the company. One week into trial, the company accepted the competitor’s settlement offer.
The competitor insisted on buying only the company’s assets, not its stock, and wanted to eliminate the risk of future competition from the company or its four officers. In return, it offered $29.5 million on a “take-it-or-leave-it” basis. This amount was not based on any prior valuation of the company’s assets.
The buyer specified that none of the money should be allocated toward the settlement, presumably so as not to admit liability for any of the claims in the lawsuit. It required the company and the four officers to execute a noncompete agreement and also entered into one-year consulting agreements at $1,000 per month for each of the individuals. Based on the buyer’s instructions, the CEO of the company had to allocate the proceeds to the following categories: (1) retailer contracts; (2) inventory; (3) noncompete agreements; and (4) consulting agreements.
The CEO’s valuation assigned $13 million to cover the value of the company’s assets and inventory, over $4.45 million to cover the defendants’ noncompete agreements, $48,000 to cover the consulting agreements, and $12 million to cover the four officers’ “personal goodwill.” A true-up from a renowned appraisal firm did not occur until some eight months later. The CEO chose the appraiser, and the buyer approved the selection. At trial, the appraiser explained he was not allowed to create any new categories and was “solving back” to the purchase price. Under his analysis, the retailer contracts were worth only $9.3 million and the noncompetes only about $3 million. This left $16.7 million to cover the defendants’ personal goodwill. The CEO ultimately adopted his figures.
‘Plug’ figure: The plaintiff, on behalf of the minority shareholders, sued the officers, who were majority shareholders in the company, alleging self-dealing. According to the plaintiff’s expert, the company had little, if any, value, at the time of the transaction. Consequently, the noncompete and consulting agreements from the four defendants were worthless. The entire $29.5 million purchase price was in effect payment for settling the lawsuit and belonged to the company, the expert said.
The court agreed that there was no meaningful valuation. It also agreed that the deal was not an arm’s-length transaction in an open and unrestricted market. However, in light of the potential the company had to offer to certain synergistic buyers, it was reasonable for the buyer to pay $13 million for the retailer contracts. This amount belonged to the company, the court determined. It also was reasonable for the defendants to be compensated for their consulting agreements and the noncompetes.
But the court flat out rejected the 40% allocation to personal goodwill. Considering the company’s financial situation, it would take a lot to convince a fact finder that it is appropriate for the CEO to award himself and the other officers an additional $12 million because “they worked so hard and deserved it,” the court said. It found the personal goodwill agreements “stunning in that it is not clear that anything is being sold.” It rejected the idea that personal goodwill could serve as a “plug” figure. The defendants were unjustly enriched by the $12 million allocation for personal goodwill, the court concluded, and ordered them to pay the amount to the company.
Takeaway: Jim Alerding (Alerding Consulting LLC) notes that the court was well aware that there was no fair market transaction and there never was any intent on the part of the buyer to purchase any personal goodwill. In fact, by the CEO’s own admission, the buyer seemed unfamiliar with the very concept of personal goodwill. To the extent there was any tradable personal goodwill, the noncompete and consulting agreements ensure that such value was transferred to the buyer, and the buyer paid compensation for it, says Alerding. He also notes that, without saying so, the court seems to recognize that there is such a thing as “pure personal goodwill,” goodwill that cannot be transferred by its nature and thus has no “market value.”
Find an extended discussion of Potok v. Rebh, 2014 Phila. Ct. Com. Pl. LEXIS 318 (Sept. 16, 2014) in the December issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.
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The best way to estimate customer attrition
The August BVU (subscription required) featured an interview with Sean R. Saari (Skoda Minotti). Recently, Saari published an article, “Developing Supportable Attrition Rates in Customer Relationship Valuations,” in NACVA’s QuickRead.
Historical rates: The article points out that the analysis of historical attrition rates to estimate future customer attrition is the method that is often the most supportable. However, it’s also the most time-consuming of the methods typically used. Also, its use is “predicated on the company having kept detailed historical sales data.”
The simplest method in estimating attrition is to rely on a qualitative estimate from management. However, this is the least supportable to auditors, “who may have difficulty relying on the estimate without a corroborating quantitative analysis (unless such quantitative data is not available),” writes Saari. Another method is to see whether any of the guideline public companies analyzed have made acquisitions. If they have, they must disclose the useful lives assigned to the acquired customer relationships, so it may be possible to back into an attrition rate.
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New resource for BV experts in an advisory role
BV experts can act as advisors to help business owners understand value and help them see how they can tap into that value. A new book, Unlocking Private Company Wealth, by Z. Christopher Mercer (Mercer Capital), will help you understand how to talk to business owners about managing their private company wealth. You’ll receive a diagnostic tool to help you understand your private company owners’ needs regarding wealth management.
Free buy-sell tools: Thanks to the baby boom tidal wave, exit planning is a hot topic. When you buy the print book, you’ll receive a free download of Mercer’s book on buy-sell agreements. You’ll also get two checklists: one for buy-sell agreements in general and one for buy-sell agreement promissory notes.
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Designing a global BV designation and education system
Regulatory pressures and the need to better serve the public interest are making it imperative for the BV profession to harmonize globally. A panel of global BV educators will debate the issues and challenges in the design of a global BV designation and accreditation system. The “Lively Debate on Global Business Valuation Education” will take place on October 23, immediately following the annual general meeting of the International Valuation Standards Council (IVSC) in Toronto, Canada.
Panel members are April Mackenzie, CEO of the IVSC; Ben Elder, global director of RICS Valuation and EQS; Bob Morrison, chair of ASA Business Valuation Committee and chair of IIBV Education Committee; Doug McPhee, global head of KPMG BV education; and Pierre Maille of PwC Montreal and vice chair of the Canadian Institute of Chartered Business Valuators (CICBV).
Hosted by the International Institute of Business Valuators (IIBV) and Business Valuation Resources (BVR) and sponsored by American Appraisal, this event is free. If you can’t make it in person, the event will be webcast live. For details, click here. In the meantime, join the discussion of this topic on BVR’s LinkedIn page.
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See you soon at the AICPA FVS Conference
BVWire will be attending the AICPA Forensic & Valuation Services Conference in New Orleans November 9-11, and we hope to see you there. New tracks, new training, and some excellent preconference workshops highlight this year’s must-attend event.
Jam packed: A total of seven tracks of sessions will be presented, and four of them are new for this year’s conference: Hands-On Valuation, Hands-On Forensics, Cutting Edge, and Industry. The other tracks are: General Valuation, General Forensics, and Litigation. Also, the AICPA is kicking off a new educational program for up-and-comers called the NextGen FVS Professionals Program, which is tailored to individuals with fewer than five years of forensic accounting or BV experience. Three preconference workshops will be available: Computer Forensics Bootcamp for Fraud Investigators, Fair Value Measurements in Financial Reporting, and Growing Your Practice and Balancing It All!
Online streaming: If you can’t attend in person, the sessions can be streamed directly to your PC and you can earn CPE credits without leaving your office. Different online options are available so that you can customize your own program. For details about online attendance, go to the AICPA’s online conference Web page.
See you there!
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Opportunity for financial damages experts
Meyers, Harrison & Pia LLC is seeking experienced financial damages professionals to join the firm, which performs work on a national level. The company may consider opening new locations so the right individual or group can join its team. For details, see the ad at right. Send your CV and a summary of your qualifications to Erica Marcantonio, PHR.
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BV movers . . .
People: Joseph Emanuele joins California-based Hemming Morse LLP as a principal in its Forensic and Financial Consulting Services Group … Laura Hardin joins Alvarez & Marsal’s Houston office as managing director in its expanding Global Forensic and Dispute Services group … Bill Hickl, managing director of UHY Advisors in Texas, has been named to the University of Houston alumni board of directors … Patrick Lowrance joins as manager at Kennedy & Coe in the manufacturing practice at the Wichita, Kan., office … Loren McCutchen is the new director of due diligence services practice in Houlihan Lokey’s Dallas office … Jose Vila joins the Miami office of Cherry Bekaert as an audit partner serving both publicly and privately held companies.
Firms: Duff & Phelps Corp. has acquired the restructuring and insolvency division of RSM Farrell Grant Sparks in Dublin, Ireland … Institute of Financial Accountants (IFA) based in the U.K. will team up with the Australian Institute of Public Accountants (IPA) to establish one of the largest international professional accounting organizations committed to small and midsize firms … The Dallas-based firms Whitley Penn and JonesBaggett will complete their merger by November 1, which will increase the Dallas staff to 248 employees.
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Two good CPE events coming up
Appraisals (USPAP), Valuations (SSVS1), and Calculations in Litigation (October 23), featuring James Alerding (Alerding Consulting), Jay Fishman (Financial Research Associates), and Carla Glass (HSSK). Three of the most trusted and experienced experts on professional standards and valuations for litigation and deposition join BVR for an in-depth look at what every appraiser should know when doing appraisals and appraisal work in a legal setting.
The Best Way to Work With Your Client's Auditor (November 4), featuring David Dufendach, Lisa Iizuka, and Jenetta Mason (all Grant Thornton). Part 10 of BVR’s Online Symposium on Fair Value Measurement features this panel of experts in a series of hypothetical case studies and live examples on how best to navigate the intersection of fair value measurement and fair value auditing.
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