It’s time for the 2010 Survey of BV Firm Best Practices and Economics
BVR surveys the entire profession on financial, compensation, marketing, certification, specialization, and other essential management topics every two years. It’s the only survey of business valuation firm management available, and the deadline for participating is October 15th. Your contributions are valuable to the entire profession; last time, in 2008, over 600 business valuation firms participated.
There are two benefits to providing data:
- You get the Participants’ Survey Highlights Summary free, and
- You have the option of getting the entire results for $99 (non-participants pay $249).
So, thanks in advance for being included this year. Begin the survey questionnaire now by clicking here (you can return to complete the process at any time if you’re interrupted!).
Ask the experts: Valuing private company stock with a related put right
A BVWire™subscriber recently asked if we’d seen any case law on chartable contributions with put rights—i.e., when a taxpayer donates private company stock together with a put right to sell the stock back to the company, how does the related put right affect any discount for lack of marketability (DLOM) in valuing the gift at fair market value (FMV)?
To get at the answer, Robert Duffy (Grant Thornton) first referenced Hackl v. Comm’r, a 2003 decision in which the 7th Circuit upheld the Tax Court in finding that donations of private company stock were gifts of “future interests” and thus did not qualify for the annual gift tax exclusion (court opinions available at BVLaw). To protect against a “Hackl-type” exclusion, tax attorneys began adding put rights to any agreement to donate private company interests. “But, the issue you raised is: Does the put right impair the ability to get a credible DLOM,” Duffy says. “To ‘fix’ this, the put right was worded to buy back at FMV but FMV was to be computed as if the put right did not exist. That, in my opinion, allows for a fully-discounted value.”
Mercer: the devil is in the details. Court decisions are generally too fact-specific to provide appraisers with sufficient guidance, comments Chris Mercer(Mercer Capital). Similarly, the value of a put right in this case will depend on the facts and circumstances and is a matter of “diligent investigation,” he says. For instance:
- Is the put exercisable immediately? Or is there a required holding period or any other conditions precedent?
- At what price can the put be exercised?
- How is the exercise price to be determined—at a specific appraised value, or a negotiated value? “All put rights are not equal,” Mercer notes.
- Once exercised, how long does the company have to fulfill its responsibilities under the put, and under what terms? (e.g., cash or an interest-bearing note)
“When the facts and circumstances are [more clearly] specified, the value of the put right becomes clearer,” Mercer says. For his complete case study on how to value a put right related to the gift of an illiquid interest, including guidance from USPAP, the ASA BV Standards, and shareholder-level DCF models, check out Mercer’s article in the next (Nov. 2010) Business Valuation Update™.
In the meantime, get all the answers to current tax questions at BVR’s Advanced Summit on Business Valuation: Resolving Tax & Legal Issues this November in Washington, D.C., featuring experts Duffy and Tim Lee (Mercer Capital), plus comments from the always-candid Judge David Laro, top tax attorney John Porter (Baker Botts LLP) and Mel Abraham.
Further debate on whether pass-through entities create additional value
In last week’s BVWire™ piece “Three Fallacies when Tax Affecting”, Mark Harrison (Meyers Harrison & Pia) asked readers to consider some statistics that undermine the “29.4% benefit” that seems to often appear post-Bernier and Delaware MRI.
In a letter to the editor, David Bishop (Bishop & Company) responded:
1. I understand the point that the actual tax rate of a small company might be lower than the rate used for tax affecting but I am wondering: Why even use an after-tax valuation method with such a small company? If the company is so small that you have to consider the actual tax rate, isn’t it too small to be comparing to public companies (where you get the after-tax information). Seems like information from public companies would not be very helpful because of the disparity in size. Why not use a pre-tax valuation methodology such as a multiple of EBITDA—the way it is done in real world transactions for small companies.
2. If the likely buyer is a larger company, it seems like the relevant marginal rates are those applicable to a buyer rather than the seller. In those cases, why should the buyer care what the seller would pay? In creating the hypothetical tax rate, isn’t it more important to consider the likely tax rate of the buyer?
3. I understand the judge in the case also assumed that all earnings would be paid out while you make the point that most of the earnings are not paid out. Isn’t it flawed to even consider distribution rates when calculating tax rates (cash flow available to a shareholder is a different concept from net income)? But if you do consider distributions, shouldn’t you assume a 100% distribution to make sure your method is consistent. In other words, tax affecting uses hypothetical rates not real rates. Why is the real distribution rate relevant in this methodology? Seems like using actual distribution rates would distort your results because some business like to keep more cash in the business just because they don’t want it to be in the family bank account (a form of mental accounting), not because the business needs it.
4. Looks like to me that business appraisers and courts get tied up in all these contortions because they are trying to use after-tax net income from public companies as the guideline information. Apparently, they think it is more scientific when in fact almost all of these transactions in the real world are priced on a pre-tax basis. No need to jump through all these extra hoops unless you goal is to be precisely inaccurate.
Any thoughts? Send your response to email@example.com.
Start with backlog analysis when valuing A/E/C firms
During last week’s BVR webinar Valuing Architecture & Engineering Firms Ian Rusk and Michael O’Brien (Rusk O’Brien Gido) discussed the valuation challenges, operations peculiarities, and emerging trends unique to this volatile industry. One such issue is backlog. “Two years ago, while backlog was important, it did not take a front seat, if you will, in the valuation process,” reports O’Brien. Now it's a different story. This is especially true with firms that are acquiring other practices. “They spend more time trying to understand the backlog, how firm that backlog is, who is it with, can they pay, and so on and so forth,” he adds.
Backlog has been “a very important shift in the norms in valuation in the A/E industry here just in the last year,” Rusk concurred. Rusk and O’Brien saw healthy A/E firms’ backlogs disappear as projects were put on hold or canceled. The issue has changed industry dynamics, so “as appraisers, you have to be even more skeptical when you're looking at future earnings, projections and backlog,” he adds. “It's going to be incumbent upon the appraiser to assess the risk,” O'Brien agreed.
Patient records are ‘professional goodwill,’ despite non-compete
Remember our recent report on McReath v. McReath (BVWire # 96-2), in which we said the Wisconsin Court of Appeals may have just revised the majority rule on the disposition of private practice goodwill to say that all salable goodwill is a marital asset, subject to division, whether corporate or professional. Further, a non-competition agreement can serve as proof that at least some portion of professional goodwill is saleable, according to McReath.
Now we have McKee v. McKee—which also valued a dental practice, in this case the owning wife’s 33% interest. The wife’s expert valued her interest at only $97,000, essentially ignoring the buy-in price of her two partners (one as recently as 2005, for $749,000). In a buy-sell transaction, the wife’s expert explained, the value of goodwill is allocated into “identifiable and unidentifiable goodwill,” but in a divorce, under the applicable majority rule, “the distinction is between personal . . . and business goodwill.” Patient records fell into the former category, he said; in fact, a non-compete in this case “proved” the existence of professional goodwill—and the court agreed, adopting his $97,000 value because “if the wife’s one-third interest was sold, the only assets which would be marketable would be the equipment and accounts receivable.” The Tennessee Court of Appeals affirmed, finding the valuation complied with the majority rule.
Query: Under McReath, would the patient records constitute salable professional goodwill, as evidenced by a prospective buyer’s likely demand for a non-compete? Moreover, what if the wife retired the day after divorce: Would a sale of her interest likely garner more than $97,000, thus demonstrating the inequities (discussed by McCreath) that could result from excluding salable professional goodwill from the value of a professional firm? Have these cases served to confuse or clarify the issue? Send your comments to BVWire’s legal editor, and look for a broader discussion in BVR’s Guide to Personal v. Enterprise Goodwill, the 2011 edition coming soon.
And by the way, the digests of McCreath and McKee are in the current (Oct. 2010) Business Valuation Update™. Copies of both court opinions are now available at BVLaw™.
Many insurance agency valuations have led to bad acquisitions and missed opportunities
Chris Burand (Burand & Associates) questions the high prices that have been paid for many insurance agencies over the past few years. “Were/are those prices too high relative to the seller’s fundamental value?” asked Burand in a recent Insurance Journal article. Heavily leveraged and publicly financed buyers usually focus on the arbitrage value. While Burand also considers the implication of arbitrage value, it is not where he puts the most weight for fair market value. Instead, he focuses on the inherent value of an agency's ongoing operations. “Arbitrage-based valuation in a bubble economy will always elevate prices beyond the firm’s fundamental value.”
Click here for the complete article “Agency Valuations: A Victim of the Credit Bubble?”
Buyers don’t automatically get software licenses…
IP Spotlight reminds us of the importance to M&A due diligence and valuations of the 9th Circuit decision that a software user is a licensee NOT an owner of a copy of the software (Vernor v Autodesk), where the copyright owner 1) lays out the fact a license agreement is in force, 2) significantly restricts the user’s ability to transfer the software, and 3) imposes notable use restrictions. The software licenses held by the to-be-acquired entity may not automatically transfer in the transaction; the acquirer may need to get written consent from the copyright owner.
Goal of M&A is more than transferring value
Stephen McGee (Grant Thornton) has some fun with valuation formulas by coming up with a version of standard equations for use in M&A transactions: Price = Value + (S+C)e.
- V is the quantiﬁable value calculated using one of several traditional valuation approaches: comparable public companies, comparable transaction multiples or a discounted cash ﬂow analysis – methodologies you can use to calculate a somewhat scientiﬁc value for a company
- S is the story, and it needs to be a compelling one
- C is the competition generated to buy the company, and
- e is the emotion that comes with any M&A transaction.
“The goal of any M&A transaction should be to create — and not simply transfer — value,” writes McGee. He believes sellers who approach the transaction from the point of view of Price = Value + (S+C)e can expect the selling price to be greater than the company’s value.
Click here for McGee’s article “Using M&A Transactions to Create Value”, which was published in the recent issue of Dealmaker.
Lost profits v. lost business
Using the landmark copyright case Viacom v. YouTube as an example, Mark Gottlieb (MSG CPAs) explains how a lost profits case differs from a lost business case. “In considering whether a case merits a claim for either or both, one must examine the facts and circumstance early in the litigation process to analyze the appropriate theory of recovery. The final determination can directly affect the appropriate damage calculations as well as the identification of proper claimants to the litigation. In some instances, the courts have allowed both lost profits and the decrease of the market value of the subject business; however, on some occasions, the court has allowed one or the other,” explains Gottlieb.
For the complete article click here.
Yeanoplos appointed to Arizona Board of Appraisals
Arizona Governor Jan Brewer recently appointed Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos PC) to a three-year term on the Arizona Board of Appraisal, a state agency that regulates real-estate appraisers.
Get more business doing damages and lost profit valuations—and save on Fannon’s upcoming damages valuation guide
Next Friday, October 8, BVR’s Webinar Series on Damages Essentials kicks off. Designed by Nancy Fannon, this is the most substantial and complete training in this specialized valuation field ever offered. The first part of the series include four CPE sessions; you can sign up for them singly or as a series at significant discounts.
The first session in the series is “Lost Profits Calculations: Methods & Procedures” featuring Robert Gray and James O’Brien (ParenteBeard, LLC). Gray and O’Brien will discuss what every appraiser needs to know when engaging in a lost profits case: from calculations methods and related supporting – and admissible – evidence to the business engagements involved in lost profits work.
To register for this or any future session in the series click here. And extra value: you can register for the series plus get the Comprehensive Guide to Lost Profits Damages for Experts and Attorneys, edited by Fannon, for $399 (or with an annual subscription to the on-line guide for $499. Separately, the CPE and Guide would cost over $800.
BVR’s best-in-market valuation databases continue to grow
The BIZCOMPS® database has been updated with $137 million worth of new sold businesses-about 350 new transactions. The new transactions span the gamut of industries, including manufacturing, retail, wholesale, services and more. The update includes valuable seller's discretionary earnings data and seller's discretionary earnings valuation multiples. This update brings the database's total transaction count to nearly 12,900 sold businesses. For more information on BIZCOMPS, click here.
The Valuation Advisors' Lack of Marketability Discount Study™ also received a substantial update when over 350 new transactions were added. This newest update adds companies that have IPOed as recently as August 2010 with pre IPO transactions as recently as July 2010. This update brings the database up to 4,724 transactions. Also, subscribers to the database can visit the Subscriber Services page to find an updated summary data table and a transcript from the Valuation Advisors' teleconference that took place in July 2010. For more information on the Valuation Advisors' Lack of Marketability Discount Study database, click here.
What's more, the 2011 FMV Companion Guide has been posted to the Articles page for the FMV Restricted Stock Study. The new Companion Guide gives insight into the new data that has been added to the database and discusses FMV Opinion's preferred methodology for calculating discounts for lack of marketability, including illustrative examples.
Convergence continues apace…
The FASB sent out a press release Tuesday announcing that they’ve “completed the first phase of its joint project with the IASB to develop an improved conceptual framework” and issued Concepts Statement No. 8, Conceptual Framework for Financial Reporting, including Chapter 1, “The Objective of General Purpose Financial Reporting,” and Chapter 3, “Qualitative Characteristics of Useful Financial Information.”
You could be excused if you were a little confused about what a “concept statement” from FASB is. So, here’s their definition: “Concepts Statements are not part of the FASB Accounting Standards Codification™. Concepts Statements are intended to set forth objectives and fundamental concepts to be used by the Board as a basis for developing future Accounting Standards Updates.”
The key point is that IASB and FASB continue to work toward harmonization in what seems like a slow but inevitable process.
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