The use of pre-IPO data is a widely used and accepted method for estimating a discount for lack of marketability (DLOM). New pre-IPO data for the first quarter of 2021 in the Valuation Advisors Lack of Marketability Discount Study should be of interest to valuation analysts.

High discounts: “The pre-IPO discounts this quarter are higher than they usually are,” says Joseph Cotton of Valuation Advisors LLC, the firm that researches and provides the data for the study. “Recently, the stock market has been hitting new highs. Also, valuations for medical, healthcare and drug development related companies have been increasing rapidly in value. These factors led to higher discounts this quarter, as demand for IPO shares increased.”

For U.S. transactions, the median discount was 53.7% for the 1Q2021 zero-to-three-month time frame (compared to 39% for all of 2020 and 21.5% for all of 2019). For all transactions (U.S. and non-U.S.), the 1Q2021 zero-to-three-month time frame median discount was 51.4% (compared to 35.5% for all of 2020 and 21.2% for all of 2019).

Pre-IPO studies and restricted stock studies are the most commonly used methods for estimating a DLOM. Which is better? You should not rely on only one approach but use evidence from several sources for your analysis.

New evolving ESOP case raises familiar valuation-related issues

A new ESOP litigation is underway in federal district court related to a 2011 transaction in which the majority owner of the company sold his remaining stock to the company’s ESOP. The Department of Labor is the plaintiff, and many of its allegations against the seller, company directors, and the independent trustee have a familiar ring. Recently the court denied both parties’ motions for partial summary judgment, finding resolution of the issues required development of the evidentiary record.

Backstory: The company is Kurt Manufacturing, a closely held Minnesota company. William Kuban was the majority shareholder (75.6%) and chairman of the board. Besides Kuban and his daughter, the board included three non-Kuban-related members. In 2011, the non-Kuban directors approved the sale of Kuban’s shares to the company’s ESOP. The deal left the ESOP with 100% of company stock. This was a debt-financed transaction. On advice of the seller-side financial advisor, Chartwell, the directors appointed Reliance Trust to represent the ESOP’s interest in negotiating a purchase price. Stout Risius Ross (SRR) was the designated ESOP appraiser. The transaction closed on Oct. 5, 2011. The closing price was $39 million.

Breach of fiduciary duty claim: Six years later, the DOL filed an initial complaint, which it amended. In essence, the DOL alleges that Reliance and the non-Kuban directors breached their fiduciary duties to the ESOP and Reliance allowed the ESOP to pay more than fair market value for the seller’s stock, enriching him and the defendant directors (“prohibited transaction” claim). The DOL argues the directors are liable as co-fiduciaries and were knowing participants in the transaction.

According to the DOL, the directors “orchestrated” the transaction in that they and the seller arranged the price, structure, and financing in advance and only considered Reliance and SRR, but not other ESOP professionals, for the transaction. Reliance’s role was to “rubber-stamp” a done deal.

Also, the DOL contends, Reliance breached its duties to the ESOP when it failed to act with an “eye single” to the ESOP. Emails, the DOL says, show Reliance was only concerned about closing the deal, not with getting the best result for the ESOP. For example, when the seller insisted on securing compensation of nearly $500,000 to serve as consultant to the company, Reliance was primarily concerned about this amount raising a “red flag” for the DOL and IRS, saying “any counter changes we ask for are to help protect [Kuban], [Kurt], and Reliance from the DOL.” Reliance counters that $39 million was the price the parties settled on after discussions, primarily over Kuban’s salary. The purchase price included a substantially reduced salary to Kuban. Reliance also says it secured various favorable terms for the ESOP.

Control premium: The issue of control also features in this case. SRR, in a draft analysis of transaction fairness, said a primary benefit of control was the ability to change the capital structure of the company. This was one factor SRR considered in applying a 10% control premium to the stock prices of the guideline companies it used for its guideline company method (SRR also did a DCF analysis and combined the results). The DOL claims that the ESOP did not gain control of the company’s board and its voting rights did not change. Reliance’s failure to question the use of a control premium alone resulted in the ESOP’s overpayment of at least $4.7 million. Reliance argues valuing the stock on a control basis was appropriate. For one, the parties negotiated an investor rights agreement that allowed the seller to designate one member of a five-member board until the seller’s noted was paid. The ESOP was able to elect the remaining members.

The court found all of these, and a host of other issues raised, are disputed issues of material fact that preclude summary judgment.

Stay tuned for further reporting as the litigation develops.

A digest of Scalia v. Reliance Trust Co., 2021 U.S. Dist. LEXIS 38705 (March 2, 2021), as well as the court’s opinion will be available soon at BVLaw.

Today! Third and final part of ‘Integrated Theory’ webinar series

A very special BVR webinar series concludes today with the authors of Business Valuation: An Integrated Theory, Z. Christopher Mercer and Travis W. Harms (both with Mercer Capital). They will present the third in a three-part series of webinars based on their acclaimed book, which is designed to demystify modern valuation theory and show how to apply fundamental valuation concepts. The first installment of the webinar series gave an overview of the integrated theory, and the second installment examined enterprise cash flows. The third and final installment of the series will be today, April 21, when they will delve into shareholder cash flows. If you are a BVR Training Passport holder, you have access to archive recordings of the first two, and you have a pass for the third. This series is definitely a must to watch!

BVU poised to cover an exciting slate of 2021 conferences

One of the hallmarks of the Business Valuation Update (BVU) monthly newsletter is its in-depth coverage of conferences—not just in the U.S. but around the world. BVU editors are on the ground (or online) collecting important takeaways, new ideas, and the latest thinking on front-burner valuation topics. Coverage of spring conferences around the globe will soon kick off with these events: the Houston Chapter of the American Society of Appraisers (ASA) Energy Valuation Conference (May 12), the New York State Society of CPAs Business Valuation and Litigation Services Conference (May 17), the 2021 ASA Complex Securities Virtual Conference (May 20), and the ICAEW Valuation Conference from the United Kingdom (also May 20).

Here’s a sampling of last year’s coverage (access is by subscription):

• Pandemic, ESOP Woes, Fair Value, Crypto, and Fraud at the NYSSCPA Conference;

• 25 Tips on Dealing With COVID-19 From the NACVA Conference;

• Attorneys and Valuers Link Up at the AAML/BVR Virtual Divorce Conference;

• Recap of the VSCPA Business Valuation, Fraud, and Litigation Services Conference;

• Appraisal Disciplines Reveal Breaking Trends at the ASA Conference; and

• Global Valuers Converge for the Art and Science of Business Valuation Conference.

M&A strategy pros convene April 30

A discussion of trends in transaction valuations in the context of M&As is part of the agenda at the spring M&A Strategy Forum on April 30, hosted by the Transaction Advisors Institute. This live online program will explore a range of current challenges impacting complex transactions and examine innovative methods to improve deal performance. Registration is $100 (free for members of the Transaction Advisors Institute). One session we’re eyeing: Strategic v. Private Equity v. SPAC, which discusses valuation formulations of these acquirers. For more information and to register, click here. BVWire will be there!

Burrage scholarship recipient named

As part of the Thomas Burrage Award for Compassion, Collegiality and Character (see last week’s coverage), a scholarship of $1,000 has been presented to Sheyla Lopez, a student at the University of New Mexico (UNM). Burrage was also known for giving his support and guidance to young people in the profession, and UNM was his alma mater. “Sheyla has a unique background and is currently working on both her master’s degree and her law degree,” says Dr. Rich Brody at UNM, who knew Mr. Burrage and who chooses students for the scholarship. “Sheyla spent much of the summer working on a huge fraud project with me (research paper) and hopes to work for the FBI once she has finished with her education. She is a great student and has taken both my fraud examination class and my forensic accounting class. She also did a lot of work with our student chapter of the Association of Certified Fraud Examiners (ACFE). I only wish I had more students like Sheyla.”

The scholarship was given by the Expert Resource Connection, co-founded by Mr. Burrage, which is a group of business valuation and forensic accounting professionals who share resources and collaborate on engagements. Contributions to the scholarship fund can be made by check payable to: Thomas Burrage Scholarship Fund, c/o 940 Wadsworth Blvd., Suite 200, Lakewood, CO 80214.

Learn to say ‘no’ to some clients, says former ANEVAR president

Some business valuation clients are “dangerous,” and valuers need to say “no” to them, advises Dana Ababei, former president of the National Association of Authorized Romanian Valuers, Romania (ANEVAR). These risky clients “put pressure on valuers, do not care about anyone, avoid paying for the services when the value is not what they expect and rather look for another valuer whom they subject to the same pressure,” she writes in the 2021 edition of VALUE: Wherever It Is, a publication from ANEVAR. For the good of the valuation profession, valuers should say “no” to these clients and tell them why. “I believe trust is built on the truth that we tell people, not on what they want to hear,” she says.

BV movers . . .

People: Ronald H. Pachino, CPA, ABV, CFF, CGMA, has been elected a tax partner at Newport News, Va.-based PBMares; his area of focus is business valuations and litigation support, including civil litigation, family law, bankruptcy, estate and gift tax, mergers and acquisitions, business loss compensation, dissenting shareholder cases, economic loss calculations and resolutions, and international mediation matters … Ray Lampner, CPA, ABV, CVA, CFF, CGMA, CEPA, has been promoted to partner-in-charge of the CPA Consulting Services practice at Naperville, Ill.-based Sikich LLP; he oversees the operations and client service initiatives for the firm’s transaction advisory services, forensic and valuation services, and business succession planning practices … Brad Muir, a supervisor at Vallit Advisors LLC, has earned the Accredited in Business Valuation (ABV) credential from the AICPA; he is also an ASA candidate, and he focuses on dispute advisory, forensic accounting, and business valuation services to clients across various industries in a wide variety of complex matters … Wynand Mullins has been appointed a senior managing director in the Australian Forensic and Litigation Consulting practice of FTI Consulting Inc., based in Sydney; he is certified as a forensic accounting specialist and business valuation specialist, and he focuses on dispute advisory, financial investigations, and contentious valuations … The CBV Institute, Canada’s valuation professional organization (VPO), has given Tom P. Muir, FCPA, FCA, FCBV, of Muir Investments Ltd. (Toronto) the honor of Life Member standing.

Firms: Duben & Associates of Encino, Calif., will relocate to smaller offices in Valencia effective May 1; during the pandemic, it learned that it could be more efficient on behalf of clients and staff while occupying a smaller physical footprint.

Please send your professional and firm news to us at editor@bvresources.com.

CPE events

• Valuing Shareholder Cash Flows. April 21, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Travis Harms (Mercer Capital) and Z. Christopher Mercer (Mercer Capital).

In the third and final webinar of this three-part series, the authors of the new third edition of Business Valuation: An Integrated Theory examine shareholder cash flows and discuss the restricted stock discount (and the restricted stock studies) and the pre-IPO discount. They also delve into the inputs to the quantitative marketability discount model (QMDM).

• Valuing Telehealth Services. April 27, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Todd Zigrang (Health Capital Consultants) and Jessica Bailey-Wheaton (Health Capital Consultants).

Learn about the types of telehealth services typically provided, such as clinical services, management services, and the provision of technology, and how these services may vary by healthcare industry subsector. This is part of BVR’s Special Series presented by the BVR/AHLA Guide to Healthcare Industry Finance.