Daubert challenges direct valuation of corporate guaranties

As promised, we’ve been following Baldwin v. Bader, the U.S. District Court case that considers the novel question of how to value personal guaranties provided by corporate insiders to secure company debt.  (See BVWire™ #70-2)  Although it’s not uncommon for the owners and directors of small, closely held businesses to undertake the risk in return for financing, the insiders of the cash-poor, financially troubled company in this case received additional shares as compensation for extending their guaranties.  Only one shareholder refused to participate, and later sued the directors for breaching their fiduciary duties by allegedly diluting his shares. 

At trial, the directors offered an expert who relied on Valuing Small Businesses and Professional Practices, by Shannon Pratt, Robert Schweihs, and Robert Reilly (VSBPP), and information from a workshop by the Institute of Business Appraisers (IBA), to support his proposition that the directors’ risk was comparable to the risk of equity investors.  But the dissenting shareholder objected, claiming that the authorities fail to give direct guidance on valuing insider guaranties apart from appraising a business.  The court agreed, and precluded the evidence—but the directors were given a “second bite at the apple” when the presiding judge retired and other procedural issues merited a second Daubert hearing.

This time, in Baldwin v. Bader (July 28, 2008), the defendant directors offered new but similar authority from the just-released Cost of Capital (3d. ed., 2008), by Shannon Pratt and Roger Grabowski.  The dissenting shareholder objected to the “eleventh hour” interjection of additional material.  But a financial expert need not anticipate every “nano detail” that might come up in defending an opinion against Daubert, the court held.  At the same time, Daubert does not permit a valuation technique that no expert has ever used before, and for which there appears to be no direct support in the BV professional literature—the defendants lost their expert evidence for the second and apparently last time.

What‘s your opinion?  The court called the question a close one—a complete abstract of its long, carefully crafted opinion (which also details the ultimate decision on liability and damages) will appear in the October Business Valuation Update™.  A full text of the court case is available at BVLaw™.  We’ve already fielded some feedback on the decision: Did the court set the Daubert hurdle too high?  Is there sufficient support among BV authorities for comparing the risk of insider guarantors to equity investors—especially those who receive additional shares as compensation for undertaking the risk?  Add your opinion by emailing the editor, and we may feature your comments in an upcoming edition of the BVWire   

Only ourselves to blame?

Four business appraisers sent their comments about last week’s BVWire article titled "Appraisers send 'serious concerns' to the SEC" (available here.)  The original article discussed a letter that several appraisal organizations (the authors) sent to the SEC which criticized the SEC’s Draft Report on Financial Accounting.  The authors’ letter stressed “that valuation specialists and the valuation community have an important role to play in fair value accounting” even though the SEC Draft implied otherwise. 

BVR’s 2009 Business Valuation Firm Economics & Best Practices Survey (available in September—preorder here) brings into focus the impact of fair value accounting in the business appraisal profession.  The 2009 Survey indicates a sea change in this area, citing the increased billings related to financial statements (FASB 157, 141R, 142, etc.) and their growth from an “other category” in 2006 to almost 18% of total BV billings in 2008.   With the amazing growth in the fair value area, the focus on the SEC’s acceptance of business appraisers seems even more relevant.

Some of the feedback the BVWire received included:

From a CFA, ASA appraiser:

Almost three years ago at the last joint AICPA-ASA Conference, Scott Taub of the SEC gave a speech that can be paraphrased as follows (my words):

The accountants have a single regulatory body over the profession (the AICPA), with a single set of standards, a single set of accreditation criteria, robust oversight and enforcement of professional standards, uniform technical standards, and effective peer review.  If the valuation profession expects to continue to do work for financial reporting purposes in the U.S., it had better raise its performance to the level of the accountants on all these points.  If not, expect to be shut out of doing financial reporting work for public companies.  Regulate yourselves effectively, or we will impose it upon you from above.

Sitting in that ballroom with several hundred of my professional colleagues, a chill ran down my spine.  We were warned.  None of us should be surprised at what the SEC Advisory Committee has said.  While our profession has countless meetings to discuss the future intent to somehow work better together some day, and valuation standards and practices converge at geologic speed, the train is leaving the station and we're not on board.  If the SEC shuts us out, we have only ourselves to blame.

From a CPA, ABV appraiser:

At a recent meeting of the California CPA Litigation Steering committee I brought the SEC Draft to the attention of the committee.  I also provided a copy of the ASA/Appraisal Foundation response.  It is my understanding that the subject has been referred to the senior members of the California CPA society for response.  Clearly the business appraisal profession needs its voice to be heard just as strongly as the real estate contingent.

From an ASA, CPA, ABV, MCBA appraiser:

“…highly trained professionals who meet rigorous valuation-specific requirements involving experience, education, training and testing; who adhere to the Uniform Standards of Professional Appraisal Practice; and, who observe strict ethics and independence mandates” and that they “encourage greater understanding of professional appraisal designations and the body of knowledge of our profession.”

I don’t know whose reports they’re reviewing every day, but they sure don’t meet these criteria.  (And yes, I’m talking about “credentialed” appraisers.)

From a non-credentialed fair value appraiser

Enough whining already………Define, create, improve and distribute proper FAS 157 guidance, education and training or concede the business to an accounting equation (at worst) or the ABV community.  I can attest – from my attendance - that the only current in-depth coverage of Fair Value relates mostly to statutory dissention appraisals.  Hello legacy BV community: 59-60 and the myriad of associated “creative interpretations” means nothing in the FAS 157 space!  Adapt your practice to this type of work or step aside.

If you’d like to add your feedback to this ongoing discussion, please email bvwire@bvresources.com.

Top Free Downloads

Loyal BVWire readers are quite familiar with the phrase we often include in many of our articles—“…that is posted to the Free Downloads page.”  We’ve looked at the recent download statistics and it appears the total of the July 2008 downloads is one of the largest in history at 2,050 downloads—that’s almost double the number downloaded in May or June.  Are you curious what your fellow business valuation professionals are downloading?  Well, here’s a list of the top ten downloads and their totals for July:

Download Title


Valuing Employee Stock Options for Closely Held Companies (New in July)


What is Reasonable Compensation?  (New in July)


How Much is Your Business Worth—According to Inc. and BVR


New Financial Reporting Valuation Guidelines  (New in July)


IRS Business Valuation Guidelines


Valuation Advisors DLOM Study


The Comprehensive Guide to the Use and Application of the Transaction Databases


Registration Rights Agreement  (New in July)


Quantifying Company Specific Risk


Business Valuation Update™ January 2008 Issue


Driving Value blog

The Driving Your Company’s Value blog, hosted by Bill Quackenbush, MBA, ASA, CBA, and Jim Rigby, ASA, ABV, CPA, is seeing a sharp increase in readership. Located at www.drivingvalue.com, the forum hits a diverse readership and focuses on what drives a company’s value and how to capitalize on those value drivers.  Comment, discuss, share—and sign up here to submit your own postings. 

Valuation for tax purposes—top revenue producing area

According to BVR’s 2009 Business Valuation Firm Economics & Best Practices Survey, valuations conducted for tax purposes continue to be the top revenue producing area for the industry.  Slightly more than 21% of respondents listed taxes as their top revenue producer, followed closely by the family/matrimonial area. Taxes also top the lists of the fastest growing specialty areas among BV practitioners—as well as the most profitable.

Estate and gift taxes are the main issues generating work for BV appraisers.  As the baby boomer generation continues to age, E&G tax is likely to remain in or near the top spot over the next few years.  To stay abreast of the current valuation case law and current articles regarding estate and gift issues, subscribe to BVR’s Guide to Estate & Gift Tax Case Law.  The results of the benchmarking survey will be published in BVR’s 2009 Business Valuation Firm Economics & Best Practices Guide (available in September—preorder here.)

Biggest BV driver in software company valuations

ClearConceptsInternational.com recently posted an article by Dave Kauppi (MidMarket Capital, Inc., Hinsdale, IL), which details the number one driver for business valuations in software and information technology companies: recurring revenue streams.  What counts is the timing of the initiatives taken to create contractually recurring revenue—implementing them prior to the sale will ramp up the company’s valuation, whereas no buyer will pay you for improvements they need to make themselves post acquisition. Dave writes, “On a value scale, contractually recurring revenue is a 10, expected historical revenue is a 6 and a sales pipeline is a 3. Move your 3’s and 6’s to 10’s and recognize a big boost in your business selling price.” 

Knowing this, it is important to take steps to maximize recurring revenue streams in order to secure a high business valuation.  This requires converting existing agreements to contractual agreements and giving customers incentives to add-on additional contractual services.  The company needs to rally its sales team behind this cause by creating commission plans that award a higher commission to recurring revenue contracts.  The sales team is key in ensuring a high valuation: “If a salesman’s lack of performance is costing you $50,000 in EBITDA and your company will sell at a 7 times multiple, this laggard will cost you $350,000 in transaction value.” Read all of Dave’s tips here.

Same Report, corrected publisher

The August 6th issue (issue 71-1) of the BVWire incorrectly listed the publisher of the 6th Annual Restaurant Valuation Trends Industry Data ReportThe correct publisher is Restaurant Research, LLC, located in Connecticut.  The Report is not listed on their website but interested parties can email them at info@restaurantresearch.info for more information and pricing.

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