August 31, 2011 | Issue #107-5  

The Judges will ask: Does your story really
make sense?

“Why would a wealthy elderly lady willingly destroy half the value of her estate,” Judge Mark Holmes of the U.S. Tax Court asked 200 appraisers at the L.A. Chapter of the Appraisal Institute’s IRS Valuation Summit last week. “That’s the question you have to ask yourself when you’re trying to explain the transfer of hard assets” to legal structures such as limited partnerships and corporations. ”You’d better have a good story to describe why a discount is valid,” he concluded.

Ron Cerruti (IRS Field Service Territory Manager) agreed with the Judge—with a major point of emphasis. “You need to write well,” he said (offering his own opinions, not those of the IRS). Reading poorly written reports “starts to piss us off after a while,” he quipped, before reading five excerpts from valuation report language that literally made no sense. “We have lots of time,” Cerruti added, in all seriousness. “And if you get past us, you don’t have to worry about Tax Court. So put in the effort to make a good argument for your position.”

Paul Frederic Marx (Rutan & Tucker), a leading trust and estate lawyer, admitted that he’s particularly wary of appraisers who “cherry-pick methods to get desired results.” His solution? ”Fire the appraiser and hire a new appraiser. There’s a higher standard of professionalism here,” he warned, citing the standard of care that’s necessary to determine highest and best use in real estate, for example.  “Advocate [for your opinion] and explain why you choose the methods that work in each particular case.”  

Houlihan Lokey provides proxies for risk-free rate after downgrade

What are the new considerations for cost of capital determinations, given the recent S&P downgrade of U.S. debt? Should analysts add a default premium—or even a “country risk” premium?”  Four Houlihan Lokey professionals (Cindy Ma, Terence Tchen, Tim Smith and Andrew MacNamara) provide some current options in their new article, “The ‘risky’ risk rate: does the downgrade of US sovereign debt change commonly-used valuation principles?” published in Financier Worldwide (subscription required):

  • One alternative risk-free asset is the ‘AAA’-rated (or equivalent) sovereign debt of other countries.
  • Another alternative might be to use ‘AAA’-rated U.S. corporate bonds as risk-free proxies.
  • Perhaps analysts might derive a risk-free rate by removing the portion of yield attributable to credit risk from U.S. Treasury yields; or,
  • They could remove credit risk from U.S. Treasury yields by estimating the additional required rate of return for a non-‘AAA’ rated security compared to an ‘AAA’-rated security.

Each of these scenarios has its problems as well as its merits, the authors caution—warranting a carefully supported analysis of any cost of capital adjustments.

Law firm valuation provides ‘peculiar’ problems

“Lawyers never quite want to resolve buy-sell agreements because they want to keep their options open,” according to Ron Seigneur (Seigneur Gustafson) in his Law Firm Valuation Checklist, appearing in the most recent (July 2011) BVUpdate. Law firms are also in a state of transition and their partners are used to litigation, Seigneur pointed out, two current facts that create more opportunities for business appraisers and financial consultants in the buy-out context.

A new case out of the California Court of Appeals proves many of Seigneur’s points true. In Rappaport v. Gelfland, 2011 WL 3215379 (Cal. App) (July 28, 2011), a 31% percent partner in a 3-partnerfirm decided that after five years, he wanted to dissociate. (“We’re finding that if you have a book of business as a lawyer, you can get cash offers to jump firms,” Seigneur noted.) The partners couldn’t agree on a buy-out price under the state’s partnership statute, which essentially provided for the greater of the going concern or liquidation value. The BV expert for the departing partner helped convinced the trial court that, “because of the peculiar relationship between dissociation and the wind-up process when applied in the law firm context, a construct is created to calculate a value [as of the stipulated valuation date] based upon individual assets being liquidated over time, and then bringing the value ‘back’ to the date of dissociation.”

These assets included accounts receivable, a large contingency-fee lawsuit, and litigation for one “unmanageable” client. The trial court “fully credited” the partner’s expert for the values for all three asset categories and the appellate court affirmed, altering nothing but a slight math error. Read the complete case digest in the October 2011 Business Valuation Update; the court’s decision will be posted soon at BVLaw.

Download update. Given the trickier aspects of law firm valuation, we’ve also added Seigneur’s comprehensive checklist of financial documentation and discovery in these cases to our popular download site: get your free copy here.

Valuing IP in bankruptcy requires more sophistication

Analysts will find IPmetrics’ review of valuing IP in a bankruptcy context useful. As they have seen in other contexts (e.g., valuing patent infringement damages under the now tighter Uniloc standards), using simple ratios and “rules of thumb” is far less likely to pass scrutiny by a court (and an attorney client) than before. “A specific audit” of the IP at issue is now required, says IPmetrics.

What makes a good expert witness directory?

This month the Courtroom Insight blog asked: “What makes a good expert witness directory?” Part 1 of the two-part answer was directed to attorneys and Part 2 to experts.

When considering such an investment, experts should evaluate whether the value received is worth the expense, writes Mark Torchiana, Courtroom Insight Blog CEO. Ultimately, the most important barometer of success is measured the number of potential clients who contact the expert. You can influence this success by:

  • Differentiating yourself from other experts in your field
  • Providing meaningful information to attract attention from clients
  • Appearing in expert directory searches and/or major search engines
  • Regularly updating your professional information
  • Emailing profile listings to other attorneys

Are you listed with the BVR Expert Directory of Business Appraisers?

Size premium driving middle market
M&A activity

Data published in GF Data’s Second Quarter 2011 Report reveal unprecedented differentials in the valuations and debt multiples between small and large transactions, according to a recent GF Data press release. The gap “indicates the resurgence of an even more severely bifurcated market that is less accommodating to smaller transactions,” the GF Data sources add. “The size premium also extends to, and to some extent is caused by, disparities in debt availability to larger and smaller businesses," says B. Graeme Frazier IV, Principal and Co-Founder of GF Data. "While this is not apparent in the overall data, when you look at Total Debt/EBITDA multiples for deals in the $10-25 million TEV range, they are on par with 2010 levels in the high two’s, [and] yet for larger deals, Total Debt/EBITDA went from an average of 2.8x in 2010 to 3.9x in the first half of 2011."

SOX costs have shifted private firms exit strategy, new study says

The costs of complying with the Sarbanes-Oxley Act of 2002 (SOX) for private firms that are still trying to find an efficient if not profitable exit strategy is the subject of a new study by Francesco Bova and Gordon Richardson (Univ. of Toronto), Miguel Minutti-Meza (Univ. of Miami), and Dushyantkumar Vyas (Univ. of Minnesota). Among its principal findings: First, SOX appears to have shifted the firms’ exit incentive from an IPO to a public acquisition. The costs of SOX compliance may be larger for IPO firms, which need to create SOX infrastructure from scratch, than for acquired firms, which can leverage on their acquirer’s existing SOX infrastructure.

Second, private targets that invest more in pre-acquisition SOX compliance post larger deal multiples. This suggests that pre-sale SOX compliance "bumps up" a target’s valuation multiples due to its predicted lower compliance costs after the acquisition. By the same token, private firms with less SOX compliance may post lower acquisition multiples.

Download a working version of the paper, “The Sarbanes-Oxley Act and Exit Strategies of Private Firms” here.

2011 edition of International Valuation Standards now available

The International Valuation Standards Council (IVSC) recently published a completely revised edition of the International Valuation Standards. The result of a three-year improvement project, the goal of the new standards is to promote consistency and transparency throughout the valuation process. According to the IVSC, “the standards cover the valuation of a wide range of assets - financial instruments, real property, intangible assets, and business interests - are included, and for common applications such as valuations for financial reporting and of real property interests for secured lending.”

BVR’s best-in-market valuation databases continue to grow

We’ve just added over 400 new private company transactions to BIZCOMPS, bringing the total in the database to over 12,000. BIZCOMPS focuses on small company transactions; the median selling price of the companies added is $166,000.   So, it’s a perfect resource for market comparables when your subject company is a “mom and pop” or sole proprietorship.

The Valuation Advisors Lack of Marketability Discount Study online database has also been updated and now includes 7,100+ transactions in pre-IPO private stock and options.

Auto dealers next on the YS advisory docket

BVR and YS Advisory continue to make great strides as they apply their business valuation expertise to owners' strategic growth planning. Through various partnerships with industry associations, publishers and other groups that work closely with owners and other key executives, YS gets out in front of these audiences to advise on value enhancement and exit or succession planning. On September 15th, 2011 Kevin Yeanoplos (Johnson Yeanoplos, P.C.) will represent YS on webinar “How to Maximize the Value of Your Dealership or Dealer Group.” The webinar will be co-produced with Dealer's Edge, a leading information provider to the auto dealership community. Business appraisers working with auto dealer owners will benefit from the insight of Yeanoplos and co-panelist Butch Williams  (Dixon Hughes). Look for more news on YS Advisory in the near future as the partners deliver business valuation know-how beyond the appraisal community.

Kick-off the fall CPE season with the first-ever Online Litigation Symposium

On Tuesday, September 13th, BVR’s Online Symposium on Litigation & Economic Damages begins with “Working With Financial Experts.” Featuring attorneys Timothy Devlin and William Marsden Jr. (both Fish & Richardson), this program will address what every appraiser and attorney should know when pairing up for trial or deposition testimony, from improving workflow and communication to preparing for challenges from both sides of the case. BVR’s Online Symposium continues for twelve months with thirteen installments of advanced programming related to appraisals for litigation. Featuring many expert contributors from the Comprehensive Guide to Lost Profits Damages for Experts and Attorneys, this series has been carefully put together by Guide editors Nancy Fannon (Fannon Valuation Group) and Jonathan Dunitz (Friedman Gaythwaite Wolf & Leavitt), with an estimated 26 CPE and CLE credits available. For more information on subscription benefits and prices contact BVR today.

And join appraiser Drew Dorweiler (Dartmouth Partners Limited) on September 15th for “Valuing Sports Franchises,” the latest installment of BVR’s Industry Spotlight Series.  The world of team ownership is much larger than the names of a few celebrity owners might suggest; the industry is in fact much larger and deeper, due to the prevalence of minority ownership stakes, their transfer and trading. In this webinar Dorweiler will explain why franchise valuations are more common, complicated, and profitable than you may think.

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Copyright © 2011 by Business Valuation Resources, LLC
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