BVR Logo August 26, 2020 | Issue #215-4

BVWire is your go-to source for the latest in the business valuation profession. Highlights for this week include:



IRS deals with triple whammy as it
reviews valuations

The government shutdown, budget cutbacks—and now the pandemic—have impacted the IRS and how it selects and reviews tax returns that include valuations. During a recent webinar, a former IRS manager who dealt with valuations at the agency (and who was there during the last financial crisis) gave some advice on preparing valuations for estate and gift tax purposes in today’s environment

Déjà vu? Unlike the 2008 economic downturn, the IRS now has much less staff doing valuation work—about half of what it had back then, reports Michael Gregory (Michael Gregory Consulting LLC). Therefore, staffing is a concern that may impact the quality of the review process. The IRS can close out more cases faster with a less rigorous attention to quality, so there is a danger in that regard.

As the IRS did back in 2008, it will give more attention to certain elements of valuations. “They focused on the low-hanging fruit because that was the easiest to do,” he says. The first and foremost red flag is a discount for lack of marketability (DLOM), especially if DLOMs are being increased without adequate explanation. Second on the IRS radar screen has been S corporations because this is related to the issue of tax affecting, although it is not as prominent anymore due to tax law changes and recent court cases, Gregory notes. The third red flag is reasonable compensation. These three areas will continue to be targeted as the most likely areas of noncompliance the IRS will scrutinize while it has less resources to work with.

Gregory worked for the IRS for almost 30 years, much of the time dealing with valuation matters. He is now in private practice, and he stressed during the webinar that his views and opinions are his own and not those of the IRS. The webinar, which also included experts from Empire Valuation Consultants, is free and is available if you click here.

Extra: Gregory will co-present a four-hour workshop on normalizing compensation today, August 26, at 10 a.m. PT (1 p.m. ET). Stephen Kirkland (Atlantic Executive Consulting) and Paul Hamann (RCReports) will join him. To register, click here.

In a crunch, court adopts company’s DCF model as fair value indicator

In a statutory appraisal action prompted by the 2016 buyout of minority shareholders by the controller of a private company, the Delaware Court of Chancery recently found there was no meaningful market-based evidence of fair value and neither expert opinion, based on standard valuation methods, was “wholly reliable.” Forced to decide, the court adopted one expert’s discounted cash flow analysis.

‘Monumentally different valuations’: In 2012, McWane Inc. bought a controlling stake in Synapse Wireless (Synapse), an “internet of things” (IoT) company. IoT was seen as a growth industry, but Synapse never lived up to its promise. The company kept missing management’s projections by a wide margin and became reliant on ongoing funding from McWane to keep operating. The 2012 merger agreements gave McWane a right to buy newly issued Synapse shares at a per-share price based on the 2012 merger, as well as a right, beginning in 2018, to require the remaining minority shareholders to sell their stock to McWane.

In late 2013, McWane sued Synapse, alleging breaches and misrepresentations. The litigation settled in late 2015, with McWane winning a reduction in price of its call option to $0.42899 per share, reduced from the $4.997 per share it paid in 2012. McWane also secured a right to exercise the call option immediately and did so in early 2016. At that time, it acquired ownership of 99.346% of Synapse by offering shareholders $0.42899 per share. The petitioner rejected the offer and asked the Delaware Court of Chancery for a fair value determination under the state’s appraisal statute.

At trial, the parties offered expert testimony. Both experts used the same three valuation techniques (analyses of prior purchases of company stock, comparable transactions analyses, and discounted cash flow models). The experts even “materially agreed on several important inputs,” the court observed. However, “as has become standard fare for appraisal litigation, the experts reached monumentally different valuations,” the court said.

In a nutshell, the petitioner’s expert arrived at a fair value of $4.1876 per share. The company’s (respondent’s) expert declined to provide a single valuation, but his summary values ranged from $0.06 per share to $0.11 per share.

The court rejected the market-based evidence, including McWane’s acquisitions of Synapse stock preceding the 2016 merger. Neither the stock purchases following the 2012 merger nor the 2016 merger took place in a competitive market, the court said. As for the 2012 merger, the court said this transaction was “stale” and did not represent evidence of Synapse’s value at the time of the 2016 merger. Synapse, in 2016, faced different prospects than it did in 2012, the court noted.

‘Dicey valuation method’: The court also rejected the experts’ comparable transaction analyses, calling this approach “a dicey valuation method in the best of circumstances.” The experts’ DCF valuations also had “significant flaws,” the court said. It found particularly troubling both experts’ reliance on management projections, considering Synapse’s consistent failure to meet forecasts.

Normally, the court said, a fact-finder might determine neither party met its burden of proof and neither was entitled to a verdict. However, the statute required the court to provide a fair value appraisal. Therefore, the court decided to rely on the company expert’s DCF (with a slight adjustment), noting the expert “credibly made the best of less than perfect data to reach a proportionately reliable conclusion.”

The fair value of the company on the merger date was $0.228 per share, the court concluded—a notable drop from the $0.42899-per-share price McWane had offered to the dissenting shareholder in the context of the squeeze-out merger.

A digest of Kruse v. Synapse Wireless, Inc., 2020 Del. Ch. LEXIS 238 (July 14, 2020), and the court’s opinion will be available soon at BVLaw.

D&P offers infographic on cost of capital
amid COVID-19

Which financial market and economic indicators did Duff & Phelps take into consideration when it arrives at its recommended U.S. equity risk premium and accompanying normalized risk-free rate? Take a look at its infographic that tracks the impacts of COVID-19 on a number of important macroeconomic and risk indicators. “The coronavirus (COVID-19) outbreak has generated an unprecedented reaction in both global financial markets and the economy, and the resulting uncertainty highlights significant challenges for estimating cost of capital inputs in the current environment,” the firm says.

Recently, Duff & Phelps decreased its recommended U.S. normalized risk-free rate from 3.0% to 2.5% for use as of June 30, 2020, according to a client alert. This new rate, used in conjunction with a (reaffirmed) recommended equity risk premium of 6.0%, implies a “base” U.S. cost of equity capital estimate of 8.5% (6.0% + 2.5%).

Estate planning opportunity amid depressed business values

Among the key takeaways from the recent ENGAGE 2020 conference sponsored by the AICPA was one of particular interest to business valuers. “The pandemic has created some temporary financial planning opportunities,” says Steve Siegel, JD, LLM, president of The Siegel Group. “If you have a client who plans to pass their business along to a child one day—while business values are low, this is a useful time to get a new business appraisal. If you wait, values may recover, and federal tax laws may be less generous to business owners seeking to transfer their interests to family members.”

A two-part article in The Estate Planner gives a good overview of the exit planning process for closely held and family businesses. “Planning to sell a closely held business might start with a valuation three to five years before the targeted exit date,” the article says. It also cites a PwC study that found that only a quarter of these businesses have any succession or exit plans.

NACVA honors 40 Under Forty for 2020

NACVA’s 40 Under Forty program recognizes emerging leaders for their past accomplishments and their contributions yet to come. To see all of the 2020 honorees, click here.

Free webinar tomorrow on valuations for
marital dissolutions

Join us for a free, action-packed, 60-minute webinar of short compelling insights into business valuations in a divorce context from leading experts. For example:

  • Family law attorney Andrew Soshnick (Faegre Drinker) on the application of discounts in divorce cases;
  • Valuation expert Jim Hitchner (Valuation Products and Services) on when COVID-19 was known and knowable from a business valuation standpoint;
  • Attorney Richard West (West Family Law Group) on comparative equitable distribution spreadsheets;
  • CPA and valuation expert Michelle Gallagher (Adamy Valuation) on tax and BV settlement strategies in the COVID-19 era; and
  • Attorney Adam John Wolff (Alter, Wolff & Foley LLP) on how an uncertain economic future impacts the negotiation of prenuptial agreements.

To register for this free webinar, click here. It also serves as a preview of what you’ll see at the Virtual Divorce Conference, which will bring together attorneys, valuation professionals, and industry experts. The conference is presented by the American Academy of Matrimonial Lawyers (AAML) and Business Valuation Resources (BVR).

ASA to use vFairs for virtual annual conference

It’s been interesting to see how virtual BV conferences have been evolving. Earlier this year, we mostly saw Zoom being used in simple formats. NACVA went a step further and used a combination of Zoom and GoToMeeting for its Virtual Super Conference that was effective and easy to use. An online speed networking feature has been added to the AAML/BVR Virtual Divorce Conference (starting September 9) that will match you up for a series of short one-on-one video conversations. The ASA just announced that it will use vFairs for its annual conference in October that will include an online microsite featuring scheduled presentations, real-time networking via a combination of chat tools, and access to post-event content on demand. While we hope we can soon get back to live face-to-face events, these virtual substitutes have shaped up nicely to provide the next best thing.

Highlights of KPMG’s Q2 valuation brief

COVID-19 dominates a lot of the discussion in the latest edition of KPMG’s International Valuation Newsletter (12th edition), published quarterly. This edition examines the effects the pandemic has had on key focus areas of valuation (share prices, analyst consensus forecast estimates as well as beta factors by sector). It also summarizes the key challenges when implementing various valuation approaches in the context of today’s challenging environment.

There is also an update on recent capital market data relevant to any valuation analysis. Highlights of the report’s market update are:

  • Major stock market performances: Since the massive drop in stock prices in the first quarter of 2020, all indices taken into consideration have since increased, regaining part, but not all, of the value lost;
  • EURO STOXX 600 sector multiples: Valuation multiples have decreased across all sectors;
  • Current risk-free rates for major currencies: Interest rates fall again, with Germany experiencing negative interest rates again for the first time since Q3 2019; and
  • Country risk premiums: There are varying trends for country risk premiums, with China and Russia showing little movement since December 2019, while Brazil and India have increased.

The full issue is available if you click here.

BV movers . . .

People: Kirk Jarrett, CPA/ABV, CVA, a partner at Atlanta-based Nichols Cauley & Associates, has been elected chair of The Georgia Society of CPAs for 2020-21.

Firms: Naperville, Ill.-based Sikich LLP will permanently shift its workplace model to one centered on allowing its more than 1,000 professionals to work from home indefinitely; the firm will replace its 14 current U.S. offices with 30 micro offices that employees can use when not working from home or at client sites … Pasadena, Calif.-based KROST has introduced several new service areas, including employee retention credits, transfer pricing, and PPP loan forgiveness specialties for borrowers and lenders … West Hartford, Conn.-based blumshapiro will acquire The Brighton Co. (Burlington, Mass.), a firm that offers outsourced CFO, controller, and accountant functions … Pennsylvania firm Simon Lever is consolidating two of its West Shore offices into one larger space in lower Allen Township to allow for expansion … Cerrone, Graham & Shepherd of Worcester, Mass. has relocated to new offices within the city.

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

CPE events

  • Masterclass in Normalizing Compensation. August 26, 10:00 a.m.-2:00 p.m. PT/1:00 p.m.-5:00 p.m. ET. Featuring: Stephen Kirkland (Atlantic Executive Consulting), Paul Hamann (RCReports), and Michael Gregory (Michael Gregory Consulting).

Three nationally known experts share insights and sources to help determine reasonable compensation for your clients.

A free, action-packed webinar of short compelling insights into business valuations in a divorce context from family law attorneys and valuation experts.





We welcome your feedback and comments. Contact Andy Dzamba (Executive Editor) or Sylvia Golden, Esq. (Executive Legal Editor) at: info@bvresources.com.

 


LinkedIn Icon
Twitter IconYouTube Icon

Business Valuation Resources, LLC
111 SW Columbia Street, Suite 750, Portland, OR 97201
1-503-479-8200 | info@bvresources.com
© 2019. All rights reserved.