Over 1,000 CPA/ABVs get ‘greetings from the IRS’
The AICPA National BV Conference in New Orleans this week attracted over 1,000 CPA/ABVs to hear best practices and professional updates along five tracks: fair value for financial reporting, litigation, fundamentals, niche, and emerging/hot. Attendees also received greetings from the IRS—“not always what you want to hear,” quipped Brenda Woolbert, Team Manager for IRS engineers and appraisers. Woolbert sent a shout-out to only one, Warren Miller, for giving her session “a great set-up” on the potential minefields that part-time appraisers could stumble over. (Miller’s comments appeared in last week’s BVWire™.) The specific behaviors that have led to recent penalty investigations include:
- Assuming facts that do not exist
- Purposefully excluding a valuation approach that produces credible results
- Ignoring strong market evidence
- Presenting false information
- Including implausible assumptions as to future events
- Assuming forms of ownership that do not exist
- Intentional disregard of professional standards of appraisal practice
- Any participation by an appraiser that results in a value determination intended to reduce tax without objective and credible evidence to support the appraisal
With the recent extension of § 6695A penalties to estate and gift tax returns, the IRS has an even stronger tool to address perceived appraisal abuses, Woolbert said, although she identified a possible inequity. Memorandum AM 2007-17 clearly restricts application of 6695A penalties to “gross” and not “substantial” misstatements of value, while both standards apply to the assertion of penalties under income tax provisions. In the future, the IRS may correct or amend § 6695A to apply to substantial misstatements of value in E&G tax cases.
Another potential minefield: Under the current process, an investigation can proceed against the taxpayer without involving the appraiser. “This is an unfortunate instance where the appraiser has not been afforded the opportunity to discuss the appraisal at the examination level,” Woolbert said. No penalties or sanctions will be imposed without a comprehensive investigation, however, during which the appraiser may discuss his/her work. The Service is still developing a website for practitioners, and may issue further guidance on 6695A penalties in the future. On a positive note: the new AICPA BV Standards, SSVS No. 1, will “absolutely” meet the compliance criteria of Notice 2006-96, the interim guidelines on qualified appraisal/appraiser under the Pension Protection Act.
Want to stop working weekends? Then “please consider the IRS an employer.” The engineering division has several openings—a rare and challenging opportunity to work “for lower pay but you don’t work weekends,” Woolbert said, with her signature sense of humor (which is of course her own, and not that of the IRS, along with her statements and opinions). For current employment information, click here.
Is FASB listening to business valuators?
“The easy answer is ‘no’,” according to Michael Mard, one of eleven appraisers on the FASB’s Valuation Resource Group (VRG). Mard, who spoke on a fair value panel with Yassir Karam and moderator Jim Hitchner at the AICPA BV conference, also said that the Financial Accounting Board may not be listening to auditors or CFOs, either. After the release of SFAS 157, the Board was “getting inundated with questions,” Mard explained. They wanted to structure the guidance, hence the formation of the VRG. But when they started hearing that businesses were not ready to comply with 157 requirements—and the VRG suggested postponement—the Board basically said, “too bad.” As reported in last week’s BVWire, after some discussion, the Board rejected a blanket postponement of 157’s effective date, granting a one-year deferral only for non-financial assets, to align with the expected effective date of 141R (which is still due for release “any day,” Mard said). Of the $141 trillion currently at play in the U.S. economy, 60% is invested in public companies. “The markets are going nuts over this,” he added, referring to the controversy caused by FASB pronouncements. “Sarbanes-Oxley was just a warm-up.”
Private equity: MBAs with checkbooks ‘run amok’
“When I come back next year, the topic will be the private cost of capital model and how you will no longer need public cost of capital models,” Rob Slee announced at his AICPA session on transfer pricing for private companies. As first reported in the BVWire, Slee is still working with academics and analysts to survey “every stop for capital in private markets,” from banks to business owners. “We’re in the middle of something better,” he promised.
In the meantime, Slee—an investment banker and private business owner— considers valuation to be perhaps more important than even appraisers do. “It’s the language of the private capital markets.” If an owner ever says, “I’ve never thought about it [the value of my company],” then that person is lying. “I think about it once a minute,” Slee admitted. Owners aren’t idiots so much as ignorant; their companies have an infinite range of value depending on the transfer method. An ESOP will turn on fair market value, for example, while an MBO (management buyout) will invoke investment value. In his practice, Slee takes private company owners through a transfer “spectrum” to demonstrate pricing dependency on the owner’s selection of a particular method. But if they covet a private equity buyout, their optimism may border on idiocy. “What are PE groups? MBAs with checkbooks run amok,” he said. After picking the “low-hanging fruit” from the U.S. economy, PE funds are now turning to international markets such as China and India, with over $1 trillion in their “checking” accounts.
“My mission is to keep this American adventure alive,“ Slee said, by helping business owners make value-added decisions, including their use of professional appraisers as transfer pricing consultants. “We can engineer solutions and create transparency for owners to see through the ‘constellation’ of values,” and possibly get a cut of the deal, too. For more on his financial engineering for the middle market, including his IBA article on Private Business Appraisal as Viewed Through Value Worlds, visit Slee’s website.
PE’s achievement: reintroduction of ‘anxious vigilance’
“Why don’t CEOs of public companies manage as well when their firms are public as they do when their firms are private?” That was a central question posed at the American Enterprise Institute’s conference on the History, Impact, and Future of Private Equity in Washington, D.C. last week, attended by Warren Miller (Beckmill Research). “The answer is the age-old problem of ‘agency’,” Miller reports, from a panel discussion led by Steve Kaplan (Univ. of Chicago, formerly with Ibbotson’s). “When companies are public, CEOs tend to think like employees, largely because they can control their own boards,” Kaplan said. “When private, CEOs must think like owners because of the close and intense supervision their PE principals provide.”
Presenter Karen Wruck (Ohio State) cited PE for two achievements: reinvention of the market for corporate control and routinization of systems to organize firms for value creation. While “corporate control” used to mean competition among management teams to manage resources, it now refers to capital providers competing in the market to govern the corporation. Given their “operating expertise,” PE managers have “blurred the line between financial buyers and strategic buyers,” Wruck said, bundling residual risk-bearing and governance rights. They have reintroduced “anxious vigilance” into corporate governance, a “trust but verify” attitude that doesn’t require managers to own the firm outright but facilitates efficiencies in risk-bearing.
PE is “about organizations, not markets,” Wruck added, “about relationships, not transactions.” For instance, 64% of the $39 billion in private placements during the first nine months of 2007 were to “relationship investors.” Traditional investing—what she called “disembodied third-party investing”—no longer works because shareholders have no direct involvement in value creation and governance. In other words, publicly held firms cannot solve the agency problem. The notable exception—Warren Buffett—“proves the rule,” Wruck said.
Read Revenue Ruling 59-60 once a month
When was the last time anyone read Revenue Ruling 59-60? “You should be reading it once a month,” Gary Trugman told AICPA BV attendees. “Every time I read it, I find something new. It’s an amazing document.” It’s even more amazing that it came from the government. “They got something right,” he said. This timeless, seven-page document is now among the free valuation downloads at BVResources.
What analysts are still struggling to get right: determination of a company-specific risk premium in the development of an appropriate discount rates, the topic of Trugman’s talk. “There’s a new kid on the block that’s worth looking at,” he said, referring to the Butler Pinkerton Model™ Company-Specific Risk and TCOE Calculator™, which Trugman reviewed in last week’s BVWire and also helped rename, adding the “total cost of equity” (TCOE) element. “This is the first time that we as appraisers can calculate TCOE for public companies based on Total Beta,” he explained, referring to the concept developed by Prof. Aswath Damodaran. The calculations are only as good as the selection of guideline public companies, but even without good comparables, the model can calculate industry COE. “What an addition to the profession,” Trugman said. “This is neat stuff,” and it’s now available at BVResources.
New study says probability of IPO exit is 20% to 25%
Remember the days when the SEC would accept simple rules of thumb? Since the burst of the venture capital bubble, it’s become rare for a company to get funding in the unproven "concept" or "business plan" stage, said presenters Neil Beaton and Robert Duffy in their session on technology risk cycles. "There has to be product feasibility." To increase accuracy and acceptance, Beaton suggested expanding the definition of tech company development from the traditional three stages (Early, Expansion, and Mature) to five: Very Early, Early, Break-Even, Expansion, and Mature.
The Grant Thornton team also recently discovered a new academic study: Private Equity Discount: An Empirical Examination of the Exit of Venture Backed Companies (Journal of Investment Management, 2003), available here. The authors track over 52,000 financing rounds for 23,208 unique firms 1980-2000, concluding that the probability of an IPO exit is roughly 20% to 25%. Beaton and Duffy are currently working with the authors to update the data, possibly to include additional metrics and stages of firm development. From their initial analysis, “there is more risk than meets the eye, ” Beaton said. Early stage companies don’t fit the “standard” valuation mode and innovative thinking is required to get “outside the box.” Most importantly, “don’t attempt this at home.” BVWire will continue to follow the efforts by Beaton and Duffy to expand and apply this exciting new research.
AICPA welcomes two more to BV Hall of Fame
Congratulations to Nancy Fannon and Mike Crain for their induction into the AICPA BV Hall of Fame, “created in 1999 to recognize individuals whose lifetime achievements and contributions have significantly advanced the valuation discipline for CPAs,” said Robin Taylor, chair of the AICPA BV Steering Committee, in presenting the awards. Fannon was cited as a “thought leader” in the profession, “one of the most active people in the AICPA BV community” whose knowledge and service was exceeded only by her research, expertise, and education on controversial issues such as the uses and abuses of market databases, the valuation of S corporations, and lost profits/economic damages. Oh—and she’s written books on all three subjects, having just published Fannon’s Guide to the Valuation of Subchapter S Corporations with BVResources, which will release her two additional guides early next year.
Crain has been just as active in the valuation community. “It is hard to find a role that he has not filled—and filled well,” Taylor said, including highlights such as his membership on the AICPA BV Committee, the Journal of Accountancy editorial advisory board, and national and state litigation taskforces. His body of work is outstanding and his commitment to the profession unparalleled. And oh—Crain holds five different credentials related to valuation and forensic services. “There are not many others” like him, Taylor said.
From the Big Easy to the mile-high mountains
Further congratulations to the AICPA team that put together an amazing conference, with an attendance that broke the record for any prior standalone national BV conference (only the biannual joint gatherings with the ASA have attracted more). Particular recognition should go to Robin Taylor and members of the Steering Committee: Jim Andersen, Jim Hitchner, Christine Baker, Cindy Collier, and Ron Seigneur.
If you weren’t able to join the 1,000+ attendees at the Big Easy—where good times as well as great presentations were certainly on a roll—then think about joining 500+ attorneys and top BV professionals for the Law Education Institute’s annual “Business Valuation Forensic and Litigation Services Program” in Vail, Colorado, January 4-9, 2008. “This is a great way to get some solid education and some great networking among national leaders of the legal profession, ” says planner and presenter Ron Seigneur, “and an opportunity to chase the snow down the slopes at a world-class ski resort.” Joining Ron will be presenters Cindy Collier , Nancy Fannon, Tom Hilton, Gail Markham, Bill Kennedy, Thomas Burrage, and more. For the full curriculum and details on registration and lodging, surf—or ski—to www.lawedinstitute.com.