December 1, 2010 | Issue #99-1  

Need evidence that ERP requires analyst judgment?  Here it is

A hat tip to Ron Seigneur (Seigneur Gustafson) for letting us know Pablo Fernandez (IESE Business School, Madrid, Spain) has collected recommendations on the equity premium from 150 corporate finance and valuation textbooks published between 1979 and 2009 by authors such as Brealey, Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, and Arzac. In his updated article, “Equity Premium in 150 Textbooks,” Fernandez found “that their recommendations regarding the equity premium range from 3% to 10%, and that 51 books use different equity premia in various pages. The 5-year moving average has declined from 8.4% in 1990 to 5.7% in 2008 and 2009.”

For more of his articles see:

The works of Prof. Fernandez are but one part of the expanding puzzle regarding the equity risk premium and its quantifying methods, Seigneur notes. Surveys should also never serve as the sole proxy for more traditional empirical evidence in rate development models, such as the Private Company Cost of Capital construct developed by Slee and Paglia. Both survey databases provide a great basis for sanity checks, but should not be used as direct inputs.

Redundancy in DLOMs may violate Daubert

Nancy Fannon (Fannon Valuation Group) recently told BVWire that “Dr. Robert Comment (Johns Hopkins University - Carey Business School) has written what I think is an important perspective regarding redundancy that exists in the large DLOM adjustments many appraisers take in their valuations.” The abstract from his paper “Business Valuation, DLOM and Daubert: The Issue of Redundancy” reads:

“It is not well known that core valuation methodologies such as DCF analysis have the effect of discounting the future cash flows of small businesses substantially, generally by 40% to 60%, dollar-for-dollar, for lack of size alone. Because there is a strong empirical relation between size and liquidity, there is a great likelihood that any supplemental discounting for illiquidity will be redundant and entail double discounting. Accordingly, the large liquidity discounts or DLOMs that are accepted practice in business valuation and that have been embraced by many judges presumptively violate the Daubert requirement for reliability.”

“While this may cause a firestorm, I think it is an important discussion to begin to have,” Fannon says. “Dr. Comment offers the perspective, often forgotten, of where we started from to begin with--that is, the magnitude of discount already embedded in our core valuation methodology.”

IRS expert reviews public LP data and finds (surprise!) more support for §2703 attacks against FLPs

More and more, courts are asking for concrete, empirical data to back-up a business appraiser’s adjustments and assumptions, particularly in the tax context. A recent article by Francis X. Burns, along with two colleagues at Charles River Associates, tries to answer the call regarding the safe harbor provisions in IRC Sec. 2703(b)(3), which generally requires the tax appraiser to ignore a partnership’s transfer restrictions unless they are 1) a bona fide business arrangement, 2) not just a tax-avoidance device, and 3) comparable to similar arm’s length agreements among unrelated parties.

Frequently, parties will introduce experts to testify that, based on their general experience, a transfer restriction such as a right of first refusal (ROFR) with an extended pay-out period is typical among independent parties. “A more direct means…is to compare the LP terms with those found in arm’s length agreements,” writes Burns, a frequent expert for the IRS. He and his co-authors reviewed public SEC filings and identified over 1,100 restricted LP agreements covering a range of industries and businesses. Their findings? “While ROFRs aren’t uncommon, it’s rare to find ROFR terms that restrict the liquidity of transfers through installment payments.” In fact, nearly three out of four agreements with ROFR provisions mandate that the partnership buy-back the interest at the same price and terms as a third-party party. For the authors’ complete research and conclusions, read “Valuing Limited Partnership Interests,” in the Oct. 2010 Trusts & Estates (article available by subscription only).

BVR continues to provide valuation Insights

We’ve just posted new articles from Insights, the esteemed valuation quarterly published by Willamette Management Associates and provided exclusively to subscribers of BVResearch. The new content includes:

  • Analysis and Observations Regarding the Keller v. United States Decision (Steve Akers)
  • Estate Planning in Uncertain Times (John H. Draneas, Esq)
  • Reallocating Wealth After Christiansen: A Fresh Look at Formula Clauses (Michael E. Morden, Esq.)
  • The Application of a Multi-Level Valuation Discount in the Gift or Estate Valuation of a Tiered Entity—A Review of Relevant Judicial Precedent (James G. Rabe)
  • Recent Developments in Valuation Issues Related to Fair Value Accounting (Robert F. Reilly)
  • Income Tax Implications of Industrial and Commercial Property Mortgage Debt Restructuring (Robert F. Reilly)
  • Partnership Debt Restructuring or Renegotiation—Income Tax Planning Considerations (Robert F. Reilly)
  • Intangible Asset Identification and Valuation in The Bank and Thrift Industries (Robert F. Reilly)
  • Personal Intangible Assets and the Sale of the Closely Held C Corporation (Robert F. Reilly)
  • The Combined Discount (Robert P. Schweihs)
  • Tune Up Your Estate Plan in Anticipation of Sweeping Changes to Estate Taxes (Domingo P. Such III, Esq. and Tina Davis Milligan, CPA

With this addition, the continually updated BVResearch now boasts over 500 articles from Insights, plus a fully searchable database (by expert, topic, or specific term) of the most current valuation resources and authorities.

Crain provides literature review of the size effect

Michael Crain (University of Manchester - Manchester Business School; Florida Atlantic University; The Financial Valuation Group) recently published his article A Literature Review of the Size Effect on the Social Science Research Network (SSRN).

Crain’s abstract reads:

“The size effect in the finance literature refers to the observation that smaller firms, on average, have higher returns than larger firms. It also describes the contribution that firm size has in explaining stock returns. Discovered by Banz (1981) in testing the Sharpe-Lintner Capital Asset Pricing Model, subsequent research finds the size effect has diminished or disappeared since the 1980s in the U.S. and UK after small-cap funds were launched. Firm size is thought to proxy for underlying risk factors associated with smaller firms. Observed variations in the size effect can be explained by such underlying factors like market liquidity that change over time. Related research finds the size effect is linked to the January effect. The size effect occurs primarily during January has little or no presence in the other 11 months, which confounds empirical research on risk-reward relationships. Research also finds the size effect is concentrated in smaller listed firms, making the effect nonlinear.”

Adams Capital asks, ‘is there any goodwill left?’

As of this year’s third quarter, the number of U.S. public companies with goodwill decreased to a low of 2,431, and goodwill on the balance sheets fell to $1.8 trillion after reaching a high of $2.2 trillion in 2007, according to Adams Capital. “Accounting rule clarifications and interpretations continue to bedevil the financial reporting for many companies. With continued economic uncertainty, there is a focus on accurate fair value measurements for intangible assets including goodwill. The Financial Accounting Standards Board (FASB) has recently proposed changes to the goodwill impairment test that could affect companies as early as December 31, 2010,” the analysts add.

Read the full report “Goodwill - Is There Any Left?”, which includes M&A market data during the past 12 months.

Middle market deal volume continued to increase in 3Q 2010

Recent data from GF Data Resources reveal “deal volume for 3Q edged upwards from 30 deals in 2Q to 33 completed transactions for the quarter,” indicating a climb “toward the peak volume of about 50 deals per quarter through 2006 and the first half of 2007.  “The third quarter of 2010 was, by all measures, the cool drink of water that a parched middle market had been waiting for,” said Andrew T. Greenberg, Chief Executive and Co-Founder of GF Data Resources LLC. “We expect that deal volume will continue to expand heading into 2011, although we would stop well short of saying the market has strengthened enough to be impervious to backsliding.”

GF Data Resources provides data on private equity-sponsored M&A transactions with enterprise values of $10 to 250 million, and the firm’s database draws from data provided by 163 private equity firms on 1,267 transactions closed between Jan. 1, 2003, and Sept. 30, 2010. As of the 3Q report, 151 firms were active contributors. 

Join Yeanoplos and Rataj tomorrow for ‘Show Me the Money!’

With the release of BVR’s latest publication, Reasonable Compensation: Application and Analysis for Appraisal, Tax and Management Purposes, BVR is hosting a special webinar on the topic tomorrow, December 2.  Originally presented at the BVR/Morningstar 3rd Annual Summit on Business Valuation in Divorce  in Chicago, experts Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos), co-author of Reasonable Compensation, and Edward Rataj (CBIZ Human Capital Services) will update their presentation and answer audience questions. 

More information on this presentation, as well as special discounts on Reasonable Compensation, is available here.

Get more business valuing healthcare entities

Throughout 2011, the AHLA/BVR Guide to Healthcare Valuation will come to life as editor Mark Dietrich and contributing authors join us for a monthly webinar focusing on one of the topics covered in the Guide.  Subscribers to the series receive instant access to each of the twelve programs in the series as well as access to the Healthcare Desktop Learning Center: a multimedia archive of all past BVR Healthcare webinars. Current Series programs include:

Upcoming programs include:

  • Ambulatory Surgery Centers: Current Valuations, Benchmarking, & Forecasting
  • The Anti-Kickback Statute and Stark Law: Avoiding Valuation of Referrals
  • Valuing Management Services Contracts Between Physicians and Hospitals
  • Valuing Clinical Co-Management Arrangements
  • Lost Profits Damages in Medical Practices
  • Fair Market Value in Healthcare
  • Personal v. Professional Goodwill in Medical Practice Valuations
  • Damages for Violating Noncompetes and Other Claims Involving Physicians, Hospitals & Healthcare Facilities
  • Physician Compensation in an Era of High Demand and Limited Providers
  • Accountable Care Organizations: What Are They and What Do You Need to Value?

For more information, visit BVR’s Training Page, or contact BVR sales department at

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December Events

Show Me the Money! The Exploration, Examination and Dissection of Reasonable Compensation
December 2, 2010
10:00am - 11:15am PT

The Use and Application of Option Pricing Modeling
December 16, 2010
10:00am - 11:40am PT
Featuring: Scott L. Beauchene and James Walling

Valuations for IRC 409A Compliance
New Date: December 22, 2010 10:00am - 11:40am PT
Featuring: Neil Beaton and David Dufendach


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