December 5, 2012 | Issue #123-1  

The most problematic adjustment for appraisers is also the most common

“Owners’ compensation is always the most difficult,” says one participant in our latest online survey of normalization adjustments, “especially in professional practices.” Others say these are difficult, too:

  • Adjustments that the owners cannot support—e.g., they estimate spending $10,000 a year on business travel, but then cannot verify the expenses through receipts or other documentation;
  • Values for nonoperating assets such as real property (and convincing the owners to pay for the related appraisals);
  • Debt and interest expenses and amortization relating to fair value adjustments;
  • Unreported cash;
  • Fixed asset outlays, especially when the mix of accumulated depreciation and historical increases in additional outlays creates a downward-trending net fixed asset figure, which cannot continue in perpetuity; and
  • Retirement benefits.

“Kids involved in the business always present challenges,” answers another survey-taker. Still another maintains that no single adjustment is problematic, “but some are more time-consuming and require greater research and thought.” Indeed—consider these highlighted results of the survey, so far:

  • Respondents are evenly split as to when they perform financial analysis relative to normalization adjustments. Nearly a third (32%) analyze before, 30% perform after, and 38% perform financial analysis both before and after normalization adjustments.
  • As to the ever-challenging adjustment to owners’ compensation, just over half (58.5%) of respondents consider this a “normalization” adjustment, but 41.5% consider this a “control” adjustment.
  • On average, a strong majority (75%) does not adjust for nonowner’s compensation, but 25% do.
  • Just over half (53.7%) make owner compensation adjustments in minority interest valuations, but, on average, nearly 47% do not.

“The results so far emphasize both the large variance among practitioners and the overall importance of normalization adjustments to the valuation results,” says Brandi Ruffalo (Valuation & Forensic Partners), who designed the survey.

Still seeking input & insights. “Please take the time to participate in this groundbreaking study,” Ruffalo says. “You will help shape our profession and ensure the results reflect how we collectively practice today.” To participate, click here now.

And don’t miss the Advanced Workshop on Normalization Adjustments on December 6, a four-hour workshop in which Ruffalo and Garth Tebay (Value Defined) will analyze the complete survey results and provide the most current and credible methods for making these critical adjustments.

Federal Circuit: Georgia-Pacific is not a rule (and never will be)

In a new decision, the U.S. Court of Appeals for the Federal Circuit reaffirmed that the 25% rule of thumb is a “fundamentally flawed tool for determining a baseline royalty rate” in patent infringement cases, citing its recent opinion in Uniloc v. Microsoft.

At the same time, just because the plaintiff’s damages expert discussed the rule (“which is no longer a ‘rule,’” the court said), his analysis wasn’t “irretrievably damaged,” particularly since he relied more prominently on other factors. For instance, he separately determined that the infringing products earned 9.2% more in operating profits than noninfringing devices. He also conducted a Georgia-Pacific analysis to show that the royalty was reasonable in light of the “unique relationship of the parties, the nature of the invention, and the nature of the industry,” the court said, in an opinion by Judge Randall Rader. He could have stopped there, but sua sponte, the judge added the following line of dicta:

Once again, this court does not endorse Georgia-Pacific as setting forth a test for royalty calculations, but only as a list of admissible factors informing a reliable economic analysis.

As BVWire readers know, Judge Rader has publicly criticized the Georgia-Pacific framework outside of the court, calling it a “flawed methodology.” In this particular case, according to Dan Jackson (AlixPartners): “The Federal Circuit is clearly telling everyone that Georgia-Pacific is not a means to an end; it is simply a tool to assist an expert in identifying the types of questions that may be important to a reasonable royalty analysis. Two very interesting observations I take away from the case,” he adds: 1) financial experts cannot derive a royalty based solely on an evaluation of just the Georgia-Pacific factors; but 2) a federal court should accept the analysis if reasoned and well supported.

Read the complete digest of Energy Transportation Group, Inc. v. William Demant Holding, 2012 LEXIS 21200 (Oct. 12, 2012), in the January 2012 Business Valuation Update; the Federal Circuit’s decision will be posted soon at BVLaw.

3rd try is the charm for USPAP 2014-2015?

The Appraisal Standards Board (ASB) has just issued Third Exposure Draft of Proposed Changes for the 2014-15 edition of the Uniform Standards of Professional Appraisal Practice (USPAP).
This exposure draft includes:

  • Revisions to reporting and communication requirements;
  • Reporting options;
  • Retirement of Standards 4 and 5; and
  • Other revisions and additions as needed to ensure clarity and relevance.

Written comments are due by Jan. 25, 2013.

Taxpayer loses any discount for
‘endangered’ artwork

If you’ve been anxiously anticipating the fate of the artwork by Robert Rauschenberg—which has ruffled a few feathers in the appraisal world—then worry no longer. Last week, the IRS agreed to drop its position that Canyon, a work that combined painting, collage, and a stuffed bald eagle, was worth $65 million to the heirs of the artist’s estate. For their part, the heirs agreed to drop their assertion—based on three art appraisals—that the work had no marketable value because federal law prohibits the sale of the bird in any form. They also agreed to donate the piece to a museum without claiming any amount as a charitable deduction (despite the $65 million IRS appraisal).

The only winner: The Museum of Modern Art in New York City (and its visitors), which beat out others contending for a special showing in 2013.

Should expert depositions be on an endangered list?

By far the most controversial aspect of the Colorado Civil Access Pilot Project (or CAPP), which began the first of this year, has been the rule limiting “all aspects of the expert’s testimony” to the disclosed report and work files. In other words: no depositions.

“The perception was that a fair amount of cost was going into expert depositions,” explained the Hon. Rebecca Kourlis, formerly a justice on the Colorado Supreme Court and now the executive director at the Institute for the Advancement of the American Legal System (IAALS), which spearheaded the project. “Depositions in general can be abused,” she said, in a special session on national civil litigation reform at the recent AICPA FVS Conference in Orlando, Fla. “They cost too much money and are too long, and can be used for ‘gamesmanship’ rather than investigating the issues in dispute.”

For those who maintain that due process entitles or even requires parties to depose opposing experts, remember: “We try death penalty cases without expert depositions,” Kourlis said. Criminal rules of procedure don’t permit them (and neither, by the way, do Tax Court procedures). Notably, during the early stages of CAPP, only the medical malpractice bar successfully lobbied to retain litigants’ rights to take expert deposition testimony, but the Colorado Supreme Court, which had to approve the final project, “did not buy the argument that depositions are critical to business cases.”

After one more year observing the project in operation, IAALS will collect and analyze data to determine whether the project’s provisions achieved their efficiency and access goals enough to merit recommendation as permanent amendments to the state rules. “Things they are a changing,” Kourlis told the AICPA audience. “Be aware that this is happening across the nation.”

NACVA leads other BV/FVS credentials with over 5,000 designees

The National Association of Certified Valuation Analysts has just posted a current (as of third quarter 2012) and comprehensive Business Valuation (BV) and Financial Forensics Credential Comparison Chart.

The summary chart of nine separate credentials provides a side-by-side list of their prerequisites, training requirements, recertification requirements, and “other” features, such as the credentialing organization’s annual dues and the approximate number of designees holding each credential. Leading the way: NACVA, with 5,100 CVA designees, followed by ABV, with 3,000 designees, and ASA, 1,200 designees.

Good data still hard to find for fractional interests

“I am valuing an undivided interest in real estate,” says Diane Mooney in a current thread in LinkedIn’s Business Valuation & Advisory Network (membership required). “Is anyone aware of any database with similar transactions?

An age-old question with no new answers. “To the best of my knowledge there is none,” offers Noreen Dornenburg. “Instead you have a lot of case law and a number of elements based on the specific type of real estate, number of holders, etc., on which the courts based their decisions. This is a real specialty, like valuing golf courses or nursing homes, not to be taken on lightly.”

“I agree with Noreen that (to the best of my knowledge), there is no such database,” says Rod Burkert. “But you may want to take a look at an interview Eric Nath did with the BVUpdate in September 2010,” in which he discussed the Ludwick case, which involved a 50% undivided interest in a vacation home.

“I agree with all of the comments above,” adds Pete Butler. “The discount is highly dependent upon the unique circumstances of the case,” he says, such as the type of real property; its underlying value (expected return); its ability to be partitioned; and its related tenancy agreements, debt, and size. “Even if there was a database per se, one could only anecdotally reference it,” Butler says. For instance, he just valued the same percentage fractional interest in two separate properties, but based on their unique facts, he came up with materially different discounts. That said, Butler provided the group with a list of studies that he references when valuing undivided interests:

  • Harris-McCormick-Davis study;
  • Healy study;
  • Patchin study;
  • Peterson-Hansen-Klafter study;
  • FMV Opinions Inc. study;
  • Humphrey study;
  • Eckhoff Accountancy Corp. study; and
  • Willamette Management Associates studies. 

Possible new twist. In addition to these studies, Dornenburg may review the prices of time shares, “which are technically not undivided interests,” she says, “but do parallel them in a number of ways. These act as a reality check for me, but aren't to be relied upon as direct data, as usually they yield a premium over the value of the real estate, not a discount.”

IVSC identifies best practices for valuing specialized public properties

Consider this valuation challenge: A public building that provides a special service—such as a fire station—is sitting on land that could potentially support a business or commercial development, but public safety dictates that it serve the needs of the community. How would you value such property for a range of purposes—including financial reporting, internal transfers, and monopolies pricing? To what extent should the value(s) reflect social objectives? How should analysts account for the fact that such specialized properties rarely trade?

To help answer these questions, the International Standards Council (IVSC) has just released the exposure draft for Specialised Public Service Assets; comments are due Feb. 28, 2013. Also just released: the IVSC’s discussion paper on Investment Property, with comments due March 1, 2013.

Year-end CPE still available

Our final training schedule for 2012:


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