Are the Big 4 ‘out to get’ the FV valuation specialist?
That was the first of several “hardball” questions lobbed by moderator Bo Brustkern (Arcstone Partners) at an auditors/analysts panel during BVR’s 3rd Annual Summit on Fair Value for Financial Reporting in New York City this week. Small to midsize valuation firms are making substantial efforts to serve not only their company clients but also the ultimate end-users (public consumers) of financial statements, by making the fair value measurements as robust as possible—what Brustkern calls “bulletproof.” Frequently, however, the auditor’s response feels “asymmetric,” he said. The reviewer might send back a list of 50 questions, giving the impression that the report didn’t even get read—or worse, that the valuation analysis was “silly.” Either way, the ensuing discussions “chew up a lot of the client’s time,” Brustkern said.
“Be careful using the term ‘bulletproof,’” answered Tony Aaron (Ernst & Young). “Bullet-resistant should be more your goal.” Aaron—who gamely took on Brustkern’s auditor questions (in his own capacity, not for E&Y or the Big 4 firms)—also downplayed any “conspiracy theory.” Auditors often use templates, checklists, and other tools to perform their attestation function, he said—i.e., to determine whether financial statements are GAAP-compliant. It’s their job to be skeptical—more so if they haven’t worked with the valuation specialist or don’t see a basic level of sophistication. The bottom-line: “When you look at a report and it says all the right things and has all the right analyses and conveys the analyst understands fair value in the particular context,” that will go a long way to reducing an auditor’s skepticism, Aaron said. “If your work is consistent with the attestation function there should be no fight.”
Toolkit on Contributory Assets. Brustkern, Aaron, and panelist P.J. Patel (Valuation Research Corp.) agreed that the level of guidance from peer groups (such as Fair Value Forum) and industry organizations has pushed the valuation profession to greater sophistication. “We are constantly looking at best practices and reviewing our internal procedures,” Patel said. Three working groups at The Appraisal Foundation are developing best practices in contributory assets (Aaron is a member), customer relationships (Patel), and control premiums. An example of their excellent, interactive work: The Identification of Contributory Assets and the Calculation of Economic Rents. Look for complete write-up of their session in the next (March 2010) Business Valuation Update™.
Divorce court adopts fair value standard, sort of
The husband was a commercial real estate developer in Alabama; during his divorce, a court-appointed expert valued his minority (25%) interest in several entities at just over $1 million. Based on evidence from the husband’s expert—including negative values for some entities and over $1 million in debt—the trial court applied a 40% combined discount for lack of marketability and lack of control to value the businesses at approximately $602,000. To do otherwise would be to “ignore the reality of the financial condition” of the parties and the properties, the court said.
The wife appealed, claiming that marketability and minority discounts should not apply to closely held, ongoing business values in divorce. No Alabama court had addressed the issue—so the Court of Appeals considered case law from states that have applied a “fair market value” standard in divorce (permitting discounts under the willing buyer/willing seller scenario), and those precluding discounts, including Brown v. Brown (N.J.), which adopted the statutory fair value standard (no discounts) from the dissenting shareholder context.
In general, Alabama divorce courts apply the broad, “equitable” standard, requiring the valuation to be “fair to all parties,” the appellate court explained. However, “like New Jersey, Alabama law recognizes the concept of ‘fair value’ in the dissenting-shareholder context,” the court added. Thus, when the divorcing parties do not plan to sell the marital business, “it makes little sense to determine fair value by the measuring stick of a hypothetical sale price.” To do so would artificially deflate the business value, causing a windfall to ongoing owner and an unfair, reduced price to the minority spouse, the court held. It cited Standards of Value, by Jay Fishman, Shannon Pratt, and William Morrison (2007). A single judge dissented, so the case appears ripe for appeal to the state Supreme Court. Read the complete digest of Grelier v. Grelier, 2009 WL 5149267 (Dec. 2009) in the next (March 2010) Business Valuation Update™; a full-text of the court’s opinion will be available at BVLaw™.
SEC offers guidance on market participants
One of the most elusive issues in fair value for financial reporting is the identification and application of the “market participant” perspective. “We call it the mythical participant,” Tony Aaron quipped, at BVR’s Fair Value Summit III. “It’s a hypothetical.” The concept has been around for years (think willing buyer/willing seller construct in fair market value). But, “embedded in the concept of market participant are values in use and values in exchange,” commented Neil Beaton (Grant Thornton), who chaired this year’s event. For example—say you can identify two market participants in the chip industry, but one wants to buy the company, the other wants it as a source of supply. Which perspective do you apply? “There’s an even harder issue,” added panelist Tom Miller (Quist Valuation). What if a small company’s sole asset is IP—which market participant perspective do you consider: vertical or competitive integration? And do you consider management’s perspective? “Only if market participants would take the same view,” Beaton said.
Final word. “Don’t overanalyze these situations; it will all be speculation unless you have some documented support,” Beaton said. “Do a broad, overall view of market participants rather than a bifurcation, and explain any lack of precision that exists.” Valuation analysts may also want to review a speech by the SEC’s Evan Sussholz on Dec. 7, 2009, which gives agency views on the market participant assessment, including four lists of questions to ask. “Sussholz lays it all out and indicates that the SEC would expect any reporting document to follow its process and assumptions,” Brad Pursel (Brown Smitth Wallace) told FV III attendees. The SEC speech is another example of best practices guidance currently coming from regulatory authorities.
Free webinar with 2010 cost of capital report, by Grabowski
The 2010 Duff & Phelps Risk Premium Report is on its way: Co-authored by Roger Grabowski and David King, this year’s compilation expands on prior cost of capital measures, particularly for small target companies, by including rate of return adjustments for distressed and delisted companies. Like previous editions, the 2010 Risk Premium Report also posts historical equity risk premiums (ERPs) and size premiums for 25 size-ranked portfolios using eight alternative measures of company size. Special offer: This year, purchase the Report through BVR and receive the Cost of Capital Reader, a free, 125 page, fully searchable supplement of current articles and presentations, including Grabowski’s article, “Cost of Capital Estimation in the Current Distressed Environment.”
Short-term, bonus offer: Purchase the Report now and for no additional cost, you can attend BVR’s 100-minute teleconference, “Duff & Phelps Report 2010: Learn from the Master,” featuring Grabowski, on February 18, 2010. (For those who don’t purchase the Report, the session is still available at the regular low cost.) The cost of capital “Master” will highlight everything appraisers need to harness the latest data, walking through the new and historic measures and answering real-time (and real-life) questions along the way. For more information, click here.
Just in time: BVR’s new Guide to Restaurant Valuations
The U.S. restaurant industry should gradually recover this year as consumers ease recession-era spending cuts, says a new report from the National Restaurant Association (NRA). Restaurant sales should reach $580 billion this year, up 2.5% from the year before. (After adjusting for inflation, industry sales will essentially remain flat—but that’s better than 2009, when they took a 2.9% drop.) "The past two years have been very challenging for our industry," says the NRA’s chief executive. "While there are still substantial challenges ahead, the outlook is improving." Despite job losses in 2009, the restaurant sector still outperformed the national economy; job growth is expected to resume in 2010, with an additional 1.3 million career and employment opportunities to come over the next decade.
Outlook improving for appraisers, too. "Little rays of restaurant sunshine have been cutting through the grim economic news over the last several months. So when the NRA headlines a rainbow, it’s time for valuation professionals to take notice,” says Ed Moran. “After crafting new menu offerings that are tasty and, yes, easier on the pocketbooks, all the national chains are preparing to open their doors to more consumers. What’s not to like?" In BVR's Guide to Restaurant Valuations, Moran shows business appraisers—those new to the restaurant niche and old hands—how to apply the NRA's giant toolbox of information plus traditional valuation methods, site inspections, management interviews, checklists, and more—to produce comprehensive, credible restaurant valuations. The new release comes just in time to take advantage in the industry upswing; pre-order your copy today.
Where can you get more Insights on current valuation topics?
We’ve just posted numerous new articles from Insights, the esteemed valuation quarterly published by Willamette Management Associates and provided exclusively to subscribers of BVResearch at BVResources. The new content includes special-focus articles on ESOP-related valuations, feasibility analyses, fairness opinions, and more, by noted Willamette experts Robert Reilly, Charles Wilhoite, and a dozen other business appraisers and attorneys. 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. Recent additions include:
- A Rate/Flow Model: An Alternative Approach to Determining Active/Passive Appreciation in Marital Dissolutions by Z. Christopher Mercer
- Current Topics in Bank Valuation: Reflections on Industry Trends and Emerging Financial Reporting Issues (2009 teleconference transcript)
- Business Valuation Conference Summit on Lack of Marketability Power Point Presentation, by Ashok B. Abbott
- Built-in Capital Gains Discount: Estate of Jelke v. Commissioner by John W. Porter, Esq.
- Valuing Assets For Estate and Gift Tax Purposes: It’s in the Eye of the Beholder by John W. Prokey, Esq.
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