February 22, 2012 | Issue #113-4  

Lance Hall to intern: Welcome to the valuation world

Critics of the FMV Restricted Stock Study (and restricted stock in general) make three common mistakes, says Lance Hall (FMV Opinions Inc.), responding to a posting by what he says was an “uncredentialed intern at a Florida accounting firm,” featured in last week’s BVWire.

“First, they object to the fact that the underlying data are not exactly like the company they are trying to value. Welcome to valuation,” Hall says. Second, critics “assume that you need a statistical regression formula with a 90% accuracy to determine the discount. It doesn’t exist. Welcome to valuation.” Given these mistakes, the third is to use models for which there is no empirical proof and “no exactly alike companies,” Hall says, explaining:

In other words, the strict standard by which critics judge restricted stock studies [do not apply to] the tools they prefer, especially for those favoring methodologies like option pricing models and the QMDM. Asking the obvious, if liquid options are bought and sold on liquid stocks, what does an option model tell you about liquidity? Answer: Nothing. The QMDM is not based on empirical data and cannot be proven (or disproven) empirically.

“While we would all like the magic formula to determine a discount for lack of marketability that could be proven empirically, that magic formula doesn’t exist and will never exist,” Hall concludes. “For those of us in the valuation profession, we must continue to do what we have always done, and that is perform an analytical, thoughtful, and well-reasoned analysis.” Welcome to our world.

We’ve posted Hall’s complete article, including why valuation professionals still favor restricted data as the “number one” tool in deriving the marketability discount, here.

New D&P Calculator built to save time, money, mistakes

The new Duff & Phelps Risk Premium Calculator has just arrived. Created by James Harrington and Roger Grabowski (both Duff & Phelps), the D&P Calculator is a web-based model into which users can enter 1-18 inputs and receive an Executive Summary, an Excel spreadsheet, and an HTML package of the results, including four cost of equity estimates (one that is unlevered). Plus, the Calculator is current with 2012 data. The PDF version of the 2012 Duff & Phelps Risk Premium Report, with over 70 pages of new material—including an extensive discussion of adjustments in the current economy—will be available in March.

“The D&P Calculator was created to save appraisers huge sums of time and money,” says Adam Manson, BVR’s manager of financial research. “There’s no need to look up numbers in tons of tables or to plug in your subject’s data into numerous regression formulas; the Calculator does all the heavy lifting for you. Additionally, the Calculator greatly improves your accuracy—a user may mis-key a number or formula, but the Calculator will not. The D&P Calculator not only gives you the ERP and size premium, but it will actually insert it into various cost of equity formulas for you as well, giving a final COE calculation.”

Free webinar on 2012 D&P data and calculator: Purchasers of the D&P Report and/or Calculator will receive complimentary access to a webinar with co-creator Harrington on Tuesday March 13: Introducing the 2012 Duff & Phelps Risk Premium Report & Calculator, which includes a live demo of the calculator and an in-depth discussion of all the new 2012 data.

Proposed limits to valuation discounts are ‘same old, same old’

President Obama’s proposed 2012 fiscal year budget, recently submitted to Congress—aka the Green Book—recommends modifying valuation discounts. In particular, the proposal would create an additional category of restrictions (“disregarded restrictions”) that would be ignored when valuing transfers by family members to a family-controlled entity if, after the transfer, the restriction would lapse or could be removed by the family. (See page 135 of the Green Book for more.)

 “For those who have been following this issue, what appears in this year’s Green Book is no different than the proposals included in earlier years,” writes Linda Trugman, chair of the ASA BV Committee. Since this is an election year, Trugman doesn’t believe that anyone in Congress will “push” the President’s proposal on discounts, at least not until after November, “but ASA's Government Relations Committee is keeping an eye on this.”

Do IP assets have any value apart from a bankrupt company?

After a large manufacturer of photographic supplies went bankrupt, the trustee tried to recover salary and dividend distributions to its executive shareholders as fraudulent conveyances. To refute these claims, the shareholders’ solvency expert valued the company’s goodwill at roughly $12 million at the time of the transfers. To boost this amount, he relied on an intangible asset appraisal by the shareholders’ BV expert, who valued the company’s patents, unpatented know-how, trademarks, customer relationships, and licensing agreements at just over $23 million. The trustee objected, claiming the intangibles valuation was pure speculation—and the bankruptcy court agreed.

“There is no evidence that any specific intangible had any value independent of its value in an ongoing business,” it held, particularly unpatented know-how and customer relations. Further, the debtor’s value was tied into its licensing contracts with Kodak and others. When the business ran into financial troubles and couldn’t make its royalty payments, it risked the loss of these licenses, “which would likely further devalue the business’ intangibles,” the court said. Indeed, when Kodak pulled its license, the company went under. Read the complete digest of Pryor v. Tiffen, 2011 Bankr. LEXIS 4950 (Dec. 6, 2011) in the March 2012 Business Valuation Update; the court’s decision is posted at BVLaw.

The pitfalls and possibilities of bankruptcy engagements: On March 1, join Jeff Risius and Jess Ultz (both Stout Risius Ross) for Business Valuation Issues in Bankruptcy, a 100-minute webinar that will cover what the increasing number and complexity of insolvency cases means for valuation experts.

Top three ways to assess a BV recruit’s writing

In this competitive market for experienced BV analysts, many hiring firms do (and should) assess a candidate’s writing skills, says John Borrowman (Borrowman Baker), in a current discussion for LinkedIn BV professionals (membership required). But many may fall back on simply asking for a redacted client report, which can raise problems of confidentiality as well authorship, since reports are often the product of more than one contributor. What are the best alternatives?

  • “Perhaps a better measure of written communications ability would be an article written for a professional journal,” says Michael Molder (Marcum). “If the candidate has never written for publication, they can always write a page or two on some relevant case or BV concept in order to provide a writing sample. Besides, anybody who's never written an article (even for an internal, firm newsletter) is likely not senior enough to be responsible for the content of a report.”
  • “Another way to assess the potential writing skills of the analyst is by review of his or her list of CE credits. Has the analyst taken or participated in any report writing or advanced report writing courses?” asks Jeffrey Harwell (Rylander Clay & Opitz).
  • “The best way to observe an appraiser/analyst's writing—and maybe more importantly, the related problem/critical thinking skills—is to develop a hypothetical BV problem/issue, based on a ‘real world’ situation, and let the analysts/candidates solve the problem,” says Pete Butler (Valtrend). “This way, all analysts/candidates solve the same problem for better comparability, and it mitigates any problems” regarding confidentiality and authorship.

9th Circuit comes down solidly in favor of subsequent events

A wealthy Californian went to great lengths to avoid paying taxes on $660 million in capital gains, largely by transferring the source of the gain to an out-of-state company shortly before his death. Not only did his estate not report the $660 million on his state income tax return, it also deducted $62 million on his estate tax return for the estimated amount that the decedent might owe if his tax-avoidance scheme failed. The IRS at first disallowed the entire deduction, and then, after the estate settled the taxpayer’s claims with California for $26 million, permitted a deduction for that amount.

The estate sued for a refund of the resulting deficiency ($11 million) in federal district court, which granted summary judgment on behalf of the IRS, finding that the amount of California’s tax claim was not ascertainable with reasonable certainty as of the date of death. The taxpayer appealed, and just last week the 9th Circuit rendered its decision in Marshall Naify Revocable Trust v. United States, No. 10-17358 (Feb. 15, 2012). After acknowledging the split of authority among federal circuits, the court found that, in its jurisdiction, “the law is clear that post-death events are relevant when computing the deduction to be taken for disputed or contingent claims.” Notably, in this case the taxpayer’s expert didn’t necessarily help the taxpayer’s arguments by showing that the claim could support a range of possible values, from $0 to $62 million, with a 67% likelihood of success. We’ll have a complete digest of the Marshall Naify decision in the April 2012 Business Valuation Update; email the editor if you’d like a copy of the 9th Circuit opinion.

PE holding periods have increased by 25%, says new report by PitchBook and Grant Thornton

“The median holding period for private equity portfolio companies has grown significantly in recent years,” says the introduction to the just-published Private Equity Exits Report, 2012 Annual Edition, available through co-authors PitchBook and Grant Thornton:

For companies exited in 2011, the median holding period was 4.81 years—25% higher than for investments exited by the end of 2008. This creates a great need for exit activity to increase. Interestingly, however, the record capital overhang [leftover from investments prior to the financial crisis] has the potential to be part of the solution in the form of secondary buyouts. If this were to happen, it wouldn’t change the overall inventory but would improve the median hold period.

The new report takes a close look at the inventory levels of specific industries to determine which, if any, industries are “hot,” or if the number of exits in any given industry is merely proportional to the overall inventory. Even more pressing: Does the study predict whether the worst of the economic crisis is behind us? “When we launched our first joint report,” say the collaborators, “we were as eager as everyone else to dig into the data to see if we could find an answer. As is often the case, the resulting report raised more questions than it laid to rest, some of which we have tried to explore in this second issue of the report while at the same time raising new and larger questions.”

The Appraisal Foundation wants BV specialists for its boards

Earlier this month, The Appraisal Foundation (TAF) began soliciting candidates to serve on its board of trustees as well as its appraisal practices board, whose members have traditionally come from non-BV disciplines. To round out its representation, “The Appraisal Foundation is interested in expanding the diversity of its Boards by considering applications from business leaders with an interest in valuation or involved in various appraisal disciplines,” reads the current announcement.

Completed applications must be received no later than April 2, 2012. The individuals selected for the board of trustees will serve three-year terms beginning Jan. 1, 2013, and those selected for the appraisal practices board will serve three-year terms beginning July 1, 2012. Application packages are available at the TAF website, here for the at-large trustees and here for the appraisal practices board.

FASB/IASB seek additional outreach on revenue recognition

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) will host a series of outreach meetings in March, April, and May 2012 on their revised joint proposals for the recognition of revenue, published in November 2011. “The meetings form an important part of the boards’ program of outreach activities on this second set of the revenue recognition proposals and they reflect the importance of revenue to all companies,” say the boards in a recent joint release. In addition, the boards will make audio recordings of the roundtable discussions available shortly after each roundtable at their respective websites, www.ifrs.org and www.fasb.org

Beat the winter blahs with enlightening CPE

Try these mid-winter webinars to brighten your BV curriculum and expand your expertise in a variety of current and critical areas:

  • Valuing Radio Stations takes place February 23, when Peter Bowman (Bowman Valuation) and industry expert Paul Fink (St. Clair Co.) discuss how to value radio stations in the information age, including the treatment of additional services (Internet streaming and/or news and online chat services) and compliance with FCC licensing and other regulatory requirements.
  • The Valuation of Hospitals will air on February 28, featuring Don Barbo (Deloitte Financial Advisory Services) and Robert Mundy (GatesMoore). The webinar will address all of the technical, regulatory, and business challenges in valuing the most iconic entity on the healthcare landscape. Or—subscribe to the entire 2012 Online Symposium on Healthcare Valuation and receive automatic access to each monthly installment plus the Healthcare Desktop Learning Center, which includes the entire 2011 Symposium and the first installment of the 2012 Symposium.
  • On March 8, David Dufendach and Jason Andrews (both Grant Thornton) will present the Advanced Workshop on Monte-Carlo Simulations, an intensive, four-hour workshop that will demystify this powerful modeling technique through case studies and hands-on examples. (Co-sponsored by Oracle Crystal Ball.)


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