February 5, 2014 | Issue #137-1  

The wait is over! New resource replaces defunct SBBI Valuation Yearbook

BVR and Duff & Phelps officially announce the forthcoming 2014 Duff & Phelps Risk Premium Calculator and Valuation Handbook. Production is underway for the Handbook,which will be included with any Risk Premium Calculator subscription and also available for purchase on its own. For more information on the Handbook and the Calculator contact BVR sales at 503-291-7963, ext. 2, or sales@bvresources.com.

Be sure to register for the debut webinar, The 2014 Duff & Phelps Calculator and Valuation Handbook (February 20) with Roger Grabowski, hosted by BVR. This free webinar is the first presentation of the Duff & Phelps 2014 Valuation Handbook, the newest and best resource for cost of capital data. Filling the void left by the discontinued SBBI Valuation Yearbook, the Valuation Handbook includes all critical year-end data necessary for cost of capital determination along with the materials included in Duff & Phelps’ long-standing annual publication, the Risk Premium Report. Join Grabowski, leader of the brain trust behind this new publication, for the first opportunity to learn about the compilation, presentation, and utilization of the data in this powerful resource.

Does using pre-IPO data for DLOM double count the discount?

The use of pre-IPO studies to measure a discount for lack of marketability has gained acceptance among valuation analysts and the Tax Court. Still, though, there is some criticism over this method. One notion kicking around recently is “double counting,” meaning that some of the transactions in the pre-IPO databases are calculated with a DLOM already in them.

Not true: “Double counting of discounts is not occurring when viewed in the larger context of the transaction,” says Brian Pearson of Valuation Advisors LLC, who developed the Valuation Advisors Lack of Marketability Discount Study. This is the only online database of pre-IPO private stock and option transaction data from 1985 to the present. It recently hit the 10,000 mark in terms of the number of transactions it contains.

In a recent interview with Business Valuation Update, Pearson reacted to the idea that the discount is double counted. “While it is true that some of the transactions include a prior discount, it helps to understand the process by which this ‘discount’ was calculated,” he says. “Under the fair value standards for option and stock issuance and the AICPA’s guide to fair value, the commonly used valuation method of PWERM (probability-weighted expected return method) requires consideration of a DLOM. So if the enterprise value is $10 per share and the CPA BV professional, under the fair value guidelines, assigns a 30% discount, the reported transaction price is $7. If the company goes public at $12, in theory, you have two discounts at two different periods (30% and 20%). However, this is where the theory of multiple discounts fails, since in reality the transaction is just one transaction, from the time of investment until the time of liquidity (i.e., the IPO date).”

He continues: “Prior to the fair value standards, in an arm’s-length negotiation of the price, the same process would have occurred, except it would simply have been reported as a $7 transaction with the discount as ((12 - 7)/12), or 41.66%. Thus, the concept of “two discounts,” although implicit in the process, wasn’t being publicly reported. In fact, the same level of DLOM is occurring in both situations—it’s just that the fair value standards for pre-IPO transactions shed better light on the process of how such pre-IPO values are being arrived at now.”

Free article: Read the complete interview with Pearson in the article “Is the Lingering Criticism of Using Pre-IPO Studies for DLOM Justified?” available from BVR as a free download. 

Court condemns calculation report as indicator of company’s fair value

There goes the evidence! As we have reported on various occasions, a calculation of value has its purpose, but it cannot substitute for a full appraisal in proving value in court, as a recent decision in a shareholder dispute shows.

Backstory: The plaintiff founded a company providing management services to ambulatory surgical centers. He hired the defendant as the company’s president. Several oral and written agreements between the parties provided for the plaintiff’s granting the defendant 300,000 membership units in the company. This amounted to a 10% interest and was given in exchange for the company’s right to buy back the shares if it terminated the defendant for cause or he resigned from the company. At some point, the defendant sold 30,000 shares to two investors for $10 per share. He also proposed a buy-sell agreement that mentioned a $10-per-share price, but the plaintiff never accepted it or signed on to it. When the relationship between the parties broke down, the plaintiff sued to establish the fair value of the company’s stock, both to determine the value of the defendant’s interest and to exercise his right to repurchase the stock. The defendant counterclaimed to enforce his right as 10% shareholder of the company. He insisted he should receive $10 per share.

Both parties presented experts. However, the defendant’s appraiser testified that he had only been hired to prepare a “calculation of value,” not a full appraisal. The defendant had not furnished the numerous materials necessary to perform a valuation, and “more work should have been done” for a fair valuation of the company at the date of termination, he said. He added that the defendant’s proposed buy-sell agreement would be “part of the consideration” if he were to value the defendant’s shares alone but not if he were to assess the company’s worth on the termination date. The plaintiff’s expert dismissed the $10-per-share price as an “arbitrary amount” that was based on unreliable projections. He concluded that the company’s fair value was $4.2 million and the fair value of the defendant’s interest in the company was $368,700.

Falls far short: The trial court agreed with the plaintiff’s expert. It flatly rejected the buy-sell agreement as evidence of value and also dismissed the opinion of the defendant’s expert since his “calculation of value” was nothing more than an agreement between the appraiser and the client “as to the manner in which the appraiser’s work is to be done.” By the defendant expert’s own account, his calculation fell far short of the work necessary for a report that contained an “actual fair valuation of [the company].” The trial court’s ruling meant the plaintiff expert’s valuation was uncontested. The appellate court affirmed, finding the lower court provided sound reasons for excluding the defendant expert’s opinion. Since the plaintiff’s expert used the proper methodology, the trial court could rely on his valuation.

Read more about Surgem, LLC v. Seitz, 2013 N.J. Super. Unpub. LEXIS 2491 (Oct. 16, 2013) in the March issue of Business Valuation Update; the court’s opinion will appear soon at BVLaw.

Strine confirmed as next Delaware chief justice

The Delaware Senate has officially confirmed the nomination of Chancellor Leo Strine to be the next chief justice of the Delaware Supreme Court. As one commenter put it: "A new era of the Delaware judiciary has begun."

Since 2011, Judge Strine served as chancellor of the Delaware Court of Chancery, the preeminent arbiter of corporate matters, where he has left a deep imprint through his often-lengthy opinions, full of quotable comments and courtroom asides.

In one case, In re Southern Peru Copper Corp., he issued a 105-page decision in which he found in favor of the noncontrolling stockholders and approved a $1.26 billion award based on the court's own DCF analysis. Neither the merger process nor the price was fair, and the Southern Peru directors had breached their fiduciary duty of loyalty, he concluded.

Warrants and ESOPs

“The independent appraiser that issues a fairness opinion to the [ESOP] trustees must be familiar with how warrants work, has valued them, and has fully taken them into consideration when looking at the underlying transaction,” advises James G. Steiker, chairman and CEO of SES Advisors Inc. Steiker spoke at a recent ASA webinar, Demystifying Warrants: How & Why They Are Used in Leveraged ESOP Transactions.

“Warrants are being negotiated as extensively as purchase prices in many of these transactions,” he says. “It’s an important device and shouldn’t be treated as a side-kicker.” He also addressed several fiduciary issues and concerns surrounding ESOPs with warrants in their structures:

  • Is “adequate consideration” fair, inclusive of warrant value?;
  • Prudence;
  • The magnitude of warrant exercise; other case obligations, including ESOP repurchase obligations (distributions);
  • Reasonableness of dilution from warrants and other forms of synthetic equity;
  • The need for “S” distributions in a less-than-100% ESOP;
  • Has the company adequately analyzed 409(p)?; and
  • Does warrant design protect S corp status?

Look for more commentary on ESOPs in 2014 in a future issue of the Business Valuation Update.

BV Movers . . .

People: Wilkins Miller Hieronymus LLC announced the addition of Bob Slaby, CPA, CVA, who joined the firm’s Mobile, Ala., office in July 2013 as an accountant with a concentration in tax and business valuations … Lisa Knee has been named tax partner at EisnerAmper’s Melville (New York) office. Her area of expertise is advising and serving families and owners of closely held businesses … Sheri Fiske Schultz, director of litigation support and business valuation services for Fiske & Co., has been recognized by the South Florida Legal Guide as one of the “Top CPAs and Financial Support Professionals” for 2014 … James Walker has joined Cherry Bekaert LLP as a partner in the firm’s tax practice based in Richmond, Va. With over 30 years of experience serving closely held businesses and their owners, nearly 600 of Walker’s clients will be transferred to Cherry Bekaert’s client roster.

Firms: BDO Canada completed mergers in November and December last year with Raymond Yuill Chartered Accountants and McCuaig & Co., both based in Nova Scotia. Both merged firms will operate under the BDO name, with over 100 offices across Canada … Goldstein Schechter Koch merged with De Meo, Young, McGrath & Co. on January 1, confirming GSK’s goal of expanding throughout southeast Florida.

New webinar series on BV reporting and testimony

BVR’s four-part Advanced Webinar Series on Reporting & Testimony begins on February 7 with Step Up Your Game: Effective Business Appraisal Reporting. Join L. Paul Hood Jr. (The University of Toledo Foundation) and Timothy Lee (Mercer Capital) to learn how business appraisal reports must evolve to serve an increasingly sophisticated and critical reading audience.

Then, join BVR for the remaining programs in the Advanced Webinar Series on Reporting & Testimony:

Get under control

The Advanced Workshop on Control Premiums & Discounts (February 27) features two of the professions most experienced voices on one of its perennial challenges. Through an intensive four-hour, hands-on tutorial, James Alerding (Alerding Consulting) and James Ewart (DixonHughes Goodman) will provide the most complete picture of this issue ever presented, including a consideration of professional guidelines, judicial decisions, and best practices. Join them to learn about how to effectively and reliably identify, assess, and normalize control adjustments.

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