February 26, 2014 | Issue #137-4  

Year-end 2013 data to replace the SBBI Valuation Yearbook are now available

Although the SBBI Valuation Yearbook has been discontinued, analysts can still complete their year-end 2013 valuations—and never miss a beat. By February 28, critical year-end data will be made available to everyone who preorders the new 2014 Valuation Handbook—Guide to Cost of Capital, published by Duff & Phelps and available as a print publication from BVR in late March 2014. If you order the new Valuation Handbook between now and when it’s available, you will receive “Key Year-End Data as of 12/31/13” as a PDF document via email. This document will be available starting February 28.

The new Valuation Handbook will include two sets of data: (1) all of the critical year-end data that were previously available in the now discontinued SBBI Valuation Yearbook; and (2) data available as part of Duff & Phelps' long-standing annual publication, the Risk Premium Report—all of which will be available as part of the powerful Risk Premium Calculator. The Calculator will also be updated with CRSP size premia and IRP data by the end of March. The Calculator also includes all historical risk premium reports back to 1998. The Handbook will be included with orders of a Risk Premium Calculator subscription and also available for purchase on its own.

Exact same data: Roger Grabowski (Duff & Phelps) said during a free BVR webinar that the new resource will use exactly the same data sources and same methodologies as the discontinued products. “I can assure you that the data and methodologies are consistent with what you received in last year’s Yearbook,” he says.

BVR applauds the incredible efforts of Grabowski, his colleague Jim Harrington, and the others at D&P for developing this critical new resource so quickly. By February 28, “you will be equipped to do any cost of capital calculation for year-end 2013,” Grabowski says.

More details: To listen to the archive of the free webinar that fully explains the new 2014 Valuation Handbook, click here.

To receive the “Key Year-End Data as of 12/31/13” by email and preorder your copy of the Calculator and Handbook, click here.

Practical way to deal with tricky issue of shareholder loans

Very often during the valuation process you’ll come across a shareholder loan recorded on the books of the subject business. Your first impulse will be to determine its fair market value, but wait a minute. The question must be asked: “Is this a bona fide loan or is it really equity?” The trouble is, there is no straightforward answer; and yet a reclassification of debt to capital could have a multi-million-dollar impact on total value.

Nebulous guidance: A bright-line test for debt versus equity simply does not currently exist, according to Christine Baker (Meyers, Harrison & Pia LLC). Speaking at a recent webinar, Baker pointed out that valuation literature is “very general and sort of nebulous without any clear guidance” on this issue. In terms of the courts, family law courts around the country “have not voiced their views on this topic to date.” So where do we look?

Experts in the legal field have directed us toward case law in bankruptcy and Tax Court opinions. A sampling of cases includes Fin Hay Realty Co. v. United States (398 F.2d. 694 (3d Cir. 1968)), in which the Tax Court applied 16 factors to determine the nature of an advance from the shareholder to the business and consequently whether it was debt or equity. Similarly, in the case AutoStyle Plastics, Inc. (269 F.3d 726, 45 U.C.C. Rep.Serv. 2d 964, 2001 FED App. 0378P (6th Cir. 2001), the bankruptcy court outlined an 11-factor test (based on factors originally used in Roth Steel Tube Co. v. Commissioner, 800 F.2d 625,630 (6th Cir. 1986), to recharacterize tax claims) to determine whether an advance was debt or equity.

Consider this: The resolution of a debt-versus-equity issue is like searching for a result along a continuum, which has at one end debt and at the other end equity. Baker advises that in some cases the valuation expert may wish to consider treating a nonperforming “loan” as a preferred equity interest. In other circumstances, a practical step may be to present counsel with two valuation scenarios: One in which the valuation conclusion assumes the loan is not a bona fide debt of the company and another in which the valuation conclusion assumes the loan is legitimate and is to be included (at its fair market value) in the overall determination of the parties’ net worth. These are several alternatives that may assist the parties and their respective counsel in negotiating an equitable settlement.

For an archived version of Baker’s webinar, Valuing Shareholder Loans in Divorce, click here (purchase required).

Divorce court wrestles with ‘vague and conflicting’ goodwill testimony

Goodwill in a professional partnership poses unique challenges for valuators and courts, especially in a divorce setting. In a recent Texas case dense with valuation issues, it came down to corporate goodwill. “Logic tells me there is some,” the trial court said, “but it’s probably impossible to quantify.” The finding triggered an appeal.

The husband was a principal at KPMG, one of the Big Four accounting firms. A partnership agreement provided that a principal’s sole interest in the firm was his required contribution to a capital account. In case of “separation,” by which the agreement meant death, withdrawal, or retirement, the member would receive the balance of his capital account, excluding any amount he owed under a loan he took out to fund his interest in the firm. At year-end 2010, the amount in the husband’s capital account was $715,000, and the loan amount was $700,900.

At trial, the wife argued that KPMG was a partnership, not a corporation, and that fair market value was the proper valuation. Under the applicable case law, if the asset is an interest in a partnership, any increases in the asset’s value that accrue during the marriage may be a community asset, whereas increases in a corporation’s net worth are not an asset of the community of each of the corporation’s shareholders.

Excess earnings: The wife's expert, an ASA, did not perform an appraisal under the USPAP but did perform a calculation under the ASA standards. His report did not mention the agreement; it referred to tangible value but did not use the term “goodwill” or differentiate between commercial and professional goodwill. Under an excess earnings approach, he determined that the husband owned a tenth of one percent partnership interest and that, of his $1.5 million average annual income, $700,000 was reasonable compensation and $800,000 was income attributable to the KPMG ownership interest. Applying a 33.3% cap rate, he concluded that the fair market value of the interest was $2.4 million. The buyer of the share would be someone with “the skill set to be able to step in and receive the salary plus the excess income,” he explained.

The husband’s expert acknowledged that a large professional practice might possess commercial goodwill but emphasized that “corporate governance” was critical to valuing interests in a firm such as KPMG. According to him, “the only way to obtain value for your partnership interest is to sell it back to the firm.… You get the capital account, you pay off the debt[,] and that’s what you get.” Here, the interest was $14,100, the value of the capital account, minus the loan against it.

“I don’t find that the contract controls,” the trial judge stated. At the same time, the court found only professional goodwill. Even if there were commercial goodwill and it could be quantified, the husband could only access it by remaining employed in the future, the court added. Perhaps, if the company were to liquidate in the future, “he might get some piece of the value.” It emphasized that the wife’s expert did not use the appropriate method to determine fair market value and concluded that the partnership interest was worth $14,000. After a thorough review of case law, the Court of Appeals affirmed, pointing to the “vague and conflicting” expert testimony as to the existence and availability of commercial goodwill.

As appraiser Jim Alerding (Alerding Consulting) sees it: “This is almost a ‘what side of this do you want me to argue’ situation. Without a doubt, a KPMG partner makes more than the average accounting firm partner makes; consequently, there is likely excess income generating excess value and it’s reasonable to attribute the excess value to the enterprise and not to the individual. But you can also claim that the partnership agreement should govern the value for such a large enterprise that is likely not to ever sell. Looking at FMV, there really are no hypothetical buyers for KPMG. There also is no hypothetical buyer for this partner’s interest in KPMG because interests are not bought and sold on an individual basis.”

Find an extended discussion of Hill v. Hill, 2014 Tex. App. LEXIS 292 (Jan. 9, 2014), in the April issue of Business Valuation Update; the court opinion will be available soon at BVLaw.

Web gab: DLOM sparks online banter

On the Valuation LinkedIn group, the question posed was: In valuing a private company, what is the typical range to consider for lack of marketability?

Doesn’t exist: As you might expect, a number of responses correctly pointed out that there is no typical range, as each valuation situation is unique and a thorough analysis of the subject company is needed. One commenter said: “DLOM in a private company is dependent on many factors including the availability of buyer for the private company, stake that is proposed to be sold off (majority attracts lower DLOM), cash reserves of the company, probability of the company getting listed in near future. All these factors need to be critically understood prior to a call on DLOM.”

Another commenter, a derivatives valuation expert, uses put options to estimate DLOM. He gives this example: “You initially valued the stock at $10 per share. To guarantee that you can sell at $10, you need to purchase a put option, with a $10 strike price. The maturity of the put option can be obtained from something like a dribble rate. Let's assume you calculate the put option at $2. Then the discount you need to take is $2/$10 = 20%.” Someone pointed out that the put option method has its critics and that no single method should be used.

Cutting remark: One commenter lit into the person posing the question, saying it shows “an alarming and troubling level of amateurishness and naïveté.” Not content with this jab, he continues: “Frankly, you very likely should not be completing such a valuation project (alone) if you have no knowledge of/experience with this topic, and it seems that you don't.” Ouch!

Value of public healthcare firms on the rise despite pressures

Despite recent widespread compression in profitability (gross margins and EBITDA margins), the total enterprise value of public companies across the healthcare industry continues to increase, reveals an analysis from PCE.

The analysis, which examines healthcare M&A activity, reports that every subsector of healthcare experienced a drop in M&A transaction volume in the fourth quarter of 2013 except equipment and supply. However, things are expected to change. The analysis states: “Most M&A professionals involved in the healthcare industry attribute the 2013 year end ‘wait and see’ mood to the anticipation and uncertainty of the rollout of the Affordable Care Act (ACA) compounded by the Federal government’s divisive decision-making budget malaise. The ACA has now been launched, Washington budget policymaking appears to be recovering, and the public equity markets are at record highs, so the tentativeness toward M&A and investing in this sector is expected to dissipate in 2014.”

Over the past 10 years, healthcare was the hot industry in terms of M&A, with average volume growth of 17.8% per year and a whopping 75.4% overall increase, according to PCE. The segment grew from 784 transactions in 2004 to 1,375 in 2013, fueled mostly by an ever-changing business and regulatory environment.

Special cost of capital issue of Business Valuation Update

Cost of capital is the theme of the March 2014 issue of Business Valuation Update. Here’s what you’ll see:

  • The Implied Private Company Pricing Model (IPCPM): Ko = (FCFF1/P) + g (Bob Dohmeyer, ASA; Peter Butler, CFA, ASA; Rod Burkert, MBA, CPA/ABV, CVA, ASA). The authors have developed a model designed to be more reliable than the build-up method for estimating the cost of capital of a small privately held business. This model uses the authors’ new Implied Private Company Pricing Line 2.0 (IPCPL).

  • BV Community Reacts to New Cost of Capital Tool (BVR Editor). Feedback—both positive and negative—was swift from the valuation community on the implied private company pricing line (IPCPL), a new method to estimate the cost of capital for private companies.

  • IPCPL Developers Field Queries on the New Model’s Underlying Data (BVR Editor). The IPCPL developers answer some of the many questions about the method as a whole and the underlying transaction data it uses.

  • It’s in There! So What Else Is Included in Your Estimated Cost of Capital? (Ted Israel, CPA/ABV/CFF, CVA). A few elements of valuing private companies are frequently adjusted for as a separate factor—but they also may already be embedded in the analyst’s estimated cost of capital.

  • Does the Size Effect Still Exist? New Analysis From Pratt and Grabowski (BVR Editor). In the upcoming fifth edition of their essential book, Cost of Capital: Applications and Examples, Shannon Pratt, FASA (Shannon Pratt Valuations), and Roger Grabowski, FASA (Duff & Phelps), reveal new analysis that examines the existence of the size premium.

To read these articles—plus a digest of the latest court cases—see the February issue of Business Valuation Update (subscription required).

BV Movers . . .

Joseph Graff of Ross, Rosenthal & Co. (Morristown, N.J.) has been named to the Foundation for Morristown Medical Center’s board of trustees … Nicole Gossett, who specializes in healthcare and physician practice valuations, has joined Decosimo Advisory Services of Tennessee as a valuation services manager … Bethany M. Hearn has been promoted to principal at the Champaign, Ill., office of CliftonLarsonAllenCarol Surowiec has joined Cherry Bekaert LLP as tax partner in its South Florida practice … Crystal Zhang has been named assistant vice president at The Brenner Group Inc. in Cupertino, Calif. Her responsibilities will primarily focus on business valuation for tax and financial reporting … Amy L. Geer, CPA, CVA, has joined Hoerner & Associates LLC of Michigan.

Firms: Averett Warmus Durkee has opened a new office in Altamonte Springs, Fla. … Baker Tilly Search & Staffing LLC of Wisconsin has been named one of Inavero’s 2014 Best of Staffing Talent Award winners … BDO of Illinois was recognized with the Work-Life Seal of Distinction for 2014 by WorldatWork’s Alliance for Work-Life Progress, which honors organizational success in work-life effectiveness … Woodbridge International, a global mergers and acquisitions firm specializing in middle-market companies, announced the opening of its new office in Santiago, Chile. 

CPE events 

Advanced Workshop on Control Premiums & Discounts (February 27), featuring James Alerding (Alerding Consulting) and James Ewart (Dixon Hughes Goodman). This intensive, four-hour workshop will present the profession’s most complete look at a complex and persistent set of challenges: recognizing, determining, and applying adjustments for control. Attendees will learn how simple considerations of cash flow, goodwill, and marketability and basic choices in the level of value and valuation approach can affect—and be affected by—discounts and premiums for control.

Two more installments in the Advanced Webinar Series on Reporting & Testimony:

  • How to Succeed as a Jointly Retained Expert (March 7), featuring William Morrison (WithumSmith+Brown) and John Johnson (SaxBST). Learn how to succeed as a neutral, court-appointed expert when working with both parties and the court.

  • New date: Omissions & Commissions: Errors, Challenges & Solutions in Business Appraisal Reports (March 12), featuring L. Paul Hood Jr. (The University of Toledo Foundation) and Timothy Lee (Mercer Capital). This program, previous scheduled for February 28, will feature expert Lee and attorney Hood in an examination of professional guidelines, judicial decisions, and real-world examples compiled into a must-attend presentation on how to avoid the most common and mortal mistakes in business appraisal reporting, be they by omission or commission.

Challenges in Measuring the Fair Value of Intangible Assets (March 4), featuring Robert Reilly (Willamette Management Associates). The third installment of BVR’s Online Symposium on Fair Value Measurement examines the process and procedures by which intangible assets are valued for fair value purposes. With guidance from ASCs 820, 805, and 350 and Reilly’s professional experience and expertise, this is a must-attend presentation.

Utilizing the Implied Private Company Pricing Model: The Cost of Capital Wizard (March 5), featuring Robert Dohmeyer (Dohmeyer Valuation Corp.), Peter Butler (Valtrend), and Rod Burkert (Burkert Valuation Advisors). In November 2013, Dohmeyer and Burkert unveiled the implied private company pricing line (IPCPL), a model for estimating cost of capital for private businesses whose revenues are less than $150 million. On March 5, they return with Butler to unveil the implied private company pricing model (IPCPM), a derivation of IPCPL that adjusts for companies with outlier fundamental characteristics and allows for a departure from the IPCPL.



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