BVR Logo January 15, 2020 | Issue #208-2

BVWire is your go-to source for the latest in the business valuation profession. Highlights for this week include:

Paper examines goodwill impairment as a leading indicator

As accounting rule makers ponder the idea of upending the current goodwill impairment model and reverting back to one of amortization, a series of papers is exploring this topic. The papers, issued by the International Valuation Standards Council (IVSC), examine whether the principles of business valuation are compatible with the concept of goodwill amortization. The valuation profession feels strongly that they are not compatible.

News value: The first paper (which has been downloaded thousands of times) concluded that goodwill is not a wasting asset, a conclusion supported by empirical evidence. The IVSC has released the second paper in this series, “Information Value of the Current Impairment Test: Leading or Lagging Indicator?” It concludes that, while the current impairment model provides “significant” information to users of financial statements, it’s performance as a leading indicator has been inconsistent. The paper points out various reasons for this inconsistency and says that reverting back to amortization would only make matters worse. The paper lays the groundwork for “practical solutions to enhance the information value of the goodwill impairment test,” and these solutions will be presented in the upcoming third and final installment.

The FASB’s project on this matter is in “initial deliberations” and the IASB will issue a discussion paper in February. A coordinated effort is underway in the business valuation profession to continue to provide feedback to rule makers on this important issue.

Lost profits claims fail to meet New York’s strict standard

Establishing lost profits under New York law can be difficult. The evidentiary burden is high, particularly when the plaintiff is a new business, and experts relying merely on sales and revenue projections are not providing convincing evidence, as several damages cases make clear.

'Reasonable certainty': Most recently, in IceMOS v. Omron Corp, the plaintiff, a business selling special semiconductor transistors, sued the defendant over the alleged breach of a supply agreement that was subject to New York law. The plaintiff claimed various types of damages, including lost profits.

New York law requires the plaintiff to show that lost profits are foreseeable and “within the contemplation of the parties at the time the contract was made.” Moreover, the plaintiff has to establish lost profits with reasonable certainty. A new business or one entering a new market does not have “a reasonable basis of experience” and therefore is subject to a stricter standard, the court explained. It said that projections of future profit “typically will not be enough to establish reasonable certainty.” The plaintiff has to show a history of profit or an analysis that compares the new business with other comparable and profitable businesses. The court found the plaintiff was a new business as it was trying to enter a new market. Its lost profits calculation was solely based on projections from the company’s president and two experts. Even if the court allowed that this was not a new business, the plaintiff would fail the reasonable certainty test, the court found. The experts’ opinions were “laden with assumptions,” and the plaintiff made no attempt to “connect any quantifiable data to its projections of lost profits.” The court struck the lost profits claim.

Similarly, in the 2018 case MYImagination v. M.Z. Berger & Co., centering on a new stationery company, the court found lost profits were not available to the plaintiff. For one, the plaintiff initially conceded that it was a new business with no track record and that lost profits or lost opportunities damages would be speculative. The plaintiff later tried to walk back these statements but failed given the record. The court also found flawed the plaintiff expert’s methodology for calculating lost profits, noting he seemed unaware of key facts and relied blindly on statements from the plaintiff as to possible sales and profit margins.

Then there is the Washington v. Kellwood case, a protracted litigation involving a startup that wanted to enter the compression sportswear market and made a license agreement with the defendant to market and promote the plaintiff’s products. The relationship broke down, and the plaintiff sued, alleging breach of contract. To calculate lost profits, the plaintiff’s expert performed a yardstick analysis in which he compared the plaintiff, a new business with less than $200,000 in sales during its brief existence, to Under Armour, the leader in this market, which at the relevant period had sales of between $49.5 million and $195 million. The expert, without proof, maintained the plaintiff’s revenue would have been 50% of Under Armour’s revenues but for the defendant’s breach. A jury awarded the plaintiff $4.35 million in lost profits, but the district court vacated the verdict, ultimately awarding the plaintiff $1 in nominal damages. The 2nd Circuit later agreed with the district court that the plaintiff “failed to proffer evidence from which lost profits could be established with reasonable certainty.” The 2nd Circuit said the plaintiff’s assumptions that, but for the defendant’s breach, “a commercial would have aired and consumers would have purchased millions of dollars in [the plaintiff’s] products were ‘purely hypothetical.’”

A digest of IceMOS Tech. Corp. v. Omron Corp., 2019 U.S. Dist. LEXIS 196610, 2019 WL 5960069 (Nov. 13, 2019), and the court’s opinion, will be available soon at BVLaw.

Digests and court opinions for My Imagination v. M.Z. Berger & Co., 2018 U.S. Dist. LEXIS 184346 (Oct. 29, 2018), and Washington v. Kellwood Co. (IV), 2017 U.S. App. LEXIS 21871, are currently available to BVLaw subscribers, as are digests of earlier rulings in the Kellwood case.

Pablo Fernandez on common errors using WACC

A new paper presents a real valuation a well-known investment bank performed using two usual methods that are supposed to provide the same value. The trouble is the bank came up with very different values using the two methods. The reason: “Following a recipe without thinking,” says Pablo Fernandez, a professor in the department of financial management at the University of Navarra—IESE Business School in Spain. He is a widely published author (ranked No. 1 in downloads on SSRN) who conducts a regular survey of market risk premiums and risk-free rates used in countries around the world.

Out of sync: In the new paper, “The Most Common Error in Valuations Using WACC,” he explains that there are two usual methods to value shares that, if properly applied, provide the same value: (1) the present value of expected free cash flows discounted with the WACC rate and then subtract the value of debt; and (2) the present value of expected equity cash flows discounted at the required return to equity. “Both valuations must provide the same result because both methods analyze the same reality under the same hypotheses; they differ only in the cash flows taken as the starting point for the valuation,” he writes. But, in many cases, valuers come up with different values, he observes.

Readers of BVWire should be familiar with the views Fernandez has about the overuse of math as a way to avoid necessary judgment. “The main thing I see is too little use of common sense,” he once told us. “Many valuators want to take a theory and a recipe, apply it, and justify it by simply saying that it’s commonly used by others.” He sees many valuation reports that talk only in terms of models and “almost nothing in terms of how the world really works.” Part of the reason is the nature of consulting. “Consultants tend to bombard clients with math or jargon to confuse, impress, or justify the fee,” he says. “It’s not about what the client understands of what you’re telling them. In finance—actually in most jobs—you put in a lot of words—strange words—and you use a lot of synonyms so that the people not devoted to the topic understand almost nothing.”

Everything new in BV—at your fingertips

Busy practitioners find it hard to keep up with all that’s going on in the business valuation profession. Fortunately, you can get caught up on everything that’s happened with two new resources from BVR. The Business Valuation Update Yearbook, 2020 edition, covers the most innovative approaches and techniques, leading conferences, reviews of new tools and resources, and changes in regulations and standards in the profession with on-the-ground reporting from valuation experts, thought leaders, and the BVR editorial team. This year’s edition has been expanded to include monthly news flashes of important developments both in the U.S. and globally, so the volume represents a complete chronicle of what went on in the profession.

The Business Valuation Case Law Yearbook, 2020 edition, represents BVLaw’s analysis of the most noteworthy court decisions of 2019 in the areas of marital disputes, breach of contract actions, dissenting shareholder disputes, federal taxation (including estate and gift tax cases), intellectual property cases, bankruptcy litigation, and more. You’ll learn about legal principles, valuation methodology, and how to present expert opinions. It also contains the court opinions and a case listing by state/jurisdiction, court, and case name, followed by a short description of the key valuation issue of each case.

The BV profession in France is strengthening

The valuation profession in France is not regulated, and there are no formal requirements or obligations to hold specific credentials. The accounting and audit professions are regulated in France but not valuation. However, there is a growing demand to see strong levels of professionalism and transparency in the valuation profession, explains Amaury Catrice, director general of the French Federation of Evaluation Experts (FFEE) in an interview. For example, most of the French universities and business schools now have business valuation in their curricula. Continual Professional Development (CPD) courses are also expanding, and other professional bodies are offering educational programs for their qualified professionals who want to move on to business valuation. “While valuation per se is not regulated in France, valuation professionals and the reports they prepare interact often with heavily regulated functions, for example in the preparation of fairness opinions which are regulated under the AMF [the stock market regulator in France]; or in the preparation of financial statements prescribed by IFRS,” Catrice notes.

BV movers ...

People: Tulsa, Okla.-based HoganTaylor has admitted Clay Glasgow, CPA, ABV, CFF, CFE, to the partnership as an advisory partner; he is based in the firm’s Little Rock, Ark., office, and he advises clients in the areas of financial management, forensic accounting, business valuation, litigation, and mergers and acquisitions. Also, the firm has promoted Glenn Vestrat, CVA, to senior manager (Tulsa office) and Randy Preslar, CPA, ABV, CAIA, to consulting manager (Little Rock office) in the Business Advisory practice … Andrew Bostian, ASA, MST, was elected partner in West Hartford, Conn.-based Blumshapiro’s litigation and business valuation group in Quincy, Mass.; his experience includes valuations for gift and estate tax purposes, bank financing, litigation support, charitable contributions, equity-based compensation, and equity buyouts … Chicago-based Grant Thornton has named David Hazels national managing partner of advisory services; he joined the firm in 2002, and most recently served as the firm’s national managing partner of risk services … Andrew Suh, CPA, has joined New York City-based PKF O’Connor Davies as a partner to lead the firm’s transaction advisory services practice.

Firms: Portland, Maine-based Baker Newman Noyes is looking to increase staff in its new office in Woburn, Mass., which will employ about 20 professionals to start (capacity of 40); the firm will also add staff in Massachusetts, New Hampshire, and Maine over the next 12 to 24 months, the firm says … Chicago-based BDO USA expands its wealth advisory practice with the acquisition of Biegel Waller Investment Advisory Services of Columbia, Md.; the deal brings 10 partners and professionals to BDO … Princeton, N.J.-based WithumSmith+Brown has acquired KSJG of Irvine, Calif.; eight partners and approximately 55 other team members will join the Withum team … Continuing its growth plan for the East Coast, New York City-based PKF O’Connor Davies LLP has acquired Dworken, Hillman, LaMorte & Sterczala LLP of Shelton, Conn.; this is the fourth group to join the firm in the last year, and the Shelton office will be the firm’s 12th location in five states … CliftonLarsonAllen (CLA) has acquired McHale Caruso Scullion & Knox (MCSK) of Fort Myers, Fla.; the firm will work alongside CLA’s Florida team of nearly 300 professionals … Cleveland-based HW&Co. has added Finkler & Co. CPAs of Middleburg Heights, Ohio.

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