Going 'green' is worth about $20,000

In response to the Sustainability Value: A New Definition of Value? item in last week’s BVWire, a Business Valuation Resource's customer shared a valuation report with us that included a reduction in the discount rate based on the target company’s “green” initiative.  The appraiser reduced the company-specific risk calculation by 0.1 based on the appraiser’s judgment that the small food business, which had eliminated nearly all of its waste by working with suppliers to get rid of packaging, was “more sustainable than competitors and was building a stronger brand in the market.”   In this particular case, the reduction in discount rate increased the final fair market value approximately $20,000.  The appraiser suggested that other BV consultants might consider adding language to their valuation reports along the lines of “no adjustment of value was considered based on the environmental practices” for target companies that are less committed to this issue—“at least this would show that you considered sustainability in your analysis,” he told the BVWire.  

Valuing employee stock options for closely held firms

Many appraisers may not be aware of just how high the bar for valuing employee stock options (ESOs) was raised with the release of Statement of Financial Accounting Standards (SFAS) No. 123(R) by the FASB and regulations pertaining to IRC Section 409A by the U.S. Treasury. SFAS 123(R) states that “employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments” (italics added).  Many of us have turned to the Black-Scholes Option Pricing Model, but this model was created for publicly traded options and fails to account for the unique characteristics associated with ESOs – especially those of closely held companies.  Consider the chart below:




 Traded Options

ESOs for Closely Held


New shares issued if exercised (dilutive)?


Yes, dilutive


Who receives exercise price?

Paid to 3rd party

Capital contribution to issuer


Options are marketable?




New options affect value of existing options?




Options can be forfeited?




Options have vesting period?


Typically yes


Options are exercised early?


Frequently yes


Common stock share value known?


No, must be determined


Underlying shares marketable?




A more appropriate and a much more flexible approach to valuing options is to use a binomial lattice model.  In fact, only a well executed lattice model can be readily modified to correctly value ESOs, given their unique attributes.  Furthermore, the value of common stock and the value of ESOs must be estimated simultaneously because of the dilutive aspects of the options. If a lattice model is not being used along with a bisection methodology for allocating value, the results may be misleading and the error in valuation can be substantial.

To learn more about the valuation of employee stock options in private firms, read Keith Sellers', Yingping Huang's & Brett King’s (all professors from the University of North Alabama) free article here (originally published in the Business Valuation Update), as well as their article in the Journal of Accountancy here. Also, get some ESO valuation help with these authors’ new Calculator (The BVR/DVA 123R Compliance Calculator™) located at BVMarketData.com.

A response to growth

After last week’s BVWire leaked some preliminary results from the 2008-2009 Business Valuation Firm Economics & Best Practices Survey—specifically noting the exponential growth in the BV industry—we received some feedback from our readers. CFO Ken Becker, CMA, CPA (Portland, OR) commented, “With the accounting profession moving from historical cost basis to current value, it would be surprising if the BV field was not growing quickly.  The challenge for the BV profession must be to maintain quality during rapid growth.”  Good observation.  Quality is important and is something the AICPA’s SSVS 1, NACVA’s revision to their standards, and the ASA’s latest version of USPAP (all effective January 1, 2008) all push towards.  Have comments?  Send them to BVWire@BVResources.com.

Goodwill: a personal matter

The recent decision by the U.S. Tax Court in Derby et al. v. Commissioner contains important information for appraisers who have clients in the healthcare industry.  Often, a medical practice has very few tangible assets, and the real value lies in goodwill and the covenant not to compete.  Mark Dietrich, CPA/ABV (Mark Dietrich, CPA, PC, Framingham, MA), a current member of the AICPA's Health Care Expert Panel, said that “Sometimes there is an assumption made by appraisers that non-competes are automatically included in the fair market value.  But if you are valuing for an actual transaction and the buyer and seller are writing a contract, you need to know the precise terms of the non-compete to assess what elements of goodwill and other intangible assets are included in the transactions, and that the non-compete lasts for a sufficient amount of time to warrant treating the valuation cash flows as perpetual.” 

In the case of Derby, the appraised value of the practice was $4 million, and the sale price was $1.2 million (the value of the hard assets, with the doctors in the practice receiving long-term employment with generous compensation packages).  The problem then was that the practice was sold to a nonprofit, and the sellers treated the difference in price as a charitable donation.  So the issue before the court was whether the petitioners were entitled to the charitable contribution deductions claimed under Section 170(a)(1) of the IRS Tax Code.  However, under that statute, no deduction can be taken if something is given in return (in this case, the value of the long-term employment and compensation package.  The actual compensation in the employment contracts was significantly greater than that used in the taxpayers’ valuation of the practice). Therefore, the U.S. Tax Court rejected the claim for the deduction. 

“I think it was about time that the courts revisited Norwalk and they do so in the Derby case.” Mark said. “Norwalk established that absent a contractual right, personal goodwill of a professional is not an asset of the corporation employing them, and can’t be transferred without a covenant not to compete to prevent them from taking their goodwill elsewhere.” 

For more information on key points in the Derby case, visit Mark’s blog here.

New research—impact on registration rights agreements by Rule 144 Amendments

Laurie Green, a partner in the Ft. Lauderdale office of Holland & Knight LLP, provided the BVWire with a summary of her firm’s study on the effects of the new six-month holding period Rule 144 amendments which took effect on February 15, 2008.   Ms. Green was a speaker in The Knowledge Congress’s June 11, 2008 presentation entitled “SEC Adopts Amendments to Rules 144 and 145,” where she originally spoke on this topic.  Prior to Holland & Knight, Ms. Green spent 11 years at the SEC and served as a Special Counsel in the Office of Mergers and Acquisitions for the Division of Corporation Finance.

Ms. Green and her team reviewed approximately 150 registration rights agreements that were filed after the Rule 144 amendments took effect to determine the impact of the amendments on the market practice for registration rights agreements.  The Rule 144 amendments should reduce or eliminate the need for registration rights agreements for non-affiliates of the issuer.  See the results of this study at our Free Downloads page, located at BVResources.com.  

Information on restricted stock transactions can be found in The FMV Restricted Stock Study™ database, which provides various details including lack of marketability discounts and whether the private placement was issued with registration rights.  Visitors can read the database’s free Companion Guide, which provides details on registration rights agreements and their effects on the liquidity of restricted stock.

Contrasting Murphy with Jelke

Peter Mahler (Farrell Fritz, P.C., New York City) provided the BVWire with the following insight into built-in gains and the recent Murphy decision:

The discount for built-in gains has captured much interest and controversy in the courts and business valuation community in recent years.  All this attention, including that generated by last year's important 11th Circuit decision in Jelke v. Commissioner (see the January 2008 issue of the Business Valuation Update, available as a Free Download here), has centered on estate and gift tax matters utilizing a fair market value standard.  A recent valuation decision by a New York trial judge grapples with the BIG discount in a very different setting, arising out of a buy-out in a shareholder oppression case, where by statute, the court must value the company under a fair value standard which assumes a going concern and where, as a matter of policy, the courts are loathe to give the acquiring majority shareholders a "windfall" based on speculative future liabilities.  In this case of apparent first impression involving a real estate holding company, Murphy v. U.S. Dredging Corp., the court reconciles the competing considerations by deducting the present value of the tax based on an assumed 19-year holding period based on a number of evidentiary factors reflecting the controlling shareholders' actual investment plans.  To that extent, Murphy parts ways with Jelke's "arbitrary assumption" of liquidation as of the valuation date requiring a 100% discount, and is an important reminder that discounts under the fair market value and fair value standards can differ.

Read Mr. Mahler’s full article in the August issue of the Business Valuation Update, and view his blog on business dissolution and other disputes here.

BV experts and M&E appraisers growing business together

In the valuation world, everyone knows BV experts continually seek training and resources to make their appraisal work increasingly defensible, reliable, and accurate. For some engagements, business appraisers find it much easier and more practical to work with third party specialists, such as a certified and experienced machinery and equipment (M&E) appraiser. Regarding the use of the work of specialists in the engagement to estimate value, the AICPA’s Statement on the Standards for Valuation Services (SSVS 1) paragraph 20 states:

In performing an engagement to estimate value, the valuation analyst may rely on the work of a third party specialist (for example, a real estate or equipment appraiser). The valuation analyst should note in the assumptions and limiting conditions the level of responsibility, if any, being assumed by the valuation analyst for the work of the third party specialist. At the option of the valuation analyst, the written report of the third party specialist may be included in the valuation analyst’s report.

Paragraph 34 of SSVS 1 details a frequent method used in the appraisal world: the adjusted net asset method under the asset approach.  If you decide to engage a machinery and equipment appraiser for this portion of your engagement, you can rely on them to take care of identifying the assets and liabilities, assigning a value (individually or in the aggregate) and if applicable, the liquidation costs.  The more appraisers bring in an M&E appraiser, perhaps the more engagements they can handle a year, and vice versa.  With the blessings and full implementation of SSVS 1 this past January, John Harris ASA, MCBC, CM&AA (director of the NEBB Institute) and his membership recommend business appraisers and M&E appraisers seek a way to capitalize on the unification of standards - making the work produced as accurate as possible, and perhaps reaping the increased profitability.  Having an M&E appraiser as part of your toolkit of appraisal services may help you distinguish yourself in a bid, especially when the engagement requires more than one approach.

To help appraisers network and understand the value M&E appraisers can offer, join moderator John Harris and his outstanding panel of experts in their upcoming teleconference, Valuing Machinery & Equipment. The panel includes Dr. Stanley Pollock JD, DMD, SBA, CBA, MCBA, CMEA (Professional Practice Planners, Inc.), George A. Abraham CSBA, BCBA, CMEA, FCBI, BCB, MCBC (Business Evaluation Systems, Inc.), KC Conrad CBA, MCBC, CMEA, SBA (American Business Appraisers) and Gary Leeman CPA, ABV, CMC, SBA (Gary Leeman CPA, PC).  Click here to register for this teleconference, but hurry—the event is next week on Wednesday, July 29th at 10 am PT. 

Making internet research a little easier

Let’s face it, internet research can be a difficult and time consuming process.  Despite our best efforts, we often come up fruitless in our searches.  In an effort to solve this problem, Jan Davis (JT Research, Portland, OR) has compiled her professional expertise into the new publication The Business Valuation Internet Research Guide.  This book is filled with useful links to pertinent valuation resources, as well as helpful tips to target your searching.  View the table of contents here, and purchase the book here. Note that the book can be purchased as a paperback or as a downloadable PDF which contains active links.


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