Should a Private Cost of Capital Method replace
CAPM and BUM?
Most appraisers recognize the judgments and assumptions built into the process of converting measurable public market data into proxies for private company valuation. Capital asset pricing needs to be “modified” with a series of adjustments to the cost of capital figures derived from the public markets. This standard valuation process that has some financial theory risks but it has been implicitly sanctioned by USPAP, SSVS-1, and particularly by Revenue Ruling 59-60 which justifies valuation methods based on data from actively traded stocks.
Rob Slee (Robertson & Foley, Charlotte, N.C.) and John Paglia (associate professor of finance at the Graziado School of Business and Management at Pepperdine) are two of the experts who have never been comfortable with the theory that public company data can be substituted for private value; both have been publishing on this subject for a number of years. Slee has identified a long list of contradictions arguing against this practice: public and private markets have different risks and returns, liquidity, access to capital, pricing mechanisms, holding periods, and transaction costs.
A review of the latest Pepperdine study appears in the August BVU, available today.
‘Big victory’ for small businesses in new reasonable
In 1972, a son took over his father’s foundering packaging business as CEO. Over the next thirty years, he bought new equipment, refurbished a new factory, and attracted new clients, building the firm’s annual revenues to nearly $10 million. In 2002 and 2003, his total annual compensation (salary plus performance bonus) exceeded $2 million—and the IRS challenged the amounts as deductions, allowing only $660,000 per year. At trial to the Tax Court, both parties’ experts analyzed the CEO’s compensation by reference to public company comparables, but only the IRS expert applied the “independent investor” test (i.e., whether an independent investor would be satisfied with the rate of return after investing in the taxpayer). The court found neither expert “completely convincing,” largely because their comparables were not sufficiently similar to the taxpayer. So, the court did a thorough analysis of all the evidence under the “five-factor test” of Elliott’s Inc. v. Commissioner, the 9th Circuit decision (1983) that looks to comparable companies and also the employee’s role within the firm, its financial condition, conflicts of interest, and more. The court then allowed all of the taxpayer’s compensation in 2002 and substantially all ($1.28 million) in 2003.
“This is a great victory for small business entrepreneurs in terms of the logic in paying them fair value for their contributions to an enterprise’s success,” comments Ron Seigneur (Seigneur Gustafson LLP). “This case also has an excellent discussion of the Elliotts decision as well as the independent investor test,” he adds. “Most importantly, it points out why business owners need financial experts to help them sort out what constitutes reasonable compensation for tax and other analyses.” Read the complete digest of Multipak Corp.v. Commissioner, T.C. Memo. 2010-139 (June 22, 2010) in the Sept. BVUpdate; the court’s opinion will be posted soon at BVLaw™.
More importantly, watch for BVR’s Guide to Reasonable Compensation, by Ron Seigneur and Kevin Yeanoplos, coming soon to BVR’s full-reference online library and bookstore.
Experts address common errors appraisers make in
During the recent BVR webinar on fairness opinions, Craig Jacobson (Citrin Cooperman & Co.) and Jeffrey Rothschild (McDermott Will & Emory) touched on the pitfalls in preparing a fairness opinion. “As in any valuation assignment, it's important to be aware of matching the discount rates and the projections,” explained Jacobson. “I was at a gathering of valuation and legal people yesterday evening and one of the questions that was asked of me was ‘what's the biggest valuation error that you see?’ To me, it was hands down, a mismatch of discount rates and the risk inherent in the projections.”
Other fairness opinion warning signs:
- Inadequate due diligence
- Selection of guideline companies/transactions
- Comparison with industry and general economic data
- Inappropriate application of valuation discounts and premiums
For the complete presentation by Jacobson and Rothschild, click here.
Co-management arrangements among physicians and hospitals are an opportunity for appraisers
“Alignment, integration, and engagement of physicians is a key strategy for health systems seeking to create high-performance, high-quality, and high-efficiency organizations. One way physicians and hospitals are trying to achieve this common goal is through co-management arrangements,” writes Anne Shiramitaro (Health Capital Consultants).
Business appraisers can play a roll in this new model of emerging healthcare organizations because an acceptable compensation structure must be established. “In order to avoid regulatory or compliance complications, an independent valuation consultant should be engaged to provide a certified opinion that the co-management arrangement is both at fair market value, and commercially reasonable. Appraisers can also assist the healthcare enterprises involved in defining the scope of the activities performed by the co-management company and extensively review the appropriateness of the metrics that determine reimbursement,” adds Shiramitaro.
For the complete article “Co-Management Arrangements – Aligning Physicians and Hospitals” click here.
BVR hosts Oregon NACVA meeting
NACVA members met in BVR’s conference room on July 16th to discuss a Case Analysis in Person (CAP) for recertification purposes. Stuart Weiss, CPA/ABV, CVA and president of the Oregon chapter of NACVA conducted the CPE session. Prior to meeting, the group had read a FLP valuation report in order to discuss the report’s strengths and weaknesses during the session. The consensus was that the author, who was anonymous, did a good job of explaining his discounts for lack of control and marketability. However, the report failed to comply with NACVA report writing standards.
Weiss also handed out one of his own sanitized reports of a dental practice, and let the group critique his work. Among the more interesting debate points was whether it is necessary to use WACC in a practice heavily financed by debt. The next meeting is scheduled for September. “I think this profession needs as much peer review as it can get,” Weiss remarked.
Siebert becomes CICBV honorary fellow
Congratulations from BVR to Lorne Siebert of Siebert Pask in Calgary; he’s the 2010 recipient of the FCBV honorary fellow designation–the highest business valuation honor in Canada. Lorne receives his award at the CICBV/ASA National Conference in Miami October 6th.
FASB moves on its decision on investment properties
At its last meeting on July 14th, FASB tentatively decided to publish a proposed Accounting Standard Update requiring an investment property (as defined in IAS 40) to be measured at fair value. This project will also consider how the fair value of a leased investment property should be handled. The Board acknowledges that the decision does not fully converge with international financial reporting standards, which permit but do not require investment properties to be measured at fair value. For more information click here.
The number of ASAs increased 7% over last year
Bill Quackenbush’s (Advent Value) first ASA Note from the Chair (July 21, 2010) reveals the ASA’s BV membership increased 3.5% this year over last, and the number of BV ASAs are up 7% from last year.
Valuing a car dealership? Learn from the experts this week
This Thursday appraisal experts Jim Alerding (Clifton Gunderson) and Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos, P.C.) will join Carl Woodward (Woodward & Associates) for “Valuing Auto Dealerships”, a webinar addressing how current challenges impact the value of auto dealerships as well as how appraisers can tackle the classic obstacles to the valuation process.
As an exclusive bonus, registrants get a copy of the BVR Industry Spotlight Report on Auto Dealerships, a PDF just created for the session. The Report contains industry and transaction summaries from Pratt’s Stats and other BVR data sources.
For more information on this program or to register click here.
Just added to Summit on BV in Divorce: Bernier Methodology in Pass-Through Entity Valuation
At BVR’s 2nd Annual Summit on BV in Divorce attendees heard an overview of the Bernier decision, which addressed ongoing debates with regard to fair value versus fair market value and the use of key person and marketability discounts in valuations of pass through entities. For the 3rd Annual Summit on BV in Divorce, appraisers Mark Luttrell (Mayer Hoffman McCann P.C.) and Mark Harrison (Meyers Harrison & Pia, LLC) will join BVR to address the application of this decision in pass-through entity appraisal – commonly the most divisive and material issue in divorce valuation, and often the subject of immediate and intensive cross-examination on all variables and assumptions. More information on this and all other sessions at the BVR/Morningstar 3rd Annual Summit on BV in Divorce is available here, along with a complete agenda, speaker profiles, and more general Summit information. Register by August 13 and save $300.
Help your lawyer clients understand BV with update to Pratt’s “BV Handbook”
Business valuation confuses many lawyers. So, the American Bar Association hopes to sell lots of the latest edition of Shannon Pratt’s The Lawyer’s Business Valuation Handbook. Most sections of the 675+ page handbook include illustrative “Questions to Ask” that can be employed to gain a better understanding of the expert’s treatment of the subject matter. Extensive case citations to courts’ positions on all types of business-valuation issues are also included.
View the table of contents.
Correction: We posted an incorrect deadline for responding to the International Valuation Standards Council (IVSC) exposure draft of proposed new International Valuation Standards (IVS). Comments should be received by September 3rd and may be sent as email attachments to CommentLetters@ivsc.org, or by post to the International Valuation Standards Board, 41 Moorgate, London EC2R 6PP, United Kingdom.
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