Proposed USPAP revisions prompt sharp criticism from ASA BV Committee
Members of the American Society of Appraisers (ASA) “are not happy with” some of the current proposed revisions to the Uniform Standards of Professional Appraisal Practice (USPAP), reports Linda Trugman, chair of the ASA BV Committee, in a recent e-update to members. Among other changes set forth in the exposure draft for the 2014-2015 USPAP, the most controversial are those to the definitions of “assignment results” in Section 2a and “report” in Section 2b.
In particular, a letter signed by Trugman on behalf of the ASA BV Committee expressed its concern that that elevating draft reports to the status of “assignment results” would counter the prevailing trend in litigation matters to preclude discovery of an appraiser’s draft materials. Moreover, the proposed broader definition of “report” would include “any communication of an opinion of value … at any time” (emphasis added in the letter). Instead, “we believe the definition of a ‘Report’ should be linked to the completion of an assignment.” To read the ASA’s letter to the Appraisal Standards Board (ASB), click here.
What else can concerned BV professionals do? That the proposed USPAP revisions have got this far may be related to the lack of adequate BV representation on ASB, says Trugman. Inertia may also be a culprit. “Complaining is easy,” she says, “but getting involved takes time and commitment.” Although the deadline for commenting on the USPAP exposure draft has passed, one vacancy still remains on the ASB, “which needs to be filled by someone in the BV discipline,” Trugman says. Applications will be accepted through Aug. 1, 2012; for more information, click here.
Over 95% of BV professionals still use the market approach
The vast majority of respondents (95.6%) to our recent online poll say they routinely consider the market approach—i.e., the application of private company transactions data as well as guideline public company data—to help reach an ultimate conclusion of value for a subject private company. Of these respondents, 85% consult Pratt’s Stats, while 62% also use BIZCOMPS and 45% use the IBA database. Not surprisingly, most survey participants said that a lack of sufficient comparables might lead them to reject the market approach in any case or simply use it as a “sanity check.” Other reasons: The subject company doesn’t have access to public markets, is insolvent, is in the early stages of development, or is in a niche industry. “I don’t use transactional data at all,” said one respondent, “unless there are a LOT (at least 30) of transactions within an attenuated time frame (three years, max).”
The range of comments about the reliability of market data went to both extremes. “The existing databases are pure, unadulterated garbage, hyped up as something reliable to all the ignorant CPA/appraisers in the BV business when they are anything but,” said one. “Any data helps,” said another, while still another respondent said: “The market approach is one of the most objective resources a valuator can use to value a business. The income approach is subjective in so many respects.” Consider these comments from respondents as well:
- Public guideline companies are in a different stratosphere when it comes to the size of the companies we value, so I do not use that method. I will always consider the private market data, but if there are too few transactions in a particular industry, or the data points are too widespread to determine true industry multiples, I will reject the method.
- I find it extremely difficult to apply market data to a small business, unless there is an overwhelming amount of data. The subjectivity of expense classifications, discretionary expenses, and lack of detail make any comparisons almost meaningless.
- In our opinion, transaction data MUST be considered. EVEN IF you can't get sufficient reliable “numbers,” you can still get an idea of activity in the market, which is very useful to know.
- Ultimately, there is no perfect answer, other than the price after a sale. Since we are tasked to value the company without knowledge of a sale, we must provide our best estimate. However, it is just an opinion, and the imperfect data from the market approach is often good enough to help form a reasonable opinion.
- Generally, specific transaction data has not been very useful to me over the years … other than sanity check info. There are just too many problems with getting apples-to-apples comparisons.
- Market data is useful in gauging the terms and structure of transactions. For example, if the value of the subject is $X, how would a buyer and seller structure a transaction for $X?
- Ninety-nine percent of the time I reject the public transaction data as comparables are simply too big to compare to a smaller firm. Seventy-five percent of the time I only utilize the private transaction data as a reasonableness check on the income approach. Most of the data from the leading databases is quite old, but if value is similar to income approach, I might apply secondary weighting to the market approach to hedge my bets. I think most appraisers fall into this pattern.
- Examination and consideration of market data is an important part of most business valuations. The data is not perfect, and much may not be known about a given transaction, but it is what many buyers, sellers, and intermediaries use to price and justify value. In each case, it is the appraiser's judgment that is most important in interpreting and applying the information derived from various market transaction data sources.
Given the continued interest in (and extremes of) the debate on the market approach, we’ve left our online survey open. Please take the time to add your answers and comments; we’ll continue to highlight the results next week—in particular, how appraisers use market data to calculate capital inputs for their subject company. We’ll also feature the complete survey results in “The Market Approach Today: Deciphering Messages From the Courts, and Common Appraisal Errors,” featuring Robert Schlegel (Houlihan), Alina Niculita (SPV), and Chris Treharne (Gibraltar) on August 2.
GAO study praises IRS engineering section, but critiques art staff
After the passage of the Pension Protection Act in 2006, which created a penalty for improper appraiser practices and qualifications, and then the Tax Technical Corrections Act of 2007, which extended the penalty for misstated appraisals to estate and gift taxes, the General Accounting Office (GAO) undertook a study to explore three primary objectives:
- The extent to which individual, estate, and gift tax returns are likely to involve an appraiser and the extent to which the IRS audits them;
- How the IRS selects returns likely to involve appraisals for compliance examinations; and
- Whether the IRS’s appraisal experts are qualified.
The GAO released its findings last week: "Appraised Values on Tax Returns: Burdens on Taxpayers Could Be Reduced and Selected Practices Improved." A summary review doesn’t indicate any earthshaking insights or guidance. In general, the report commends the IRS’s engineering group for maintaining high appraisal standards and skills among its staff, but says “gaps exist” in training for its art appraisal staff. Also, the GAO recommends raising the current $5,000 threshold at which taxpayers must obtain appraisals for noncash contributions to $10,000. “Appraisers play a large role in the amount of tax reported on estate returns, but have less pronounced effects on gift and individual tax returns,” the study concludes. “Although the IRS does not specifically target tax returns that involve appraisals, the policies and procedures that the IRS has in place (e.g., targeting high-income individuals) ensures some coverage of returns that do involve appraisals.”
DE Chancery prefers supply-side ERP
If the recent Golden Telecom case was the first indication that Delaware courts are moving away from a historical equity risk premium (ERP), a new statutory appraisal action from the Delaware Court of Chancery confirms that a supply-side ERP may indeed be the courts’ preference, if not presumption. At issue was the merger of a private company that provided mental health services for state prison populations; the deal closed at $40 million, but a group of dissenting shareholders claimed the going concern value of the company was closer to $55 million.
Both parties’ experts used a capital asset pricing model (CAPM) to calculate a cost of equity, but the petitioners’ expert relied on a supply-side ERP of 5.73% while the respondents’ expert applied a historical risk premium of 6.47%, defending it as the “industry standard.” The court acknowledged its reliance on the historic ERP in the past, but then cited the following passage from Golden Telecom:
When the relevant professional community has mined additional data and pondered the reliability of past practice and come, by a healthy weight of reasoned opinion, to believe that a different practice should become the norm, this court's duty is to recognize that practice if, in the court's lay estimate, the practice is the most reliable available for use in an appraisal.
As a result, the Delaware Chancery adopted the 5.73% supply-side ERP as the “appropriate metric to be applied in valuing the company.” Its decision also discussed the appropriate beta to use in the case and rejected a novel “liquidity adjustment” to the size premium. Read the complete digest of Gearreald v. Just Care Inc., 2012 Del. Ch. LEXIS 91 (April 30, 2012) in the August 2012 issue of Business Valuation Update; the court’s decision will be posted soon at BVLaw.
Announcing the new BVR healthcare resource center
Question: What’s the name of the hottest new destination for everything related to healthcare valuation?
Answer: BVR’s Healthcare Industry Finance and Value Resource Center, of course! BVR and leading healthcare expert Mark Dietrich are thrilled to announce this launch and the new destination for valuation professionals, healthcare executives, hospital administrators, and physician-owners.
Front and center of this brand-new resource is the just-published, third edition of the BVR/AHLA Guide to Healthcare Valuation (edited by Dietrich). The new healthcare guide has added and/or updated 44 chapters, including a five-part view on physician compensation, valuation solutions for special situations, and a sample healthcare valuation report. You can view the complete table of contents on the above link (which is also available at the HC Resource Center main page).
At the new HC Resource Center, you’ll also find plenty of additional tools, such as benchmarking and practice specialty guides. If you hold any stake in the healthcare valuation arena, you’ll want to sign up for the Healthcare Value Wire, the free twice-monthly ezine published by the HC Resource Center. Bookmark the page, enjoy the resources, and watch your healthcare valuation world transform!
Damodaran: ERP is the ‘receptacle for all macro-economic fears’
Professor Aswath Damodaran has just posted his latest monthly update to the domestic equity risk premium on his website: 6.17% as of June 29. Implicit in his calculations are two key points, Damodaran emphasizes in his latest post to Musings on Markets (also available at his site): “The first is that the equity risk premium is a macro number that applies to all stocks. The second is that the ERP is the receptacle, in intrinsic valuation, for all macro-economic fears.” In fact, Damodaran continues to use the ERP as a vehicle for discussing the latest macroeconomic crises, from the U.S. ratings downgrade last summer to the more recent “default dances” in Europe.
“Should equity risk premiums vary across countries?” Damodaran asks. At first glance, the answer might be, “Of course!” After all, Greece and Russia are riskier countries to invest in than, say, Switzerland or Canada. But “there are two scenarios [in which] country risk will cease to matter,” he says. The first is when the country risk is idiosyncratic, i.e., it has no spillover effect to other countries. The second assumes the increasing “global diversification” of investors’ portfolios permits the computation of a “global” ERP, one which captures macroeconomic risks around the world and estimates betas for individual companies against a global equity index.
“Both assumptions are difficult to sustain,” Damodaran says. Institutional restrictions plus investor biases still make global diversification difficult. Bottom line: “I think that ERPs do vary across countries, with higher ERPs applying to riskier countries. Applying the same ERPs across companies will lead you to overvalue companies that have higher exposure to emerging markets.”
IVSC releases two new ‘TIPS’ on cost approach and intangibles
The International Valuation Standards Council (IVSC) has just published its first two technical information papers (known as TIPs): “The Cost Approach for Tangible Assets” (TIP 2) and “The Valuation of Intangible Assets” (TIP 3). TIP 1, “Discounted Cash Flow,” is still in production and should be available by the middle of this month.
“The principal objective of an IVSC TIP is to provide information and guidance to support the application of the principles in the International Valuation Standards,” says an IVSC release. Each TIP costs £15 ($23.26) plus postage and handling; order from the IVSC website, where you can also find the IVSC’s Code of Ethical Principles for Professional Valuers (£10/$15.51 per copy). While you’re there, you may notice that the IVSC just redesigned and expanded its website, with enhanced functionality and a new search engine.
FASB issues exposure draft on Topic 825: Financial Instruments
Just before the holiday on July 4, the Financial Accounting Standards Board (FASB) released its "Proposed Accounting Standards Update: Financial Instruments (Topic 825): Disclosures About Liquidity Risks and Interest Rate Risk."
“The Update is intended to address stakeholders’ concerns about how organizations disclose their exposures to certain risks related to financial assets, liabilities, obligations, and other financial instruments,” says the FASB, in a related announcement. “Specifically, the ASU proposes new disclosures related to liquidity risk and interest rate risk, two risks that were prominent during the recent financial crisis and that continue to be relevant to reporting organizations on an ongoing basis.”
Under the proposed liquidity disclosures standards, the reporting organization would provide information about any risks it might encounter in meeting its financial obligations. This would apply to all public, private, and not-for-profit organizations. “However, the nature of the disclosures will depend on whether the reporting organization is considered a financial institution, as defined by the proposed update.” The proposed interest rate risk disclosures would apply only to financial institutions and would provide information about the exposure of the entity’s assets and liabilities to fluctuations in market interest rates. Comments to the exposure draft are invited by Sept. 25, 2012.
Are CFOs making ‘dangerous assumptions’ about their COC?
A new article, “Do You Know Your Cost of Capital?” by the Harvard Business Review Magazine, reports that 90% of top financial officers in companies use the CAPM to estimate their cost of equity, “but that is where the consensus ends.” Based on a recent survey of CFOs, the article posits that the “300 respondents probably don’t know as much about their cost of capital as they think they do,” and in fact, may be making some “dangerous assumptions” in putting together their financial models. For instance, “the miscalculations begin with the forecast periods,” the article says, and then extend to the terminal value, the cost of debt, the risk-free rate, the “equity market premium,” and the company-specific and project-specific risks.
What’s the danger in all these disparate assumptions? They may be leading to a woefully deficient deployment of capital in the current economy. “Despite record-low borrowing costs and record-high cash balances,” the article says, “capital expenditures by U.S. companies are projected to be flat or to decline slightly in 2012, indicating that most businesses are not adjusting their investment policies to reflect the decline in their cost of capital.” With over $2 trillion at stake in corporate coffers, “the hour has come for an honest debate about how best to determine investment time horizons, cost of capital, and project risk adjustment,” the article concludes. “And it is past time for nonfinancial corporate directors to get up to speed on how the companies they oversee evaluate investments.”
A summer full of CPE
Catch up on all your much-needed CPE this summer, with the following three webinars from BVR:
- On July 12, join Ronald Seaman (DLOM Inc.) for "LEAPS and the DLOM," an in-depth look at applying LEAPS data to the determination and analysis of marketability discounts. Special pricing is available for attendees who also purchase Seaman’s book, LEAPs and the DLOM.
- On July 24, BVR’s Online Symposium on Healthcare Valuation and Online Symposium on Litigation & Economic Damages continue with "Lost Profits in Physician Practices," featuring Mark Dietrich and covering the analysis, determination, and defensibility of assessing damages for medical firms.
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