Duff & Phelps has decreased its recommended U.S. normalized risk-free rate from 3.0% to 2.5% for use as of June 30, 2020, according to a client alert. This new rate, used in conjunction with a (reaffirmed) recommended equity risk premium of 6.0%, implies a “base” U.S. cost of equity capital estimate of 8.5% (6.0% + 2.5%).

Most use spot yield: The concept of normalizing the risk-free rate emerged around the time of the 2008 financial crisis and is generally based on historical rates. A number of thought leaders disagree with the use of a normalized rate, including Professor Aswath Damodaran of the New York University Stern School of Business, who wrote that “you should be using today’s risk free rates and risk premiums, rather than normalized values, when valuing companies or making investment assessments.” In a BVWire survey from last year, most respondents said they use the 20-year spot yield on Treasury bonds for their risk-free rate. A quarter of respondents said they use the D&P normalized risk-free rate.

‘Particular facts’ justify discounts in mandatory buyback of minority interest, says Missouri
high court

Context is “crucial,” the Supreme Court of Missouri recently said in upholding the use of discounts in the court-ordered buyout of a minority owner’s shares in a family business. At the same time, the court acknowledged that, “usually,” the rationale for discounts in a mandated sale to a majority stockholder “would have limited application.”

Avoid double recovery: The impetus for this litigation was a dispute among three siblings holding equal interests in a family business. The plaintiff served as president and treasurer. When the company floundered during the 2008 recession, the two defendant siblings began to express dissatisfaction with the plaintiff’s management of the company. Eventually, they ousted the plaintiff from her positions and prevented her from entering company premises and accessing company records. When she was ousted, she received no salary, severance pay, benefits, or dividends as a shareholder of the company. The plaintiff sued the remaining shareholders for breach of fiduciary duty and shareholder oppression. The fiduciary duty case went to the jury, which awarded the plaintiff $390,000, which represented the increase in the company’s value for four years following her removal from the company. In a bench trial, the court found the defendants’ removal of the plaintiff was shareholder oppression and ordered a buyout of the plaintiff’s shares for fair value.

Both parties presented valuation expert testimony, but the state Supreme Court’s opinion contains little detail. It says the trial court stated the defense expert “applied marketability and minority discounts primarily, but not exclusively because the jury had already awarded [the plaintiff] a return on capital for a period of years following her termination” based on the original breach of fiduciary duty trial. The defense expert explained the discounts served to avoid double recovery. The trial court adopted his fair value conclusion.

On appeal to the state Supreme Court, the plaintiff contested the fair value determination, specifically the imposition of discounts. Even if the discounts might be appropriate in determining fair value of minority shares “willingly sold to third parties on the open market,” discounts were not justified where the minority interest holder was forced to sell her shares to an oppressive majority shareholder, the plaintiff argued. She cited an 8th Circuit case, Swope v. Siegel-Robert, in which the U.S. Court of Appeals, in a dissenting shareholder action, said the applicable state statute did not allow for the use of discounts in the forced sale of a minority interest holder’s shares as this would penalize the minority shareholder and “encourage” the majority shareholders to take advantage of their power.

In the instant case, the state Supreme Court did not reject the 8th Circuit’s holding in the Swope case. Further, the high court said the trial court had not disputed the holding of Swope nor had it proposed any broad principle of law as to the application of these discounts. The trial court simply agreed with the defendants’ expert that, “on these particular facts … a discount was proper.” The “particular facts,” according to the high court, were that the jury, in awarding damages for breach of fiduciary duty, compensated the plaintiff for the increase in the company’s value for four years following her removal from the company. The state high court noted that the plaintiff’s claims of breach of fiduciary duty and shareholder oppression “clearly did overlap,” lending support to the defense expert’s testimony that discounts would avoid double recovery.

At the same time, the Supreme Court expended a lot of effort explaining how fair value does not equal fair market value and it went as far as overturning an old Missouri case in which the very court had suggested that, under state law, “fair value” and “fair market value” have the same general meaning.

A digest of Robinson v. Langenbach, 2020 Mo. LEXIS 192 (May 12, 2020), and the court’s opinion are available to subscribers of BVLaw. A digest of Swope v. Siegel-Robert, Inc., 243 F.3d 486 (8th Cir. 2001), and that court’s opinion are also on BVLaw.

New twist on valuing small promissory notes

For the past few years, Bruce Johnson (Munroe, Park & Johnson Inc.) has been using data from business development corporations (BDCs) to develop a base rate of interest for small (under $10 million) privately held promissory notes, he explained during a recent webinar. These notes often carry a small IRS-approved interest rate (AFR rates), and corporate bonds from large public companies, which yield around 4% to 6%, are not comparable. BDCs are publicly traded entities that make loans to small and medium-sized, privately held businesses. Average yields for debt-focused BDCs have been around 10% (although they have spiked higher recently due to COVID-19), so that yield is used as the base rate to which you would adjust for specific risk factors related to the note, such as payment history, presence of collateral, net worth of the issuer, and more. He gave several real-world examples of building up to a market rate of interest that would be used to calculate the net present value of the note.

Any challenges? A question from the audience asked whether this methodology has passed muster with the IRS. Johnson says that he has been using this methodology for several years for estate and gift purposes and has not had any returns audited or challenged yet. In fact, the IRS is using this methodology to value notes. Johnson reports that an IRS agent called him and wanted to make sure he was using it correctly. If challenged, Johnson feels confident it would stand up to scrutiny as it is simply the same methodology bond investors use, i.e., finding the closest comparable interest rate or guideline data to value the bond.

A recording of the webinar is available if you click here. (Purchase is required, but BVR’s webinar archive is available to holders of BVR Training Passports and transcripts of the webinar are available to subscribers of the BVResearch Pro platform.)

You heard it here first: the silent spread of
COVID-19

On June 27, 2020, an interesting article in the New York Times tells the story of how health officials dismissed the risk of symptomless transmission of the coronavirus. The article also says health officials pushed “misleading and contradictory claims in the face of mounting evidence” about the ability of people without symptoms to spread the coronavirus. Of course, how the virus spreads impacts the economy, which in turn impacts the businesses that valuation experts need to appraise.

Missed the boat: Back on April 28, 2020, healthcare finance and valuation expert Mark Dietrich (Mark O. Dietrich CPA, PC) pointed out asymptomatic transmission during a BVR webinar, saying that “many have seemed to miss the boat,” including the World Health Organization, individuals, and governments who were making decisions. A case reported in Germany back in late January revealed that an individual who seemed perfectly healthy spread the disease to someone else. Until then, scientists had believed that only people with symptoms could spread the coronavirus. Despite the German case and other evidence, the risk of symptomless spreading was downplayed during March and April, says the Times article. In the meantime, the virus continued its “silent spread” throughout the world.

Dietrich is the author of a new BVR briefing: “The Real Story of COVID-19 for Valuation and Litigation Experts.” If you are a subscriber to the BVResearch Pro platform, you already have this new briefing in your library!

New version of ‘Stout Restricted Stock Study Companion Guide’ now available

The most widely used restricted stock transaction database for providing empirical support for a discount for lack of marketability (DLOM) is the Stout Restricted Stock Study (formerly FMV Opinions). The 2020 version of the “Stout Restricted Stock Study Companion Guide” is now available. It reflects updated tables and graphs that contain new transactions. The study is updated quarterly and contains 759 screened transactions with up to 60 data fields. The database includes the Stout Calculator, which makes it easy to use Stout’s methodology and determine a DLOM driven by the financial characteristics of your subject company, as well as the volatility of the market. This is the preferred analysis as opposed to a simple listing of all the studies and their average discounts and then pulling a DLOM out of what may be perceived to be thin air. To download the new “Stout Restricted Stock Study Companion Guide,” click here.

NACVA adds to credentialed ranks

In the second quarter of 2020, 47 members of the National Association of Certified Valuators and Analysts (NACVA) earned the Certified Valuation Analyst (CVA) credential, according to an announcement. Also, one member earned the Master Analyst in Financial Forensics (MAFF) credential. These members completed the training, exam, and credentialing processes for the two credentials.

Stopgap for postponed National
Divorce Conference

The AAML/BVR National Divorce Conference in Las Vegas has been postponed, but there are so many important issues that the AAML/BVR Virtual Divorce Conference was created. The virtual event will begin September 9 with an agenda that has been streamlined to focus on the issues most impacted by COVID-19 that have upended valuations, particularly those for divorce. For those of you who had registered for the Vegas event, you will receive complimentary access to the virtual event. To check out the full agenda, click here. See you there!

Proposed international valuation method using Gordon model

With the valuation of a going concern in mind, a newly proposed international valuation method uses the constant perpetual expected growth model (Gordon growth model). The proposed method accounts for a currency risk premium and the economic interaction between cash flows and exchange rates. The method is discussed in a new paper, “International Valuation: A Proposed Method Using the Constant Perpetual Growth Model,” by Thomas J. O’Brien (University of Connecticut—Department of Finance).

Preview of the August 2020 issue of Business Valuation Update

Here’s what you’ll see:

• “25 Tips on Dealing With COVID-19 From the NACVA Conference” (BVR Editor). COVID-19 was a hot topic of discussion in a number of the sessions at the NACVA and the CTI’s 2020 Business Valuation and Financial Litigation Super Conference, which was held online over five full days (June 15-19).

• “Valuers Stand Ground in Clash Over Purchase Price in SPAC Merger” (J. Russell Frawley III, MBA, CPA, ABV, Frawley & Co. PLLC). A recent SPAC merger triggered a strong disagreement between a national valuation firm and the merged entity over the fair value of equity consideration issued for the target company. A special purpose acquisition company (SPAC) is a shell company that raises capital in an IPO and then acquires an operating company to form a new merged entity.

• “Understanding the Science of COVID-19 Is Key to Assessing Valuation Impacts” (Mark O. Dietrich, CPA). For the economy to recover, the origin, transmission, and “hot spots” related to the coronavirus have to be understood. Much of the economy is highly localized, so the nightmare of the spreading virus will impact future cash flow of the smaller businesses most valuation experts work with. This is an excerpt from the new BVR briefing: “The Real Story of COVID-19 for Valuation and Litigation Experts.”

• “Flaws in North Carolina Court’s Appraisal of Reynolds American” (Gilbert E. Matthews, CFA, Sutter Securities Inc.). The wrong valuation date, a faulty reliance on other cases, and the disregard of projections highlight the court’s opinion in a shareholder dissent case involving two tobacco giants.

• “Cost of Equity and COVID-19: What to Do? (Update)” (Peter J. Butler, CFA, ASA, Valtrend). Use a forward-looking approach, implied volatilities, and total beta to determine an appropriate cost of equity to supplement one’s analysis during today’s unprecedented times.

• “The SEC’s Not-So-Gentle Reminder: Show Your Work” (PJ Patel, ASA, CFA, Valuation Research Corp.). In a recent SEC comment letter to a company about its determination that no impairment of goodwill and intangible assets was needed, the agency sounded much like every math teacher we’ve all very likely encountered: Show your work!

The issue also includes:

• An expanded section of “BV News and Trends/Global BV News and Trends.”

• Regular features: “Ask the Experts” and “Tip of the Month.”

• BV data spotlight: “DealStats MVIC/EBITDA Trends,” “ktMINE Royalty Rate Data,” “Economic Outlook for the Month,” and the “Cost of Capital Center.”

• BVLaw Case Update: The latest court cases that involve business valuation issues.

To stay current on business valuation, check out the August 2020 issue of Business Valuation Update.

BV movers . . .

People: Henry Kaskov, ASA, has launched a business valuation practice, Kaskov Valuations Inc. in St. Charles, Ill.; formerly managing director at a boutique business valuation firm where he spent over 10 years, his new firm’s website is KaskovValuations.com … The National Association of Certified Valuators and Analysts (NACVA) has named its outstanding members for the first quarter 2020: Robert W. Carter, MS, CPA/CFF, CVA, CFE, CEPA, partner in charge of the Forensic & Valuation Services group at Hertzbach & Co. PA, and Dr. Robert K. Minniti, DBA, CPA, CFE, Cr.FA, CVA, MAFF, CFF, CGMA, PI, president and owner of Minniti CPA LLC … Annapoorani Bhat, ASA, has been admitted as a strategy and integration consulting principal at Knoxville, Tenn.-based PYA; Bhat specializes in valuation and related consulting services for companies in the health sciences sector.

Firms: Williams-Keepers LLC (Columbia, Mo.) is acquiring a Mexico, Mo.-based accounting firm, Mid-Missouri Accounting Services, which specializes in accounting, tax, payroll, and bookkeeping services … J.S. Held (Jericho, N.Y.) has acquired VWM Analytics (Los Angeles), an economic consulting and forensic accounting firm; VWM specializes in matters including business interruption, economic damages, personal injury and wrongful death, and commercial disputes.

Please send your professional and firm news to us at editor@bvresources.com.

CPE events

• BVLaw Case Update. July 22, 10:00 a.m.-11:15 a.m. PT/1:00 p.m.-2:15 p.m. ET. Featuring: Sylvia Golden, Esq. (Business Valuation Resources) and R. James Alerding (Alerding Consulting LLC).

  A discussion of some of the most consequential recent valuation decisions, including two key state court rulings on the use of discounts in valuing minority interests in buyback situations, a state court decision on the admissibility of calculations of value in divorce proceedings, an expansive statutory appraisal ruling involving a public company from a North Carolina court, and rulings from the U.S. Tax Court as well as the IRS’ Office of Chief Counsel on the appropriateness of considering possible scenarios and subsequent events in a valuation.

• Fair Value Measurements Amid the COVID-19 Crisis. July 29, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Brad Taylor (Marcum) and Nicholas Parseghian (Marcum)—part of BVR’s Special Series on Fair Value.

The disruption to global economic activity and financial markets suggest that a business-as-usual approach may no longer apply to fair value measurements. Consequently, reporting entities can expect fair value measurements to receive greater scrutiny from their auditors and a heighted level of audit documentation.