Delaware Chancery adopts ‘unfamiliar’ DCCF methodology
Unusual circumstances require measures of the same order. The Delaware Court of Chancery regularly uses the discounted cash flow (DCF) method in statutory appraisal actions, but in a recent case that was not feasible.
‘Daunting task’: The case involved a group of related companies that operated in the flood barrier industry. The plaintiff had a 10% interest in the target company, which was lost when it merged with an affiliate. Under a shareholder agreement, she could force the company to repurchase her stake. In January 2012, she received an offer of $207.50 per share but declined and petitioned for a fair value determination from the Chancery.
There were multiple reasons, said the court (J. Glasscock), why the request “should be a daunting task for a law-trained judge.” For example, since this was a short-term merger, there was no reliable market price. Also, management produced no projections in the ordinary course of business. And revenue was unpredictable since sales depended on natural disasters and similar weather-related events. The target sold proprietary “Concertainer units”: rapidly deployable barriers that function as giant sandbags to protect against storms or floods. Three past events drove demand for the products during the relevant years, 2009, 2010, and 2011: an unusual dam project in the state of Washington; the BP oil spill; and the “500-year flood,” a disaster that affected three states. Their significance became a flashpoint between the parties; they argued over whether and how revenues resulting from them prefigured future revenues.
Both experts agreed that, absent cash flow projections, a DCF was not an option and performed the less common direct capitalization of cash flow (DCCF) analysis. The court said it was “unfamiliar with the methodology typically employed in a DCCF analysis” but adopted it. Because both experts agreed as to the necessary inputs and calculations, it focused on resolving disputes over values for each.
When it came to the appropriate cash flows for the analysis, the petitioner’s expert weighted the target’s actual revenues in 2010 and 2011 at 40% and 60% respectively. He then multiplied the resulting figure by a projected 55% profit margin and subtracted $1.5 million in estimated overhead expenses. The respondent’s expert weighted actual and “normalized” EBITDA figures for 2009, 2010, and 2011; the “normalized” figures backed out revenues earned from the three disasters, which the respondent took pains to characterize as “nonrecurring” events. This claim had no traction with the court, but it also questioned the petitioner expert’s unsubstantiated decision to weight the highest grossing year in the company’s history at 60%. The best predictor of future cash flows was the past cash flows for the three years, weighted equally, said the Chancery. In the final analysis, its DCCF analysis yielded a fair value of $364.24 per share.
Find an extended discussion of Laidler v. Hesco Bastion Environmental, Inc., 2014 Del. Ch. LEXIS 75 (May 12, 2014), in the July edition of Business Valuation Update; the court opinion will be available soon at BVLaw.
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Must-read case on BV report writing
“Explain everything” when writing a business valuation report, advises Howard Lewis (International Society of Business Analysts and RiskGuidance Co. LLC). Lewis, formerly with the IRS, spoke at the recent NYSSCPA Business Valuation Conference in New York City. He says the most common problem with reports is the failure to explain certain conclusions, especially discounts and multiples. “Don’t just state—explain.”
Under the radar: He asked conference attendees if anyone knew or could explain what the Gallagher case says about report writing. No one raised their hand. “I was shocked that no one appeared to know this case,” Lewis said later. “It’s a great report-writing case.”
In a detailed, comprehensive opinion by Judge Halpern, the U.S. Tax Court in Gallagher addresses nearly every aspect of private company valuation, including the application of the guideline public company method and income approaches. It also has a particular focus on tax affecting, adjustments to financial statements and cash flow projections, calculation of the rate of return, application of subsequent events, and the determination of discounts for lack of control and lack of marketability.
“Judge Halpern had many problems with both experts not being able to explain things,” says Lewis. “The judge destroyed both sides. Read it. It will help you understand your report writing—and your testimony.”
Free download: The full text of the case, Estate of Gallagher v. Commissioner, T.C. Memo. 2011-148, is available from BVR on its Free Resources page (registration required).
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Test drive the new BUM/WACC Calibrator
A working draft of a new tool to calibrate the cost of capital for small companies is now available for use—and your feedback is wanted!
The tool, the Build-up Method/WACC Calibrator, was developed by the team that gave us the implied private company pricing model (IPCPM). This is a cost of capital methodology for the valuation of small privately owned businesses (up to $50 million in revenue). IPCPM is powered by the implied private company price line (IPCPL), which uses a statistical sample of 500 small- and lower-middle-market transactions reported in the Pratt’s Stats database.
The IPCPM/IPCPL team, Bob Dohmeyer (Dohmeyer Valuation Corp.), Pete Butler (Valtrend), and Rod Burkert (Burkert Valuation), joined forces with Toby Tatum (Alliance Business Appraisal) to develop the tool, which is designed to calibrate your cost of capital developed with other sources (build-up method, total beta, etc.).
How to get it: The BUM/WACC Calibrator and user’s manual are available for download on the BVR website’s IPCPL page. The tool will expire every month, so you will need to download the updated version. Also on the IPCPL page, you’ll find links to more information on IPCPM and IPCPL, including free downloads of articles that explain the new methodology.
Feedback wanted: This tool is a work in progress, so your feedback is important. Download the Calibrator and try it out. Then, go to BVR’s LinkedIn page and join in the ongoing discussion about this tool and share your thoughts. The discussion is: The Implied Private Company Pricing Model: New Developments. Others are already trying it out, so you can see what they have to say.
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Grow your BV practice
A recent survey of participants in the Practice Builder Academy reveals that the biggest challenge facing business valuation professionals in growing their practices is getting work in the door. Almost all of the 75 responses centered around this theme. “More than a few people said they have been trying to grow their practices for more than 10 years,” says Rod Burkert (Burkert Valuation Advisors LLC), who created the academy with Mel Abraham, a valuation and entrepreneur expert. “While their tenacity is to be admired, it’s sad that so many are still trying so hard to get work.”
One tip: “Take the time to work on, not just in, your business,” Burkert advises. “For example, envision your successful practice X years from now. Who are your aspirational clients and referral sources? What are you doing to attract them?” Burkert offers more practice building tips in the upcoming July issue of Business Valuation Update (subscription required).
The Practice Builder Academy (PBA) is a 12-month mentoring program that teaches proven strategies to BVFLS professionals who want to build their practices and redesign their lives. A second program will be opening for the next wave of PBA participants at the NACVA Conference in Las Vegas (June 17-20). Burkert and Abraham will have a booth in the exhibit hall, so, if you’re attending the conference, stop by for more information.
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Finalists rave about the BVU/SPU Challenge
“You don’t learn this at school.” “Easily the best experience of my college career.” “I learned more from this than all my classes this semester. This will stand out on my resume.” “The Challenge has opened up the world of valuations to me and piqued my interest in the profession.”
This is some of the feedback from the finalists of the 2014 BVR/SPU Valuation Challenge, where 18 universities signed up to value a real business. Based on the completed evaluation forms, the Challenge was considered a great success by the participating universities. With that news, the Challenge will begin again this fall. Faculty and students interested in participating are encouraged to contact Dr. Herbert Kierulff and Adam Manson to sign up or for more information. There are cash prizes for the top three teams and a learning experience for all.
Students and faculty also benefitted from the complimentary use of data supplied by BVR and its partners. “The success of the Challenge depended heavily on the data that was supplied by BVR,” said Dr. Kierulff, Snellman Professor of Entrepreneurship and Finance at Seattle Pacific University.
BVR provided access to its Pratt’s Stats, Public Stats, Economic Outlook Update, Desktop Learning Center, and Business Valuation Update databases. BVR’s partners also teamed up with the Challenge to offer access to their valuable data. BVR would like to thank all of its great partners who offered access to their data as part of this learning experience, including:
Stay tuned for more information on the 2015 BVR/SPU Valuation Challenge.
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BV movers . . .
People: Scott Adair, chief financial officer of the Rochester-Genesee Regional Transportation Authority, is the 95th president of the New York State Society of CPAs … Darleen Armour joins BDO Consulting as a director in the Los Angeles office … Peter Thacker has been promoted to senior manager at Keiter of Richmond, Va.
Firms: Atchley & Associates LLP of Austin, Texas, was awarded the Ethics in Business Award in the small business category by RecognizeGood, a nonprofit that recognizes individuals and companies who selflessly improve their communities … Berdon LLP of New York City was awarded the best “Integrated Branding Program” by ceremony of the Association of Accounting Marketing Summit … VWC of Seattle is the newest member of BKR International.
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CPE events
Advanced Workshop on Monte Carlo Simulations: Applications & Examples (June 12), featuring David Dufendach, Randy Heng, and Oksana Westerbeke (all Grant Thornton). For any appraiser avoiding the perceived complexities and challenges of implementing, analyzing, and explaining Monte Carlo simulations, face your fears head on in this intensive, hands-on, four-hour workshop. Don’t let this opportunity slip by.
Valuing Urgent Care Centers (June 24), featuring Elliot Jeter (VMG Health). As access to healthcare expands, unmet demand and limited supply have led to the brisk growth of urgent care centers. Learn how to value businesses in this expanding segment of the healthcare economy, which is rapidly becoming an acquisition target of hospital groups and whose growth is expected to reach 40% by 2017.
Throughout July, BVR's Advanced Webinar Series on Valuations for Business Transactions focuses on the opportunities, challenges, and pitfalls for private business appraisers in transaction markets. This four-part series, curated by Craig Jacobson (Citrin Cooperman & Co.), will cover how private business appraisals are being prepared and consumed by investment banks, private equity groups, financiers, and shareholders and how new and emerging regulations are affecting these appraisal and reporting processes.
Solvency Opinions (July 9), featuring Jacobson and Stephen Selbst (Herrick Feinstein).
Opportunities and Variations between Private Business Appraisal and Appraisals for Transactions (July 16), featuring Jeff Tarbell (Houlihan Lokey) and Jacobson.
Private Business Appraisal Opportunities with Private Equity Portfolio Companies (July 23), featuring Summer Parrish (Valuation Research Corp.).
Fairness Opinions (July 30), featuring John Ashbrook (FMV Opinions).
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We welcome your feedback and comments. Contact the editor, Andy Dzamba at:
info@bvresources.com or (503) 291-7963 |
