ESOP valuations may be at a turning point

At last week’s inaugural ESOP Virtual Conference hosted by the American Society of Appraisers, the landmark Bowers case was discussed, which could represent a turning point for ESOP valuations.

Here’s the story: For over a decade, the Department of Labor has had a very aggressive enforcement stance and had not lost a major ESOP case on a valuation issue. But its winning streak ended with the Bowers case, which involved many key valuation issues that came up in prior cases as well. As in those cases, the DOL alleged that the ESOP paid more than fair market value for stock of the sponsor company. Valuation experts have long maintained that the DOL has been playing by its own valuation rules—rules that are not consistent with accepted valuation standards. But the DOL had a long track record of success using its own rules. In a stunning rebuke, the district court ruled against the DOL, stressing that the agency failed to follow standard valuation practices.

The case is “very good news” for the valuation profession, speakers at the ASA conference said, and it is “very helpful” to the ESOP community as well. The case could change the course of litigation, and it also may open the door for the DOL to finalize (at long last) regulations regarding ESOP valuations that were proposed back in 1988 (yes, 1988). Instead of finalizing the regs, the DOL has been “legislating through litigation” and through a series of settlements (process agreements) between the agency and ESOP trustees. Some of the more recent settlements have not been favorable to the DOL, speakers said, so they have not been made public.

The case is Walsh v. Bowers, 2021 U.S. Dist. LEXIS 177184 (Sept. 17, 2021), and a case analysis and the full opinion are available on the BVLaw platform.

Extra: The testifying valuation experts in the Bowers case discussed details in an article that appeared in Business Valuation Update.

Appeals court affirms modified liquidation value in shareholder dispute

In a Michigan shareholder deadlock case, a special master recommended that a sale of shares from one shareholder to the other would yield more value than if the company were dissolved. The special master used a “modified liquidation value,” which was close to the middle between the liquidation value and the fair market value of the shares. The valuation did not account for cash advance receivables, the value of noncompetition agreements, or a going-concern value. It also did not consider certain expenses that would have been incurred if the company were dissolved. The plaintiffs challenged the valuation, but the appeals court affirmed it, finding no clear error on the part of the trial court. Plus, the parties showed an initial willingness to sell their stock for the amount the valuation indicated.

Butler comments on Damodaran’s ‘dynamite’ remarks regarding COE

Last weeks’ issue covered some very choice words (some of which we can’t print here) Aswath Damodaran (New York University Stern School of Business) made about various inputs some analysts use to determine the cost of equity (COE). His remarks triggered some comments from Peter J. Butler (Valtrend), who is the co-developer of the Butler Pinkerton Calculator, which offers empirical data for total cost of equity (TCOE) and company-specific risk premiums (CSRP).

“I listened to Professor Damodaran’s excellent presentation the other week titled, ‘In Search of a Steady State: Inflation, Interest Rates, and Value; The (Inflation) Genie Escapes the Bottle!’ And yes, as BVR indicates, the professor threw some dynamite on how some (but not all) appraisers develop a cost of equity for their privately held company, such as the use of:

• “A ‘normalized’ risk-free rate—whatever that is;

• “A stagnant and backward-looking historical risk premium; and

• “The alleged and dubious size premium, which he calls fiction.”

Butler continues: “He also offered some choice words over the use of the company-specific risk premium (CSRP). For what it’s worth, I have never used a CSRP either (although I have previously been lazy and called what I am actually capturing—an unsystematic risk premium—a CSRP to match, generally speaking, the BV community’s faulty nomenclature).”

“For what it’s worth, I have never added a completely qualitative CSRP to my cost of equity—to make my valuations ‘make sense,’” he says. “I have never had a subject company that is just so unique—so company-specific—that no other company in the world has the same (or at least very similar) risk profile. Rather, I have added an unsystematic risk premium in many (but not all) of my valuations for the last 15-plus years to adjust for the less-than-perfect diversification of hypothetical willing buyers and willing sellers in the private marketplace. How do I do this? ‘Simply’ with the use of total beta, which explicitly captures total risk and, therefore, implicitly captures unsystematic (and systematic) risk. Thus, there is no need to build up the rate and potentially and easily double count risk.”

Butler concludes: “If appraisers use beta in their development of the cost of equity, which I believe we all do in one form or another, it is time to start getting the full benefit of publicly traded stock returns. The only way to do that is to also use total beta.”

Extra: A full recap of Damodaran’s remarks on how to assess inflation’s impact on company valuation will be in the August issue of Business Valuation Update.

Takeaways from the ASA Fair Value Conference

The 2022 ASA NY Fair Value Conference was held in hybrid form (online and in-person from Hoboken, N.J.) on June 16, and here are some takeaways:

• The FASB has removed from its active agenda its project that was considering whether annual goodwill impairment tests should be done away with for public companies in favor of a new model that would include amortization (see last week’s issue for details);

• The most common mistake in developing cost of capital for a foreign entity is a mismatch between the discount rate and the currency underlying the forecast;

• There is currently no empirical support for including environmental, social, and governance (ESG) factors in the cost of capital—any impacts should be reflected in cash flows;

• It is believed that the new AICPA guide to business combinations will be released before the end of this year;

• Guidance is being developed for estimating a discount rate for fair value measurements for intangible assets;

• Inflation estimates for the U.S. over the long-term rose from 2.0% in June 2020 to 2.6% in May 2022; and

• Recent SEC guidance on SPAC warrant classification have put these entities under the microscope and resulted in a number of restatements.

More details on the sessions will be included in the August issue of Business Valuation Update.

The DCF is ‘untestable,’ per new paper

The discounted cash flow method works fine for bonds but not for businesses, projects, or stocks because it is untestable, claims a new paper. “While bonds can be viewed as examples of DCF pricing, this depends on their prices often being observable and their ‘expected’ cash flows typically being bounded above by their promised cash flows,” writes the paper’s author, J.B. Heaton (One Hat Research LLC). “For capital projects, businesses, and common stocks, there is simply no way to determine whether a DCF valuation is a good representation of the causal mechanisms behind market values.” The paper, “The DCF Valuation Methodology Is Untestable,” seems to relate price to value, which valuation analysts know are two different concepts.

Date change for webinar on new Stark FMV regs

Part 1 of a two-part BVR webinar series on the new Stark FMV regs, originally scheduled for June 28, will be held on July 26. The webinar, The New Stark FMV Is a Game-Changer: Foundational Concepts and Valuation Methodology, will be conducted by Timothy R. Smith (TS Healthcare Consulting), who will provide a critical and in-depth assessment of the new definitions of fair market value under the regulations for the federal physician self-referral law commonly known as the Stark Law. Smith is the author/editor of a new book, The Complete Guide to Fair Market Value Under the Stark Regulations, which will be available soon from BVR.

CBV Institute’s new board reflects commitment to diversity

Almost half of the 2022-23 board of directors of the CBV Institute are female, but the organization “will not stop here,” said Dr. Christine Sawchuk, the group’s president and CEO.

“Our efforts to achieve even broader diversity will remain an ongoing focus of our governance efforts.” The full slate of new board members can be found if you click here. The new board chair is Patrick Coady, a partner at KPMG (Ottawa, ON), who praised past board chair, Anish Chopra. “I know I speak for the entire board when I say Anish’s dedication to the Institute, along with his commitment to governance excellence and the Institute’s strategic direction, is greatly appreciated. It is safe to say he left his mark.” The CBV Institute is Canada’s valuation professional organization (VPO) and standard-setter.

IVSC annual meeting in Fort Lauderdale, Fla., September 14-16

After two years of virtual meetings, the International Valuation Standards Council (IVSC) will hold an in-person annual general meeting (AGM) at the Renaissance Marina Hotel in Fort Lauderdale, Fla., from September 14 to September 16. There will be panel sessions, public board meetings, meetings of the Advisory Forum, and the formal AGM. Some parts of the overall program are restricted to IVSC board members and sponsor/member organizations, but other sessions and all networking events are open to anyone with an interest in valuation and the work of the IVSC. The AGM 2022 sponsors are the American Society of Appraisers, The Appraisal Foundation, HypZert, and Taqeem (Saudi Authority for Accredited Valuers). You can check out the agenda and register if you click here.

BV movers . . .

People: Josh Lefcowitz, CPA/ABV/CFF, CFE, ASA, who leads the Valuation Services Group at Cohen & Co., has been elected to the firm’s board of managers; he is based in the firm’s Pittsburgh office and has over 20 years of public accounting experience providing a diverse group of clients with dispute advisory, forensic accounting, and valuation services related to businesses, intangible assets, purchase price allocations, intellectual property, oil and natural gas rights in Marcellus Shale formation, and goodwill impairment testing.

Firms: Memphis-based Mercer Capital celebrates its 40th anniversary as one of the premier independent business valuation and financial advisory firms in the U.S. … Owensboro, Ky.-based Riney Hancock CPAs PSC is adding Umbach & Associates LLP of Evansville, Ind., a firm that provides accounting, tax, litigation support, and audit and business valuation services to clients across multiple industries, including agriculture, real estate, and auto dealers … Eide Bailly is adding Seim Johnson LLP of Omaha, Neb., a deal that will establish Eide Bailly’s first office in Nebraska, adding 20 partners and 70 staff to the firm’s ranks … Seattle-based Moss Adams LLP is adding Hermosa Beach, Calif.-based Sousa & Weber, which provides accounting, tax, and business advisory services to a diverse client base across aerospace and defense, government contractors, real estate, and private clients.

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

CPE events

• BVLaw Case Update, July 13, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: R. James Alerding (Alerding Consulting LLC), James D. Ewart (James D. Ewart LLC), and Andrew Z. Soshnick (Faegre Drinker Biddle & Reath LLP). CPE credits: 2.0.

Join veteran valuation expert and BVR’s legal editor, Jim Alerding, as he welcomes fellow valuator Jim Ewart and family law attorney Drew Soshnick for a discussion of some of the most consequential recent valuation and financial litigation decisions from state and federal courts.

• Something From Nothing? Valuing Synergies in Acquisitions and Litigation, July 19, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Jack Schwager (FTI Consulting) and Brent Miller (FTI Consulting). CPE credits: 2.0.

The speakers discuss the identification, quantification, and assessment of synergies and the impact that analysis can have on acquisition decisions and litigation outcomes.

Holiday break

BVWire will take a break for the July 4 holiday next week. We will resume publication on July 13. Have a safe, happy holiday!