New Duff & Phelps Report: Historical ERP trends downward

The just released Duff & Phelps, LLC Risk Premium Report 2009 provides updated risk premium data based on average returns through December 31, 2008. As in prior years, the Report presents information on rates of return related to company size and fundamental company risk. The size portion details findings categorized by two market-value-based measures and six “fundamental” or accounting-based measures. The risk portion analyzes data against the three fundamental measures of business risk—operating margin, variability of operating margin, and variability of return on invested capital.

New this year are the size measures of the companies comprising the portfolio of the smallest companies (25th portfolio). This data will assist users in determining the appropriateness of extrapolating the return data to small companies.

The 2009 Report also shows that the historical equity risk premiums (ERP) over long-term risk-free rates for the measures of 5-Year Average Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) and Net Income have decreased in 2008 as compared to the previous year’s report, as shown below: 

Equity Risk Premium by Portfolio Size Ranking





Measure Used for Size







5-Year Average EBITDA







5-Year Average Net Income







The new historical equity risk premiums, including the additional measures of Sales and Total Assets, can also be found in Business Valuation Update™ in its monthly “Cost of Capital” feature. The entire 2009 Report is now available through BVResources.

For more on why and how to use the Risk Premium Report in today’s environment, download Duff & Phelps Managing Director Roger Grabowski’s discussion of how the current economic environment has created problems with the traditional methods we employ for estimating discount rates for equity capital (expected return or required rate of return on equity capital).

Helping appraisers capitalize on the opportunities and navigate the pitfalls of the Pension Protection Act of 2006

The expansion of IRS rules defining appraiser responsibilities and standards has cut both ways for BV practitioners. The American Job Creation Act (2004), the Pension Protection Act (2006), and related IRS guidelines, rules, and regulations have opened the door to new business for appraisers. However, they have also defined new regulations and penalties for those practicing before the IRS. The bottom line: Proper interpretation can lead to a business advantage. Misinterpreting the responsibilities they set forth can have dire consequences.

IRS New Rules: Pension Protection Act and Beyond, a 100-minute BVR/IBA teleconference, will feature an all-star panel—tax attorney William Forsberg, Internal Revenue Service territory director Michael Gregory, the Institute of Business Appraisers’ executive director Howard Lewis, and business appraisal expert and moderator Robert Cimasi, president of St. Louis, Missouri’s Health Capital Consultants. The panel’s diverse viewpoints will give the guidance all BV practitioners need. This teleconference will take place today, Wednesday, March 18 from 10:00am-11:40am PST/1:00pm-2:40pm EST. Attendees can receive 2 CPE and/or 1.5 CLE credits. To find out more or to register, click here.

Survey highlights the relationship of IP assets in M&A and their importance in driving additional value for transactions

The M&A Insights: Spotlight on Intellectual Property Rights survey examines how corporate executives and private equity practitioners value intellectual property (IP) assets, and how they respond to the unique challenges and opportunities presented by IP. The survey—conducted by mergermarket, an independent Mergers and Acquisitions (M&A) intelligence service, and sponsored by CRA International, Inc. and the K&L Gates law firm—shows that corporate and private equity (PE) continue to recognize IP assets as a critical source of M&A transactional value and risk in today’s knowledge-based economy. It also indicates areas where corporate and PE are in consensus and where they are in conflict. Key findings:

  1. The majority of respondents (52%) believe IP will become more important to overall M&A activity in the next five years. Given the uncertain economic climate, this is seen as a shift in focus to the long-term performance of deals.
  2. When evaluating a target, 85% of corporate respondents and 72% of PE respondents view IP assets as being as important as or more important than other assets.
  3. Respondents differed in their focus on IP valuation: When asked how often they value IP assets, 32% of corporate respondents report that they always explicitly value IP assets, while 44% of PE respondents say they value IP assets less than a quarter of the time.
  4. The majority of all respondents (80%) believes that the most common consequence of insufficient due diligence is the failure to properly identify IP risks. However, a majority of corporate respondents (56%) believes insufficient time is the main challenge in conducting due diligence of IP assets, followed by lack of sufficient resources (46%). PE respondents (50%) cite the failure to link identified legal issues to the valuation models as a main challenge.
  5. During due diligence, surprisingly few respondents indicated the critical importance of understanding proprietary information and all related policies. Only 32% of corporate respondents emphasized its importance while no PE respondents identified it as a vital part of the valuation process.

George Dickos, Co-Coordinator of K&L Gates’ Intellectual Property Practice, said, “Given the global increase in the issuance of patents and trademark registrations, it seems quite consistent that IP is being viewed as more important in M&A transactions. However, it appears that due diligence relating to IP still isn't on the forefront of activities when corporate and private equity respondents initiate an M&A transaction. Like all assets, ownership of the target's IP must be confirmed and clearly documented. Sophisticated legal and financial analyses regarding IP issues during the due diligence phase can give a much better picture up-front of possible competitive advantages, opportunities and pitfalls.”

Why Total Beta trumps all other betas, courtesy of Pinkerton and Butler

Total Beta is the best and most complete measurement of risk for business appraisers to focus on in valuing privately held companies. Why? According to Keith Pinkerton, and Peter J. Butler, Total Beta:

  • Has the same perspective that we use to value private companies–namely as a stand-alone asset. All other measures of beta represent systematic risk as part of a well-diversified portfolio that is most appropriate if you are a money manager or stock analyst–not a business appraiser.
  • Captures 100% of historical (disclosed) risks. Such is the case, whether they are systematic or unsystematic risks, if the stock trades in an efficient market. No other measurement of beta, including Sum Beta, comes remotely close to this percentage.
  • Is generally much more stable than any other beta measurement, providing more confidence in the measure of risk to compare and contrast risk factors between guidelines and your closely held company.
  • Allows for direct comparison to public companies rather than relying upon averages of publicly traded data. For example: industry risk premiums used in the build-up approach capture all of the companies in an industry. Some of these companies may have little comparability to your private company. Gary Trugman’s book, Understanding Business Valuation: A Practical Guide to Valuing Small and Medium Sized Businesses, provides analyses of the Butler Pinkerton Model™:  “Now, instead of using the entire industry, we can choose better guideline data as a starting point.”
  • Captures all of the disclosed risks; one does not need to subjectively “correct” for any perceived low measurement of systematic risk—unless possibly the stock traded in an inefficient market.
  • Provides a means to defend and support one metric—Total Beta—rather than Market Beta, the size premium, and the CSRP to a judge, jury, or client. Moreover, all three of these inputs are generally more subjective (read: more volatile) than Total Beta.

What do you think? You can access a free download, “There is a ‘New’ Beta in Town—and It’s Not Called Total Beta for Nothing!” from the March 2009 BVU, at BVResources. Read Pinkerton and Butler’s article and share your views.

BV firms take it slow with hiring and layoffs, while planning for an economic rebound

It’s a sentiment offered by a number of BV firm insiders who took the time out to complete our short survey on recruitment and retention. One respondent noted: “This is a great opportunity to hire talent if you also have the ability to wait this out and be poised for whatever comes next. [It’s a] fantastic time to build infrastructure, create awareness in the marketplace, and get one's house in order.” Another who provided a similar sentiment, wrote the following: “The opportunities for valuation, litigation, and forensic services are out there. You have to work a little harder than in the past to get them. Too many people don't want to market their services and as a result see their practices decline. Attorneys, bankers, CPAs, insurance agents, etc. are prime markets for new work.”

Survey results are still coming in, so BV experts interested in offering their views can still take the survey online. As always, all responses are strictly confidential.

Clear your calendars: Spring marks the start of the BV conference season

It’s that time of year again! The business valuation conference season is already beginning to heat up, with BVR’s own Guideline Public Company Method- Exclusive Workshop with Rob Schlegel on March 26-27 in Miami. And in April, the CFA Institute will host the 2009 CFA Institute Annual Conference: Enduring Principles for Long-Term Investment Success in Orlando.

May is an especially busy month filled with a bevy of informative meetings:

The ASA’s (American Society of Appraisers) 2009 International Conference, taking place in Orlando on July 12-15, rounds out the spring and summer conference season. Think it’s too soon to start planning? Some conference planners offer early bird discounts for those who register well in advance, so now is the time to plan for all BV conferences, educational sessions, and events. To keep up with educational opportunities from a range of sources, visit BVR’s comprehensive BV-event calendar.

Countdown to April 2: SEC and FASB given three weeks to offer guidance on Fair Value

FASB Chairman Robert Herz and the Securities and Exchange Commission’s Acting Chief Accountant James Kroeker committed to providing guidance on fair value accounting in illiquid markets within three weeks at last week’s congressional hearing on mark-to-market accounting. One interesting twist: Rep. Ed Perlmutter, D-Colo. has proposed legislation to create a new federal board to oversee how accounting principles are applied to the financial markets.

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