North Carolina court validates IP valuation methods

A new statutory buy-out case demonstrates “the extreme difficulty” in valuing an early-stage company with no other assets than untested technology. One of the key problems: how to protect majority shareholders from reaping a windfall if the patented portfolios prove to be highly valuable without requiring them to overpay should the market fail to adopt the technology.

Mike Pellegrino was the court-appointed expert.  “Pellegrino has been recognized as one of the world’s leading experts in intellectual property valuation,” the court said, in Vernon v. Cuomo, 06CVS8416 (N.C. Super. Ct., March 15, 2010). His valuation report “set forth clearly and in layman’s terms the factors, limitations, assumptions, and methodologies used to determine fair value.”  Pellegrino also used statistical models (simulation algorithms and Monte Carlo simulations) to calculate fair value based on discounted future income. His approach was “appropriate for this type of business and clearly in the mainstream of IP valuation methodologies,” the court concluded.

The court’s decision validates the analysis methods that Pellegrino discusses at length in BVR’s Guide to Intellectual Property Valuation, in particular, the challenges of understanding the factors specific to the IP and also its value proposition, including estimating market share and adoption, taxes, risk, patent regulation and protections, operating budgets and capital requirements. Look for a compete digest of the North Carolina decision in a forthcoming (May 2010) Business Valuation Update™.

Has FASB taken the first real step toward fair value accounting?

“When the history of accounting in the United States is written, March 10, 2010 will go down as one of the key dates,” says Alfred King (Marshall & Stevens), in a new op-ed piece for next week’s issue of Accounting Today. That was the day the Financial Accounting Standards Board (FASB) met to consider whether U.S. GAAP should include guidance similar to IAS 40, Investment Properties (part of IFRS). This is “really big news,” King tells the BVWire™. If passed, the proposed new project would converge with IAS40, “and would permit U.S. companies, for the first time to write up assets—something we have never done.”

IAS 40 currently distinguishes passive investment property capable of generating cash flows independently of other assets, from property that the entity actively manages with the rest of its operations. This distinction is problematic.  “Investment property can be reported at Fair Value, or not, under IAS 40. This could lead to disparate accounting for otherwise identical structures,” King writes in his op-ed piece, before adding (with emphasis): “Adoption of full convergence with IAS 40 will introduce true Fair Value accounting to users of U. S. GAAP.  Are we ready for this?  Do we need it? Do we want it?” Adoption of the new standard will change the ways in which companies manage their business; the focus will switch from operations to investment. “The FASB decision to consider adoption of IAS 40, as part of a convergence effort, may seem to be a minor blip in the course of recent development in GAAP,” King concludes. “To the contrary, in [my] opinion it is the start of a truly major revolution in financial reporting.” 

Matthews and Wachter challenge Delaware court’s use of IMD

The role of the expert is to enlighten and inform the court, says Gill Matthews (Sutter Securities Inc.), and this mandate is particularly true with regards to the Implied Minority Discount (IMD).   The Delaware Chancery Court typically adjusts the comparable company analysis (CCA) upward, based on an IMD derived from control premiums.  But the “IMD rationale used by the Chancery Court is inconsistent with modern finance techniques,” says Michael Wachter (University of Pennsylvania) in the “Implied Minority Discounts in Statutory Fair Value: The Doctrine that Won’t Die”, a 100-minute BVR teleconference.

Matthews identifies two sources of error in this approach; not only is there a misunderstanding of going concern value, but there is a statistical bias in the acquisition premium studies that the courts use.

“The phrase ‘control premium’ is ambiguous,” says Matthews, The ambiguity can be avoided if experts used the levels-of-value model set forth in Chris Mercer’s Business Valuation: An Integrated Theory.  Mercer makes a clear distinction between financial control premium (FCP), strategic control premium (SCP), and acquisition Control Premium (ACP).  The Delaware Court uses ACP, and it is the expert’s role to education the Court on the differences between the levels of control and why IMD is no longer accepted by valuation experts. Matthews urges experts to read and apply Mercer’s integrated theory of business valuation.

For further reading on the subject read last week’s BVWire, or "What we have here is a failure to communicate” in the December 2009 issue of Business Valuation Update. The teleconference is also available for download.

Free BVR webinar on using the Butler-Pinkerton Calculator as an additional cost of capital tool

 On Wednesday, March 31 BVR will host Gary Trugman and BPC creator Peter J. Butler in “The Butler Pinkerton Calculator: Come and See What All the Hoopla Is About”, a free one-hour webinar.   “I have read many articles and papers on various valuation topics over my 27 years in the valuation arena, but I do not recall ever seeing so much controversy as I have seen written about the Butler-Pinkerton Calculator (BPC), ” Gary said in BVU last month.  BPC continues to extend its offering of international market data, but its use as a business valuation tool has been a continuing source of debate.

Butler and Trugman will discuss both the proper use of this powerful business valuation tool, and the current major concerns about total beta and it’s application to cost of equity calculations. Trugman admits “I had to attend four different presentations about the BPC before I finally felt like I was starting to understand it.”
“The Butler Pinkerton Calculatr: Come and See What All the Hoopla is About” begins at 10:00 am PT/1:00 pm ET; 1 CPE credit is available.  Click here to register for free

Why should public companies get all the standard
setting attention?

John Hepp and Gary Illiano of Grant Thornton (GT) just released Private Company Financial Reporting, a white paper examining accounting standards for private businesses.
NASBA, AICPA, and TAF called a panel in December 2009 because of increasing concern about the relevance of current accounting standards for private companies. Hepp and Illiano’s paper presents the case for a reexamination of private company accounting standards and looks at the impact of gradual changes to the financial reporting model.

“In my view, the crucial point in the GT paper relates to changing definitions of critical terms in the world of accounting standard-setting, and the fact that the definition of some terms has shifted over time toward the ‘financial economics’ or ‘capital markets’ model,” says Edith Orenstein of the Financial Reporting Blog.

Click on this link for the full white paper.


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