March 30, 2011 | Issue #102-5 Forward to a Friend

AICPA re-releases cheap stock practice aid; comments requested prior to May 31

The AICPA’s Financial Reporting Executive Committee has issued a working draft of the revised “cheap stock” practice aid (Valuation of Privately-Held-Company Equity Securities Issued as Compensation). The first version was issued in April of 2004, so the revised draft considers many changes in 409A/123R valuation practice since then. BVWire readers are encouraged to review the new working draft and submit their informal feedback by May 31, 2011.

AICPA practice aids provide “non-authoritative guidance and illustrations for valuation specialists, preparers, auditors and others interested parties regarding the valuation and disclosures related to privately held company equity securities issued as compensation.”

Moberly and Lyons argue IP is more valuable when protected by to your specific company risk checklist

Is intellectual property covered by a comprehensive, centrally governed security plan more valuable than the same property without such a plan? There are recent studies, that show catastrophes dealt with effectively as a result of an in-place response plan have a shorter effect on value (55 days, on the average).  So, the risk of loss due to damage to reputation is reduced.

Should this influence specific company risk analyses? BVWire participated in an international conference call last week, hosted by Mike Moberly (Knowledge Protection Strategies), with Sean Lyons (Risk-Intelligence-Security-Control (R.I.S.C.) International) in Ireland as guest presenter.  The thrust of Mr. Lyons’ engaging presentation was that as corporate defense programs evolve, from silos to enterprise security risk management systems, they should get a higher grade.  Lyons and Moberly think risk management has a particularly large influence on intellectual property and intangible assets: key employees, spyware, outsourcing, exporting and “deemed” exports, trade secrets and other confidential data, intellectual property bundles, industrial espionage, etc. 

It’s a strong argument that any specific company risk checklist should include a review of any asset protection plans in place. The more evolved the “defense” plan, the lower the risk, increasing the value of the asset defended.

Taxpayers win 9th Circuit victor in family LLC case

In the first phase of Linton v. United States, the federal district court (Washington) granted summary judgment for the government, finding that the taxpayers made indirect gifts of cash and property to their children when they signed documents on one day, purporting to authorize the transfer of assets to a family LLC, and then signed (but did not date) the documents that transferred equal LLC interests to each of their children. In the alternative, even if—by having their attorney date the LLC transfer documents nine days after the funding documents, the court found that the step transaction doctrine collapsed the transactions into a single occurrence and gift. Either way, the taxpayers lost their claim for 47% combined discounts applied to the transfer of LLC interests, and they appealed to the U.S. Court of Appeals for the Ninth Circuit.

The 9th Circuit reversed the district court on both points.  First, there was incomplete evidence regarding when the taxpayers objectively intended to effectuate their gifts, and the court remanded the case for further findings under applicable (Washington State) law. Second and more importantly, “the placing of assets into a limited liability entity such as an LLC is an ordinary and objectively reasonable business activity that makes sense with or without any subsequent gift,” the court held, citing the Tax Court’s decision in Holman v. Commissioner, 130 T.C. 170 (2008) (available at BVLaw). Accordingly, the step transaction doctrine did not apply to this case. Read the complete digest of Linton v. United States, 2011 WL 182314 (C.A. 9)(Jan. 21, 2011) in the May 2011 Business Valuation Update; the court’s decision will be posted soon at BVLaw.

Don’t look to private equity for positive valuations

Here’s a startling analysis of the investment returns and cost of capital for the “best and the brightest” owners of private companies–private equity fund managers and their wealthy individual and institutional investors: you’ve lost a ton of money since 2002 and you may be running out of cash.  A negative cashflow of over $250 billion, to be precise.  Perhaps a CD at a local bank would have been a better strategy?  What does this mean for an industry that, as Rob Slee and John Paglia report in their Pepperdine Private Capital Markets Survey, routinely predicts returns of over 20%?

Though the news so far in 2011 seems closer to breakeven, PitchBook, the leading provider of information on private capital markets and deals, offers this analysis in their latest news release:

In the past few years, limited partners have put more money into PE funds managed by U.S. investors than they have seen come back. From 2002 through the first half of 2010, those funds received a total of $1.07 trillion in contributions but distributed only $773 billion to their limited partners. For a three-year stretch from 2004 to 2006, the amount of distributions exceeded contributions, but in the following years, contributions dramatically outpaced distributions by $81 billion in 2007, $174 billion in 2008 and $78 billion in 2009. With contributions constantly exceeding distributions, limited partners have less money with which to make new fund commitments. However, the first half of 2010 showed positive signs. Even though the total amount of contributions still exceeded distributions, it was only by $7 billion. If 2011 continues on a similar track as 2010, we could find limited partners with more money in their pockets and more PE investors having better fundraising luck.

Controversial tiered investment valuation discounts often warranted and verified

Thanks to the Wills, Trusts & Estates Prof Blog for alerting us to William H. Frazier’s (Howard Frazier Barker Elliott) recent article “Valuation Discounts in Tiered Investments” (Trusts & Estates, Oct. 2010). In his article, Frazier asserts:

It’s important to realize that the discount isn’t an entity, a commodity or a “thing” in its own right, but merely a mathematical comparison of two separate concepts of value. The discount isn’t “selected,” but “determined” by a process that considers risk and reward in the context of alternative investments available in the marketplace.

If this is so, then the discount doesn’t exist because of a legal structure or design but because of the operation of economic forces that can be objectively demonstrated within a particular business construct. It’s not the complexity of the construct that gives rise to valuation differences but the existence of identifiable and measurable risk factors.

Last year Frazier and John Porter (Baker Botts LLP) were featured in BVR’s Valuing Tiered Partnership Structures webinar. Click here for the training pack.                  

FASB takes next small step towards improved standards for private company financial reporting

FASB’s parent organization, the Financial Accounting Foundation (FAF), has been indicating a desire to ramp up standard settings for private company financial reporting, supported by the release earlier this year of a report sponsored by FAF, the AICPA and the National Association of State Boards of Accountancy.

The news last Friday was that FAF intends to form a working group on this subject; this new group is supposed to issue an action plan by the end of 2011 on whether (or how) to devise rules that differ from public companies reporting requirements. An FAF release said “it will conduct outreach to stakeholders through roundtable meetings, surveys and meetings with advisory and constituent groups and others.”

It’s interesting to contemplate some of the areas where private company reporting would benefit from different standards–shareholder conflicts, family members on payroll, financial conditions of major shareholders, estate and wealth transfer agreements in place.   These would certainly help document issues that influence private company values, as would many others.  

BV firms seeing more fee pressure from law firms

It’s a sentiment offered by a number of BV firm insiders who completed our short survey on law firm clients. The respondents also indicated that law firms are getting worse at explaining the scope and legal issue of the engagement.

These trends indicate a need to educate your attorneys. Don’t take on a litigation engagement without sufficient time to prepare and disclose your expert opinion pursuant to the applicable rules. Make sure to get all the timeframes and deadlines in a case as soon as possible, so that you can send your “wish list” (document/discovery request) to the attorney with ample allowance for responses. Make sure the scope of your expert designation fits your experience and proposed testimony. Lastly, be realistic about costs and don’t whittle the scope of the engagement to fit the client’s budget if it compromises your ultimate opinion and/or compliance with professional standards.

2011 Duff & Phelps report (with the new Calculator) went in the mail this week…

The 2011 Duff & Phelps Risk Premium Report, including the new built-in risk free rate lookup and Calculator with multi-year options, has arrived from the team at D&P and shipped this week.  

Where to include synergies in a valuation report depends on if you know their value

This week on LinkedIn’s Valuation group Steven Storch (Imagem USA) asked “When writing a valuation report of a company on behalf of a strategic buyer, where would you include synergies, e.g. in the normalizing adjustments section or only in the actual valuation section?” 

Rob Burkert (Burkert Valuation Advisors) advised:

If you know, the close-to-near certainty, the $ synergies and where they will occur (revenues or operating expenses) I would put them in normalization adjustments. If you don't know the $ synergies then follow the advice given to me many years ago by my lovely wife (a CFA). Do the valuation with the "normal" normalizing adjustments. Then take a range of "% of synergies to be achieved" and recalculate the company value. So maybe the buyer expects to increase revenues by 15% and/or cut operating expenses by 5%. Construct a table that shows the value of the company for different ranges of the synergies expected to be achieved - say 10 to 20% on the revenue side and 0 to 10% on the expense side. Presto.

The "% of synergies to be achieved" method works great when you are calculating an investment value for a seller if there are multiple synergistic buyers. You can run one valuation and assume all of the buyers' offers will fall in the range of the sensitivity table. In order to accomplish this, I ask the seller: Given what you know about your business and the potential buyers, what do you think those buyers would do with your company ... i.e., in terms of revenue enhancements or cost cuts.

Pre-IPO discounts useful in a variety of valuation settings

During last week’s BVR webinar “Discounts for Lack of Marketability – Beyond 2 YearsBrian Pearson (Valuation Advisors LLC) discussed a major addition to the Valuation Advisors Lack of Marketability Discount Studya dataset of discounts where pre-IPO transactions that are more than 2 years before an initial public offering.  These discounts were taken from the same sources which provided the original data included in the VAL database.  “Essentially, the further the transaction is from a liquidity event (i.e. the IPO), the higher the discount for lack of marketability.”

Pearson outlined situations in which a timeframe for a pre-IPO discount greater than 2 years would be useful:

    • Lack of profitability
    • Low margins
    • High levels of competition
    • Low industry barriers to entry
    • Low capital requirements for new entries
    • Little knowledge required to compete
    • No intellectual property or proprietary products
    • High year to year financial variability
    • Poor industry conditions
    • Significant legal risks
    • Potential political regulation
    • Lack of quality management
    • Lack of pricing power
    • Rapidly evolving industry conditions
    • High capital expenditure requirements
    • Rapid product obsolescence
    • No business succession plans

Management forecasts often present BV challenges

Whether for business valuation, shareholder dissent & oppression issues, matrimonial dissolution, lost profits analysis, fair value analysis, capital raising, or investment banking transactions, management-produced projections and forecasts are a vital part of examining any business.  Yet when these projections and forecasts are unreliable or fall short many appraisers are unable to remedy the situation. On May 5, in the “Advanced Workshop on Management Forecasts and Projections,” expert appraiser Christine Baker (ParenteBeard LLC) will examine these and other issues in her intensive three-hour interactive web workshop.  Using live tutorials and hands-on examples, Baker will show what to do when projections are incomplete or nonexistent, and what to do when an expert is asked to develop projections, among other issues.  Click here for more information or to register.

A great opportunity to expand the range of services you offer clients

Many observers point out that more than half the small businesses in North America will change ownership in the next 15 years.   This has led to growth in the exit planning field, including a number of new certification programs.   In BVWire’s opinion, one of the best is the five-day course offered by the Exit Planning Institute.  The next session is May 2-6 in Chicago; the course outline and links to further information and registration is here. EPI’s program leads to the Certified Exit Planning Advisor certification.

Learn how the experts value a company worth less than $2 million

Mark your calendars for “Valuing a Business Worth Less than $2 Million” on April 28.  In BVR’s latest “Industry Spotlight” webinar experts Ron Seigneur (Seigneur Gustafson), Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos), and Michelle Gallagher (Gallagher & Associates) will examine valuation challenges inherent in the very small company and what every appraiser should know when tackling these obstacles.  To register or find out more, click here.

U.S. Government plans to eliminate the Statistical Abstract

The Statistical Abstract of the United States has been a standard source of economic and industry statistics since 1878. The government is planning to eliminate the Statistical Abstract, the State and Metropolitan Area Data Book, County and City Data Book and the entire Statistical Compendia branch of the Census Bureau. If you are so inclined, send a letter to your Congress person to reinstate the budget for the publication.

Copyright © 2011 by Business Valuation Resources, LLC
BVWire™ (ISSN 1933-9364) is published weekly by
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The Anti-Kickback Statute and Stark Law: Avoiding Valuation of Referrals
April 26, 2011
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Valuing A Business Worth Less than $2 Million
Thursday, April 28, 2011, 10:00am - 11:40am PT Time
Featuring: Ron Seigneur, Kevin Yeanoplos, and Michelle Gallagher


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