March 7, 2012 | Issue #114-1  

Query: Is the debate helping or hurting DLOM under Daubert?

We’re still getting responses to the ongoing discussion on how valuation analysts derive the discount for lack of marketability (DLOM), not only from restricted stock studies, but other commonly used models. For instance, “any suggestion . . . that two alternative tools (the QMDM and Option Pricing Models) are less subjective than adjustments from [restricted stock] studies is surprising,” says Terry Lloyd (FSG).

“Actually, what we all seem to be grasping for is a magic formula to determine a LARGE marketability discount,” says Nancy Fannon (Fannon Valuation Group).“Maybe instead we should ask ourselves what our lack of being able to find one tells us.” In other words, she adds:

Private [company] valuation analysts already take enormous effective discounts for size, which is correlated with illiquidity, when we use a public market rate of return. If analysts don’t know “how much” illiquidity is already built into their discount rate, then how can they know “how much more” to take?  This strikes me as the crux of the problem plaguing the DLOM debate (that, and the utter lack of direct evidence of an appropriate discount over and above this amount). Frankly, it is the same problem that has plagued the S corp. debate; we never had a discussion about how much tax penalty was baked into the market returns we use, and [thus] how could we possibly know how much to remove? Without that understanding, these round-robin discussions on DLOM and S Corps will continue to go nowhere.

Along these lines, Mike Pellegrino (Pellegrino & Assoc.) points out, “Ultimately, a DLOM is a time-value of money issue. I want to sell a share in a private company at a certain price. When do I get my cash? We as a profession need to focus on the theoretical model that explains that relationship most consistently and across the entire economy,” he says. “Isn't such objectivity a crucial virtue to our profession?”

Otherwise, the protraction of the debate and its proprietary positions may start to look like professional “arrogance,” says G. Christopher Wright, an attorney and CPA. “No wonder courts routinely ignore valuation reports,” he says. Worse—we might ask whether courts could use the current controversy surrounding DLOM to find a lack of “common acceptance by professionals in the field,” one of the four requirements of reliability under Daubert. E-mail your thoughts to the editor.

Large U.S. commercial law firms have no value?

A recent report from Europa Partners—which values the top 10 U.K. law firms between $711 million and $4.1 billion—prompted U.S. legal consultant Jerome Kowalski (Kowalski & Assoc.) to wonder, “Is there a willing buyer out there for any of these firms?” At those values—wouldn’t the equity partners be scrambling to “cash in their chips”?

“We have all learned the hard way that lawyers, trusted business advisers to the global markets, have concocted the silliest business model” for their own firms, Kowalski observes in an online article. Any other business owner can build a viable enterprise and then look forward to selling it or leaving it to family, he says. “Lawyers can do neither.” The most they get on exit is a return of capital. “More painfully, a large commercial law firm has less than zero value on liquidation or winding down.”  Even under an FMV standard, a commercial law firm is worth “nothing, really,” Kowalski believes, primarily because its most valuable assets—its working partners—are free agents, whose professional code of ethics prohibits covenants not to compete. (U.K. rules are slightly different.)

Business appraisers—especially those who value law firms in divorce, under an FMV or FV standard—may beg to differ. In the meantime, given the “wrenching” changes wrought by the recent economic crisis, Kowalski predicts “the market—and clever lawyers—will develop a new structure for the delivery of legal services, which will have real value, be saleable and scalable.” Legal project outsourcing firms (LPOs) “have already figured out how to do so and may be soon eating our lunch,” he notes. “And their enterprises have real value.”

Three big accounting changes in proposed IPR&D guide

First of all—don’t call it a “practice aid.” The current working draft of the AICPA’s Assets Acquired to be Used in Research and Development Activities is now known as “an Accounting and Valuation Guide,” David Dufendach (Grant Thornton) explained, during his recent BVR webinar. More importantly, while the former practice aid focused on business combinations, the new guide “has expanded to talk about IPR&D valuation in the context of a non-business combination or an asset acquisition,” Dufendach said. He highlighted the following “high-level accounting issues” that comprise the “really big” changes:

  1. Unit of account. Factors in considering whether to combine IPR&D assets or value and record them separately include: their phase of development; the nature of the activities involved; and the intent to manage and/or transfer the assets (in combination or separately).
  2. Defensive assets. For those assets the acquirer will hold, abandon, or employ in some way other than their highest and best use, the guide suggests considering their useful lives “as a function of the life of the asset being defended,” Dufendach said.
  3. Core technology. The new guide dispenses with any definition or description of “core technology,” because under ASC 805, “these types of assets, processes, property, and institutional understandings may meet the criteria” for recognition on their own.

The new guide also covers “at length” the issues of recognition criteria as well as attributes of an acquired IPR&D project, Dufendach said. There is also extensive commentary on determining the useful life of IPR&D assets, highest and best use, and market participants. “For valuation specialists, I just remind everyone to pay very close attention to the accounting related part of the new guide, because it has a big impact on the way we think about valuation methods and assumptions and our results.”

AICPA extends comment deadline on both proposed guides

In addition to the IPR&D guide, the AICPA’s Financial Reporting Executive Committee (FinREC) has also issued a working draft of a second Accounting and Valuation Guide: Testing Goodwill for Impairment. Since then, FinREC has sought feedback on both working drafts “from valuation specialists, preparers, auditors, financial statement users, and other interested parties,” says Yelena Mishkevich, the AICPA’s technical manager for its Accounting Standards Team.

The original deadline for comments, March 15, fell just before the busy tax season. “Due to requests for additional time from respondents, comments on these two working drafts will now be accepted until May 24, 2012,” Mishkevich says. Anyone who wants to provide feedback should still send their comments by e-mail directly to To review the working drafts, here are the links to the Goodwill Impairment guide and the IPR&D guide.

Best ways for honing financial modeling skills

“I want to enhance my financial modeling skills and want to take some online course or tutorial,” says Roy Leon, a senior compliance officer at the British Columbia Securities Commission. “Does anyone have one to share?” he asks BVR’s forum on LinkedIn (membership required). Several good suggestions arrived:

  • Both Dhawal Chotai (Mind Tree) and Sean Callow, a CFO in community banking, recommended Financial Modeling, by Simon Benninga.
  • “If you find Benninga a little too advanced, another decent book is Chanda Sengupta's, Financial Analysis and Modeling Using Excel and VBA (2d Ed. 2010),” says Rimas Liktorius (ValuationMetrix). “Sengupta starts out with the basics of Excel and VBA before delving into the building of models.”
  • "Wall Street Training ( has a selection of very good programs,” according to David Mazzerella, a Denver investment banker, and Michael Mclaughlin (EisnerAmper).
  • “Take a look at Breaking into Wall Street,” says Wissam Otaky, a financial entrepreneur: “Some of it may be a little basic [but it’s] more focused on valuations.”
  • “You can also use Excel to do simulations, but that is the long and difficult way around the barn,” offers Mike Hanrahan, an analyst from Alaska. “Roger Myerson has a good discussion of how to do Excel simulations in his book, Probability Models for Economic Decisions (with CD-ROM).” In addition, Decision Making with Insight, by Prof. Sam Savage, “has some software and a good beginning [overview],” he says.

BVR also has a workshop tomorrow! BVR’s Advanced Workshop on Monte-Carlo Simulations, featuring David Dufendach and Jason Andrews (both Grant Thornton) takes place on Thursday, March 8. This intensive, four-hour workshop will demystify this particular financial modeling technique with hands-on examples and case studies generated in Oracle Crystal Ball (a co-sponsor), but presented in PowerPoint. The Excel data will be available as a handout, so that attendees can duplicate the results. Importantly: no purchase of Crystal Ball (or any other software) is required. The presenters will focus on the methodology and application of Monte-Carlo simulations outside of any specific program.

Appraisal malpractice: It’s all about the standards

After more than 150 years in practice, the “storied” international law firm, Coudert Brothers, began to wind down. When another large commercial firm offered to buy their New York practice, the Coudert partners engaged a reputable real estate appraisal firm to value the remaining eight years on their Manhattan office lease. The USPAP-certified appraisal came back at $18 million, and the Coudert partners ended up selling the lease for $16 million.

Two years later, Coudert went bankrupt, and the plan administrator sued the appraisal firm for malpractice. In support, the plaintiff hired a financial expert, a forensic accountant with no real estate certification, to refute the original appraisal and conduct her own valuation of the lease. The defendants moved to dismiss the expert’s calculations (and the case), saying not only did she fail to apply any appraisal standards in her critique of the original appraisal, but she failed to apply any commonly accepted standards to her own appraisal, which involved valuing the leasehold under a hypothetical sale or refinancing of the building, resulting in a range of value from $31 million to $39 million.

The dispositive question was whether the original appraisal firm exercised “due care” in its application of commonly accepted professional standards in the industry, in this case, USPAP, the court held. Yet, the plaintiff’s expert “totally failed to engage with those standards,” making her approach “particularly unreasonable” and unreliable, enough to support dismissal of all claims. Read the complete digest of Development Specialists, Inc. v. Weiser Realty Advisors LLC, 2012 U.S. Dist. LEXIS 8666 (Jan. 24, 2012), in the next Business Valuation Update; the court’s opinion will be posted soon at BVLaw.

HOU ASA is calling for energy content, speakers

“The ASA’s Houston Chapter is currently soliciting topic requests for their annual energy valuation seminar, to be held on September 13, 2012 in Houston, Texas,” says organizer Tim Stuhlreyer (CCA Appraisers). Last year’s inaugural event touched on a vast array of topics, from the valuation of oil and gas reserves to private transaction data available from an industry exchange, and from the current surge in energy-related investment vehicles, such as master limited partnerships and PE structures (and their valuation methods), to the future of alternative resources and other emerging energy markets.

If you have an idea for a topic or a presenter you would like to see included in the seminar, Stuhlreyer asks you to please e-mail your suggestion to him at

Good resource for making BV ‘rain’

“As a solo who continuously struggles with business development, I've come to appreciate the advice and ideas that I get from, a site dedicated to sales and marketing for firms selling professional services,” says Rick Warner (Great Lakes Valuation), who also regularly advises ASAers in their weekly E-Letter update. “Take a few minutes to visit this website,” he says (while also noting that he has no financial interest in it). “Whether you're struggling with marketing strategy, or tactics, this site may have something to help you over the hump and kick-start your own business development efforts.”

Al King (still) opposed to FV for financial accounting

Private companies continue to question the relevance of fair value for financial reporting, said Mark Zyla (Acuitas), during last week’s NACVA CTI 2012 Congress on Fair Value in Seattle. The pushback is the cost, “but that pushback is a one-way street,” he said, and “valuation practitioners can help educate private companies on why fair value measurements are important and relevant.”

“I take a diametrically opposite position,” said fellow presenter Alfred King (Marshall & Stevens). “I am not persuaded personally that the availability of fair value information is necessarily helpful to a company or its creditors or shareholders.” Take the example of publicly traded, closed-end mutual funds, which disclose their last trading price and net asset value (NAV) every day. King says:

The NAV of a closed-end mutual fund is the fair value of all the specific assets which that fund owns. Historically, most closed-end mutual funds sell at a discount to fair value, which is significantly above the closing price—but nothing happens. Why would shareholders be willing to hold onto stock at a discount when the actual assets are [ostensibly] worth more? As an individual shareholder you do not have access to that value. The bottom line from my perspective is that the availability of fair value information on assets that are not going to be sold is purely theoretical.

Look for highlight from the FV conference in future issues of Business Valuation Update.

BVR hosts ‘Cost of Capital’ week

Get all the most important updates on cost of capital plus CPE credits by registering for:

  • Introducing the 2012 Duff & Phelps Risk Premium Report & Calculator on March 13, featuring James Harrington (Duff & Phelps), co-author of the 2012 Duff & Phelps Risk Premium Report and co-creator of the Duff & Phelps Risk Premium Calculator, who will discuss all the new data and give a “live,” guided tour of the new Calculator. Registration is free to those who subscribe to the Calculator and/or purchase the 2012 report.


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