| March 5, 2014 | Issue #138-1 |
New Updates to the Risk Premium Calculator As Roger Grabowski discussed in a recent webinar, new functionality has been built into the Risk Premium Calculator (published by Duff & Phelps) that analyzes and reports on high financial risk companies – just one of many features never previously available in any other risk premium tool. The 2014 update of the Calculator with Duff & Phelps data through December 31, 2013 is now available. Plus, data that was previously published in the SBBI Valuation Yearbook will be added to the Calculator by the end of March 2014. The Calculator is a unique tool, which delivers historical equity risk premiums (ERPs) and size premiums for 25 size ranked portfolios using eight alternative measures of company size. Also available now is a PDF document, “Preview Version of the Market Results through 2013.” This document contains key year-end data as of 12/31/13 taken from the new 2014 Valuation Handbook—Guide to Cost of Capital. You will receive this PDF document if you preorder the Calculator or Handbook. The Handbook is available with a Calculator subscription or on its own. More details: To listen to the recording of the webinar that fully explains the new 2014 Valuation Handbook, click here. To receive the “Preview Version of the Market Results through 2013” PDF by email and preorder your copy of the Calculator and Handbook, click here. Tax Court explains how to value a holding company and discount for BICG liability Just as film critics predict that a movie they see today will be a contender in next year's Oscar race, we venture to say that the Tax Court’s recent Estate of Richmond opinion will be one of the most important valuation decisions of 2014. It deals with a number of hot topics: dividend capitalization versus net asset value (NAV) approach, discounting for BICG tax, and how to avoid an undervaluation penalty. The scenario: At the time of her death in December 2005, the decedent owned a 23.44% interest in a family-owned investment holding company (C corp) most of whose assets were publicly traded securities. The total assets then were worth nearly $52.16 million, of which $45 million—or 87.5% of the portfolio’s value—was unrealized appreciation. The built-in capital gain tax (BICG tax) on the unrealized appreciation was over $18.1 million. The executors retained an accounting firm to value the company stock for purposes of reporting estate tax. The CPA who did the initial appraisal was a member of various professional groups and the author of numerous valuation reports—but he was not a certified appraiser. The estate used his unsigned draft report to declare on Form 706 that the decedent’s interest was valued at $3.15 million. In sharp contrast, an auditor for the IRS determined the interest was worth over $9.2 million. This assessment prompted a deficiency notice and the estate’s petitioning the Tax Court for review. At trial, both sides gave expert testimony as to the fair market value of the decedent’s interest. The IRS expert used a discounted NAV approach. Broadly speaking, he began with the stipulated net asset value of $52.16 million to calculate that the decedent’s interest was worth $12.2 million. He then applied a 6% discount of lack of control (DLOC) and a 36% “marketability” discount that included a 15% discount for the BICG tax. He concluded the decedent’s interest was worth approximately $7.3 million—about 20% less than the value in the deficiency notice. The estate’s trial expert was different from the valuator doing the first appraisal. He was a certified business appraiser and valuation analyst, who used the capitalization-of-dividends method. Based on historical data, he assumed an annual 5% increase in dividend payments, which would continue indefinitely. He found the market rate of return for a company with a similar profile was about 10.25%, resulting in a capitalization rate of 5.25%. Dividing the decedent’s expected dividend return for the following year by the cap rate, he arrived at a present value of about $5 million for future dividends. Alternatively, the expert provided a valuation based on the NAV method; it essentially critiqued and modified elements of the IRS expert’s valuation. For example, he proposed a 100% BICG tax discount. ‘Standing on firm ground’: At the start of its analysis, the Tax Court noted that dividend capitalization was one legitimate way to value a business and “may be entirely appropriate where a company’s assets are difficult to value.” But this approach rests “entirely on estimates about the future.” And, the court continued, “even small variations in those estimates can have substantial effects on the value to be determined.” By relying on dividend capitalization, the estate’s expert “ignored the most concrete and reliable data of value … the actual market prices of the publicly traded securities” in the company’s portfolio, said the Tax Court. By contrast, the NAV method begins “by standing on firm ground—with stock values one can simply look up.” A potential investor would have known that the company held assets whose value was easily attainable and would take those values as a starting point. Next, the court dove into the “difficulties and uncertainties” going along with the NAV—determining the applicable discounts, including one for the BICG liability. It agreed that a BICG discount was appropriate but rejected the estate's proposed dollar-for-dollar reduction as "plainly wrong in a case like the present one." Also, the estate cited circuit case law that was not controlling. The IRS expert's calculation method was equally "problematic," said the court, but his $7.8 million bottom line was "reasonable." It adopted a 7.75% discount for lack of control and a 32.1% discount for lack of marketability. A secondary issue—but one that resonates with valuation professionals—was what type of appraisal may excuse an undervaluation and exempt the taxpayer from any accuracy-related penalty. The short answer: one prepared by a certified appraiser. Find an extended discussion of Estate of Richmond, 2014 Tax Ct. Memo LEXIS 26 (Feb. 11, 2014), in the April edition of Business Valuation Update; the court opinion will be available shortly at BVLaw. Peril of projections in ESOP valuations While valuation analysts have a duty to seek out “adequate and reliable data,” they could run into problems if they disregard projections prepared by management in favor of their own projections, says a recent article on ESOP valuations. Court trouble: “You need to do your own due diligence and you need to look at comparisons in the industry,” says Frank “Chip” Brown, ABV (Willamette Management Associates), in “DOL Enforcement Strategy Targets Problems in ESOP Valuations, Speaker Says.” The article is on the Bloomberg BNA website. Brown, speaking during a recent webinar, points out that “if you create the projections instead of management, my experience is that you're going to lose in a court case, because the judge is going to ask you if you know more than the company knows.” To access a recording of the webinar, click here (purchase required). To access the article, click here (subscription required). Value-based priorities for the healthcare industry Healthcare executives have a trifecta of value-based priorities they say they must focus on for the rest of 2014. The 10th annual Healthcare Trends and Forecasts in 2014 survey from the Healthcare Intelligence Network reveals that: (1) population health management (cited by 56% of respondents); (2) care coordination (51%); and (3) integrated care delivery (42%) are the front-burner initiatives for healthcare organizations. ACA impact: Survey respondents were also asked how they expect the Affordable Care Act (ACA) to impact their businesses for the rest of 2014. Some representative responses: “Our customer base will expand greatly with implementation of physician ACO [accountable care organizations] and bundled payment programs,” says a home health/hospice provider. “Less reimbursement. We will have to be smarter and more efficient in how we deliver care and reduce costs,” says a hospital/health system. One response underscores the uncertainty that surrounds health reform from the physician perspective. “Not sure. Lack of control on hospital service expansion will create even less competition in the marketplace, making physician led delivery networks even more difficult to develop and turn into successful enterprises,” says an independent practice association (IPA). A total of 136 healthcare companies responded to the survey, which asked 20 questions about front-burner healthcare concerns, the continuing impact of ACA implementation, and the best and worst business decisions (including lessons learned). For more information and to order a copy of Healthcare Trends and Forecasts in 2014, click here. Web chat: Ex-wife gets lesson in investment value vs. FMV A discussion thread on BVR’s LinkedIn Group concerns the exposure draft issued by the International Valuation Standards Council (IVSC) on the three principal bases of value contained within the IVS Framework: market value, investment value, and fair value. One commenter notes that there certainly is a “need to determine and clearly describe the appropriate basis of value (standard of value) as well as the step-by-step methodology and metrics utilized in each valuation.” And he gives a recent example about where these different bases can come into play. Rude awakening: The commenter recently did a valuation for a client to determine his company’s investment value for a proposed buyer. The company didn’t sell, but later the client was getting divorced and his ex-wife wanted a huge amount based on the valuation report. “I told the client not to worry,” he says. He then prepared a valuation report based upon the fair market value standard of value, which was much less than the investment value. Naturally, the ex-wife wasn’t happy. “For all I know, the disgruntled ex-wife, who finally understood the differences, became a valuation analyst.” Chris Mercer (Mercer Capital), who started the LinkedIn discussion, reminds us to submit comments by March 31 on the exposure draft. Mercer is on the IVSC Professional Board, which issued the exposure draft. New edition of essential guide to lost profits The most up-to-date thinking on lost profits and damages is in the new third edition of The Comprehensive Guide to Lost Profits and Other Commercial Damages, edited by Nancy J. Fannon and Jonathan Dunitz, Esq. The focus of the guide is financial evidence: how to gather it, interpret it, and tell its story in a lawsuit or litigation setting. It blends the financial expert’s knowledge of accepted methods and procedures with the attorney’s knowledge of legal issues and insights to provide a unique and in-depth analysis and interpretation of the continually expanding body of case law. Key highlights of the new edition include:
For more information and to see the table of contents, click here. BV Movers . . . People: Hanh Duong was promoted to tax senior manager at Pannell Kerr Forster of Houston … Michael Maloney, veteran forensic specialist, has left Navigant Consulting Inc. to join the SEC's Division of Enforcement as the chief accountant … Alvarez & Marsal has named Leslie Nielson a managing director in the firm’s New York City office; she will lead the Global Human Resources Tax practice … Charles Wilhoite, managing director of Willamette Management Associates in Portland, Ore., is the newest member of the Federal Reserve Bank of San Francisco’s 12th District's Economic Advisory Council; he will serve a three-year term effective January 2014. Firms: Pisenti & Brinker of Santa Rosa, Calif., is marking its 50th anniversary this year … Sikich LLP announced its merger with 403 Labs, a Brookfield, Wis.-based information security consultancy. Kick off March with these CPE events Utilizing the Implied Private Company Pricing Model: The Cost of Capital Wizard (March 5), featuring Robert Dohmeyer (Dohmeyer Valuation Corp.), Peter Butler (ValTrend), and Rod Burkert (Burkert Valuation Advisors). Join the creators of the implied private company pricing line (IPCPL) as they walk through their new implied private company pricing model, a derivation of the IPCPL that allows for the adjustment of the IPCPL for companies with outlier fundamental characteristics. How to Succeed as a Jointly Retained Expert (March 7), featuring William Morrison (WithumSmith+Brown) and John Johnson (SaxBST). As use of jointly retained, neutral, and court-appointed experts continues to rise, guidance on how to operate in this unique role is becoming more imperative. Join Morrison and Johnson to learn from their collective experience on how to succeed as a jointly retained expert. Omissions & Commissions: Errors, Challenges & Solutions in Business Appraisal Reports (March 12), featuring L. Paul Hood Jr. (The University of Toledo Foundation) and Timothy Lee (Mercer Capital). Join Hood and Lee as they relay the painful and valuable lessons learned by appraisers whose reporting errors have been uncovered by courts, reviewers, and other consumers.
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