BVWire Issue #150-1 | March 4, 2015


Beware of deviating from objective standards in lost profits calculation

“Trust, but verify,” is a motto that has stood politicians in good stead. Valuators should take it to heart as well, as illustrated by a Daubert case in which an experienced expert abandoned his standard operating procedure to accommodate the client’s narrative.

Four-step analysis: For over 10 years, the plaintiff worked as an agent/broker for an insurance carrier. Then, the insurer terminated the parties’ contract, alleging the plaintiff had tried to commit fraud against the company. At the time of termination, the plaintiff was 70 years old.

The plaintiff, in turn, sued for breach of contract, breach of the covenant of good faith and fair dealing, breach of fiduciary duty, and “intentional interference with business relations.” Because of the unlawful termination, he lost contracts and was unable to "gain a similar agency status" with another company, he contended.

To show damages, the plaintiff offered expert testimony from a CPA who specialized in business valuation and forensic accounting. The expert performed a forensic accounting study of lost profits for a period of 10 years after termination. The calculation essentially broke down into four steps: (1) analyzing the plaintiff’s “historical gross revenues from commissions, the related business expenses and resulting net profits” from 2005 to 2012; (2) determining that the plaintiff had a work-life expectancy of 10 years; (3) using data from the Insured Retirement Institute regarding sales of annuities on a national level as a yardstick to project the plaintiff’s future annual gross commissions income; and (4) valuing the plaintiff’s “book of business” at 1.5 times the projected gross commission income for the year 2020.

The present value of future lost profits was over $486,000, the expert concluded.

Ten-year work-life estimate: In its pretrial Daubert motion, the defendant particularly attacked the expert’s assumption that the plaintiff would continue to live and work for another 10 years, based solely on the plaintiff’s statements that he was in good health, loved working as an insurance agent, and thought of the work as “retirement work.”

The expert even testified that he typically used objective data for his calculation, including the Skoog-Cieka work-life expectancy study, which, he said, was based on Bureau of Labor statistics and other Census Bureau data. The study featured tables that address work-life expectancy based on gender, age, education, and work experience. In this case, he explained, he could not use the tables because the plaintiff was older than the maximum age listed in them.

In deposition, he also noted that other tables were available based on studies of self-employed persons. He said he did not remember the names of the studies but “recalled” they showed self-employed people “typically work five to ten years longer than the work-life expectancy tables.” He said that, even though he had used the studies in other cases, in this instance he solely relied on the plaintiff’s statements.

The court agreed with the defendant that the expert’s failure to adhere to an objective standard made the analysis inadmissible. It observed that each of the Skoog-Cieka tables listed a maximum age of 75. The mean work-life expectancy for a 70-year-old male with a high school diploma was 3.74 years and the median was 2.5 years. The expert’s 10-year work-life estimate was nearly three times that suggested by the Skoog-Cieka tables, the court pointed out.

And, even though the expert’s failure to use the Skoog-Cieka study to estimate the plaintiff’s work-life expectancy did not in itself render the calculation unreliable, his failure to use any objective standard did, the court said with emphasis. It also found the expert’s calculation of the book-of-business value was seriously flawed and excluded the testimony.

Takeaway: This case is another example of what happens when an expert simply takes the client’s word for it and veers from the customary approach. In the final analysis, the expert’s “eagerness” to support the client’s position may have cost the latter the case, leaving him without credible damages testimony.

Find an extended discussion of Russell v. Allianze Life Ins. Co. of N. Am., 2015 U.S. Dist. LEXIS 1946 (Jan. 8, 2015) in the April edition of Business Valuation Update; the court’s opinion will be available soon at BVLaw.

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Mercer points out natural product line extension for biz appraisers

“Business appraisers have a tendency to think of valuations as their only product,” says Z. Christopher Mercer (Mercer Capital), a top BV thought leader and author of a new book, Unlocking Private Company Wealth. Mercer tells BVWire that the book, written for business owners and business advisers, “addresses the needs of the tsunami of ownership and management transitions that are occurring literally every day as baby boomers, who own most of our nation’s businesses, reach 65 at the rate of 10,000 per day. And they’ll keep doing so for the next 20 years or so.” Mercer has been working with business owners and their advisers for over 30 years and is now focused on helping his fellow baby-boomer business owners.

Burning issues: The book focuses on two burning issues faced by most business owners. First, most of their wealth is tied up in their business. Second, and key, is that most business owners have relatively little liquidity outside their private-business ownership. The combination creates opportunities for business owners to take action and for business advisers to help direct and influence their actions with the idea of developing liquidity outside private companies.

The first section of the book is devoted to managing private-company wealth. “In this section we talk about the One Percent Solution, which suggests taking a percentage of the value of a business as the basis for managing the wealth it creates (e.g., 1% of $10 million equals $100,000),” says Mercer. “That budget can be used for annual legal reviews, buy-sell agreement valuation, life insurance funding for buy-sell agreements, and many other critical wealth management tasks.”

The second section of the book talks about tools for managing private-company wealth, including dividend policy, special dividends, leveraged dividend recapitalizations, leveraged share repurchases, ESOPs, and more. The third section provides important perspectives regarding the management of private-company wealth for both business owners and business advisers.

What to do: To do a valuation for exit planning purposes, you need to think like an investor. In an upcoming article in the April 2015 issue of Business Valuation Update, Mercer explains how to do this. “There are at least seven ways that potential investors look at a business,” he says. Not every investor will look from every perspective, but they all are worth consideration.

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Look to ‘internal’ stock market for figuring DLOM

Large private firms often have active “internal” stock markets, which is something that should be examined when valuing a firm. “Sometimes you may have a firm of, for example, 400 people that has 60 or 70 shareholders,” says Ian Rusk (Rusk O’Brien Gido + Partners). “In each year there may be people retiring and their stock is being purchased by existing employees or new people coming into the firm. That is an active internal market to the extent that it is a healthy one where supply and demand are sort of in equilibrium. This reveals a level of liquidity to the stock that a firm without an internal market can’t demonstrate. This has a positive impact on value and it will cause us to perhaps use a lower discount for lack of liquidity than we would otherwise use.”

Rusk made his remarks during a recent webinar, Valuing Architecture & Engineering Firms. He is a contributing editor to the newly released 2015 A/E Business Valuation and M&A Transactions Study, which examines actual stock transactions among architectural, engineering, and environmental consulting firms nationwide over the last three years (over 230 in all).

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The challenge of having a lawyer as a valuation client

What is it like to have a lawyer as a client? Sylvia Golden, BVR’s legal editor, spoke with both an attorney and a valuation expert about this, and particularly about representing a lawyer who is going through divorce. In an interview in Family Lawyer Magazine, Golden spoke with prominent attorney Sanford K. Ain (Ain & Bank) and business valuator Stuart Rosenberg (Aronson LLC’s Forensic & Valuation Services Group) about divorce and valuation-related issues.

“Representing lawyers is challenging at times, but also easy in many respects,” says Ain. “Lawyers tend to be bright and inquisitive; if you educate them about divorce law, they can be very helpful in bringing their case to a successful conclusion. Education is the principle ingredient in representing lawyers: the more you educate them, the better client you have.”

Grave error: Ain also talked about when a valuator should be brought into a case. “Many lawyers do not hire experts until they’re well into the case: sometimes, so shortly before the trial that discovery has ended. That’s a grave error,” he says. “I often engage an expert at the initial meeting with the client. Once the client and I have decided to work together, I will frequently call an expert during the course of that meeting and engage them. That’s part of the education process in representing lawyers, but it’s important in representing any client.”

Says Rosenberg: “As far as controlling an attorney-client, I leave that completely up to their attorney—other than trying to convince a Type A personality attorney that their situation isn’t unique, that the judges have seen it before, we have seen it before, and the lawyers involved have seen the issues before. It might be overwhelming or unique to them because they’re emotionally involved, but it’s not unique to the experts, lawyers, and judges involved in the case.”

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Multiples and trading performance for healthcare services

The S&P Healthcare Services Index has increased by 0.1% over the three-month period of November 2014 through January 2015, thus outperforming the S&P 500 (1.1% decrease over the same period), according to the February 2015 Healthcare Sector Update from Duff & Phelps. The best performing sectors were healthcare REITs (up 12.7%) and contract research organizations (up 8.5%). The worst performing sectors were emergency services (down 8.6%), acute care hospitals (down 6.8%), and HCIT (down 6.7%).

Latest multiples: The current median LTM revenue and LTM EBITDA multiples for the healthcare services industry overall are 1.71x and 11.7x, respectively. The sectors with the highest valuation multiples include: healthcare REITs (13.32x LTM revenue, 20.1x LTM EBITDA); HCIT (3.06x LTM revenue, 19.9x LTM EBITDA); and consumer-directed health and wellness (3.05x LTM revenue, 26.6x LTM EBITDA).

The report also provides data on the pharmaceutical/medical devices/life sciences sectors.

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Key valuation topics at ASA’s April 24 event in Philly

The Philadelphia chapter of the American Society of Appraisers (ASA) will hold its annual business valuation seminar in Plymouth Meeting, Pa., on April 24. The program includes sessions focused on:

  • Unlocking private company wealth;
  • The implied private company pricing model;
  • Engagement letters: our biggest protection; and
  • Case law developments.

Early bird fees are valid until March 13. For more details and to register, click here.

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BV movers …

People: Grant Thornton’s forensic and valuation services team has announced the following additions to its team: Ronald Durkin as managing director, Brian Lopez as director, Anthony Bohorquez as senior manager, Kanzaz Phuong Nguyen as manager, and Wan Laam Tse as manager … Brad Slattery joins the Chicago office of PwC US as a transfer pricing principal. A 13-year veteran of the firm, Brad was most recently based out of its Singapore office.

Firms: The Arizona company Henry & Horne has acquired the Phoenix-based Pittman & Murdough PC including its wealth management division, which joins Henry & Horne’s affiliate, Wealth Management LLC, bringing assets under management at about $300 million … Morrison, Brown, Argiz & Farra LLC (MBAF) merged with fellow Miami-based accounting firm Kane & Co.

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Grabowski workshop on cost of capital heads list of CPE events

Fundamentals and advanced concepts of cost of capital estimation will be addressed in a special four-hour Web-based program, Advanced Workshop on Cost of Capital, conducted by Roger Grabowski (Duff & Phelps) on March 17. Some of the questions he will address include: Has the risk-free rate lost its meaning as a building block in cost of capital models? What is the current estimate of the equity risk premium? What are alternative risk measures? Grabowski will also refer to data contained in the Guide to Cost of Capital and Industry Cost of Capital literature.

Other upcoming webinars of interest:

Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist

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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963 ext. 133
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In this issue:

Lost profits

BV opportunity

DLOM tip

Lawyer as client

Healthcare multiples

ASA PA event

BV movers

CPE events








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