BVWire Issue #150-2 | March 11, 2015


Major advance in thinking about S corp taxes and value

A soon-to-be-published book is being hailed as a major advance in the area of valuations of pass-through entities. It challenges traditional notions about the differences in value between a pass-through entity and the public market C corporation. The new book reveals an abundance of research that shows that shareholder-level taxes do indeed affect a firm’s value. Up to now, this position has been refuted by the IRS and the Tax Court, largely because data has never been presented to support it. This work should provide valuation professions with the evidence they need to support their valuation conclusions. It also provides a suggestion for a new, more direct approach to pass-through entity valuation.

In the works for seven years, the book presents over 60 academic studies and papers that demonstrate that shareholder-level taxes have a definite effect on firm value. The new book, Taxes and Value: The Ongoing Research and Analysis Relating to the S Corporation Valuation Puzzle by Nancy J. Fannon (Meyers, Harrison and Pia LLC) and Keith Sellers (University of Denver), to be published by Business Valuation Resources, will be available in April. It is available for pre-order if you click here.

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Impact on healthcare firms from Supreme Court ruling

The ongoing soap opera over the Affordable Care Act now focuses on the U.S. Supreme Court, which will decide whether individuals who buy health insurance through federally sponsored exchanges are entitled to a subsidy. If they are not, millions of Americans could be left uninsured and less likely to buy healthcare services. The case is King v. Burwell, which challenges the legality of premium subsidies in as many as 37 states.

Hit to earnings: Valuation experts in the healthcare arena have been following this case because of its potential financial impact on healthcare providers. If the Supreme Court rules against the subsidies, it would mean a “single-digit percentage hit to pre-tax earnings for the publicly traded chains,” according to a report in Modern Healthcare. “HCA would see the most significant effect at 3.5% of its estimated 2016 earnings before taxes and other charges, with Tenet following at 2.9%, according to Darren Lehrich, an analyst at Deutsche Bank,” says the report.

The Supreme Court’s decision is expected in June.

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What to do if the IRS leaves you in the dark

If the IRS handles a valuation matter as a “consultation,” as opposed to an examination, neither the appraiser nor the taxpayer has the right to discuss the case with the IRS business valuer. An IRS agent or estate and gift tax attorney can simply disallow something without you being able to discuss this with the IRS valuer who made the recommendation for the adjustment. How frustrating is that?

What to do: Consider requesting a “limited scope examination” so that you can discuss the issue with the IRS business valuer involved, advises Michael Gregory (Michael Gregory Consulting LLC), who spent 28 years at the IRS on business valuation issues. That way, you can hear the full arguments and be able to present your perspective. You may even find that the IRS will simply drop the matter altogether. The agency may be overloaded with cases, or it may not be able to appropriately develop an issue.

“Also, the IRS’s track record on appeals is not good with consultation work, so the agency may prefer to drop the matter rather than escalate it,” says Gregory. He knows of one party who has been sustained three different times in full on an appeal when this has happened. However, Gregory says you should be aware that the IRS could escalate the matter to a full examination rather than proceed with a limited scope examination.

Gregory has written an article, “20 Ideas to Help Your IRS Dealings Go Smoother,” which will appear in the April issue of Business Valuation Update.

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Who is the ‘most litigious’ investor in buyout lawsuits?

As we’ve reported previously, in recent years, over 90% of all big M&A deals have triggered shareholder suits, many of them filed in the Delaware Court of Chancery. The suits contend that the sale prices are too low.

‘Cookie cutter’ suits: In a recent article in Reuters Investigates, Tom Hals identifies the plaintiff who has filed more lawsuits against companies involved in mergers or acquisitions since 2011 than anyone else—at least 40. She is Hilary Kramer, a “stock-picker and TV commentator.” Hals claims that Kramer is at the forefront of a new type of mass litigation. As soon as a deal is announced, shareholders file “cookie cutter” class actions “parroting” earnings statements or analyst reports as evidence that the buyout price is too low.

Challengers race to be named the “lead plaintiff,” even if they hold only a tiny amount of shares in the defendant company and have no real financial stake, Hals writes. Being the lead plaintiff means having the authority to agree to a settlement on behalf of the class. Plaintiffs’ lawyers meanwhile collect the largest share of the fees. “A lot of well-known activists employ the same law firms to file lawsuits against multiple companies,” a well-known plaintiff’s attorney tells Hals.

Most of the suits end in settlements, which, Hals says, are also nearly identical. Shareholders, and plaintiffs who filed suit, rarely get anything. According to research from Cornerstone, of the 77 settlements reached in 2014, only five generated more than $5 million for shareholders. Primarily, the defendants agree to more disclosure about the deal negotiations in exchange for a release from liability. And they agree to pay plaintiffs’ lawyers a mid-six-figure fee for what is typically just a couple of months’ work, Hals claims.

Pilgrims: The suits have attracted unfavorable attention from some judges, including Vice Chancellor Laster of the Delaware Court of Chancery, who has pointed out that many of them accomplish little. Plaintiffs’ lawyers rush to file a complaint rather than take time to investigate real corporate misconduct, and defense attorneys prefer to settle even a meritless case to ensure the deal goes through. “No one litigates anything,” he wrote in an opinion apropos the 2010 Revlon, Inc. shareholders litigation. “Firms who are early filers are frequently early settlers, leading some wags in the defense bar to label them ‘Pilgrims.’"

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Goodwill valuation for law firms

When valuing a law firm, how do you put a price on a lawyer’s reputation? An earnings multiplier is a common method for goodwill valuation, according to experts in law firm valuation. “Goodwill, if there is value in it, flows from the ability of the seller to successfully transfer a book of business to the buyer,” says Dale Lash, partner-in-charge of RubinBrown’s Business Valuation Services Group in Denver. Lash is quoted in an article in the March 2015 issue of the ABA Journal.

Current range: Common factors for a solo practitioner’s earnings multiplier calculations include earnings history, geographic location, the practice’s marketing plan, and the seller’s competition. “Each practice is unique, just like each lawyer,” says Ed Poll, author of Selling Your Law Practice: The Profitable Exit Strategy. “That being said, a general rule of thumb for a standardized multiple range is one-half to three times the gross revenues.”

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The use of Monte Carlo simulations in court

During a recent BVR webinar on using Monte Carlo simulations for valuing distressed companies, a listener asked about the use of the method in bankruptcy court or other court settings. Another listener offered up a case, Lyondell Chemical Co. v. Occidental Chemical Corp., 608 F.3d 284 (5th Cir. 2010), involving environmental cleanup costs, in which the Monte Carlo method successfully withstood a Daubert challenge.

In a 2012 valuation case, a court approved the use of Oracle’s Crystal Ball method (which uses Monte Carlo) for Daubert purposes despite a strong challenge from the other side. The case is RMD, LLC v. Nitto Americas, Inc.,2012 U.S. Dist. LEXIS (Nov. 5, 2012).

Jim Alerding (Alerding Consulting LLC), who was a speaker during the webinar along with Matthew Bernstein (Dixon Hughes Goodman LLP), commented that the Monte Carlo method is an acceptable statistical method to use in court. However, you need to be careful with what you put into the model.

Watch your inputs: In a recent valuation case, the Monte Carlo method itself was not attacked, but rather the inputs were the issue. The judge invalidated the analysis because the expert based it on the wrong assumptions. The case was Myservice Force v. American Home Shield, 2014 U.S. Dist. LEXIS 61207 (May 2, 2014).

The RMD and Myservice cases are available at BVLaw.

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New valuation rule for nonlisted REITs

The SEC has issued an approval order concerning the per-share estimated valuations for unlisted REITs. FINRA had filed SR-FINRA-2014-006 with the SEC that proposed two methodologies under which reported values are to be presumed reliable and included on customer account statements: (1) net investment; and (2) independent valuation. The net investment method may be used no longer than two years plus 150 days after breaking escrow. The independent valuation method requires that a third-party, independent valuation expert perform or provide material assistance in the valuation, and it must be accompanied by a written opinion or report by the issuer. This rule is effective as of April 10, 2016.

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Updated Risk Premium Toolkit is now live!

The Valuation Handbook - Risk Premium Toolkit is the new name for the Risk Premium Calculator, a Web-based model that offers defensible cost of capital measures, particularly for small target companies. The model was developed by Duff & Phelps and is offered exclusively through Business Valuation Resources.

Update: The Toolkit now includes data from the soon-to-be-released 2015 Valuation Handbook – Guide to Cost of Capital, which contains data through 2014. As a bonus, a subscription to the Toolkit includes a print copy of the 2015 Valuation Handbook – Guide to Cost of Capital and quarterly updates (a $425 value). For more details, click here.

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BV movers . . .

People: Steve Amigone, principal and transfer pricing leader at Dixon Hughes Goodman, has been named chair of the North America Tax & Fiscal Group for Praxity, a global alliance of independent accounting, tax, and business consulting firms … David Paris has joined Alvarez & Marsal as a senior director in the global forensic and dispute services group in the Washington, D.C., office … David Rottkamp has been named new partner in charge at Grassi & Co. and will be based out of the New York City office.

Firms: The research, analytics, and valuation firm Aranca was awarded the “Company of the Year: Intellectual Property (IP) Research and Valuation Advisory Services – 2014” by SiliconIndia Magazine … Grant Thornton LLP is one of the 2015 “NAFE Top Companies for Executive Women” put out by the National Association for Female Executives … Howe, Riley & Howe of Manchester, N.H., is the latest firm to join BKR International … The Indiana Chamber of Commerce has selected Kemper CPA Group LLP as one of the “2015 Best Places to Work in Indiana” … KPMG and Ryan were both named one of the USA’s “100 Best Companies to Work For” by Fortune Magazine … Murray Devine marked its first 25 years as a leading national valuation firm.

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Great lineup of CPE events kicks off with advanced cost of capital workshop

Roger Grabowski (Duff & Phelps) will conduct a special four-hour Web-based program, Advanced Workshop on Cost of Capital, 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:

S corp values

ACA ruling

IRS idea

Buyout lawsuits

Law firm multiples

Monte Carlo in court

New REIT rule

Risk Premium update

BV movers

CPE events








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