Opposing counsel: ‘My job is to tear your throat out’
In the theatre of litigation, the lawyers are the “directors” of the drama, according to attorney Jim Hennenhoefer (James A. Hennenhoefer, A.P.C., Vista, CA). The financial experts are actors who help tell the story. “It is my job to make you (the expert) look good,” he told attendees at the 2008 AICPA/AAML National Conference on Divorce last week in Las Vegas. Direct examination consists of “softball” questions, aimed at telling the court why you (the expert) are so great and your standard of value is correct. “Judging is boring, routine drudgery,” Hennenhoefer said. “We want to make it easy for them.” And attorneys also want the play to hold their attention.
His job on cross-examination is to be the villain, he said, “to tear your throat out” in a way that shows the trier of fact that you are standing on shaky ground. “You can’t fix a destroyed painting,” he added, mixing his artistic metaphors—but certainly making a point. Before most trials, Hennenhoefer will run dress rehearsals with another attorney acting as opposing counsel. “If it’s important enough for me to hire you as an expert, it’s important for me to make you shine.”
‘Expert with the most industry experience usually prevails.’ That was another hot practice tip from Michael Berger (Berger/Schatz, Chicago), who spoke on “Dissecting a Business Valuation Report” with co-presenter William Kennedy (Anders Minkler & Diehl LLP, Los Angeles). (In a unique format, the biennial AICPA/AAML conference offers at least one speaker per session from the legal field, another from business valuation.) “Hands-on industry experience is more important as long as there is some valuation experience,” Berger said.
Site visits are also critical, even if you’re the expert for the non-owner and fully expect the other side to refuse your request. “Never assume that you are not going to get a site visit,” said Jim Hitchner (The Financial Valuation Group, Atlanta). “I have seen situations where the expert never asked for a site visit because they just assumed that the other side would deny it.” On the witness stand, the lawyer asks whether the expert asked to talk to management. (The answer: “No.”) But isn’t that a standard part of a valuation engagement? (“Yes.”) Why didn’t you talk to management? (“Because I knew you wouldn’t let me.”) But of course the opposing counsel indicates that he would have permitted the visit. The moral of this particular play, Hitchner advised: “Ask every time.”
Experts weigh in on Astleford: Discounts total 85%
The item on Astleford v. Commissioner in last week’s BVWire™ added to the buzz already building around the case—the first in a long time in which the Tax Court decides valuation issues in the context of a family limited partnership (FLP). On the practical side, Owen Fiore (Kooskia, ID) points to the end result of the decision, which reviewed appraised values related to transfers of agriculture (1,187 acres of farmland), a 50% general partnership (GP) interest along with three 30% limited partnership (LP) interests. “Per the Tax Court, the total combined discounts equaled nearly 85%,” Fiore says. First, the court permitted an effective discount of over 20% for market absorption on the real estate; then a 30% discount on the 50% GP interest; and then a more than 35% combined discount on the LP gifts. “It may have taken the taxpayer four appraisers—and the IRS two,” Fiore says, “and it may have taken the Tax Court to say ‘okay’ to layered discounts, but it is a great result just on that score.”
On the technical side, Ted Israel (Eckhoff Accountancy Corp.) points to an interesting “methodology disconnect” in the case. The Tax Court combined the discounts for lack of control and marketability related to the GP interest, but it estimated them separately for the LP interests. Further, in the court’s treatment of data used to develop the partnership discounts, it rejected better data from RELPs because there’s not enough of it, but accepted the more abundant REIT data. “This reasoning first appeared in McCord v. Comm’r (2003),” Israel observes, “that an absence of comparable data can be overcome by an abundance of incomparable data.” There are also far less cumbersome ways to apply REIT data to real estate discount cases than the method the court uses, he says. (Hint: The Mergerstat®/BVR Contol Premium Study™ includes REIT takeover transactions.) Israel’s complete analysis of Astleford appears in the next (June 2008) Business Valuation Update™. To download a copy of his previous article, “REIT or Wrong: Using REIT Data to Value Privately Held Real Estate Limited Partnerships,” originally published in Valuation Strategies (July/Aug. 2005), click here.
Finally, in his current, online discussion of Astleford, Mel Abraham makes an interesting point related to the court’s calculation of “layered” discounts. If, at the first level of ownership (the 50% GP interest, which comprised 16% of the total asset portfolio), the court has already made adjustments for lack of marketability and control, then at the second or FLP level, these assets might be more akin to owning a marketable security. “Under a McCord analysis,” Abraham says, “you might look at that and say at some point, some portion of the portfolio is a marketable security piece and the rest is attributable to real estate, and you might get a slightly different result.” To listen to his free, 40-minute e-audio presentation, go to ValuationEducation.com and click on “Latest e-Alert” and then on “Current Issue.” (And just a reminder—the full-text of the courts’ opinions in Astleford, McCord—along with more than 2,700 federal and state valuation-specific cases—are available to subscribers of BVLaw™.)
What keeps BV professionals up at night?
Is it maintaining that ever-elusive quality of life/workload balance? Or is it retaining (and compensating) BV staff? And what about current trends in the business valuation profession—fair value for financial reporting, professional standards and IRS penalties, the proliferation of new information: Which do you think will have the greatest impact on your individual practice and your firm’s long-term prospects? How will you stay current with the present “knowledge explosion” in the BV profession and its related specialties? These are the three questions that our latest online survey asks. Please take three minutes to participate by clicking here.
The answers will not only enlighten our next issue—but will also inform the presentation by Ron Seigneur, Jim Hitchner, and Michelle Gallagher at NACVA’s 2008 Fifteenth Annual Consultants’ Conference at the Wynn hotel in Las Vegas, June 8 – 11. These three experts kick off this year’s “Superconference” with their session on “Practical Tips for Building a Business Valuation, Forensic, Litigation Support Practice.” For registration information and the full conference agenda, aptly titled Rising to the Top of Your Game in Valuation and Financial Forensics, click here.
FASB and AICPA post new articles on fair value
Last week the Financial Accounting Standards Board posted its new article, “Understanding the Issues: Some Facts About Fair Value.” The article’s main purpose is not “to debate the pros and cons of fair value accounting," say co-authors Robert Herz, FASB Chair, and its Director Linda A. MacDonald:
Rather, it is to provide some basic facts about fair value accounting that are important in understanding the current debate. Specifically, (1) where fair value is (and where it is not) used in financial reporting currently, (2) what fair value is (and what it is not), and (3) the approach for developing fair value estimates, including in illiquid markets.
Expanding on this topic, the current opinion page of AICPA's Journal of Accountancy provides three different points of view on fair value. “As the credit markets froze and stocks gyrated, investors and pundits naturally looked for someone, or some thing, to blame,” say the JofA editors. “Fair value accounting quickly emerged as an oft-cited problem. But is fair value really a cause of the crisis, or is it just a scapegoat? And might it have prevented an even worse calamity?” The article, "The Role of Fair Value Accounting in the Subprime Meltdown,” presents views from attorney Michael Young (Willkie Farr and Gallagher, LLP), Professor Paul B.W. Miller (University of Colorado, former FASB staff member), and Eugene Flegm (General Motors Corp.). Young's comments appear to straddle a middle ground between Miller, who advocates for greater transparency with fair value, and Flegm, who takes the auditor’s perspective that historic cost accounting is more reliable.
Marketability discounts trending downward
Since its creation in the mid-1990s, the Valuation Advisors DLOM Study™ has grown to encompass over 3,800 Initial Public Offering (IPO) transactions, updated monthly, making it the largest database for assisting in the calculation of discounts for lack of marketability (DLOM). The data are parsed into four, three-month pre-IPO timeframes up to one year and a 1-2 year pre-IPO group, and are searchable by transaction type, which helps current as well as historic analyses. Of late—during the past five to six years, discounts have trended down slightly, according to an article by Brian Pearson, Valuation Advisor’s creator, especially in the earlier timeframes—the zero-to-three months and four-to-six months. A couple of reasons may explain the trend: First, from the mid-1990s up through the crash of the tech-market, stock prices in private companies were changing relatively quickly, Pearson says, reflecting what Al Greenspan called investor “exuberance” and which IPO prices also reflected. These past four or five years have seen less exuberance, perhaps, and more of a reality-check on prices.
“The other thing that might account for a little bit of the differential is…there’s been a better attempt, certainly from the Securities and Exchange Commission’s standpoint, at trying to monitor…so-called cheap stock,” Pearson adds. “In our database, we account for that already so we make an adjustment for it if there’s a compensation adjustment. In other words, if there’s cheap stock issued and it’s an option or a stock, either way, we account for that in calculating the discount.” Pearson’s article is now available as a Free Download from BVResources. It’s just one of many in the newly updated articles and case abstracts in BVR’s Guide to Discounts for Lack of Marketability, 2008 Edition. To obtain a copy, click here.
More of ‘what matters’ in BVResearch
After adding more than 265 articles from Willamette Management Associates Insights to BVResearch™ (see last week’s ‘Wire), we’ve now just posted nearly 60 articles from Mercer Capital’s Value Matters. We’ve also added a separate department to peruse and pick out the premium Mercer content in the “Advanced Product Search” engine. For example, a search of “marketability discounts” in only the Mercer Capital Value Matters department of BVResearch turns up twenty nine results, including articles on the application of IRC Section 409A, the QMDM (Quantitative Marketability Model), and related case law. (There are 192 total articles on “marketability discounts” in all of BVResearch.) For more information—and to search the most comprehensive source for BV-specific materials—check out BVResearch now.
Live from NY: Three great BV minds tackle measuring risk
If you can’t make it to Manhattan to the NY State Society of CPAs' annual Business Valuation conference, then let us bring one of the most anticipated sessions to you: Tune in next Monday, May 19th as BVResources and NACVA present a live, three-part session on “Measuring Risk,” featuring Susan Mangiero, Aswath Damodaran, and Rob Slee. First, Mangiero takes on the risk measures of marketable securities, followed by Damodaran’s discussion on estimating equity risk premiums for emerging as well as established markets. Finally, Slee will talk about developing private cost of capital measures. Each session will feature a Q&A session that will be open to both live and teleconference attendees. To find out more, click here.
Note: Due to our coverage of the entire, two-day NYSSCPA conference, next week’s BVWire will appear on Thursday, May 22, 2008. Look for it then!