Laro to BV experts: Value conclusion is last on my list

“This program has the best panelists of any that I’ve seen in the country,” the Honorable David Laro (U.S. Tax Court) told a rapt audience at the New York State Society of CPAs 2008 Business Valuation Conference, which met in Manhattan earlier this week.  “These are the experts,” he said—and attendees might as well have returned the compliment, as the esteemed Judge spoke on everything from his own experience (“Candidly, I did not know much about discounts for lack of marketability before Mandelbaum, but I studied it and realized how important it is”), to his expectations from the professionals who walk into his courtroom.  For example—if he sees an expert passing notes to the attorney on the case, he puts a stop to it.  “That’s advocacy,” he said.  “That’s not neutrality—and I’ve seen it,” he added, meaning that some measure of damage to credibility may have been done.  “Once you are retained you must maintain your independence,” he reminded valuation experts, “because if not, [your testimony] is of no value.”  

And what about the movement toward “thinner” reports, in an effort to omit extraneous matters and shave costs for clients?  He sympathizes with the increasing complexity and cost of many valuation engagements, but expert reports should contain “all relevant information,” he said, “everything you think that the judge needs to get into her [final] opinion,” because in federal Tax Court, the reports are tantamount to an expert’s direct testimony.  Moreover, “I read the bottom-line number last,” Laro said.  “The analysis is the most important—how you took the data, analyzed it, and wed it to your conclusion.  I want transparency; I want to see your thinking—because that’s what appellate courts want to see from me” should they review his decisions (which currently enjoy a 97% confirmation rate).  One more tip: Keep your supporting data on hand, so that when an opposing counsel asks where you got the information for your report you don’t have to say that it’s back in your files.  “I always get bothered by that,” he said.  “No judge stops a trial so that the expert can run back to the office.”

Your job is to tell a story.  Echoing Laro’s comments, Mel Abraham ( told attendees that the “right” ratio for valuation reports is “two parts words and one part numbers.”   A valuation professional’s “true” job is not about the numbers—it’s about telling the story of the numbers.  “We are in the world of persuasion,” he said.  Persuasion is not advocacy; instead, it’s taking the information, data, and concepts—and putting them together in a truthful, credible opinion that persuades the users of the information and educates the trier-of-fact.  “The focus is too much on the numbers,” Abraham said, referring to clients as well as experts.  “Be the storyteller, from an objective, independent perspective.”  

Expert to expert: Don’t be afraid to tax affect

IRS agents and auditors may tell you that the Internal Revenue Service does not have an official position on tax affecting Subchapter S corporations—but “don’t believe it,” Dan Van Vleet (Duff & Phelps) told the NYSSCPA gathering.  The “official” IRS position “is to assess the reasonableness of the analysis and make a determination,” he said.  The problem: The Service may presume that tax affecting is not reasonable—a position based in large part on prior Tax Court Memorandum decisions (Gross, Heck, Adams, Wall, Dallas - all are available to subscribers of BVLaw) in which neither the IRS nor the taxpayer’s expert presented a good model for tax affecting the subject interests.  But only one of these—Gross, which concerned an “extreme” set of facts—has been affirmed by a federal court of appeals (6th Cir.).  The rest are not binding.  “The current reality is that the IRS has audited—and accepted—numerous reports involving substantial matters” that Van Vleet and his colleagues have prepared using his S Corporation Economic Adjustment Model (SEAM).  “If you use a model that explains [tax affecting] reasonably,” he said, “they’ll accept it.” 

“I’ve never been challenged,” agreed Chris Treharne (Gibraltar Business Appraisals, Inc.), who presented his S Corp model to attendees.  “If you’ve got an S Corp that’s distributing enough to cover [shareholder] tax liability, then for heaven’s sake, tax affect.  If you can explain it in your report with sound economic reasoning,” he said, “you will win.”   The economic issues that lie at the heart of the valuation of any pass-through entity are “absurdly simple,” said Nancy Fannon, the third expert on the topic—but they have been wrapped in “deceptively complex” models.  She reminded conference attendees that her article comparing the various models—including those used by the Tax Court and the Delaware Chancery Court—is available as a Free Download at BVResources (fifth on the current list) along with her book, Fannon’s Guide to the Valuation of Subchapter S Corporations).

Will ‘knowledge explosion’ blow apart BV profession?

Business valuation specialists are a lot like other professionals—what currently keeps more than a third (36.4%) awake at night, according to our latest online poll, is finding a quality of life/workload balance.  What sets them apart is the explosive growth of the profession: More than a quarter of respondents (27.3%) worry about expanding their practices into specialized niches, and a solid two-thirds majority (68.2%) believes that the proliferation of new information, technologies, and BV-specific knowledge will have the biggest impact on their practices in the immediate future.

How best to stay current with this “knowledge explosion”?  Most take CPE courses (81.8%) and attend professional conferences (68.2%—respondents could choose more than one option).  Some form local networking groups (13.6%) or they teach and write articles (18.2%).  Others “commit at least two hours a week to professional reading,” or just “read, read, read.”  But one participant believes that “staying current” has come to mean trying to cover “every theory on every issue that each of a varied group of professional leaders comes up with.”

Frankly, our undoing will be our effort to be expert economists, accountants, tax authorities, estate wizards, and writers.  We started out espousing the need to dispel with the know-it-all ‘holier than thou’ approach of some of the other appraisal fields, to understand that this isn't pure measurable science.  And we have now come to a place where we pronounce finite measure of the unmeasurable, and then struggle to find a way to justify it.  The fanciest speaker wins the day over reason and logic; and BV services have become so cumbersome to develop and administer, time consuming and expensive, that only very large cases can benefit from them.  What has all this done for our practice?  It has pushed the valuation services back to business brokers and anyone who can hang a shingle without a liability fear. For all the education and experience we have (over 25 years), we can no longer remain compliant and make these engagements [worthwhile].

What do you think—by adding expertise, has the BV profession added to its insomnia?  Please take a couple of minutes to contribute to our ongoing poll by clicking here.

Sign up to receive TAF ‘Best Practices’

The Appraisal Foundation (TAF) is giving advance notice to all interested parties that it will be releasing the Discussion Draft on Best Practices for Valuation in Financial Reporting: The Identification of Contributory Assets and the Calculation of Economic Rents on June 2, 2008, with a 45-day comment period.  Copies of the draft will be posted on the TAF website:  If you would like to review a copy on the release date, please contact Paula Douglas to be placed on the email distribution list:

The TAF also has a second working group on Best Practices for Valuing Customer Relationships.  “This group has met and is making a call for literature on the issue,” says Jay Fishman, current chair of the Foundation’s Best Practices Steering Committee.  We’ll post updates on the second working group as and when they are announced.

Calculations of value still a ‘high wire act’

Responding to the recent item “Is it safe to perform a calculation of value?” in the BVWire, appraiser and attorney Bernie Agin explains a common difficulty:  “In Ohio, our [marital dissolution] statute says ‘every’ asset must be valued by the court.  To fail to do so is asking for a reversal,” he says.  “Now comes Gino's Pizza Shop as part of a divorce case.  The marital estate can not justify a full ‘Conclusion of Value’ or ‘Opinion of value (big 'O’), so a Calculation of Value is undertaken with the hopes the case will settle.”  But should the parties go to trial, “both the engagement letter and the calculation of value report point out the limitations and scope,” Agin says, “and contain an explicit statement that a calculation of value is not an Opinion of value and the differences might be significant.”  To be accepted as an expert witness, “the magic words are ‘opinion (little ‘o’) to a reasonable certainty as to value.” In addition, Agin has spoken with a local judge, who indicates “no problem” with opinion testimony regarding a Calculation of Value so long as there is full disclosure as to its limitations and full discussion of its differences with an Opinion of Value. 

So is it now safe?  The problem isn’t that appraisers shouldn’t (or can’t) perform a calculation of value in these situations.  It’s that, at the end of the day, “the only thing that anyone will remember is that you did not do a complete job,” says Gary Trugman, and “it will be the professional’s reputation that is hurt.  While I understand that the small businesses are hard to cost-justify,” he adds, “our malpractice policy does not specify whether we are doing jobs for large businesses or small.”

“I completely concur,” says Ron Seigneur.  “Under our professional standards, like them or not, a calculation is not a conclusion and, in my humble opinion, does not rise to the level of anything that one would want to wrap a professional opinion around.  Saying that you can testify that the calculation ‘is correct within a reasonable certainty’ is like saying you are half pregnant,” he adds.  “I do understand that some courts require all assets to be valued,” but just leave it as calculated numbers, leave out the “reasonable certainty” and in turn save your reputation.

“The point we all made in the BVResources teleconference (April 30th),” says Stacy Collins, “is that it is getting to be more and more of a high wire act to do the small cases in a litigation context, where we have to balance the fee issue with the scope of the work and maintain our professional reputation at the same time.  Many valuation professionals are still coming to terms with what the new valuation standard (SSVS 1) means to their practice,” she says.  “It’s important to have discussions like this to address the risks of this type of assignment.”  For your “Conference on Demand Pack” of “Valuing a Very Small Company,” including transcript, CD, ancillary reading materials, MP3 recording, and more, click here.  

What would Hitchner do?

“When the standards [SSVS 1] were first announced, there was anxiety over how to assist an attorney who just wants a number that they can use to settle a case,” said Jim Hitchner, in his presentation on SSVS 1 at last week’s AICPA/AAML National Conference on Divorce.  So the AICPA came up with the calculation engagement, which “is quite broad,” Hitcher explained.  “You can do as much or as little work as you need, as long as you do the list of items,” he told appraisers in the audience.  And to the attorneys, “there is a level of service that the CPAs can provide you that will cost a lot less money.”

But there are problems.  One of the disclosure requirements is that a calculation engagement does not include all of the procedures and methods involved in a valuation engagement.  “You must state that had you prepared a valuation engagement, the result could be different,” Hitchner said.  A calculation engagement also involves the appraiser and the client agreeing on the procedures and methods to be used.  “In a testimony situation, that could be a problem,” Hitchner says.  “You also have to admit that, if you did more work, the value could be different.”

His solution?  “We will prepare a calculation engagement under the [AICPA] rules for settlement purposes.  If you request that we testify either in a deposition or at trial, then we will prepare a full valuation.  In my shop, we will not do a calculation for testimony,” Hitchner says.  “That doesn’t mean that you shouldn’t.  If you’re working in a locality where everyone accepts calculations, then you may be okay to do a calculation for a trial.  But all it takes is one attorney to rough you up,” he adds, echoing Trugman, et al.  Questions on cross examination (“What did you agree to do?”  “What procedures did you omit?”  “You say it could have been different. How different?”) might not be worth the price of the engagement.

FASB issues GAAP hierarchy

Last week the Financial Accounting Standards Board (FASB) released Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles.  FAS 162 seeks to correct perceived problems with prior accounting standards, in particular the AICPA’s SAS No. 69 (The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles) by directing the GAAP hierarchy to entities rather than to their auditors.  “The Board does not expect that this Statement will result in a change in current practice,” it says, but nevertheless offers this transition guidance.  The Statement will be effective sixty days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. 

Also issued last week: FSAB Staff Position (FSP) APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).

Mid-market M&A still respectable, valuations ‘healthy’

 “While merger and acquisition activity is down in both value and volume over the last twelve months, when compared to 2004 the activity remains quite respectable,” says a new article by Mike Rosenthal (PCE Investment Bankers), which takes a first look at Q1 2008 M&A transaction data.  “However, the trend over the last four quarters would indicate that we could see a further drop.”   The sub-prime contagion continues to spread; foreclosures are up; banks are scrambling for new capital and restricting access to new loans—“all of this is forcing nearly everyone to pause.” 

At the same time, “strategic and financial buyers are searching for quality assets that fill a need or act as a platform for growth,” Rosenthal says, and valuations are improving in the middle market in most segments.  “The jagged movement of multiples makes it difficult to spot trends,” but the most notable increase appears to be among middle market companies (below $50 million), for which EBITDA multiples improved from 7.9x to 8.7x from Q4 ’07 to Q1 ’08.  The data suggest that a “healthy demand for middle market companies still exists” and the market “should remain busy.”  A complete copy of “State of the M&A Markets, First Quarter 2008 Update,” is available here.

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