When a minority shareholder in an Indiana company was terminated as a director and officer, a dispute arose over whether, under a buyback agreement, the use of discounts for lack of control and marketability was permissible in valuing his shares. The trial court said yes, but the appeals court, citing case law, reversed.

Compelled buyback: The plaintiff was a founder as well as a director and officer of a company that fabricated and installed natural gas and pipeline equipment. He owned a 17.77% interest in the business. When he was terminated (involuntarily), his departure from the company triggered a provision in the controlling shareholder agreement requiring the company to buy back his shares. The valuation was to be based on the “appraised market value of the last day of the year preceding the valuation, determined in accordance with generally accepted accounting principles by a third party valuation company within the twenty-four months preceding the transfer of shares.”

The retained outside appraiser said it was engaged “to estimate the fair market value of the property…. This valuation was performed solely to assist with the valuation requirement in a shareholder agreement due to a triggering event involving [the plaintiff].” The appraiser found the plaintiff’s interest was worth about $3.5 million but applied discounts for lack of control (DLOC) and marketability (DLOM) and concluded the final value was $2.4 million.

The plaintiff sued, and the company countersued. Both sides filed motions for summary judgment. The issue for the trial court was whether, as a matter of law, under the buyback provision, the valuation could include discounts. The trial court found for the company and granted its motion.

The plaintiff appealed the decision. The gist of the plaintiff’s argument to the Court of Appeals was that, under the controlling case, Wenzel v. Hopper & Galliher, discounts were inappropriate because the transaction involved a compulsory sale. Further, the language of the shareholder agreement regarding the appraisal method precluded the use of the fair market value standard because the sale of the contested shares did not take place in the open market and the buyer already controlled the company.

Avoid windfall: The appeals court found Wenzel was applicable to the situation at hand. In Wenzel, the Court of Appeals rejected discounts in the context of a law firm’s purchase of a departing partner’s interest in the firm. The case was brought under the state’s professional corporation act. The court differentiated between fair value and fair market value and rejected the use of minority and marketability discounts in fair value cases where a controlling interest holder buys back the stock. Minority and marketability discounts were “open market concepts” that did not apply where a shareholder is compelled to sell to the majority, the court found. The use of discounts would mean a “windfall” to the buyer.

In the instant case, in rejecting the company’s argument that using the fair market value was consistent with the shareholder agreement, the court said:

The Shareholder Agreement itself recognizes that the mandated buyback of shares to the Company differs from a sale to a third party on the open market and thus, different interests must be recognized by implementing an appraised market value rather than the open-market valuation method of fair value or fair market value.

The appeals court concluded the trial court erred as a matter of law when it allowed the discounts.

A digest of Hartman v. BigInch Fabricators & Construction Holding Co., Inc., 2020 Ind. App. LEXIS 183 (May 5, 2020), and the court’s opinion, will be available soon at BVLaw. A digest and the court’s opinion in Wenzel v. Hopper & Galliher, 779 N.E.2d 30 (Ind. Ct. App. 2002), are available to BVLaw subscribers.

AICPA issues FAQs on valuing distressed or impaired businesses

Strong companies may see the current pandemic as an opportunity to fortify their balance sheets and other assets, according to the AICPA’s FAQs on Valuation Considerations When Valuing Distressed or Impaired Businesses. “The COVID-19 pandemic may have only short-term implications and strong companies may emerge stronger, while competitors with ‘heavy’ debt obligations may need to close and/or liquidate assets,” the document states. It quotes Professor Aswath Damadoran (New York University Stern School of Business), who points out: “I think it still makes sense to look at growth, profitability and reinvesting, pre-crisis, to get a sense of how much punishment companies can take. In businesses that already had anemic revenue growth, low margins and poor investment efficiency, the effects of the crisis will be far more devastating than in businesses with higher growth, margins and efficient investment.” Josh Shilts (Shilts CPA), with contributions from Maureen Rutecki (EFPR Group) and Steve York (Stern Brothers Valuation Advisors), wrote the FAQs.

Put extra scrutiny on market comps, panel advises

The market approach is obviously troublesome now, which makes it even more important to scrutinize your comps, according to a panel that participated in BVR’s second free Town Hall event on the impact of COVID-19 on valuations. The panelists were Stacy Preston Collins (Financial Research Associates), Michelle Gallagher (Adamy Valuation), Harold Martin (Keiter, Stephens, Hurst, Gary & Shreaves PC), and Gary Trugman (Trugman Valuation). They pointed out that valuation has not changed, and the market approach still needs to be considered. This holds true whether you are looking to private transactions (e.g., via DealStats) or public companies (e.g., via the Guideline Public Company Comps Tool). Of course, if there are no transactions, you may have to skip that method. In that case, can you use data from public companies? Yes, assuming you have multiples based on guideline public companies that are comparable to your subject company. Given the volatility in the market, one issue will be whether to use multiples based on the stock price that day or, say, a 30- or 60-day moving average. This should be considered on a case-by-case basis based on the array of public companies and the disparity of pricing.

A holdover question from the first Town Hall asked about putting more weight on the guideline public company method over the DCF, which the questioner felt could have major issues with the forecasts and certain elements of the cost of capital. That may be reasonable, but that decision should not be made until you finish your analysis and understand why your values differ under both approaches.

Extra: The presenters also received many questions about projections and DCF, and Trugman and Martin will be presenting a separate webinar on that topic on June 4—Discounted Cash Flow: Speculative or Convincing. To register, click here.

Willamette’s spring 2020 Insights focuses on ESOP valuations

The spring 2020 Insights from Willamette Management Associates focuses on ESOP employer stock valuations and contains a number of articles, such as “Employee Stock Ownership Plan Financial Feasibility Analysis: Financial Considerations for Shareholders” (Robert F. Reilly), “Valuation Treatment of the Repurchase Obligation Liability” (Kyle J. Wishing), “The Fiduciary Process for the Annual Update of the ESOP Share Value” (Frank “Chip” Brown), “Pizzella v. Vinoskey: A Costly Lesson to Learn” (Lisa H. Tran), and more.

Extra: Wishing and Brown recently did a BVR webinar along with attorney Chelsea Mikula (Tucker Ellis LLP). The webinar, Projection Issues Raised in ESOP Litigation, discussed some controversial matters in recent ESOP cases, such as the DOL improperly redefining the concept of fair market value and the lack of qualifications of the agency’s expert.

ASA opens nominations for Rising Stars Award

The American Society of Appraisers (ASA) has launched its third annual offering of the Rising Stars, an award that honors the brightest valuation professions, age 40 and under, who have demonstrated success over the past fiscal year. Nominees will be judged on their accomplishments, leadership, community efforts, and milestones. Self-nominations are welcomed, and nominations must be submitted by Tuesday, June 30. Click here for the nomination form.

KPMG on cost of capital in Austria

KPMG Austria recommends a risk-free rate of 0.0% and an equity risk premium of 8.5% to 9.0% as of March 31, 2020, for the Austrian market, according to its latest quarterly brief. As of April 30, 2020, a risk-free rate of -0.9% and an equity risk premium of 8.5% to 9.0% is recommended for the Austrian market.

Two new members join the IVSC

The International Valuation Standards Council (IVSC) has announced two new members: the European Mortgage Federation (Institutional Member) and the University of Economics, Prague (Academic Member). If your organization is interested in becoming a member of the IVSC, click here.

Preview of the June 2020 issue of Business Valuation Update

Here’s what you’ll see:

• “Assessing Additional Economic Risk Due to COVID-19” (Ronald L. Seigneur, CPA/ABV, CVA, ASA, Seigneur Gustafson LLP). A template that can serve as a framework of thinking about the impact of the coronavirus on a subject company. The author presents a series of questions that help assess the short- and long-term risks with respect to the subject company’s industry, physical operations, financial issues, and firm management.

• “Alternate Valuation Methods in the Era of COVID-19” (Daniel R. Van Vleet, ASA; Joseph W. Thompson, CFA, ASA; William P. McInerney, ASA; and David J. Neuzil, CFA; Griffing Group). The authors address the impact of COVID-19 on the capital markets and offer alternate valuation methods that should be considered in these turbulent times.

• “ESOP Case Appeal Stokes Controversy Over DOL Valuations” (BVR Editor). A series of court cases have generated controversy over the tactics and valuation methods the Department of Labor (DOL) has been using, including claims that the DOL has improperly redefined the term “fair market value,” does not follow generally accepted valuation principles nor standards, and continually uses an expert the valuation community deems “unqualified.”

• “Damage Valuation in a Financial Advisor Termination Case” (Howard A. Buchler, JD). In a wrongful termination of a financial advisor, the damage calculation involves a determination of the value of the advisor’s book of business at the time of termination as well as consequential and any special damages.

• “Cost of Equity and COVID-19: What to Do?” (Peter J. Butler, CFA, ASA, Valtrend). Using a forward-looking approach, implied volatilities, and total beta to determine an appropriate cost of equity during “unprecedented” times such as we have now to supplement one’s analysis.

The issue also includes:

• An expanded section of “BV News and Trends/Global BV News and Trends.”

• Regular features: “Ask the Experts” and “Tip of the Month.”

• BV data spotlight: “DealStats MVIC/EBITDA Trends,” “FactSet Mergerstat/BVR Control Premium Study,” “Economic Outlook for the Month,” and the “Cost of Capital Center.”

• BVLaw Case Update: The latest court cases that involve business valuation issues.

BV movers . . .

People: Sean Carlin, CPA, CFA, CVA, has been promoted to partner in the transaction advisory services practice at Richmond, Va.-based Cherry Bekaert; he is in the firm’s Bethesda, Md., office and his industry expertise includes the technology, restaurant, manufacturing, and service-related sectors, as well as private equity.

Firms: New York City-based CohnReznick has introduced a new transactions and turnaround advisory practice that integrates the firm’s transactional, restructuring and dispute resolution, valuation, and project finance advisory services under one umbrella to be led by managing principal Claudine Cohen … Rehmann, based in Troy, Mich., has launched a companywide rebrand with a new firm tagline, “Empower Your Purpose,” which is reflective of the firm’s efforts to help clients navigate the unprecedented impact of the pandemic … St. Louis-based Anders CPAs + Advisors has launched a newly redesigned website with simplified navigation for visitors … Springfield, Mo.-based BKD LLP has acquired CampbellWilson LLP, a healthcare consulting firm located in Dallas; the deal will become effective June 1.

Please send your professional and firm news to us at editor@bvresources.com.

CPE events

• Structure, Valuation & Tax Insights for Logistics & Trucking Companies. May 20, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: Ricky Castillo (Castillo CPA PLLC) and Jaclyn Burket Franks (Valuation Fraud & Forensics LLC).

A discussion of industry-specific adjustments to consider along with specific questions to ask business owners about economic, governmental, and location factors that impact valuation.

• Volatility Adjustments for Industry, Size and Leverage. May 27, 10:00 a.m.-11:40 a.m. PT/1:00 p.m.-2:40 p.m. ET. Featuring: James Herr (Alvarez & Marsal Valuation Services). Part of BVR’s Special Series on Fair Value.

A discussion of the basic concepts around applying volatility estimates in valuation, including common pitfalls when calculating the basic volatility measure.

Holiday Break
BVWire will not be published next week due to the Memorial Day holiday.
We will return on June 3. Have a happy and safe holiday!