Future of BV in litigation may turn on one word: ‘Fair’
The article on the “Future of Valuation Litigation”—which we’ve been discussing the past couple of weeks—essentially argues that courts should rely on contemporaneous market evidence rather than “testimony of paid litigation experts” to determine the value of public as well as private companies in bankruptcy disputes. (By the way, one of the authors has posted the article as part of his firm bio; go to Wachtell Lipton and search under the attorney tab for “David Bryan.”)
Yet, not once does the article discuss or even footnote the predominant standard of value in bankruptcy as well as tax, contract, shareholder dissent, and other “economic wrong” cases. After all, legislators, as well as the courts and the common law, could have imposed a “market value” standard in civil litigation, yet they chose to add the word “fair”—and in statutory appraisal actions, to eliminate the term “market” altogether—not only to preserve all-important policy concepts of fairness, but also judicial discretion and flexibility. As Ron Seigneur (Seigneur Gustafson) reminds us, the fair market value (FMV) standard is “not a real concept. It's what the Canadians and the English call a ‘notional concept’ because it assumes ground rules that may or may not be true in the marketplace.”
“Although judges are often interested in hearing what an experienced transaction person has to say,” agrees Jim Alerding (Alerding Consulting), “most are also in tune with the fact that ‘fair market value’ and ‘transaction value’ are two entirely different concepts. FMV is a hypothetical value and not one which can ever be ‘proven’ to be correct or exact. It is an ‘opinion’ that should include consideration of the universe of hypothetical buyers and sellers. The valuation expert should be careful to make that distinction to the trier of fact.”
“The fair market value standard is a theoretical standard used to value interests in an objective way that, especially for a small business, may never be achievable or desirable in a real world context,” says Scott Leslie (Leslie & Assoc.). “Real-world transactions always included the ‘noise’ of items specific to the transaction, which ‘taints’ ever knowing whether a consummated transaction is truly FMV or not.”
“Of course there is genuine value in considering transactional data, and it’s an important part of the analysis in nearly every engagement,” writes Wayne Nichols (Abrams Little-Gill Loberfeld). “But I’m always concerned that transactional data are too far removed from the FMV standard of value.” For example, the price may include an intrinsic synergistic goodwill component, or it may involve a liquidation sale or a transaction that failed within a year because the buyer overpaid. “Is that truly a ‘market comparable?’”
“Without question, contemporaneous market evidence of value, such as actual sale prices or market trading prices, provides excellent, if not paramount, evidence of value,” says attorney John S. Stockdale Jr. (Schafer and Weiner). “However, [such] evidence is not available in the majority of bankruptcy cases. Thus, the role of the expert valuation witness in bankruptcy cases will continue to be significant,” to help determine disputed values, he says. “Further, the process advocated by the authors will simply add an additional, costly, and time-consuming layer to the majority of bankruptcy cases.”
Bankruptcy court rejects same-time market evidence for BV expert values
As it happens, a bankruptcy/district court case has just come down right on point. The facts: The debtor provided payroll and benefits servicing to small businesses. But it was built on a “Ponzi-like” scheme by which the controlling principals used incoming cash to snap up smaller entities or worse, line their own pockets, taking a total of $130 million. The trustee sought to recover those transfers as well as the debtor’s 2001 acquisition of a company for $17.5 million. To do so, the trustee had to show the debtor was insolvent at the time of the transfers and paid more than reasonably equivalent value.
At trial, the president and CFO of the target company testified it was worth at least $10 million at the time of sale and was trading at $0.03 per share. They also pointed to a contemporaneous “strategic” appraisal that valued the business in excess of $10 million. Further, comparable acquisitions valued like businesses at $3,000 per serviced worker, which translated into a $30 million value for the target company. Industry practice used a “standard” multiple of 6x EBITDA, which generated a price of precisely $17.5 million at the time of sale.
The principals failed to authenticate the contemporaneous appraisal as anything but a business record, however, and did not present its authors or an independent expert at trial. By contrast, the trustee offered a credentialed valuation analyst, who testified the debtor had “no value” at any time during its operations. Moreover, at the time of purchase, the target company had lost a major client, leaving it with little or no business, negative earnings, and liabilities that exceeded assets by $1.9 million—which translated into a zero value.
The bankruptcy court adopted the expert’s values. On appeal, the federal district court (S.D. Fla.) affirmed, noting in particular that neither the president nor the CFO had any “professional training or experience as a business valuation appraiser.” Moreover, just because the transaction was arm’s length and included advisors—such as attorneys—and a "strategic" appraisal, this did not “constitute competent and credible evidence that [the target] had value at the time to any but an unscrupulous company like the debtor.” Read the complete digest of In re Certified HR Services Co., 2012 U.S. Dist. LEXIS 136956(Sept. 25, 2012) in the December Business Valuation Update; the court’s opinion will be posted soon at BVLaw
New release updates the role of financial experts
Just two week ago, a federal judge told us that economic cases don’t fail on liability issues—they fail for lack of competent damages evidence. Since then, we’ve been hearing from courts and practitioners alike just how important financial experts and competent, credible evidence is to the outcome of any dispute that involves valuation of a business asset or interest.
The timing couldn’t be better. The brand new, fifth edition of Litigation Services Handbook: The Role of the Financial Expert (Wiley & Sons) is now available at BVR. Edited by Roman L. Weil, Daniel G. Lentz, and David P. Hoffman, the updated edition covers every aspect of preparing and presenting a “winning” damages analysis in court, from types of cases—bankruptcy, IP, lost profits, M&A, and family law—to types of evidence, including how to develop and assess statistical analyses, cost of capital, reasonable royalty calculations, and more.
Company-specific risk premium gets the
As the BVWire goes to press, the outcome of the presidential election is still highly unsettled, with the candidates locked in a statistical tie. One thing is for certain: If either party wins the executive office—or either legislative house—by two-thirds of the vote, we’ll be hearing words such as “landslide,” “supermajority,” and “mandate.”
So why then, when well over two-thirds (71%) of appraisers who responded to our recent online survey say they typically add a company-specific risk premium to calculate the cost of capital in their modified CAPM/DCF analyses, do they still consider the issue far from settled? “It depends,” according to one representative comment. “I do apply a CSRP” when the subject company is small (only one owner) and the pool of potential buyers does not own multiple investments. But even “small businesses” can generate tens of millions in revenues and strong cash flows, attracting more professional investors. “If that is the case, I will lower or eliminate a CRSP.”
Another respondent notes that for larger companies, the market has already priced specific risk factors. Still another suggests replacing the current terminology with “an adjustment for lack of diversification" or an "adjustment for differences from comparison set."
DCF is an ‘acid test’ for public company values, Aussie article says
A discounted cash flow analysis is “a blue-ribbon standard for valuing privately-held companies,” says a new article from TheBull.com.au, a journalist-owned Australian market share site; “it can also be used as an acid test for publicly traded stocks.” The DCF is also useful for small, private company valuations, of course, and a BV expert is particularly helpful for forecasting cash flows, calculating WACC, and arriving at credible value conclusions.
The article “DCF Valuation: The Stock Market Sanity Check” is written for investors and business owners—so it covers what business appraisers know is a sophisticated analysis from a fairly simplistic point of view. Still, it offers evidence of growing if not global support for BV appraisers’ most valuable tool.
After the storm, FASB extends comment period on two key exposure drafts
In recognition that the East Coast, as well as many inland communities, are still struggling to recover from the impact of Hurricane Sandy, the Financial Accounting Standards Board (FASB) has extended the comment periods on two current drafts. Stakeholders can now provide written comments on:
A ‘NICE’ (and precise) method for valuing FLPs
As BV appraisers know, family limited partnerships (FLPs) require an assessment of each investment piece of the partnership’s portfolio to construct the most accurate value—including the costs of illiquidity—of any ownership interest. Determining marketability discounts are often the most difficult piece of the FLP valuation puzzle—particularly since they continue to flag IRS interest and possible examination.
On November 8, join William Frazier (Stout Risius Ross) and Ashok Abbott (West Virginia University) for Part 2 of BVR’s Online Symposium on Estate & Gift Tax as they present the Non-marketable Investment Company Evaluation Method (or NICE), an income-based approach for valuing equity interests in closely held investment entities (FLPs, S corps, LLCs, etc.) that sidesteps any determination of marketability/minority discounts.
‘Instant’ valuation training now available at BVR
BVR’s library of “Training Packs” now holds over 300 webinars and related materials, program recordings, transcripts, slide presentations, and ancillary reading—which have just become instantly available through a new, downloadable digital format.
Now, when you purchase an event Training Pack, you will follow the link on your store receipt or fulfillment email to download the recording, as well as its transcript, PDFs, and other materials. There’s no wait for shipping and no change in the high-quality content; customers who still want a CD-ROM can receive one on request. For more information and a list of all available downloads, visit our Training Pack webpage.
Last chance to register for LA Appraisal
The Southern Chapter of the Appraisal Institute is holding its 45th Annual Litigation Seminar in downtown Los Angeles this coming Friday, November 9. Featured sessions include “Appraisal Valuation in Bankruptcy,” presented by Valeo Schultz and Michael Linsk, and “Fractional Interests and Other Crises—Three Keys to Winning With Clients, Courts, and the IRS,” by Dennis Webb and Professor Rebecca Lonergan. For more information and to register, click here.
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