October 30, 2013 | Issue #133-5  

New model for private company pricing sparks positive feedback

The Implied Private Company Pricing Line (IPCPL) is a new approach designed to eliminate the inherent problems in comparing public and private data and to be more reliable in estimating the cost of capital for a privately held business. After it was featured in the September issue of Business Valuation Update, readers sent some very positive feedback.

For example: “The article on the private company pricing is extremely valuable to valuation professionals,” says Charles Grigsby (Grigsby Forensics & Valuation). “I have used the Butler-Pinkerton Calculator to achieve an objective determination of company specific risk as opposed to a subjective determination. The IPCPL is another objective determination (Butler is one of the authors) in achieving an objective determination of the cost of capital for a private company with sales lower than $50 million. The three authors of this article [Bob Dohmeyer (Dohmeyer Valuation Corp), Pete Butler (Valtrend LLC), and Rod Burkert (Burkert Valuation Advisors)] are among the best in the country and their research and resulting methodology is critical for application by all valuation analysts to achieve this objectivity.”

There are also a few good discussions surrounding the IPCPL model in the BVR LinkedIn group. One of the comments mentions that BVR has posted the article on its website as a free download.

Learn more: BVR will present a webinar, The Implied Private Company Pricing Line, on November 7 with Dohmeyer and Burkert, who will explain their new approach to cost of capital estimation for private businesses.

SCIN valuation in pending Tax Court case

Very little has been written about the valuation of self-canceling installment notes (SCINs), but they figure very prominently in a pending Tax Court case.

At the recent ASA Advanced Business Valuation Conference in San Antonio, William Frazier, ASA (Stout Risius Ross) talked about the Estate of William M. Davidson. According to Frazier, the case doesn’t have a court date yet, but the IRS has filed a petition claiming that the estate is undervalued and that it owes up to $2 billion in taxes (yes, billion).

William Davidson is the late owner of the Detroit Pistons, Tampa Bay Lightning, and Guardian Industries (one of the country’s largest private companies). In addition to the undervaluation allegation, the IRS is questioning the SCIN technique of selling assets to heirs based on a payment schedule that includes a provision that cancels the payments when the seller dies. The IRS says Davidson made errors in figuring his life expectancy, which caused the heirs to pay much less than fair market value.

If the Davidson estate prevails with the SCIN issue in Tax Court, “you’ll see more of these being used,” says Frazier. Stay tuned!

Valuation of partial interest discounts

The Southern California Chapter of the Appraisal Institute and the CFA Society recently presented the 2013 IRS Valuation Summit at the Century Plaza Hotel in Century City, Calif.

According to David Rosenthal (Curtis-Rosenthal Inc.), who was co-chair of the conference, valuation of partial interest discounts is an esoteric discipline, since prevalent valuation methods act as a proxy for an inefficient market with a dearth of specific market data. Lance Hall (FMV Opinions Inc.) grabbed everyone’s attention with a grim tale of aggressive IRS enforcement in which it recently barred an MAI appraiser from ever providing appraisals for federal tax purposes. This permanent injunction included requiring the appraiser to provide a copy of the order to the Appraisal Institute Ethics and Standards department as well as to all of his current and former clients.

Judge Mark Holmes (U.S. Tax Court) shared his opinion that the most defensible approaches to discount valuation are those that are supported with direct market evidence and are logical and understood by the court.

California mitigates state’s Section 409A tax penalty

Section 409A of the Internal Revenue Code made news earlier this year (BVWire Issue #127-3) when the U.S. Court of Federal Claims declared that it applied to discounted stock options.

For federal tax purposes, section 409A provides that all amounts deferred under a nonqualified deferred compensation plan represent income if they are not at a substantial risk of forfeiture. Amounts includible in gross income are also subject to interest on prior underpayments and an additional income tax equal to 20%. Besides discounted stock options, section 409A applies to traditional deferred compensation plans, payments under severance agreements, employment agreements, change in control and retention agreements, and other forms of equity compensation.

California twist: A recent California measure adds a state-law dimension to an already complicated piece of legislation. Because California automatically incorporated the federal pension rules, state law allowed for an additional state 409A penalty equal to the federal 20% penalty, imposing a 40% income tax for section 409A noncompliance. But on Oct. 4, 2013, Governor Jerry Brown signed into law a bill that will reduce the state penalty from 20% to 5%.

The new law is effective for tax years beginning on or after Jan. 1, 2013. It does not disturb the federal tax provisions or the California state interest penalty provisions.

Proponents of the measure argued that even if section 409A originally had a legitimate purpose—to prevent executives and directors from manipulating the timing of compensation payments—its broad application, based on Treasury regulations, has harmed all classes of service providers, including low-level employees and many independent contractors. The latter make up a big part of the state’s vital entertainment industry. Movie studios often enter into arrangements with actors, directors, producers, and writers that specify that the talent will provide services in one year but has a right to receive compensation in a later year. If California could not repeal the provision, it could and should mitigate the burden on the entertainment sector and similarly hurt industries by reducing the 20% additional California tax penalty.

Meanwhile the federal section 409A stock option case is awaiting trial on the valuation issue of whether the taxpayer in fact received his options at a discounted price.

A digest of the court’s pretrial decision in Sutardja v. United States, 2012 U.S. Claims LEXIS 126 (Feb. 27, 2013), is available in the June Business Valuation Update.

Valuing economic damage claims for insurance purposes

During the upcoming webinar Calculating Damages for Insured Claims (November 5), you’ll learn how business interruption insurance functions, how the nuances of these policies should be interpreted in financial analysis, and how economic damages claims are analyzed when insurance is present. Presenter: Jonathan Dunitz (Verrill Dana). Part 9 of BVR’s 2013 Online Symposium on Economic Damages.


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