September 18, 2013 | Issue #132-2  

Tax methods used for S corp valuations

During BVR’s recent webinar on valuing S corps with Nancy Fannon (Meyers, Harrison & Pia), a poll was conducted. The question was: Which tax method do you use to value S corps?

Most add a premium: More than half (55%) of the webinar audience said they deduct income taxes but add a “premium,” using one of six alternate methods. Four of the methods are those promulgated by Roger Grabowski, Chris Mercer, Chris Treharne, and Dan Van Vleet. Then there’s the Delaware Chancery method and Fannon’s simplified method. Fannon observes that most valuators favor the Delaware Chancery model, since it has been embraced by the courts and used in divorce cases.

As for other options, a quarter (25%) of respondents say they deduct income taxes and do nothing else. Twelve percent of respondents favor taking no deduction for income taxes. Fannon pointed out that it’s not surprising that people use this method, as the IRS continues to push for it in the wake of the now-famous Gross case, which rejected the tax affecting of earnings. The remaining respondents (8%) say they deduct income taxes and make an adjustment to the discount rate to account for embedded taxes.

An archive version of the webinar, S Corps … What a Long, Strange Trip It’s Been, is now available.

Opportunities in ESOP valuations

Valuation experts can take their appraisal theory and apply it to the world of ESOPs in four primary ways, according to Jeffrey Tarbell (Houlihan Lokey), who spoke at a recent ASA webinar, ESOP Valuations: A Look at Advanced Issues.

  • ESOP feasibility studies: This occurs when your existing or new client has the idea of a potential ESOP transaction and needs help with the financial modeling and financial advice to understand whether the transaction is feasible for his or her company. Of course, this will involve legal and other advisors. “But it’s a key opportunity for appraisers as well,” says Tarbell. “And this is generally the first touch point with an ESOP-related company.”
  • Fairness opinions: This is the transaction-related analysis relevant to the establishment of a new ESOP at a sponsor company. “ESOP fiduciaries are required by law not to pay more than adequate consideration for the shares, and they typically request a fairness opinion to demonstrate that they’ve met that burden,” he says.
  • Annual update: An ESOP is required to have the sponsor company’s stock appraised at least annually. “This provides a recurring, somewhat predictable and steady stream of assignments for the appraiser,” he points out.
  • Litigation support: “This is timely today due to the increased level of regulatory oversight by the DOL, among others,” Tarbell says. In a litigation engagement, valuation experts have the opportunity to use appraisal-related theory and knowledge gained in ESOP-related situations.

Conflict? Is there a perceived conflict of interest for a single valuation firm to do the feasibility study, the fairness opinion, and the annual updates? While having one firm do all three tasks has regularly been done, Tarbell sees a trend in separating the feasibility study from the fairness opinion and annual updates.

Having a valuation firm advise a company with a feasibility analysis and then “switch over” to the other side and render a fairness opinion to the ESOP trustee can raise a red flag. “That’s problematic, and I don’t think anyone would deny that,” he says. “And some of the cases that the DOL is going after fall under that circumstance.” So regardless of whether a true conflict of interest exists, there may be a perception of one.

Input needed for guidance on separating intangibles and tangibles

The Appraisal Practices Board (APB) of The Appraisal Foundation has issued a concept paper, Valuation Issues in Separating Tangible and Intangible Assets, to kick off a discussion that will lead to standardizing valuation practices in this area.

Rick Baumgardner, APB chair, says in a statement: “The Board is aware of diversity in methods and techniques currently used in the valuation of property that includes both tangible and intangible components. The APB is also aware of the perception that some methods and techniques may be in conflict with one another. It is the intent of APB to begin a dialogue as a means of identifying these methods and techniques, discuss their similarities and differences, and offer voluntary guidance as to which methods and techniques may be appropriate.”

The deadline for written comments is Oct. 31, 2013, which should be sent to

Reliable or obsolete? DE Chancery scrutinizes precrisis projections

Five years after the 2008 economic meltdown, observers look back with a good deal of hindsight. But when the Delaware Court of Chancery recently assessed the reliability of prerecession management projections for its discounted cash flow analysis (DCF), hindsight is precisely what it wanted to avoid.

After a radio broadcasting business merged into a wholly owned subsidiary of its parent company, a group of shareholders, the petitioners, asked the Chancery for a statutory appraisal. To determine the fair value of their stock on the merger date (May 29, 2009), both sides presented experts. They both agreed that the DCF was the appropriate valuation method but clashed over the issue of how committed management was in May 2009 to long-range projections (2009-2013) that were done before the economic collapse. In fact, in the wake of the crisis, in January 2009, management had produced another forecast for the year, which it updated again for each month leading up to the transaction. The May 20, 2009, forecast was the most recent one before the merger. This projection suggested a far less optimistic view of the future: Projected revenues were 16.8% lower, and operating cash flow was 40.1% lower than the respective values in the 2009 LRP. Still, there were signs that management did not entirely distance itself from the LRP.

Cyclical or secular change? The petitioners’ expert assumed that in early 2009 the industry and the company were in a cyclical slump from which they would—and would expect to—re-emerge. The steep 2008 recession would be followed by a steep recovery, and the company would return to the 2009 LRP after 18 months (i.e., in late 2011). Accordingly, he used the May 2009 forecast to project cash flows for 2009 and the 2009 LRP to project cash flows for 2010 through 2013.

In contrast, the company’s expert assumed that, by the merger date, company management and radio industry observers realized that the industry was undergoing a “secular” change, which had begun before the 2008-2009 collapse. Management considered the 2009 LPR obsolete and did not expect a return to its financial projections. Therefore, the expert incorporated the May 2009 forecast for 2009 EBITDA and then estimated 2010-2013 by using the actual EBITDA compound annual growth rate (CAGR) that the company showed in the four years following the most recent 2000-2001 recession.

This approach, the court decided, was the correct analytical framework. Even though the court normally considered premerger management projections “an appropriate starting point from which to derive data in the appraisal context,” here it was “wary” of accepting the argument that a valuation on the merger date “would anticipate a near-term return to even the 2009 LRP’s 2011-2013 cash flow projections.”

Find a complete discussion of the court’s analysis in Towerview LLC v. Cox Radio, Inc., 2013 Del. Ch. LEXIS 139 (June 28, 2013) in the October Business Valuation Update; the opinion will be available soon at BVLaw.

Go beyond estate and gift tax valuation

When valuation experts step outside the world of estate and gift tax valuations, they face a very different environment. Many “choices” are available relating to the valuation process, including both classic considerations and emerging trends. That’s why you should attend Business Valuation: Beyond Estate and Gift Tax Valuation on Sept. 27-28 in Atlanta. It’s the theme of the 14th Annual Conference of the Southeast Chapter of Business Appraisers and is co-sponsored by the American Business Appraisers.

For more information, contact Gary Fodor at 678-566-3577 or by email at

New season kicks off with super CPE events

As summer ends and fall begins, BVR has a strong lineup of CPE events.

On Friday, September 20, the second installment of BVR’s Advanced Webinar Series on Business Valuation in Divorce features series curator James Alerding (Alerding Consulting) in Goodwill in Divorce Valuation: Personal, Entity, and the Difference Between. Join Alerding as he leads attendees through the tools and analysis required to value and apportion the most common and contentious intangible asset.

Then, on Friday, September 27, the series continues with Reasonable Compensation in Marital Dissolution, featuring James Ewart (Dixon Hughes Goodman). This webinar will address the dissection and assessment of officer compensation, the most subjective and discretionary expense for many owner-operator businesses, whose complexity is only exacerbated in marital dissolution settings.

Valuing Dialysis Clinics, Part 9 of BVR’s Online Symposium on Healthcare Valuation, takes place on September 24 and features James Lloyd (Pershing Yoakley & Associates). Attendees will learn how a difficult mix of factors, including payment schemes, patient mix, and geography, affect the value and valuations of these common, yet complex, healthcare entities.

In the hour-long webinar IP Valuations for Licensed Property Acquisitions, experts Weston Anson and Jeff Anderson (both Consor) join licensing expert Ira Mayer (EPM Communications) to explore the methodologies available when valuing licensed properties for acquisition or sale. As Anson, Anderson, and Mayer will show in their September 25 presentation, the rise in businesses seeking to exploit “pure” licensing business models means both more opportunity and more risk for the valuation of these intangible properties.

In the Advanced Workshop on Estate & Gift Valuations for the IRS, expert appraiser and former IRS territory manager Michael Gregory (Michael Gregory Consulting) joins BVR on October 10 for a thorough examination of how the IRS views many of the most contentious issues in estate and gift valuations. From the structure of the IRS and its appeals and review processes to how the IRS views S-corporation and FLP valuations and discounts for lack of marketability and control, this intensive, four-hour presentation will provide attendees with unprecedented insights into how to prepare valuations for the IRS.


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