Pepperdine private cost of capital project is back up and running

On the brink of ending its long run, the Private Capital Markets Project from Pepperdine University has secured funding to continue its ongoing survey of expected rates of return of providers in the private capital market.

“I am very pleased to announce that we are back up and running due to generous underwriting from the ESOP Association and Employee Ownership Foundation,” says Dr. Craig R. Everett, the project’s director. This has enabled the project to launch a new cost of capital survey. “We know how important this study is to the ESOP and valuation communities, and we are pleased to ensure that this important independent source of data will continue to be provided to ESOP companies and valuation experts alike,” Patrick Mirza, director of communications for the ESOP Association and Employee Ownership Foundation, told BVWire.

Alternate analysis: Using public market data to estimate the cost of capital for a private company requires many assumptions and adjustments to convert data from actively traded stocks into proxies for private-company valuation. Pepperdine’s project, which produces the annual “Private Capital Markets Report” (available for free), provides an alternate analysis. The analysis is based on an ongoing survey of expected rates of return of investors, lenders, and business owners with respect to private companies.

A BVWire poll in 2019 found that 40% of respondents use the Pepperdine reports. Some practitioners use the reports as a sanity check on more traditional methods, and some use them as a primary method for estimating small private-company cost of capital.

New survey open: For this year’s Pepperdine survey, input is sought from anyone involved in the funding of private businesses, including funding providers, recipients, investors, intermediaries, and advisors. The information you provide is confidential. The direct link to the survey is pepperdine.qualtrics.com/jfe/form/SV_6rgU11Uj6TTzTQq?region=34582.

Goodwill analysis ignoring specifics crumbles on appeal

A divorce expert’s failure to link the facts related to a successful insurance company to his personal goodwill analysis was one of the reasons a Florida appeals court recently overturned the trial court’s valuation findings, which, the reviewing court said, were not based on competent, substantial evidence.

Principal revenue generator: During the marriage, the former spouses bought an insurance agency from the husband’s parents. The husband served as the company’s CEO, managed all aspects of the business, and was the largest generator of revenue. The wife worked as the agency’s bookkeeper.

The husband and wife initially paid $1.5 million for the business and also assumed the significant outstanding corporate debt. During the marriage, the business’s gross revenue nearly doubled. During divorce proceedings, the former spouses, relying on expert testimony, disagreed on the agency’s fair market value, the value of goodwill attributable to the husband, and the income available for alimony.

As for personal goodwill, under Florida case law, it is not a marital asset and excludable from the value of assets available for equitable distribution. Here, the husband’s expert analyzed the agency’s revenues and how much each employee generated for the business. He also considered how much business the husband could take with him if the agency were sold and the husband were not subject to a noncompete agreement. Based on this analysis, the expert concluded the value of personal goodwill in the company was about $1.6 million, which was 68% of the company’s fair market value (almost $2.1 million).

In contrast, the wife’s expert considered 30 transactions of insurance companies from the DealStats database. The transactions were not limited to Florida, and a few went back to 1997. Some of the transactions reported the value of a noncompete agreement—most assigned a value of less than 10%. The expert found the average of those values was 7.3% and used that figure to value the husband’s personal goodwill.

The trial court adopted the 7.3% value the wife’s expert proposed. The appeals court reversed, noting the expert “did not provide any specific knowledge about the particulars of the insurance businesses that reported transactions in the DealStats database.” The court said the expert did not disclose how involved the owners of the businesses he considered were in the company’s affairs, whether they sold insurance, as the husband here did, what the day-to-day operations were. The court also found it problematic that some of the analyzed transactions took place outside Florida and some were almost 20 years old. Importantly, the court pointed out that the husband here was the CEO of the company, was involved in all aspects of the company, and was its largest generator of revenue.

The testimony of the wife’s expert was not competent evidence to support the trial court’s personal goodwill value, the appeals court found. It overturned on this and other valuation issues.

A digest of King v. King, 2021 Fla. App. LEXIS 3170, 2021 WL 822476 (March 4, 2021), and the court’s opinion will be available soon at BVLaw.

Extra: Last week’s coverage of the Columbia Pipeline case, in which the Delaware Court of Chancery recently ruled in the now active breach of fiduciary duty action, omitted the case citation. The citation is: In re Columbia Pipeline Grp., Inc., 2021 Del. Ch. LEXIS 39, 2021 WL 772562 (March 1, 2021). The online version of the article now includes the citation.

Be on the lookout for BI misrepresentations

Business interruption (BI) insurance claims are on the rise, and there are “great opportunities” for analysts on both the business owner side as well as the insurance company side, according to Michael Haugen (JS Held), in an article in the April issue of Business Valuation Update. The demand for valuation and forensics experts is partly due to a great deal of misrepresentations in the claims. Haugen stresses that a misrepresentation does not necessarily mean fraud—it can simply mean an honest mistake. But a great deal of real fraud is going on in this area.

In the article, Haugen gives over a dozen ways to “sniff out” misrepresentations. One of them is to look for corroborating evidence to confirm the narrative about the loss with other sources, such as data from accounting records or other documents. In one case, Haugen was measuring the loss at a manufacturer that had two different plants. A fire shut down one of the plants, and the work was shifted to the other plant. The business income loss claim included increased labor expenses due to outsourcing to third-party labor, which was more expensive than in-house labor. To corroborate this, budgets were examined that revealed that outsourcing was planned in the normal course of business. This did not match the narrative told to the analysts about the extra expense due to the damage.

But just how far do you go in trying to detect misrepresentations? After all, it takes time and effort, which means extra costs. Haugen advises that you work with the insurance carrier and business owner when sorting out potential misrepresentations and whether to try to flush out the correct answer.

April 15 deadline for call for papers on new Stark regs and healthcare valuation

BVR is seeking proposals for papers on issues of fair market value, general market value, and commercial reasonableness under the new Stark regulations. The Centers for Medicare & Medicaid Services (CMS) released a final rule that modernizes and clarifies the regulations that implemented the Medicare physician self-referral statute (the Stark Law). The papers will be peer-reviewed, and we would like to see proposals from experts in all valuation disciplines, including experts not only in business and compensation valuation, but in machinery and equipment (M&E) and real estate as well. Please send an email with a summary of the topic of your proposed paper to andyd@bvresources.com. The deadline for proposals is April 15.

Fingertip guides to valuation cases in new BVR compendium guides

BVR’s valuation and case law compendium guides contain a very helpful feature: a handy summary table of hundreds of cases (by jurisdiction) that gives you the case name, date, specific court, and the main valuation issue in the case. From the table, you can quickly refer to the case digest section for an analysis and other details, such as the names of the judge and valuation experts involved (when known). You can also access the full court opinions from BVR’s BVLaw database. The guides also have a section of recent articles from top practitioners.

There is a series of these updated BVR guides, the latest being the fourth edition of Intellectual Property Valuation Case Law Compendium. Also recently released is the fifth edition of the Business Valuation in Divorce Case Law Compendium. New editions of other compendia are in the wings; the next one is valuation in bankruptcy and financially distressed firms.

Global BV News

PwC examines working capital in DACH and Benelux regions

An interesting analysis of how the COVID-19 pandemic has put cash and working capital into the limelight is in the 2021 edition of PwC’s annual “Working Capital Report,” DACH and Benelux regions. DACH is comprised of Germany, Austria, and Switzerland, while the Benelux region is made up of Belgium, the Netherlands, and Luxembourg. The report points out an important fundamental: “Cash tied up in working capital provides no yield.” Stockpiling cash to ease the way to recovery is certainly valid, but the key to driving value will be the optimal management of working capital. “Now is the right time to focus on cash and working capital management,” the report says. “Not prioritizing cash is both ignoring an opportunity to drive value and risking a negative impact on cash flow.”

Appraisal value does not control fiduciary litigation, Court of Chancery says

In 2019, in the Columbia Pipeline statutory appraisal case, the Delaware Court of Chancery found the unadjusted deal price was the best evidence of fair value. The appraisal litigation, however, did not close the case. The contested merger prompted more actions. In a lengthy opinion, the court recently evaluated claims of breach of fiduciary duty filed by a different set of plaintiffs. The court ruled that the new claims were not subject to the fair value determination from the appraisal proceedings and the litigation could proceed.

Background: The contested merger closed in July 2016. The subject was Columbia Pipeline (Columbia), a midstream company that developed, owned, and operated natural gas pipelines and related assets. The buyer was TransCanada Corp. (TC). The deal price was $25.50 per share.

Columbia’s plan to sell itself attracted a number of possible buyers. The new plaintiffs claim that, once TC emerged as a committed bidder, Columbia’s CEO and its CFO favored TC. The plaintiffs say these executives shut out other bidders and prevented the company from developing other alternatives. The executives, who served as key negotiators, had conflicting interests, held meetings with TC without the board’s approval, and made confidential disclosures to TC about the competition. Ultimately, TC was able to take advantage of the executives’ breaches and force the company to accept a lowered bid.

Same facts, different analysis: In the statutory appraisal litigation, the court, after its exhaustive review of the facts surrounding the sales process, acknowledged that aspects of the sales process were problematic. At the same time, the court found the process was sufficiently sound “to make the deal price a persuasive indictor of fair value.”

In the instant litigation, the defendants argued the statutory appraisal rulings should be binding on the plaintiffs in this action and the court should dismiss the plaintiffs’ complaint. After a lengthy discussion of case law and applicable legal theories, the court found the plaintiffs in the fiduciary litigation were not bound by the prior findings.

The appraisal decision was concerned with determining “whether the petitioners had been exploited in the sense of being deprived of what would fairly be given to them in an arm’s-length transaction,” the court noted. The appraisal decision did not evaluate whether the sales process resulted in the best value reasonably available to stockholders, which applies in the fiduciary litigation. The court said the damages remedy the plaintiffs in the fiduciary case could pursue is the difference between the price the stockholders received and the higher amount TC or another bidder would have paid. The court found the complaint supported “a reasonable inference that the stockholders lost out on a higher valued transaction” because of the actions of the executives and TC.

Moreover, the court said, the complaint supported a reasonable inference that the executives “tilted the sales process in favor of TransCanada and against the other bidders so that they could obtain a cash deal that would enable them to retire with the change-in-control benefits. The favoritism that TransCanada received was persistent and substantial.”

The court denied the defendants’ motion to dismiss.

A digest of the appraisal decision, In re Appraisal of Columbia Pipeline Grp., Inc., 2019 Del. Ch. LEXIS 303, 2019 WL 3778370 (Aug. 12, 2019), and the court’s opinion are available to subscribers of BVLaw.

Extra: In the upcoming May 2021 Business Valuation Update, Gil Matthews (Sutter Securities), a frequent commentator on the Delaware Court of Chancery, provides an extended analysis of the court’s approach to determine value in appraisal proceedings as opposed to fiduciary litigation.

Mercer and Harms tie BV together into one neat bundle

Business valuation is like one huge jigsaw puzzle, and practitioners can often find themselves focusing too much on the individual pieces. A framework of thinking is needed to help fit all the pieces together successfully. That’s where the “integrated theory” of business valuation comes in. This is a concept put forth by Chris Mercer and Travis Harms (both with Mercer Capital), who explain it in a series of BVR webinars.

It all jells: When you listen to Mercer and Harms, it seems as if everything you’ve learned about business valuation comes together in a very logical and understandable way. They contend that any question or challenge an analyst faces can be answered by paying attention to three elements: cash flow, risk, and growth expectations. True, it may seem as if you’ve heard this before, but not in the way they present it, which makes it all fit together very nicely. They also do a very enlightening demonstration of how the three approaches to value (income, market, and asset) are interrelated.

The first installment of the webinar series gave an overview of the integrated theory, and the second installment examined enterprise cash flows. The third and final installment of the series will be April 21, when they will delve into shareholder cash flows. BVR Training Passport holders have access to archive recordings of the first two, and they have a pass for the third. This series will definitely become a classic!

Extra: An excellent companion to the webinar series is the new, third edition of Business Valuation: An Integrated Theory, by Mercer and Harms.

New association formed for healthcare compensation pros

The American Association of Provider Compensation Professionals (AAPCP) is a new nonprofit group whose members advise and lead healthcare organizations on provider compensation, contracting, planning, recruitment, retention, strategy, and, yes, valuation. The fair market value of physician compensation and related arrangements is an area subject to increasing scrutiny amid complex regulations. The determination of FMV is handled by staffers at healthcare systems as well as external valuation experts, and both these groups are among the ranks of AAPCP members.

BVWire spoke with Alex Krouse, JD/MHA, who is legal counsel at Parkview Health and one of the key people behind the formation of the AAPCP. He told us that the organization will develop a body of knowledge, resources, best practices, and training for individuals and firms engaged in provider compensation. Plans also include providing certification and an interactive forum. They were planning their first annual conference last spring, but the pandemic derailed that event, which will be rescheduled. The agenda included topics of interest to all healthcare valuation experts, such as:

• A regulatory overview for provider compensation professionals;
• Nuts and bolts of FMV and commercial reasonableness;
• Compensation surveys and updates; and
• FMV for “thorny” deal scenarios.

The fledgling AAPCP looks like it’s off to a great start!

Extra: BVR has a call for papers on the new Stark regs and healthcare valuation. Proposals are due April 15. Click here for details.

McKinsey examines consumer goods and retail in the wake of COVID-19

Consulting firm McKinsey has some very useful economic and industry reports, research studies, and regular briefings. The latest briefing (dated March 17) assesses the long-term effects of COVID-19 on the consumer goods and retail sectors. In consumer goods, company performance has been “all over the map” as growth soared in 2020 but with the large firms capturing the lion’s share. In retail, success in a post-COVID-19 world will require “hastened progress” on several long-standing imperatives and some new strategies. One of these long-standing mandates, of course, is the shift to “omnichannel,” led by digital shopping. Too many retailers are still making decisions based on a brick-and-mortar mindset.

A lot of free material is available from McKinsey on economic and industry analyses, particularly with respect to the COVID-19 crisis. For example, one chart shows projected small-business recoveries by industry (click here to view), and another shows the most likely scenario for COVID-19’s impact on domestic GDP in various countries (click here to view). All of this material is free, and you can sign up for regular alerts on the McKinsey website.

Data breaches threaten brand values, says study

A recent study from Infosys and Interbrand analyzes the maximum risk of brand value loss in case of data breaches. For the “100 Best Global Brands” ranked in the 2020 Interbrand list, the maximum risk amounts to a loss of 11% of brand value. “While this figure doesn’t look dramatic, it can translate to more than 100% of net annual income, depending on sectors,” the folks at MARKABLES said in a statement. MARKABLES is a provider of data designed to support the valuation of IP assets. The authors of the study suggest that brand owners should re-evaluate “hygiene” aspects of customer experience, such as cybersecurity. MARKABLES adds that brand owners should establish the value of their brands, quantify the risk they are exposed to, and rethink their approach to both risk avoidance (cybersecurity) and risk management (brand insurance coverage).

Global BV News

Registration opens for CBV Congress 2021

Tax Court rejects claimed deduction for management fees

The U.S. Tax Court recently agreed with the Internal Revenue Service that management fees a corporation paid to its three shareholders over a three-year period were not deductible since none of the fees were paid “purely for services” and the petitioner failed to show the fees were “ordinary, necessary, and reasonable.” Rather, they represented disguised distributions, the court found.

Disparate shareholders: The petitioner operated an asphalt paving business and had three shareholders. The company’s president owned 20% of the stock, an S corporation held 40%, and a C corporation also owned 40%. The court noted that the determination of the deductibility of the management fees was to be determined on an individual shareholder basis.

Under the applicable regulations, a corporation may deduct ordinary and necessary expenses, including salaries and other compensation, incurred during the tax year for the purpose of conducting a business or trade. Management fees are only deductible if they are payments “purely for services.”

The evidence suggested that the claimed fees were disguised distributions to shareholders, the Tax Court found, noting the company never made distributions to shareholders. Further, the management fees were evenly distributed closely to the shareholders’ interest in the company. Also, the company had little or no taxable income after the payment and deduction of the management fees.

The court also pointed out the petitioner failed to provide evidence, documentary or otherwise, for the cost or value of any particular service. No witness could explain how the fees were determined or what service they related to. Services were not even performed by the shareholder companies but by individuals from other entities. “Petitioner has to connect the dots between the services performed and the management fees it paid. Petitioner failed to do so,” the court said.

The court also examined the fees paid to the individual shareholder, i.e., the president of the company. It noted the individual shareholder is an employee of the company and provides services on an ongoing basis. However, the total compensation paid to him in his role as president must be reasonable. Here, the court said, the payments were not for any services beyond his responsibilities as president. The IRS, the court said, provided persuasive expert testimony that the executive was already overcompensated by his salary and bonus alone.

This case was a clear win for the IRS and an epic fail on the part of the petitioner, which presented its case poorly. It’s as if the petitioner over the years dared the IRS to catch it if it could, and the IRS did.

A digest of Aspro, Inc. v. Comm’r, TC Memo 2021-8 (Jan. 21, 2021) , and the court’s opinion will be available soon at BVLaw.

Goodwill impairments fell 10% in 2019: D&P study

Total goodwill impairment declined to $71 billion in 2019, down 10% from $78.9 billion in 2018, according to the “2020 U.S. Goodwill Impairment Study” by Duff & Phelps. Although impairments dropped, this was the second highest level after the 2008 financial crisis, the study says. The study examines general and industry goodwill impairment (GWI) trends of more than 8,800 U.S. publicly traded companies through December 2019. The top three industries with the largest increase in GWI in 2019 were communication services, information technology, and consumer staples. This edition also gives a preview of the impact of the COVID-19 pandemic on goodwill impairments taken by U.S.-based public companies. “At the time of writing, the disclosed top 10 GWI events for 2020 reached a combined $54 billion, far surpassing the top 10 in 2019 (at $37.4 billion),” the study says.

Call for papers: New Stark regs and healthcare valuation

Recent regulatory changes will have a significant impact on valuations in the healthcare sector, and BVR is developing content designed to help practitioners navigate the new rules.

The Centers for Medicare & Medicaid Services (CMS) released a final rule that modernizes and clarifies the regulations that implemented the Medicare physician self-referral statute (the Stark Law). The new rule went into effect Jan. 19, 2021, and is designed to make it easier for hospitals and physicians to maintain compliance with the statute in the era of value-based care. The rules impact healthcare valuations and include guidance on how to determine whether the compensation being given to physicians is at fair market value.

Call for papers: BVR is seeking proposals for papers on this topic that will be peer-reviewed. The papers can address any topic related to issues of fair market value, general market value, and commercial reasonableness under the new Stark regulations. Also, we would like to see proposals from experts in all valuation disciplines, including experts not only in business and compensation valuation, but in machinery and equipment (M&E) and real estate as well.

Please send an email with a summary of the topic of your proposed paper to andyd@bvresources.com.

BVR is the publisher of several guides to healthcare valuation, including the BVR/AHLA Guide to Valuing Physician Compensation and Healthcare Service Arrangements, 2nd edition (Mark Dietrich and Timothy Smith), and the BVR/AHLA Guide to Healthcare Industry Finance and Valuation, 4th edition (Mark Dietrich).

We look forward to hearing from you!

Global BV News

Comments due in April on two IVSC exposure drafts

The International Valuation Standards Council (IVSC) has issued two exposure drafts with comment deadlines during April. One exposure draft is on a new standard for the valuation of financial instruments, which is part of the ongoing effort of the organization’s Financial Instruments Board. Comments are due by April 19. You can find the exposure draft if you click here, and you’ll also find a form for feedback. A second exposure draft is titled “Additional Technical Revisions 2021,” which proposes changes to the International Valuation Standards issued in 2019. Comments on this draft are due April 30, and you can find the document if you click here.

Eurozone private M&A soars despite COVID-19

Private equity acquisition prices in the eurozone soared to a new record, according to the free Q4 2020 Argos Index, confirming an overheated rebound to what now appears to be a business value “blip” caused by COVID-19. The Argos Index measures private midmarket-company valuations. What did private equity pay unlisted European SMEs during the fourth quarter? Deal volumes dropped, but the new record multiple climbed to 11.1x EBITDA. Conducted since 2006 by Epsilon Research for Argos Soditic, the index is calculated based on the information contained in the Epsilon Multiple Analysis Tool (EMAT), the database of European acquisition multiples and deal analysis reports (€1 million-to-€500 million deal value).

Preview of the April 2021 issue of Business Valuation Update

Here’s what you’ll see:

•  “Do Not Use the Arithmetic Mean to Average Multiples” (Gilbert E. Matthews, CFA, Sutter Securities Inc.). Valuation professionals should not use the arithmetic mean of multiples. It is mathematically incorrect because it gives excessive weight to high multiples. A multiple is an inverted ratio with price in the numerator. Therefore, the harmonic mean should be used as the appropriate measure of central tendency.
• “Letter to the Editor: Comments on Using Jensen’s Alpha for Active and Passive Appreciation.” This is a Letter to the Editor from Ashok B. Abbott, Ph.D. (West Virginia University), in response to a prior article on segregating passive from active increases in the value of an asset in the context of marital dissolution.
• “Letter to the Editor: Response to Dr. Abbott’s Comments on Using Jensen’s Alpha for Separating Active and Passive Appreciation.” This is a Letter to the Editor from Mark Filler that responds to comments from Dr. Ashok Abbott about Mr. Filler’s prior article on the use of Jensen’s alpha. Dr. Abbott’s comments can be found elsewhere in this issue.
• “What Business Appraisers Can Learn From the GameStop Saga” (Joseph W. Thompson, CFA, ASA, Griffing Group). The lesson for appraisers in this saga is to be aware of potential pricing issues when using guideline public companies in the Reddit orbit. In the short term, the underlying price may not be representative of its “fundamental value” during the volatile period.
•  “14 Ways to Detect Misrepresentations in Business Interruption Claims” (BVR Editor). Business interruption insurance claims are on the rise, and analysts need to be on the lookout for misrepresentations. Michael Haugen (JS Held) conducted a session on this at the recent AICPA FVS Conference, and it’s an area where valuation experts would do well to bolster their knowledge and skills in financial forensics. Haugen gives some tips on how to “sniff out” misrepresentations in these claims.
• “New BVR ‘Power Panel’ Series Offers Seasoned Insights on Timely Issues” (BVR Editor). The first in a series of “power panel” BVR webinars drew a huge audience and brought together highly experienced thought leaders in the profession to address current issues via questions from the audience. The panel, moderated by Jay E. Fishman (Financial Research Associates), consisted of Michelle F. Gallagher (Adamy Valuation), Ken Pia (Marcum), and Jeffrey S. Tarbell (Houlihan Lokey).

The issue also includes:

·   A full 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,” “ktMINE Royalty Rate Data,” “Economic Outlook for the Month,” and the “Cost of Capital Center.”

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

Will the future of BV be in good hands?

The answer is a definite “yes,” and the key factor will be the willingness of the new generation of practitioners to give back to the profession. The future of the valuation profession depends on contributions practitioners make to the advancement of the profession, says a panel of seasoned experts on a BVR webinar. Giving back includes volunteering on committees at their respective organizations, contributing articles, writing books, and conducting conference sessions and webinars.

Get involved:The panel noted that, whether it be the ASA, AICPA, NACVA, or whatever organization you belong to, there are opportunities to contribute. All of the organizations have made efforts to attract young talent to serve on committees and contribute to education and marketing activities. Another way of fostering future leaders is through writing and speaking opportunities. For example, the panel noted that the upcoming new edition of Shannon Pratt’s classic text Valuing a Business will have seasoned experts and young rising stars co-writing chapters.

The panel, moderated by Jay E. Fishman (Financial Research Associates), consisted of Michelle F. Gallagher (Adamy Valuation), Ken Pia (Marcum), and Jeffrey S. Tarbell (Houlihan Lokey). The webinar was the first in a new series of “power panel” programs that bring together highly experienced thought leaders in the profession to address current issues via questions from the audience. The next episode will be on April 6—click here for details.

Tax Court allows for ‘slight’ discount for lack of control for majority interests in real estate holding companies

In a gift and estate tax dispute, the estate and Internal Revenue Service agreed to apply discounts for lack of control and marketability to the majority interests in a number of real estate holding companies. The U.S. Tax Court noted that, in prior decisions, the court found no discount for lack of control applied. However, given the parties’ agreement, here the court said it would apply a “slight” or “low” discount.

Considerable power over LLCs: During her lifetime, the decedent gave fractional interests in a number of limited liability companies to family members. A family trust of which the decedent was the trustee held the majority interest in the LLCs. The LLCs held ground leases in various California properties. During her lifetime, the decedent also served as manager of the companies. Under the LLCs’ operating agreements, the majority interest holder had considerable powers, including the right, “in conjunction with the manager,” to elect to dissolve the companies.

The IRS found gift tax and estate tax deficiencies. For both the gift and estate tax calculations, the IRS determined a higher fair market value of the LLCs based on the valuations of the ground leases. In terms of the estate tax, experts for the estate valued the majority interests by applying discounts for lack of control and lack of marketability. For its part, the IRS argued a lower discount for lack of control and marketability than the estate had used were appropriate. The estate petitioned the Tax Court for review.

Both parties retained experts to analyze the appropriate discounts for each LLC. Both parties used the adjusted net asset value approach to value the LLCs, but the experts had different approaches to calculating the discounts.

Regarding the discount for lack of control, the estate’s expert used the Mergerstat Control Premium Study, which measures control premiums on transactions of publicly traded companies. The expert compared premiums paid to acquire 50.1% to 89.9% controlling interests with those paid to acquire 90% to 100% interests. He explained that the difference in premiums between the two blocks suggested a discount for controlling interests that lacked total control. He then considered factors specific to the LLCs, including the possibility of costly litigation should the majority interest holder attempt to liquidate and dissolve the companies.

In contrast, the IRS’ expert used closed-end funds classified as real estate funds to calculate the discount for lack of control. The data indicated a range of 3.5% to 15.7%, with a median discount rate of 11.9%. Comparing the funds to the subject interests, he found that closed-end funds were “minority interests and completely devoid of any control.” Therefore, a discount for lack of control for the subject interests should be at the “bottom of the range” of the closed-end discount rates. He arrived at a 2% rate.

The court noted the LLCs’ operating agreements gave significant power to the majority interest holder and the family trust held a majority interest in every LLC. Therefore, the discount for lack of control “should be low.” The court noted that it had accepted valuations of discounts based on closed-end funds for purposes of determining minority-interest discounts, not discounts for lack of control for a majority interest. Further, the closed-end funds the IRS’ expert used were too dissimilar to the subject LLCs. Therefore, the court rejected the 2% discount rate.

The court also “hesitate[d] to adopt” the estate expert’s range (5% to 8%), finding he proposed a higher rate based on the risk of potential litigation when there was no evidence in the record that minority interest holders would sue in case of dissolution. The court found a 4% discount for lack of control was appropriate.

This case also includes a discussion of the discount for lack of marketability and a charitable contribution discount. In general, the Tax Court found the estate’s experts, in valuing the various properties, presented a more reliable discount analysis.

A digest of Estate of Warne v. Commissioner, T.C. Memo 2021-17 (Feb. 18, 2021), and the court’s opinion will be available soon at BVLaw.

SPAC transactions included in 2021 Mergerstat Review

The special purpose acquisition company (SPAC) flourished during 2020, and SPAC transactions are included in the 2021 edition of the Mergerstat Review. A SPAC is a shell company that raises capital in an IPO and then acquires an operating company to form a new merged entity. The Mergerstat Review features tables to highlight aggregate deal volumes and deal values for your analysis. Also, the FAQ page has been updated for the new edition. The 2021 edition will be available in mid-April in PDF format and early May for the print edition.

Mergerstat Reviewis an annual publication (with monthly updates) that presents compiled statistics relating to U.S. and cross-border mergers and acquisitions that involve both publicly traded and privately held companies. Data on M&A announcements and purchase prices are presented annually and quarterly, for the current period and historically, including details on individual deals and trends in prices, methods of payment, multiples, and premiums.

Updated DealStats Companion Guide now available

The DealStats public- and private-transaction database has a newly revised Companion Guide that reflects updated charts, graphs, and exhibits. The guide also covers recent enhancements made to the platform, such as the inclusion of the weighted harmonic mean. Also, the platform now allows a guest search so that a nonsubscriber can fully utilize the “Quick Search” and “Search” tabs to view limited information on the “Data” tab. Another enhancement was made to the download option for “Only Displayed Fields” and “All Available Fields,” which now includes a second worksheet, which contains the “Summary” tab information (so users have a record of their search criteria, their selected/deselected transaction IDs, and their summary statistics). You can find the updated Companion Guide if you click here.

Extra: Attend a free Zoom session on March 11 that will give an overview of DealStats as well as a live demo.

Credential program for value growth advisors June 7-11

A natural extension to valuing a business is advising business owners on ways to maximize that value. A training and credentialing program is available for valuation professionals who want to add this type of advisory service to their practices. The Certified Value Growth Advisor (CVGA) program is a five-day course that focuses on the fundamental best practices that drive value of any business. You will also learn how to build on those drivers to develop a short-term tactical plan and long-term strategic plan for the client’s business. The next CVGA program is scheduled for June 7-11 and will be in a virtual environment. For more details, click here.

Global BV News

New IVSC paper on business valuations and ESG

Although there is an increased awareness in environmental, social, and governance (ESG) factors, there is no common approach on how to reflect ESG in business valuations. That’s the topic of a new perspective paper from the International Valuation Standards Council (IVSC) that represents an early step “on the path toward a more systematic approach to the incorporation of ESG into business valuation practice and standards,” the organization says. The IVSC had a recent panel discussion, Unlocking the Value of ESG, and a recording of that is available. The IVSC would like to hear your views on this paper and on ESG as it relates to valuation. Share your feedback through the IVSC Group page on LinkedIn or by emailing contact@ivsc.org.

For more reading on the topic, see KPMG’s Quarterly Brief—International Valuation Newsletter for the first quarter of 2021. The KPMG brief suggests an approach to viewing business valuation through an “ESG lens” that involves assessing the ESG impact on cash flows and the discount rate and using probability-weighted scenarios.

Federal Circuit explains concept of ‘built-in’ apportionment

The Federal Circuit, in ruling on a patent infringement case involving two major pharmaceutical companies, recently clarified the apportionment requirement. The court found the plaintiff based its reasonable royalty calculation on a comparable license that closely covered the value of the patent in the instant case and made further apportionment unnecessary.

The plaintiff, Vectura Ltd., owned a patent that covered “composite active particles” for use in dry-powder inhalers. The defendant, GlaxoSmithKline LLC (GSK), made certain inhalers that Ventura said contained composite active particles that violated its patent. A jury awarded Ventura a reasonable royalty of 3% of GSK’s $2.99 billion in sales for the infringing inhalers. The award was nearly $90 million.

GSK unsuccessfully challenged the award in post-trial motions and subsequently with the U.S. Court of Appeals for the Federal Circuit.

Regarding the damages challenges, the Federal Circuit noted that the parties had a “licensing history.” Most relevant for this litigation was a 2010 nonexclusive, worldwide license Vectura had granted GSK related to more than 400 patents, covering certain GSK respiratory therapeutics. At trial, Vectura’s damages expert used the 2010 license in determining a reasonable royalty. Specifically, she used the 2010 license’s top-tier royalty rate and the royalty base, which consisted of total sales of licensed products for the royalty base. Vectura offered evidence that the key part of the 2010 license covered the contested invention and that the 2010 license and the hypothetical negotiation dealt with “roughly very similar technology.” Also, Vectura argued, successfully, that the principles of apportionment were “baked into” the 2010 license. Therefore, it was not necessary to perform further apportionment.

The district court found, where a party relied on a sufficiently comparable license, it could adopt that license’s royalty rate and royalty base without further apportionment or proving that the infringing features drove the entire market value of the accused product.

The Federal Circuit said, in ordinary circumstances, using the entire market value as the royalty base is only permissible if the plaintiff can show the patented feature created the basis for consumer demand or substantially created the value of the component parts. However, the Federal Circuit went on to say that the court’s case law provides that, if the reasonable royalty is based on a sufficiently comparable license (or comparable negotiation), further apportionment is not necessary. The idea is that the comparable license has a “built-in apportionment.”

Such was the situation here, the Federal Circuit said, noting that GSK’s own damages expert acknowledged how close and comparable the 2010 license was to covering the value of the patent giving rise to the suit.

A digest of Vectura v. GlaxoSmithKline LLC, 2020 U.S. App. LEXIS 36393; __ F.3d__; 2020 WL 6788757 (Nov. 19, 2020), as well as the court’s opinion, is available to BVLaw subscribers.

Current USPAP extended for one year

The Appraisal Foundation’s Appraisal Standards Board (ASB) announced that the current edition of the Uniform Standards of Professional Appraisal Practice (USPAP) will be extended by one year. The 2020-2021 USPAP will now be effective until Dec. 31, 2022. This extension does not impact continuing education requirements. For more details on the extension and some FAQs, click here.

Blast from the past on forecasting

During a recent BVR webinar, Josh Shilts (Shilts CPA PLLC) mentioned a helpful article that appeared in the Harvard Business Review (HBR), “How to Choose the Right Forecasting Technique.” After reading the article, Shilts realized that it was written in 1971! But what it covers still holds true, he says. It covers the basic features and limitations of classic forecasting techniques, including qualitative methods, time series analysis, and causal methods. There’s a nice chart that compares the different techniques and includes typical applications, computation times, accuracy ratings, reference material, and more. “This was gold to me when I found it,” he says. The HBR article is freely available if you click here.

New paper on IBOR reform and valuation

For many years, interbank-offered rates (IBORs) have set the benchmark rate for lending on an unsecured basis. By the end of 2021, countries (including the U.S.) plan to phase out IBOR and move to a new benchmark known as alternate reference rates (ARR). The International Valuation Standards Council (IVSC) has issued a Perspectives Paper—IBOR Transition: A Valuation Guide that outlines the key challenges that arise for valuation professionals from the termination of IBOR. The paper also summarizes the areas that can contribute to “valuation uncertainty” and thereby increase “valuation risk” in appraisals of financial instruments arising from the transition away from IBOR.

Agenda set for NYSSCPA BV and litigation services conference May 17

BVWire always attends the annual New York State Society of CPAs Business Valuation and Litigation Services Conference, and registration is now open for this year’s event, which will be webcast May 17. This full-day conference will feature updates on cyber security, high-tech investigations, and e-discovery; cryptocurrency tracing, location, and seizure; valuation of distressed and bankrupt companies; cannabis company operations and valuations; exit and estate planning; IRS court testimony; SPACs; and practicing with Zoom. Click the link above to check out the full agenda.

Global BV News

Cost of capital parameters in Europe as of Dec. 31, 2020

ValueTrust has released a seventh edition of its “European Capital Market Study” that serves as a comprehensive compilation of capital market parameters such as cost of capital and implied as well as historical risk premiums for European countries. The study also includes trading multiples and total shareholder returns across a wide range of industries. Here are a few key findings:

• The risk-free rate declined from 0.21% as of Dec. 31, 2019, to -0.14% as of Dec. 31, 2020, the further decline in 2020 largely being the consequence of measures the European Central Bank took to fight the COVID-19 crisis;

• After reaching the highest market-value weighted mean, at 9.0%, as of Dec. 31, 2018, the implied European market return decreased to 7.0% as of Dec. 31, 2020. Overall, the implied market return decreased to the lowest level within the study’s observation period; and

• The technology sector shows the highest multiples on average, followed by the industrials sector; the financial sector continues to have the least expensive valuation level of all sectors.

New IACVS chapter formed in India

AICPA votes to exclude new BV glossary from standards

The AICPA Forensics and Valuation Services Executive Committee has voted not to adopt a proposed new glossary of terms into its valuation standards. This is welcome news for valuation practitioners who had concerns about making the new glossary part of the authoritative standards.

Massive overhaul: The new glossary was issued in exposure draft form with comments due January 31. The document, International Valuation Glossary—Business Valuation, is the result of a collaboration of the ASA, AICPA, RICS, TAQEEM, and CBV Institute and represents a massive overhaul of the existing version. It contains many more technical terms and methodologies, some of which have emerged since the current version was published in 2001. The AICPA sought comments on the content of the glossary and whether it should be included in the AICPA’s Statement on Standards for Valuation Services (VS Section 100).

In a letter to the BVWire editor (published here), Dr. Michael A. Crain (Florida Atlantic University), former chair of the AICPA BV committee, expressed concern that the inclusion of the new glossary in the standards could increase risk for practitioners and pointed out that it may be better to issue the glossary in nonauthoritative form, such as a practice aid. During a BVR “power panel” webinar, leading practitioners agreed that risk could be increased, especially in a litigation context. Some of the new glossary entries include methodologies that are unknown to some practitioners, so opposing counsel could ask the practitioner whether he or she used the methodologies listed. A “no” answer could seriously impact the expert’s credibility in the eyes of the court. An attorney who represents accounting professionals in professional liability matters also agreed, telling BVWire that the “proposed revised documents increase the potential for professional risk.”

Unanimous vote:The vote not to adopt the proposed new glossary into the AICPA valuation standards was unanimous, according to an announcement from the AICPA FVS committee. The announcement also noted that all feedback on the exposure draft was evaluated and will be shared with the glossary’s working group.

LLC buyout at fair value poses ‘conundrum’ for the court

In allowing LLC members to buy out a departing member to avoid the dissolution of the company, a court had to determine the fair value of the departing member’s interest in a holding company. The court, in large part, relied on the fair market valuation the remaining members’ BV expert performed, which was premised on an orderly liquidation of the company.

The plaintiff and the defendants owned a limited liability company (TONG). The plaintiff owned 37.5%, whereas the defendants owned 62.5%. TONG’s only asset was its 100% stock ownership in another holding company, Palm Park, which owned three properties. Neither TONG nor Palm Park were involved in managing the properties.

The plaintiff sued the defendants for constructive fraud and judicial dissolution. The court initially concluded TONG should be dissolved as a matter of law. But, in an amended final judgment, the court, under the applicable state statute, found the defendants had the option of buying out the plaintiff’s membership interest.

Net asset value approach: Both parties agreed the net asset value approach was appropriate to determine the fair value of the plaintiff’s interest in TONG. Only the defendants offered a valuation from a BV expert, who said he was retained to “determin[e] the Fair Market Value of a 37.5% Membership Interest in [TONG] on a control marketable basis” as of the valuation date. The expert’s fair market value determination was based on a hypothetical “orderly liquidation” of TONG, including the sale of Palm Park. Under the orderly liquidation premise, the expert accounted for capital gain taxes related to the various transactions and other obligations a liquidation would trigger. He concluded that the fair market value of the members’ equity in TONG was worth almost $3.1 million and the plaintiff’s 37.5% interest was worth a little less than $1.2 million.

The plaintiff objected that the liquidation premise made no sense where the defendants elected to purchase Horizon’s interest in TONG instead of having the company be liquidated so that the defendants could continue to benefit from the investment in TONG and Palm Park “as a going concern.” Therefore, the court should not give any weight to the expert’s valuation.

The court disagreed. It noted that “there is no dispute that the orderly liquidation premise is an accepted method for determining the fair market value of holding companies” (referencing IRS Rev. Rul. 59-60). Further, the court said, fair market value was concerned with a hypothetical sale involving a hypothetical buyer and a hypothetical seller. It “is not determined by deciding the price that would be arrived at by the specific buyer and seller involved in the particular transaction under consideration.” The likelihood of liquidation was not a proper consideration for determining the FMV of the plaintiff’s interest in TONG “and is not a basis for refusing to consider [the expert’s] valuation report.” However, acknowledging that the case did present “something of a conundrum,” the court said it would consider the fact that there would not be an actual dissolution when assessing the equities of the case. At the same time, “it would be a sad end to the unfortunate story underlying this case” if the buyout would jeopardize the continued existence of Palm Park. In an effort to conclude the lawsuit quickly and enable the parties to get on with their respective business lives, the court found the fair value of the plaintiff’s interest was $1.65 million.

A digest of Finkel v. Palm Park, Inc., 2020 NCBC 84 (Nov. 18, 2020), and the court’s opinion are available to subscribers of BVLaw.

IVSC seeks candidates for financial instruments board

The International Valuation Standards Council (IVSC) is looking to recruit up to three new members for its Financial Instruments Standard Board. The board, formed in 2018, guides the development of international valuation standards for financial instruments and recently issued an exposure draft (comments due April 19). Individuals appointed to serve on any IVSC board serve for a term of three years. Applications are due by March 31. For details, click here.

Online master’s program in BV begins April 1

The application deadline is March 15 for the spring semester of the online master’s in business valuation (MBV) program at Florida University Southeast (FUSE), and classes start April 1. At the recent Second Annual Conference on the Art and Science of Business Valuation, Heidi DiCicco, FUSE president, talked about the program, which consists of three semesters (six months each). After successful completion of the first semester, students will receive the credential of Business Certified Appraiser (BCA) from the International Society of Business Appraisers (ISBA). By the end of the program, students will have successfully prepared a portfolio having four different financial analysis and valuation reports. FUSE MBV graduates meeting the standards of International Association of Certified Valuation Specialists (IACVS) credentialing will automatically be granted the International Certified Valuation Specialist with Advanced Studies in Financial Instruments (ICVS-A) credential without having to complete a separate comprehensive examination on valuation concepts. In addition, the MBV prepares students to sit for the Level 1 Chartered Financial Analyst (CFA) examination, and various business valuation and appraisal certifications, such as the Certified Valuation Analyst (CVA), Certified Business Appraiser (CBA), and Accredited Senior Appraiser (ASA).

For a copy of the 2021 MBV program, click here. The course scheduling is flexible and can accommodate the student’s work schedule no matter where the student is geographically.

Agenda available for Energy Valuation Conference May 12

A post-COVID-19 outlook for the energy sector, downstream refineries, upstream reserves, oil and gas valuations, and complex infrastructure assets are some of the topics on the agenda for the Houston Chapter of the American Society of Appraisers (ASA) Energy Valuation Conference on May 12. BVR will present a live webcast of the conference, now in its 11th year, which will feature nationally recognized speakers who are profession leaders. Early-bird pricing is available through March 31. For more information and to register, click here.

Global BV News

New online guide to valuation standards around the world

The folks at Valuology have compiled profiles of the valuation regulatory infrastructure in over 100 jurisdictions around the world. The profiles include such information as legal and regulatory requirements for valuations, the use of International Valuation Standards (IVS), the existence of local valuation professional organizations (VPOs), whether the VPOs issue their own standards, and more. Marianne Tissier (Valuology) tells BVWire that she also did a paper based on the profiles, titled “The Path to Global Valuation Standards: Ambition and Reality.” To access the profiles and the paper, click here.

Preview of the March 2021 issue of Business Valuation Update

Here’s what you’ll see:

• “Price Versus Value: A Transaction and Litigation Perspective” (Craig A. Jacobson and Richard B. Peil, B. Riley Advisory Services). According to disciples of modern portfolio theory and its efficient market hypothesis, shares of public companies should always trade at a price equivalent to their economic value, making it impossible for investors to experience short-term arbitrage profits. But try to explain that theory to any hedge fund manager or day trader who purchased or sold GameStop Corp.

• “Monetary Remedies in Trademark Infringement Litigation” (Stanley P. Stephenson and Gauri Prakash-Canjels, Litigation Economics). Remedies in the Lanham Act are used to punish wrongdoers in trademark infringement litigation, but courts applying that law have dealt differently with some key issues, especially monetary remedies. This article outlines some such problems and how the courts have dealt with them.

• “The NICE DLOM Method Gets a Few Shots in the Arm” (BVR Editor). The nonmarketable investment company evaluation (NICE) method, which first appeared in 2006, is included in leading valuation books, but it has not gained much traction and had not appeared in any court cases—until now. Plus, a streamlined version of the model will be out soon, according to the method’s developer, William H. Frazier (W.H. Frazier & Co. Inc.).

• “Using a Discounted Cash Flow Methodology in Uncertain Times” (Ronald L. Seigneur, Seigneur Gustafson LLP). A fundamental look at the method taking center stage during the pandemic. This article outlines how the DCF method works and to highlight the nuances and trap doors that will be encountered and must be overcome to reliably apply the method to derive an indication of value that is well reasoned and supportable for the application intended.

• “Assessing Additional Economic Risk Due to COVID-19 (Update)” (Ronald L. Seigneur, Seigneur Gustafson LLP). This is an update to a previously published 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.

• “Global Valuers Converge for the Art and Science of Business Valuation Conference” (BVR Editor). A recap of helpful tips and insights from this conference that attracted close to 300 attendees from all over the world.

The issue also includes:

• A full 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,” “Stout Restricted Stock Study and DLOM Calculator,” “Economic Outlook for the Month,” and the “Cost of Capital Center.”

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

Is the new CMS rule that impacts healthcare valuations now at risk?

This past December, the Centers for Medicare & Medicaid Services (CMS) released a final rule that modernizes and clarifies the regulations that implemented the Medicare physician self-referral statute (the Stark Law). The new rule, effective Jan. 19, 2021, is designed to make it easier for hospitals and physicians to maintain compliance with the statute in the era of value-based care. The rule impacts healthcare valuations and includes guidance on how to determine whether the compensation being given to physicians is at fair market value.

We’ve read several articles (see one here) indicating that the new rule may be at risk of delay or replacement due to the GAO’s finding of a technical deficiency, i.e., CMS failed a required 60-day notice period for the new Stark regulations. As a result, the articles say the new rule may be impacted by President Biden’s memo of January 20 announcing a regulatory freeze, thus raising the possibility that the new administration may revisit and revise the final rule.

Tim Smith (TS Healthcare Consulting LLC) tells BVWire that, based on what he has heard within the healthcare community, it is unlikely that the new Stark regs will be changed or delayed, despite the technicalities of the notice period and the regulatory hold. Smith is the co-author of the BVR/AHLA Guide to Valuing Physician Compensation and Healthcare Service Arrangements.

Mollie Gelburd, associate director of government affairs at the Medical Group Management Association (MGMA), agrees that it is not likely that the new rule will be delayed or revised. While the GAO finding (see it here) says that the rule indeed failed the notice period that requires a 60-day delay from the date the rule is published to when it is effective, the Biden administration would have to make an argument that, because of that, the rule did not go into effect on January 19 and thus falls under the regulatory freeze signed one day later. That is unlikely, says Gelburd, for several reasons. “It is unclear whether President Biden has the authority to do that and the rule has bipartisan support,” she tells BVWire. “Also, the rule has the support of the healthcare provider community which has its hands full with the pandemic, so I don’t see President Biden trying to exert authority to have the new rule fall under the freeze memo.” Congress could strike down the rule under the Congressional Review Act (CRA), Gelburd explains, but that is also unlikely. “Congress has largely been supportive of the Stark regulations,” she points out, “so they are not likely to choose to undo the new rule.”

The position of CMS is that the regulations are in effect as scheduled. Smith reached out to CMS, which issued this statement: “The regulations finalized in CMS-1720-F (Medicare Program; Modernizing and Clarifying the Physician Self-Referral Regulations) are effective, except for the revisions to 42 CFR 411.352, which have the delayed effective date set forth in the final rule in order to give physician practices that qualify as ‘group practice’ time to comply with any changes that may affect their physician compensation models.”

Smith and Mark Dietrich (Mark O. Dietrich CPA PC), both of whom gave input to CMS during the development of the rule, conducted a BVR webinar that discussed its impact on healthcare valuation. A recording of their webinar is available if you click here (free for BVR Training Passport Pro holders).

NICE DLOM method gets a nice boost

The nonmarketable investment company evaluation (NICE) method for estimating a discount for lack of marketability (DLOM) first appeared in 2006 and is included in leading valuation books. But it has not gained much traction and had not appeared in any court cases—until now, according to an article in the upcoming March issue of Business Valuation Update. The article includes a portion of the Tax Court transcript in which the IRS expert gives his opinion of the method. The method’s developer, William H. Frazier (W.H. Frazier & Co. Inc.), was one of the experts in the case. Also, the article points out that a streamlined version of the model will be out soon.

While NICE is referred to in the context of estimating a DLOM, it does not determine DLOM as a separate and distinct amount. Instead, it is an income-based method that embodies the DLOM as well as discounts for control and lack of liquidity in the discount rate and views them as investment risks. The method is not designed for operating businesses. As its name implies, it is designed specifically for determining the fair market value of equity interests in closely held investment entities, such as family limited partnerships, S corporations, and limited liability companies.

Today! ‘Integrated Theory’ authors kick off webinar series

A very special BVR webinar series begins today with the authors of Business Valuation: An Integrated Theory, Z. Christopher Mercer and Travis W. Harms (both with Mercer Capital). They will present the first in a three-part series of webinars based on their acclaimed book, which is designed to demystify modern valuation theory and show how to apply fundamental valuation concepts. The first installment is today, February 17, and it will give a conceptual overview of the integrated theory and explore its fundamental principles. The authors will then describe the integrated theory on an equity basis, giving particular attention to the conceptual scaffolding that it provides to discussions of the levels of value and the associated valuation discounts and premiums. They will conclude this installment by extending the conceptual basis for the integrated theory to the enterprise value perspective.

Discount offer: Webinar attendees get a special $30 discount on the book. For details on the webinar and how to register, click here (this webinar is included in BVR’s Training Passport Pro holders).

FASB OKs goodwill triggering standard update for private firms

The Financial Accounting Standards Board has decided to give private companies and not for profits the option to assess at a later point a situation that might trigger a goodwill impairment. This change is designed to address the cost and complexity of having to perform triggering event evaluations and measure potential impairment in interim periods although they only prepare GAAP financial statements annually. FASB expects to publish the new standard in late March and entities that exercise this option don’t have to monitor for triggering events in between reporting periods. This is part of the FASB’s efforts to advise companies on how to account for the impact of the pandemic, and it has delayed implementation of certain rules. Separately, FASB is working on a new standard that will require companies to write down a portion of goodwill each year, instead of doing annual impairment testing.

Global BV News

IVSC roundtable on new standards for financial instruments

The International Valuation Standards Council (IVSC) will hold a virtual roundtable on February 18 on the proposed new international standards governing the valuation of financial instruments. The IVSC’s Financial Instruments Board issued an exposure draft, and comments are due April 19. During the webinar, members of the board, led by Gavin Francis, will discuss the background to the initiative and share details of the current exposure draft. You can register for the webinar if you click here.

Extra:The IVSC is looking to recruit new members for its Financial Instruments Standard Board. Applications are due by March 31. For details, click here.

DOL and Professional Fiduciary Services settle ESOP suit

The DOL recently settled a suit against Professional Fiduciary Services (PFS) related to a 2012 transaction in which PFS served as trustee in an ESOP acquisition of outstanding company stock. Following the playbook, DOL alleged PFS breached its fiduciary duties by causing the ESOP to pay more than fair market value for the shares.

The company was Contractors Register Inc., a New York-based company that provides construction search engines. According to Bloomberg, the company publishes regional directories and databases for the construction industry. In 2010, the company’s shareholders recapitalized most of their equity in the company with long-term, low-interest notes. The company’s capital structure was highly leveraged, but the balance sheet showed over $90 million in cash. The remaining shareholder then wanted to sell his interest to employees via an ESOP. The acquisition, which took place in late 2012, left the ESOP with 100% of the company stock.

PFS was engaged as independent trustee. PFS hired an independent appraisal firm and a law firm to act as trustee counsel.

Familiar complaint:The DOL’s complaint alleged PFS breached its fiduciary obligations to the plan by failing to scrutinize the valuations underlying the transaction and overlooking red flags, such as overly aggressive revenue projections, which produced an inflated valuation of the company’s stock. Among other things, the DOL objected to the projected 2.2% compound annual growth rate for 2013 to 2017. The DOL said the appraiser did not explain how the company would achieve this growth rate but simply relied on management projections. Further, projections of capital expenditures and working capital needs were unreasonable. Also, there was no real negotiation over the purchase price.

The seller offered to sell the outstanding shares for $26,770,000. The independent valuator arrived at a value range between $26.2 million and $40.5 million, with a midpoint of $32.9 million (3.4 to 4.1 times average EBITDA). PFS agreed to a price of $26.7 million. The seller provided 100% of the financing in the form of a note from the company. There were no warrants or other claims on equity.

The DOL sued PFS in December 2019. In December 2020, the parties agreed to a settlement in mediation.

Settlement: Under the recent settlement, PFS will pay $750,000 to the ESOP in three installments. Also, PFS and its president, John Michael Maier, agreed that Maier would no longer accept engagements to serve as trustee in new ESOP formation transactions. PFS notes that the settlement does not prevent PFS/Maier from accepting engagements to sell ESOP stock, serving as successor trustee, undertaking stock acquisitions for existing ESOPs, undertaking, releveraging transactions, and continuing to serve as trustee for existing clients. PFS also agreed not to accept indemnification from CRI or other ESOP clients for breach of fiduciary duties violations. Under the settlement, PFS and Maier do not admit to any breach of their fiduciary duty to the CRI ESOP.

2020 EBITDA multiples rebound, per DealStats

In 2Q20, EBITDA multiples (median selling price/EBITDA) across all industries dropped to 3.7x as deal activity almost came to a halt, according to BVR’s DealStats Value Index (DVI) report for 1Q 2021. But the multiples rebounded by the second half of 2020, to 4.7x in the third quarter and 4.4x in the fourth quarter, returning to levels near historical norms (see graph). “In doing so, this continued the trend of the median EBITDA multiple reporting at its highest level during the second half of the year as seen from 2015 to 2018 and in 2020,” the report says. As small businesses still navigating through the COVID-19 pandemic and a new administration implementing its economic policies, DealStats will continue to monitor the trends in the EBITDA multiple.

LEI up but at slowing pace, reports BVR’s EOU

In December 2020, the U.S. Leading Economic Index (LEI) improved 0.3%, to 109.5 points, which follows an increase of 0.7% in November, reports the Economic Outlook Update (EOU) published by Business Valuation Resources (BVR). The report noted that the LEI’s slowing pace of increase in December suggests that U.S. economic growth continues to moderate in the first quarter of 2021. The report further states that, while the resurgence of COVID-19 and weak labor markets remain barriers to growth, the Conference Board expects the economy to expand by at least 2.0% (annual rate) in Q1 and then gain momentum throughout the year.

The 54-page December 2020 Economic Outlook Update contains expansive research from leading authoritative resources, which you can use in your valuation reports as long as you give proper attribution. To learn more, visit bvresources.com/eou.

Damodaran updates cost of capital data

Professor Aswath Damodaran (New York University Stern School of Business) has started his annual posting of data updates on his website that include risk-free rates, equity risk premiums, corporate default spreads, corporate tax rates, country risk premiums, and other data—all of which is free. He does a series of posts on his blog based on these new data. The first post takes a look back at 2020 and explains the background of his annual data analysis. A recent survey of valuation analysts found that 13% use Damodaran’s data for developing an estimate of cost of equity.

Fairness opinion provider rankings for 2020

The “Global Mergers & Acquisitions Review: Full Year 2020/Financial Advisors” from Refinitiv contains M&A statistics and also rankings for worldwide providers of fairness opinions. Here are the top five providers (based on the number of transactions) of announced fairness opinions rendered in the United States:

1.    Stout (2019 rank: 2);

2.    Duff & Phelps (2019 rank: 1);

3.    Houlihan Lokey (2019 rank: 3);

4.    J.P. Morgan (2019 rank: 4); and

5.    Piper Sandler (2019 rank: 9).

Globally, the top five providers of announced fairness opinions are:

1.    CITIC (2019 rank: 8);

2.    Duff & Phelps (2019 rank: 1);

3.    (tie) Houlihan Lokey (2019 rank: 4);

4.    (tie) Stout (2018 rank: tied for 3); and

5.    J.P. Morgan (2018 rank: 2).

Global BV News

Kohli scores again with top celebrity brand value in India

Virat Kohli, captain of the India national cricket team, has topped the powerful celebrity brand list of Duff & Phelps for the fourth year in a row, according to its Celebrity Brand Valuation Study 2020: “Embracing the New Normal.” The report is a deep analysis of how endorsements affect the brand value of celebrities alongside other factors such as age, fees charged per endorsement, social media presence, and the like. It also examines the impact of the pandemic on both brand value rankings and the celebrity endorsement space. Kohli has a brand valuation of $237.7 million followed by actor Akshay Kumar, at $118.9 million

Indiana Supreme Court issues key ruling on discounts in compelled buybacks

Last year, in a compelled buyout, the Court of Appeals sided with the departing minority shareholder when it found discounts did not apply in a closed-market sale. In a freshly minted decision, the Indiana Supreme Court reversed the Court of Appeals, finding there was no blanket rule disallowing discounts in a compelled buyback. This is especially true where the parties exercised a shareholder agreement whose terms suggested the use of fair market value.

Compelled buyback:The plaintiff was one of the founders of the company and held a minority interest in it. In 2018, he was terminated without cause. Earlier, all shareholders made an agreement that specified how the buyback price of a terminated shareholder’s interest would be determined. The company would buy the interest at “appraised market value,” as determined by an independent valuator and in accordance with generally accepted accounting principles. The independent valuator applied discounts for lack of control and marketability.

The plaintiff asked the trial court for a declaration that discounts are inapplicable because the shareholder agreement here did not “contemplate a fair market value standard.” Ruling on the parties’ motions for summary judgment, the trial court essentially found that the term “market value” as used in the agreement was synonymous with fair market value. According to the trial court, the word “appraised” was an adjective modifying “market value,”

The Court of Appeals reversed, finding, under controlling case law, discounts were inappropriate because the transaction involved a compulsory sale. The company petitioned for transfer to the state Supreme Court.

Parties’ freedom to contract: The opening paragraphs in the Supreme Court opinion make the court’s preference for the company’s arguments clear. The court said, notwithstanding policy concerns that may preclude the use of discounts in certain circumstances, “we hold that the parties’ freedom to contract may permit these discounts, even for shares in a closed-market transaction” The court went on to say, that, “under the plain language of this shareholder agreement—which calls for the ‘appraised market value’ of the shares—the discounts apply.”

The court said prior case law dealing with a statutory buyout “doesn’t control” in a situation such as here, “where the valuation term comes not from a statute but from a contract that contemplates the shares’ ‘appraised market value,’ not their ‘fair value.’”

The agreement’s plain and unambiguous language shows the parties to it agreed to value their shares as if they were sold on the open market, the Supreme Court said. Further, even if “the valuation term were somehow ambiguous,” the court would still find that “fair market value” was the appropriate standard.

A digest of Hartman v. BigInch Fabricators & Construction Holding Co., Inc., Indiana Supreme Court, case no. 20S-PL-618 (Jan. 28, 2021) (Hartman II), and the court’s opinion will soon be available at BVLaw. A digest of the Court of Appeals opinion in Hartman v. BigInch Fabricators & Construction Holding Co., Inc., 2020 Ind. App. LEXIS 183 (May 5, 2020), and the court’s opinion, are now available to BVLaw subscribers.

Many thanks to attorney Drew Soshnick (Faegre Drinker Biddle & Reath LLP) for alerting us to this important decision.

Free Excel models on valuing complex debt

During a recent BVR webinar, several case studies were presented on valuing complex debt instruments. The presenters offered to the audience an Excel file that contained the models used for the three case studies: (1) simple convertible debt using the DCF/yield method for the debt component and the Black-Scholes model for the option component; (2) convertible debt using a lattice model approach; and (3) valuation of warrants. If you would like a copy of the Excel file, send an email to info@bvresources.com with the words “Excel for complex debt” in the subject line, and we will be happy to get it to you. Ideally, you should listen to the case studies that the models relate to, and you can access a recording of the webinar if you click here (free to BVR Training Passport Pro holders; otherwise, it must be purchased). The webinar, Navigation Through the Maze in Complex Debt Instruments Valuation, was presented by Mark Zyla (Zyla Valuation Advisors), Rajesh C. Khairajani (KNAV), and Faisal Lakhani (KNAV).

Fiat Chrysler brand portfolio valued using 1% royalty rate

The portfolio of Fiat Chrysler brands is worth EUR 10.4 billion based on a preliminary valuation using an 1% average royalty rate, according to a white paper from MARKABLES. PSA Peugeot recently acquired Fiat Chrysler Automobiles, and its assets were valued in a purchase price allocation. The white paper notes that the valuation (which is still preliminary) makes Fiat Chrysler the 12th most expensive brand portfolio ever changing hands in an acquisition. The brands include Fiat, Chrysler, Dodge, Jeep, Ram, Alfa Romeo, Lancia, Abarth, Maserati, and SRT. The 1% average royalty rate “is in line with the royalty rate applied in 2011 when Fiat took over Chrysler,” the MARKABLES paper says. “The royalty rate might seem surprisingly low, considering the awareness and reputation of famous passenger car brands. However, it reflects weak profitability in the consumer vehicles sector, overcapacities, technological changes and environmental issues.” MARKABLES is a provider of data designed to support the valuation of IP assets. You can download its full white paper if you click here.

YE2020 data are now in the Cost of Capital Professional

Year-end 2020 data, including equity risk premia, CRSP decile size premia, and industry betas/IRPs, are now available in BVR’s Cost of Capital Professional platform. The platform is a simple, transparent, and cost-effective service for estimating the cost of capital and is designed to bring more professional judgment and common sense back into the process, which has become too much of a complex “black box” of applied mathematics. It supports the buildup method and CAPM calculations for any valuation date. It also gives you the flexibility to choose the start year for historical return data based on what segment of history you believe best offers a reasonable basis to make estimates of expected future returns. For a personalized demo of the platform, click here.

Reminder: Comments due on 2022-23 USPAP

The fourth exposure draft of proposed changes to the 2022-23 edition of USPAP is available for review, and the Appraisal Standards Board is accepting public comments. You can submit comments and access the exposure draft if you click here. Comments are due by February 17.

BVR to webcast Energy Valuation Conference May 12

For the third year, BVR is pleased to partner with the Houston Chapter of the American Society of Appraisers (ASA) to present a live webcast of the Energy Valuation Conference on May 12. The conference, which is in its 11th year, will feature presentations from nationally recognized speakers who are profession leaders, covering a range of important topics in the industry, including a post-COVID-19 outlook. Early-bird pricing is available through March 31. For more information and to register, click here.

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KPMG on business valuations and ESG

While environmental, social, and governance (ESG) factors are seeing a “remarkable increase in awareness,” there is no “common approach regarding how to systematically factor ESG into financial valuations of specific target businesses,” says KPMG’s Quarterly Brief—International Valuation Newsletter for the first quarter of 2021. The KPMG brief suggests an approach to viewing business valuation through an “ESG lens” that involves assessing the ESG impact on cash flows and the discount rate and using probability-weighted scenarios. The brief also contains an update on recent capital market data, including major stock market performances, valuation multiples, current risk-free rates for major currencies, and country risk premiums. The full brief is available if you click here

Attorney sees trouble with proposed new BV glossary

If the new proposed glossary of business valuation terms makes its way into the valuation standards, practitioners will face more exposure to professional risk, says an attorney in a Letter to the Editor. The new proposed glossary is out in exposure draft form with a comment period ending January 31 (see our prior coverage for details).

To the BVWire editor:

I am a civil trial lawyer, and my practice for 45-plus years has included the representation of accounting professionals in addressing and defending malpractice claims and license issues. Accordingly, I noted with interest some proposed items, including a revised glossary of terms, related to business valuation services by accountants.

I need to say that I have concerns about creating a situation where the “standard of care” for a business valuation accountant might markedly shift by the creation of new terms, definitions, and processes that such professionals may not be using now; the legal standard refers to what the reasonably prudent accountant would, or would not, do in same or similar circumstances. Accordingly, I believe the proposed revised documents increase the potential for professional risk.

Further, the Florida Supreme Court ruled midyear 2019, effective at that point and going forward, that the Florida courts will shift to the Daubert methodology currently used in federal courts in evaluating the extent of expert testimony allowed in a given case. Florida had been a Frye jurisdiction on that standard, and Frye essentially focused on one question: whether the expert’s opinion is generally accepted by the relevant scientific community. The Daubert standard offers a list of factors to consider. Florida’s evidence code, within FS 90.702, in its current form, provides: A witness who is qualified by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if: (a) the expert’s specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue; (b) the testimony is based on sufficient facts or data; (c) the testimony is the product of reliable principles and methods; and (d) the expert has reliably applied the principles and methods to the facts of the case.

I believe the risk that may arise in the proposed revisions to the glossary is it would become part of AICPA’s business valuation standard and implicitly make the valuation methods and technical terms generally accepted. And, in my experience with such experts, I am not convinced that many of them use these valuation methods and terms in the proposed revisions and may have difficulty in explaining them.

Signed

Michael J. Corso

Florida Bar Board Certified in both civil trial and business litigation law

Henderson, Franklin, Starnes & Holt P.A.

Fort Myers, FL

During a recent BVR webinar, a panel of business valuation thought leaders urged practitioners to submit comments on the proposed glossary by the January 31 deadline. You can find more details including how to submit comments in our prior coverage.

U.K. and U.S. courts differ on COVID-19 business interruption claims

A recent article in the New York Times reports that the U.K. Supreme Court recently ruled that insurers must cover COVID-19-related losses. This is a huge victory for small-business owners whose business interruptions claims often have been rejected by insurers. In contrast, many U.S. courts (state and federal) have sided with insurers and granted motions to dismiss the plaintiffs’ cases.

Legal test case: As in the U.S., many business owners in the U.K. discovered that insurers were reluctant to pay business interruption claims related to the pandemic. As the Times article explains, the many rejections caused Britain’s financial services regulator, the Financial Conduct Authority (FCA), to file a legal test case on behalf of policyholders in the country’s highest court. The goal, the FCA says, was “to urgently clarify key issues of contractual uncertainty for as many policyholders and insurers as possible.”

The test case sought to litigate key issues and obviate the need for individual policyholders to resolve their individual issues with their insurers. The FCA says for its test case it identified 370,000 policyholders with 700 types of policies that were issued by 60 insurers.

According to the Times article, the Supreme Court’s recent judgment (Jan. 15, 2021) says pandemic-related losses and losses flowing from governmental shutdown orders are covered under two key terms that appeared in many of the policies. They are the “disease clauses,” covering losses from any occurrence of a disease that must be reported to authorities, and “prevention of access clauses,” covering losses when public authorities block access to the business premises. Further, the court ruled that businesses would be able to make claims for partial closure of business or orders that were not legally binding but that encouraged businesses to close days ahead of an order becoming law.

The FCA says it will work with insurers to conclude as soon as possible processing of eligible claims. The goal was to provide businesses with interim payments wherever possible.

Two hurdles: Meanwhile, in the U.S., business owners filing suit against insurers that denied claims for business interruption losses, in many instances, have failed to get beyond the motion to dismiss stage. Diesel Barbershop is a case in point. Here, a number of barbershops operating in Texas challenged the insurance company’s rejection of their claims under policies that were essentially identical. The policies included two hurdles to coverage. One was that they required an accidental, direct physical loss to the property. The court agreed with the insurer that the businesses were not “tangibly ‘damaged’ per se.” The plaintiffs did not plead direct physical loss to their buildings, the court said.

Further, the court agreed with the insurer that, even if the plaintiffs had shown direct physical loss to their properties, they still would not prevail on their claims because of the virus exception contained in the policies.

A companion case is Turek Enterprises, which arose in the Eastern District of Michigan and had facts similar to those in Diesel as well as an almost identical business insurance policy from the same insurer. This case, too, was dismissed.

Digests of Diesel Barbershop, LLC v. State Farm Lloyds, 2020 U.S. Dist. LEXIS 147276; 2020 WL 4724305 (Aug. 13, 2020), and Turek Enterprises, Inc. v. State Farm Mutual Automobile Insurance Co., 2020 U.S. Dist. LEXIS 161198 (Sept. 3, 2020), as well as the courts’ opinions, are available at BVLaw.

Hitchner poll reveals COEC sources of choice

The January 2021 issue of Hardball With Hitchner includes the results of polls that reveal what sources valuation practitioners use for developing cost of equity capital (COEC) estimates. The results of the polls taken in 2020 show that the Duff & Phelps data are “widely used and accepted” and that the BVR Cost of Capital Professional has “gained usage,” Hitchner says (see below)

Analysts’ Usage Percentages of COEC Data Vendors

COEC Source	2/25/2020	1/21/2020
Duff & Phelps Navigator	84%	92%
BVResources COC Pro	24%	21%
Damadoran’s data	13%	12%
Pepperdine survey	8%	13%
Other or none of the above	13%	7%
(Source: Hardball With Hitchner, Issue 3, January 2021)

“Damodaran’s data” refers to the work of Professor Aswath Damodaran (New York University Stern School of Business), who publishes a huge amount of free data on his website. The Pepperdine survey refers the Private Capital Markets Project from Pepperdine University, an analysis based on an ongoing survey of expected rates of return of providers in the private capital market.

During a conference session in 2019, Hitchner used both the Navigator and Cost of Capital Professional platforms on a hypothetical company. The result was a cost of equity range from both platforms that was “not that much different,” he said. Full coverage of that session is in an article, “BVR and Duff & Phelps Cost of Capital Platforms Go Head-to-Head at VSCPA,” which appeared in the November 2019 issue of Business Valuation Update.

Hardball With Hitchner is a monthly publication written by James Hitchner (Valuation Products and Services). For subscription information, click here.

Reminder: Comments due on AICPA’s proposed standard on financial instrument valuation

The AICPA’s Auditing Standards Board (ASB) has proposed a standard designed to provide practitioners with more guidance on auditing management’s estimates of the fair value of financial instruments, including on the use of pricing services. The proposed standard provides guidance:

·   When management has used the work of a specialist in making accounting estimates, as well as other proposed amendments to enhance guidance when evaluating the work of the management’s specialist;

·   On the use of pricing information from pricing services when evaluating management’s estimates related to the fair value of financial instruments; and

·   When using the work of an auditor’s specialist.

The Proposed Statement on Auditing Standards (SAS), Amendments to AU-C Sections 501, 540, and 620 Related to the Use of Specialists and the Use of Pricing Information Obtained From External Information Sources, has a comment period that ends February 4. Please send comments to CommentLetters@aicpa-cima.com.

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‘Amazing’ rebound for valuations in India