BVWire quotes an article in QuickRead, a publication of the National Association of Certified Valuators and Analysts (NACVA), that says the Implied Private Company Pricing Line (IPCPL), a new model for estimating the cost of capital for small private companies, “is an exciting development and contribution to the cost of capital determination.”
IPCPL aggregates 500 Pratt’s Stats private company transactions and directly estimates the aggregate IRR on free cash flows. By using fair market value prices paid for small privately held companies, all of the public security return extrapolation issues are rendered moot. Effects of liquidity, unsystematic and systematic risk, and taxes are already reflected in (i.e. “baked-in”) the market clearing prices.
“Based on the current work, results, and communication between the developers and the valuation community, the IPCPL Model will gain credibility and acceptance by valuators and users of business valuation in the near future,” writes Jeff Harwell (Harwell & Co.) who currently serves on NACVA’s Standards Committee. “Any valuator who appreciates the market approach or has operational or transactional experience will be drawn to the Implied Private Company Pricing Line like comfort food. While the cost of capital debate continues and one resource transitions, many of us can look forward to future developments, advancements, and another helping of IPCPL.”
The IPCPL model was featured in the September 2013 issue of Business Valuation Update, and the article is now available as a free download. In addition, you can learn more about IPCPL at BVR’s Cost of Capital Resource Center and receive monthly updates on the back page of the Business Valuation Update in the Cost of Capital Center section.
The use of pre-IPO studies to measure a discount for lack of marketability has gained acceptance among valuation analysts and the Tax Court. Still, though, there is some criticism over this method. One notion kicking around recently is “double counting,” meaning that some of the transactions in the pre-IPO databases are calculated with a DLOM already in them.
Not true: “Double counting of discounts is not occurring when viewed in the larger context of the transaction,” says Brian Pearson of Valuation Advisors LLC, who developed the Valuation Advisors Lack of Marketability Discount Study. This is the only online database of pre-IPO private stock and option transaction data from 1985 to the present. It recently hit the 10,000 mark in terms of the number of transactions it contains.
In a recent interview with Business Valuation Update, Pearson reacted to the idea that the discount is double counted. “While it is true that some of the transactions include a prior discount, it helps to understand the process by which this ‘discount’ was calculated,” he says. “Under the fair value standards for option and stock issuance and the AICPA’s guide to fair value, the commonly used valuation method of PWERM (probability-weighted expected return method) requires consideration of a DLOM. So if the enterprise value is $10 per share and the CPA BV professional, under the fair value guidelines, assigns a 30% discount, the reported transaction price is $7. If the company goes public at $12, in theory, you have two discounts at two different periods (30% and 20%). However, this is where the theory of multiple discounts fails, since in reality the transaction is just one transaction, from the time of investment until the time of liquidity (i.e., the IPO date).”
He continues: “Prior to the fair value standards, in an arm’s-length negotiation of the price, the same process would have occurred, except it would simply have been reported as a $7 transaction with the discount as ((12 – 7)/12), or 41.66%. Thus, the concept of “two discounts,” although implicit in the process, wasn’t being publicly reported. In fact, the same level of DLOM is occurring in both situations—it’s just that the fair value standards for pre-IPO transactions shed better light on the process of how such pre-IPO values are being arrived at now.”
Free article: Read the complete interview with Pearson in the article “Is the Lingering Criticism of Using Pre-IPO Studies for DLOM Justified?” available from BVR as a free download.
BVR and Duff & Phelps officially announce the forthcoming 2014 Valuation Handbook and the Risk Premium Calculator. Production is underway for the Handbook, which will be included with any Risk Premium Calculator subscription and also available for purchase on its own. For more information on the Handbook and the Calculator contact BVR sales at 503-291-7963, ext. 2, or email@example.com
Be sure to register for the debut webinar, The 2014 Valuation Handbook and the Risk Premium Calculator (February 20) with Roger Grabowski, hosted by BVR. This free webinar is the first presentation of the 2014 Valuation Handbook, the newest and best resource for cost of capital data. Filling the void left by the discontinued SBBI Valuation Yearbook, the Valuation Handbook includes all critical year-end data necessary for cost of capital determination along with the materials included in Duff & Phelps’ long-standing annual publication, the Risk Premium Report. Join Grabowski, leader of the brain trust behind this new publication, for the first opportunity to learn about the compilation, presentation, and utilization of the data in this powerful resource.
BVWire reports that the Financial Accounting Standards Board has released the first two GAAP alternatives created by the Private Company Council (PCC). These alternatives provide private companies with (1) an alternative accounting model for goodwill; and (2) a simplified hedge accounting approach for qualifying interest rate swaps.
The goodwill alternative, Accounting for Goodwill Subsequent to a Business Combination, allows a private company to amortize goodwill over a period of up to 10 years and to apply a simplified impairment model to goodwill. Step 2 of the impairment test would be eliminated and replaced with a simpler calculation. Companies that choose the alternative will have to test for impairment only when a triggering event occurs that would indicate that the fair value of an entity may be below its carrying amount.
Impact: Although the goodwill alternative is designed to cut the cost of compliance for private companies, they may elect not to adopt it. That’s because if they are acquired by a public company, they would have to undo the election and restate financial statements. So there may be little impact on valuation analysts—for now.
The FASB also voted to add a project to its technical agenda to consider similar alternatives to the existing goodwill impairment model for public companies and not-for-profit entities. Of course, if this is approved, private companies would have less risk of restatements, so more of them may adopt the alternative. This would have a greater impact on valuation analysts.
Learn more: Speaking of the PCC, there will be a webinar on February 4, Private Company Considerations in Measuring Fair Value featuring Mark Zyla (Acuitas Inc.). This is part of BVR’s 2014 Online Symposium on Fair Value Measurement and will look at potentially game-changing proposals by the Financial Accounting Foundation’s Private Company Council (PCC) to make changes and exceptions to GAAP for private companies. Join Symposium curator Zyla to find out how these alterations, subject to FASB endorsement, could affect valuation, fair value measurement, and GAAP standards
A recent ruling in the multifaceted Chapter 11 bankruptcy litigation of Residential Capital (ResCap) contains a noteworthy analysis of the alleged diminution in value of the collateral of junior secured noteholders (JSNs). Bankruptcy experts have observed that only a few decisions have tried to measure the decrease in value of collateral.
‘Global summary’ valuation: ResCap was one of the leading originators and servicers of residential mortgage loans in the country. In May 2012, ResCap and its affiliated debtors petitioned for Chapter 11 bankruptcy. The JSNs held or managed entities holding junior secured notes. To keep their business operating as debtors in possession, the debtors sought to obtain post-petition financing and authorization to use the cash collateral encumbered by existing debt facilities. They negotiated a cash collateral order with the JSNs that established the latter’s right to adequate protection for the use of their collateral.
In subsequent litigation over ResCap’s reorganization plan, the JSNs claimed a right to recover an adequate protection claim of $515 million based on the diminution in the aggregate value of their prepetition collateral as used during the case under a number of consensual orders.
Both sides agreed that the amount of the adequate protection claim was the difference in the value of collateral between the effective date and the petition date. Moreover, they agreed that $1.88 billion was a baseline value at the effective date. They disagreed over the value of the collateral on the petition date. The JSNs had the burden of proof. They presented opinions from four experts who sought to determine the fair market value of the various assets that were part of the collateral by considering, to the extent applicable, the prices the assets commanded in a post-petition auction process and adjusting back to the petition date. Also, one of the experts presented a single “global summary” of the opinions, arriving at a net fair market value of $2.79 billion.
The court found the valuation unreliable. For one, it incorrectly assumed the debtors could have sold the JSN collateral on the petition date free and clear of certain obstacles. However, at trial, one of the experts admitted that the sale of mortgage servicing rights would have required consent from the residential mortgage-backed securities (RMBS) trustees and government-sponsored entities, coming at a high cost. Also, in this case, most of the assets could not simply be handed to a buyer who could instantly benefit from full value “as if the assets were commodity products.” According to the court, the experts “ignored the reality” of the dire situation of the debtors just prior to the bankruptcy. Thus, even though it was “mindful” of the JSN money the debtors had spent during the case, the court found this spending did not mean they incurred a diminution in the aggregate value of their collateral.
An extended discussion of In re Residential Capital, LLC, 2013 Bankr. LEXIS 4844 (Nov. 15, 2013) is in the February issue of Business Valuation Update; the case will be available soon at BVLaw.
That was the question raised by several speakers at the 8th International Conference on the Valuation of Plant Machinery and Equipment (ICVPME) in St. Petersburg, Russia.
Raymond Rath (Globalview Advisors LLC), who attended the conference and presented a session on fixed asset valuation, tells BVWire that Sir David Tweedie, current chair of the International Valuation Standards Council, stressed the continued need for increased standardization of valuation practice in the overall valuation profession. Sir David highlighted comments by the then acting chief accountant (now chief accountant) of the SEC, Paul Beswick, about the fragmented nature of the valuation profession in the United States and the concerns this creates for third parties that rely on valuations.
Sir David and other speakers raised the question of whether the valuation profession can continue to be a self-regulated profession or whether—similar to the accounting profession in the U.S.—greater government oversight will be warranted.
“As BV people, we’re always trying to find good compensation data so we can properly normalize financial statements,” says Stuart Weiss, CPA/ABV. “However, most of the good data focuses on companies that are too large for most of us. And even if we wanted to purchase such data, we’d spend thousands of dollars to get it.”
Now, fortunately, there are data available on small companies that include salary, bonus, equity, benefits, and perk data for CEOs, presidents, COOs, CFOs, and other categories of management. Weiss spoke with Wayne Cooper, chairman of Chief Executive Group, whose firm developed a compensation product for businesses of $10 million in sales and below, which is the market for most business valuation professionals.
Weiss asked Cooper how the idea came about for a CEO compensation report for private companies. “About three years ago, we created a research group on behalf of our clients,” recalls Cooper. “This report came from our subscribers asking us for good information on private companies. There are about 5,000 public companies in the U.S. and there’s a lot of information on them. But there are about 3 million private companies and there wasn’t reliable data on compensation trends and best practices for those firms. Their boards and the CEOs wanted that information to benchmark themselves and their companies. We went out and surveyed our audience and got a tremendous response. Over 1,200 CEOs filled out the survey that included very detailed information about their own compensation as well as their senior executive team.”
Cooper continues: “Given that some of our customers were small companies and didn’t need the data on the bigger companies, we did a version that just focuses on under $2 million, $2 to $5 million and $5 to $10 million in revenue. This version came out this past September.”
Interesting trends. “One thing to note is the variation in total CEO compensation between top quartile and bottom quartile,” says Cooper. “While the median was $225,000, the top quartile was $586,000 and the bottom quartile was $112,000. Another interesting point is how different the average (mean) is from the median. In this case, the top 10% skew the overall average. Some of them had very lucrative packages and may have sold the company that year, and got big equity gains that one year.”
Read more. The full interview with Cooper is in Weiss’s article, “Insights Into Recent Data on Small Private Company Executive Comp,” which is available as a free download from BVR. The report, Small (Under $10 Million Revenues) Private Company Executive Compensation Digest 2013-2014, is available at www.bvresources.com.
Since leaving the Internal Revenue Service and opening his own firm, Michael Gregory (Michael Gregory Consulting LLC) has reviewed many business valuation reports. He finds enough errors to typically generate a four- to six-page paper of significant comments followed up by a discussion of the documentation provided.
“What does this tell me?” he writes in his recent book Business Appraisals and the IRS. “It tells me that you should have a third party conduct a real review of your work.” And this should not just be an afterthought, he says. It should be made a formal part of the work flow. The review should cover readability as well as technical competency, including math in spreadsheets. This will help prevent many of the more common errors Gregory saw during his stint with the IRS and, since then, in scores of reports by business valuation expert witnesses in the private sector.
BVWire reports a number of recent promotions, new hires and other activities of people across the business valuation industry.
Beth Fenton joins the team at HSSK as director of business development at its Dallas office. Beth’s main focus at HSSK is to help the firm find new opportunities to provide its excellent service in the areas of business valuation, litigation consulting, and financial restructuring … Dan Vuckovich was recently appointed to the State of Montana’s Board of Public Accountants … PJ Patel has been named co-CEO of Valuation Research Corp. Mark Brattebo, who served as co-CEO with William Hughes since 2001, will step down from day-to-day management but will continue to serve his existing clients, assist with the transition, and remain on VRC’s board. Hughes will continue to serve with Patel as co-CEO … Greg Stephens has been named chief appraiser to accompany his role as senior vice president of appraisal operations and compliance at Metro-West Appraisal … Russ Williams and Chris Wolf are new associates at Intrinsic, which is expanding its business valuation practice … Gary Korn will lead the new valuation services line at MorganFranklin Consulting … Melinda Harper, founder of Harper Hofer & Associates, has been named to the board of Colorado HealthOP … Monica Kaden, a principal at Fischer Barr & Wissinger, recently conducted a “Health Care Valuation” presentation at Brach Eichler, a law firm in Roseland, N.J. … Mark Warshavsky (Gettry Marcus CPA, P.C.) gave a presentation, “Drafting Business Valuation and Buy-Sell Provisions for New York Closely Held Limited Liability Companies,” to an audience of 80 attorneys in Melville, N.Y.
BVWire reports on a session at the recent AICPA Forensic & Valuation Services Conference 2013 in Las Vegas conducted by Robert Reilly (Willamette Management Associates), who discussed current issues in bankruptcy valuations. The issues are:
- There is no bankruptcy code definition (or standard) of the term “value”;
- The use of hindsight in the valuation is discouraged;
- The valuation analyst’s reliance on management-prepared financial projections is often questioned;
- The analyst’s selection of valuation variables is often questioned;
- Current interest rates may be considered reasonably low;
- The reasonableness of the analyst’s due diligence is often questioned;
- Consider all of the income tax effects on the debtor value;
- Use of industry valuation rules of thumb is often questioned;
- Performing the cash flow test within a solvency analysis; and
- Use of the market approach in an inactive market is often questioned.
Reilly, along with Dr. Israel Shaked, are the authors of A Practical Guide to Bankruptcy Valuation.