Bankruptcy Court pumps up discount rate for company-specific risk

The debate over how to build up a discount rate never loses its fizz, as a recent appeal from a bankruptcy court decision shows.

Small change, big effect: The debtor was a closely held company that specialized in hydrographic surveying and navigational mapping—a niche business. Its five principal shareholders had unique qualifications and long-lasting relationships with the U.S. Army Corps of Engineers, which they used to obtain government qualification contracts. Eventually, 90% of the company’s revenues came from projects for the Corps. After bankruptcy, the debtor proposed a reorganization plan under which it would retain all of its 23 workers and not allow the appellants to acquire a majority interest in the business. The court’s plan approval turned on the valuation of the debtor’s equity interests.

The appellants’ financial expert said the company should be valued as a going concern. He used an income approach to determine “the earning capacity of the business” and a “build-up” discount rate of 18.44%, allocating only 1.5% of it to the company-specific risk. He did not believe the departure of any one of the five principal employees would seriously affect the company’s ability to preserve its contracts with the Corps. He concluded that the debtor was worth $960,000. The debtor’s rebuttal expert called the rate “way understated” and said the company-specific risk in this case was “major.” He gave an example of how “just a few tweaks in the discount rate … can make a huge difference in the valuation.” He said the opposing expert “failed to separate the value of the business from the value of the professional owners of the business” and also did not appreciate the difficulty of replacing key personnel given the principal shareholders’ unique technical skills. The rebuttal expert suggested the discount rate in this case could range from 40% to 75%.

Key role of principals: The bankruptcy court acknowledged the impact of the discount rate on the valuation number and emphasized that a willing buyer assessing the debtor company would consider the key role the principal shareholders played in getting Corps contracts and the latter’s importance to the survival of the company. In the court’s view, “if you don’t have the employees and you don’t have the contracts, what have you got left?” Ultimately, the bankruptcy court arrived at a value of $200,000, without identifying the discount rate it applied or specifying the adjustments it made to the proposed valuation.

On appeal, the district court affirmed. The bankruptcy court did not unduly focus on the risk factors. And just because it did not give a mathematical formula for how it got to $200,000 does not mean it “pulled the number out of thin air,” the district court said. The bankruptcy court’s computed value aligned with the rebuttal expert’s proposed range of discount rates.

Find an extended discussion of Vision-Park Properties v. Seaside Engineering, 2014 U.S. Dist. LEXIS 41923 (March 27, 2014), in the June issue of Business Valuation Update; the court’s opinion will appear soon at BVLaw.

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Industry expert vs. BV analyst

A common question from business owners and their advisors is: Should we use an industry expert or a business valuation professional to value our company? Gettry Marcus (Woodbury, N.Y.), a valuation and forensic accounting firm, responds by pointing out that, while an industry expert is familiar with the unique aspects of a particular line of business, a valuation analyst can gather that same knowledge. This is done through “independent economic and industry research, and one or more interviews with members of management,” the firm says. “This information, combined with the valuation expert’s experience and training over many years, informs his or her judgment and knowledge as it relates to several key portions of the analysis.”

Career advice: Of course, we agree with this, but let’s take it a step further. Should the valuation analyst become a specialist? When we recently asked the very experienced members of the BVU Editorial Advisory Board  for their thoughts on career advice, the most frequent answer we received was that valuation analysts should develop a specialty, whether it be related to an industry or a particular type of valuation (such as lost profits, intellectual property, ESOPs, etc.).

“Find a niche where you can position yourself as an expert as early as you can in your career,” advises Rod Burkert (Burkert Valuation Advisors LLC). “The temptation is to say you can do all valuations,” observes Lance Hall (FMV Opinions). However, the profession has advanced to the point where being a generalist may not be the best idea. “Business valuation has become a true specialty,” says Gary Trugman (Trugman Valuation Associates). “It is not meant for the practitioner who wants to do a little of this and a little of that. When you’re sick, you go to a specialist—not the family doctor.” Specialization can also enhance the value of your services, as Hall points out: “Once you invest in specialization, it’s easier to differentiate your services and maintain higher fees.”

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No easy money in M&A shareholder suits for plaintiffs

A recent report from Cornerstone Research examines trends in shareholder litigation related to mergers and acquisitions. Some highlights:

• For the fourth consecutive year, shareholders filed suit in more than 90% of M&A deals valued over $100 million;
• In 2013, 94% of M&A deals prompted challenges from shareholders;
• M&A deals attracted an average of more than five lawsuits (the Dell Inc. buyout led to 26 suits, which distinguished this transaction as the most litigated deal in 2013);
• The "go-to court" for M&A litigation has been the Delaware Court of Chancery, which during the past four years has been followed by New York County, N.Y.; Santa Clara County, Calif.; and Harris County, Texas; and
• In 75% of the deals, there was a resolution before the deal closed. As to the resolution, 88% of the cases resulted in a settlement, 9% were withdrawn by the plaintiffs, and 3% ended in dismissal by the court.

Olga Koumrian, a principal of Cornerstone, points out that in 2013 shareholders settling their claims received monetary returns only 2% of the time. Many of the settlements are disclosure-only settlements, meaning the defendant merely agrees to provide more transactional information to the shareholders. Some courts, including judges in the DE Chancery, have voiced criticism about these settlements because they provide little value to the shareholders. Perhaps in response to the courts' critical view, plaintiff attorneys have demanded fewer attorney fees in these cases in recent years. 

Valuing M&A damages: The April issue of Business Valuation Update includes an article that discusses a case in the Delaware Chancery Court that dealt with M&A damages. The case was settled before the court could render a verdict, but the expert who testified for the plaintiff gives an inside look at how the valuation of the M&A damage claim was done.

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ASC valuation multiples are on the rise

Buyers are paying higher multiples for controlling interests in ambulatory surgery centers (ASCs), according to the 2014 ASC Valuation Survey from HealthCare Appraisers Inc.

Prevailing rates: When purchasing a controlling interest in a single-specialty ASC, 70% of the respondents reported prevailing valuation multiples of 6.0 to 7.9 times EBITDA, while 30% reported lower valuation multiples ranging from 4.0 to 5.9 times EBITDA. This is comparatively higher than the previous survey, in which 57% of respondents reported valuation multiples of 6.0 to 7.9 times EBITDA for controlling interests in single-specialty ASCs, while 43% reported lower valuation multiples ranging from 3.0 to 5.9 times EBITDA.

Multiples for controlling interests in multispecialty ASCs are also higher according to the survey, which received responses representing well over 500 ASCs throughout the country.

Acquisition activity is expected to remain high this year, as 68% of respondents plan to purchase between one and five ASCs, 16% plan to purchase between six and 10 ASCs, and 4% plan to purchase 16 ASCs or more. Twelve percent of respondents are not planning to purchase any ASCs over the next 12 months.

ASC valuation webinar: Get some insight on ASC valuation from a recent webinar, Valuing Ambulatory Surgical Centers, featuring Todd Sorensen and Kevin McDonough (both VMG Health), two veteran valuation experts in this field.

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Meyers, Harrison & Pia LLC joins with Mark O. Dietrich, CPA, P.C.

A formal affiliation between Meyers, Harrison & Pia LLC and Mark O. Dietrich, CPA, P.C., has been announced. Dietrich, the “foremost expert in the field of healthcare valuation in the United States,” says Mark Harrison, will serve in an Of Counsel capacity to MHP. The combination of these two firms offers diverse expertise in the areas of commercial damages, expert testimony, healthcare valuation and the healthcare regulatory environment, noncompetition agreements, marital dissolution, S corporations, and cost of capital.

“This relationship affords us the opportunity to work together on complex valuation and litigation matters and take advantage of our unique skill sets,” says Dietrich. “I am pleased to have the ability to undertake projects that, in the past, were outside the capacity of a smaller firm.”

Dietrich has done more than 350 valuation engagements in the healthcare industry and has authored or edited over 100 books and articles in this area, including the BVR/AHLA Guide to Healthcare Valuation and BVR's Guide to Physician Practice Valuation.

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BV movers . . .

People: Michael S. Camacho was named partner at the Providence, R.I.-based firm LGC+D and will serve as internal control specialist and lead the firm’s corporate solutions niche … Gregory Cowhey joined the Philadelphia office of McGladrey LLP as a principal and will direct the firm’s financial investigations and dispute practice … Former FBI agent Ernest C. Cooper was named lead partner in the Forensic Services Division of Vicenti, Lloyd & Stutzman LLP, Glendora, Calif. … South Florida-based forensic accountants and insolvency advisors Soneet Kapila and Barry Mukamal announced they are forming a new consulting firm, KapilaMukamal LLP, that will specialize in fiduciary and insolvency services, with offices in Fort Lauderdale and Miami … Matt Snow was elected CEO by the 200-plus partners of Dixon Hughes Goodman beginning June 1. Snow currently serves as regional managing partner in the firm’s Charlotte, N.C., office. Ken Hughes, the current CEO, will remain on as chairman of the Executive Committee.

Firms: The international association of independent accounting, consulting, and legal firms Abacus Worldwide welcomed the following new member firms: Ramírez, Gutiérrez-Azpe, Rodríguez-Rivero y Hurtado SC, of Mexico City, Mexico; Hamada Law Firm, of Amann, Jordan; ZBS Group LLP, of New York City; and Acutus LLP Chartered Accountants, of Singapore and Hong Kong … Operational Risk & Regulation magazine named KPMG LLP, New York City, “Best Overall Consultancy” at its annual awards … Porte Brown LLC was recognized as one of 2014’s Best Places to Work in Illinois by The Daily Herald Business Ledger.

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Powerhouse lineup of speakers at ASA Philly event

Aswath Damodaran (Stern School of Business), Robert James Cimasi (Health Capital Consultants), John J. Barton (Brandywine Valuation Consultants LLC), and Dennis C. Reardon, Esq. (Reardon & Associates LLC) make up the impressive list of speakers at the ASA Philadelphia Chapter’s upcoming 2014 Business Valuation Seminar on May 2.
The program features sessions focused on:

• Considering commercial reasonableness in healthcare valuation (Cimasi);
• Dealing effectively with the variety of uncertainties that arise in business appraisal (Damodaran);
• Developing cost of capital using Duff & Phelps in the wake of Morningstar’s exit (Barton); and
• Recent federal income, gift, and estate tax law developments that affect business appraisal (Reardon).

For more details, and to register, click here.

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CPE Events

Using the Distributor Method to Value Customer Relationships (May 6), featuring: PJ Patel and Edward Hamilton (both Valuation Research Corp.). The Online Symposium on Fair Value Measurement continues with a look at how to implement an objective, market-based proxy for use in valuing customer relationships.

Valuing Veterinary Practices (May 8), featuring: Byron Farquer and David McCormick (both Simmons & Associates). As a consumer or an appraiser, you may think you know veterinary practices. Join two of the most knowledgeable and experienced voices in veterinary practice management, operations, brokerage, and appraisal to learn how much there is to know about this expansive and diverse industry.

We welcome your feedback and comments. Contact the editor, Andy Dzamba at: editor@bvwire.com or (503) 291-7963