Pratt says Prof. Comment’s DLOM paper has ‘serious flaws’
The working paper by Dr. Robert Comment (Johns Hopkins Univ.), “Business Valuation, DLOM and Daubert: The Issue of Redundancy” has caused a small firestorm within the BV community regarding the determination and application of the discount for lack of marketability (DLOM). At the most recent annual AICPA National BV Conference in Las Vegas, Dr. Shannon Pratt (SPV) challenged Comment’s assertions, analysis, and conclusions. Among his criticisms:
- Comment derives his data from 551 fairness opinions, typically governed by dissenting shareholder statutes and applying the “fair value” standard, the majority of which preclude marketability discounts. “The basic foundation of his study is flawed from the get-go,” Pratt said.
- Comment maintains that fairness opinion values presumptively concern competitive, fair market value prices. Pratt says that “all of Comment’s transactions are control transactions in public companies, which, by their nature, would not be expected to have any DLOM.”
- Comment says that owners of private companies have demonstrated a continued willingness to incur IPO flotation costs, expressed as a percentage of the post-IPO market value, which indicate the “maximum tolerable private company discount” of roughly 6%. Pratt says: “This statement makes the outrageously naïve assumption that any company can go public at any time.”
- Comment ultimately concludes that any DLOM is likely to be redundant to the size discount and is “obviously improper under Daubert.” Pratt’s reply: “As I have said many times, investors cherish marketability.” As a result, “they extract a much higher cost of equity capital for lack of marketability [in private company interests] compared with publicly traded companies.”
- When asked whether Comment’s paper would pass Daubert, Pratt simply says: “No.” He also refers interested appraisers to his article, “In Defense of Discounts for Lack of Marketability,” published in the Fall 2010 Business Valuation Review.
Comment responds. In the interest of furthering professional education and debate, we’ve extended Dr. Comment an opportunity to defend his DLOM conclusions. Don’t miss the first BVR webinar of 2012, Why Your DLOM Is Vulnerable to a Daubert Challenge, featuring Dr. Comment on Thursday Jan. 12, 2012.
BV responses to SEC call for unification reflect . . . disunity?
Predictably, members of the BV community have started to respond to the SEC’s deputy chief accountant Paul Beswick’s recent published remarks critiquing the valuation profession for lack of a “unified voice” and unified standards. Beswick’s position “sounds eerily reminiscent of what I wrote in the ASA BV E-Letter in Oct. 2008,” writes Bill Quackenbush (Advent Valuation):
The fragmentation of our profession has created internal politics that no one else really cares about and obfuscates our ability as a profession to speak with any credibility. The SEC and Congress have already looked at the business appraisal community askance, mostly because they desire our input and we cannot speak with one voice. We should do some serious soul-searching as a profession and figure out how to effectively participate and lead in this forum rather than, at best, be regulated and, at worst, be marginalized out of relevance.
Similarly, Mark Krickovich (MK Appraisal Group) writes that the “BV community has created some of its own problem,” for instance, by tolerating the issuance of “free” credentials or those that don’t require substantial testing and oversight. At the same time, “don't forget how the SEC [and the] FASB . . . chose to ignore an entire body of BV knowledge and court-case precedent in favor of a creating their own standard, which, in the end, is very similar to FMV,” Krickovich writes. In its tighter review of third party valuation reports, ostensibly for lack of detailed assumptions and support, “I also know that the [regulators] and audit community are attempting . . . to create a ‘Narrow Band of Assumptions’ that all appraisers completing FV must follow.” This trend toward standardization “may turn out to be the best course for the public investor community, but it does require a different mindset, I think.”
As past chair of the Executive Advisory Board of NACVA, the Texas Society of CPAs’ Business Valuation, Forensics and Litigation Services Committee, and the AICPA’s Accredited in Business Valuation Review Course Task Force, “I can attest that there was a comprehensive, well-organized ‘fair disciplinary mechanism’ in place at [all organizations],” writes Paul French (Lain Faulkner & Co.), who sums up the current state of the profession as follows:
- Years ago there was very little substantive differences between the various standards, and the differences are growing smaller year by year.
- There are multiple “fair disciplinary mechanisms” to encourage proper behavior and enforce the rules of the profession in the public interest.
- Moving the bell curve [on the quality of BV professionals and practices] “takes time and will be a process of continuing improvement,” French says, “as the profession continues to add and vet new tools and techniques.”
Linda Trugman, current chair of the ASA BV Committee, writes in her most recent monthly update to members that the ASA will “continue to monitor the situation.”
New executive compensation resource from Chief Executive Group & BVR
Having a difficult time locating current, comprehensive, benchmark compensation information for executives? In partnership with the Chief Executive Group, publishers of CEO Magazine, BVR now offers two compensation reports, one for the CEO level position and one for senior executive level positions (which can be purchased as a package deal here).
These products present benchmarking data from 789 participating private companies and report best practices on CEO and senior executive positions across the U.S. The reports included data from 115 companies with revenues between $1 million and $5 million. BV appraisers can use the reports to benchmark a company’s compensation practices against those of companies with comparable profiles and equity compensation plans. Learn more about components in the compensation mix and uncover salary, bonus, benefits, and perquisites for senior key executives. For a free download that tells more about this excellent resource, click here.
Larsen clarifies IPEV’s approach to DLOM
As a current member of the IPEV Board as well the FASB’s Valuation Resource Group, David Larsen (Duff & Phelps) offers five points to clarify any confusion surrounding the use of marketability discounts for financial reporting purposes, in general, and the content of the IPEV valuation guidelines, in particular:
- The IPEV guidelines provide best practices for estimating the fair value of private equity and venture capital investments for financial reporting, consistent with applicable accounting standards including FASB ASC Topic 820 and historical IFRS. “The IPEV Board expects to make minor changes to the IPEV Valuation Guidelines in 2012 to account for wording changes reflected in IFRS 13,” Larsen reports. “No conceptual changes are expected.”
- ASC 820 defines an orderly transaction as one that assumes exposure to the market for a period before the measurement date to allow for customary marketing activities. Thus, “it is not appropriate to add an ‘on top’ discount to account for the time required to market the asset, as that time has already theoretically passed, culminating with the theoretical sale on the measurement date,” Larsen says.
- The IPEV’s FAQ (question 15) responds to those who were confused about whether or not an “on-top” discount for marketability was needed. The IPEV guidelines “do not provide a one-size answer” for estimating the fair value of private equity and venture capital investments, Larsen says, and analysts should read the FAQ in conjunction with the complete guidelines along with the facts and circumstances of any case.
- Section 3.4 of the IPEV guidelines clearly states that analysts must account for specific features of an investment (such as control, non-control, liquidity, etc.) when using a market multiple approach to estimate its fair value. “Most importantly,” Larsen observes, “when using a ‘multiple’ to estimate value, analysts must calibrate it for differences between the subject investment and the comparable companies from which the ‘multiple’ is derived.”
- The IPEV guidelines are consistent with U.S. and international GAAP, which do not permit an “on top” discount for time to market an investment, Larsen notes. The valuation guidelines do not discuss a pro rata DLOM, but focus on the characteristics of an individual investment and methodologies that may apply to estimate the amount a market participant would pay in an orderly transaction on the measurement date.
Account for S corp values in the discount rate, Fannon says
Prof. Jack Bogdanski (Lewis and Clark Law School) was “right on” when he advised BV analysts in the most recent BVWire to “tweak the discount rate” when valuing S corp stock,” writes Nancy Fannon (Fannon Valuation Group). “However, I respectfully disagree when he adds, ‘but don’t call it tax affecting.’ I think we are most helpful to the court (and other users of our reports) when we state clearly how we are addressing this issue, and adjusting the discount rate is exactly what we should be doing.” If analysts don’t know why, Fannon suggest they can listen to the AICPA-sponsored webinar that she and Prof. Keith Sellers (Univ. of Denver) are giving on Jan.19, 2012; or they can check out BVR’s 2011 webinar by the same team, “Pass-Through Entity Valuation: The Significant Impact of Academic Research on the Debate.”
Five ways to ensure successful defined-value clauses
After the recent string of taxpayer victories in cases concerning the use of defined value clauses, attorneys George Karibjanian (Proskauer Rose) and Stacey Delich-Gould (Cahill Gordon & Reindel) provided attendees at the most recent ABA Joint Meeting of the sections on Taxation and Real Property, Trust and Estate Law in Denver, Colo., five ways to “draft a (theoretically) successful defined-value transaction”:
- All parties, including the “spill-over” beneficiary, should be parties to the purchase and sale agreements.
- If the “spill-over” is to pass to another trust, such trust should have a different trustee than the primary trust in the transaction.
- All parties should retain separate legal representation or, at a minimum, should be afforded that opportunity.
- Professional valuations “are a must,” say the attorneys. Further, the spill-over beneficiary, as a party to the operative agreements, should have the right to challenge the valuation or obtain its own appraisal.
- The spill-over beneficiary (or trust) should receive significant value; this will help justify the independent review and approval of the value.
For more guidance, see our report of Estate of Hendrix v. Comm’r, in which the Tax court recently clarified the “arms-length” standard by which to establish an independent “spill-over” beneficiary.
Congress steps into DOL/ERISA fiduciary controversy
The 2012 fiscal year appropriations bill in Congress boosts funding levels for the Department of Labor (DOL)—but comes with several constraints on the DOL’s most controversial regulatory proposals, says an update from the Washington D.C. Employment Law blog. Of particular interest to BV appraisers, the current appropriations package includes a provision that would:
Prevent the Employee Benefits Security Administration (EBSA) from using appropriations funds to promulgate a proposed rule issued in 2010 that revises the definition of “fiduciary” for the purposes of rendering investment advice under the Employee Retirement Income Security Act (ERISA). In September 2011, the EBSA announced that it had decided to re-propose this rule. The Manager’s Statement explains that this section shall not be construed as preventing the agency from publishing a new or revised [rulemaking] relating to the definition of a fiduciary, provided that interested parties and stakeholders are afforded a sufficient opportunity to review and comment on the proposed rulemaking.
BVR symposiums: where to go for all your 2012 CPE
Next Tuesday, Jan. 10, BVR’s Online Symposium on Litigation & Economic Damages continues with What Should I Say? Reports & Reporting Standards in Litigation, featuring Michael Crain (The Financial Valuation Group) and James Alerding (just retired from Clifton Gunderson). In this sixth installment of the symposium, valuation professionals will learn best practice to prepare their reports (and themselves) for the most aggressive challenges in deposition, courtroom, and other litigation contexts.
This year will also see a return of BVR’s groundbreaking Online Symposium on Healthcare Valuation. This monthly series of cutting-edge programming begins with an Economic & Regulatory Update on Jan. 24, 2012 featuring series curator Mark Dietrich; followed by The Valuation of Hospitals on Feb. 28, 2012, featuring Don Barbo (Deloitte Financial
Advisory Services LLP) and Robbie Mundy (GatesMoore). Subscribers to all 12 programs not only receive an estimated 24 CPE credits, but also access to BVR’s Healthcare Desktop Learning Center, an online multimedia library of all healthcare webinars dating back to 2002, including the entire 2011 symposium. For more information on the 2012 symposium, click here.
IASB seeks comment on proposed amendments to IFRS 10
The International Accounting Standards Board has just published the proposed amendments to IFRS 10, Consolidated Financial Statements, for public comment. The proposed amendments seek to clarify “when an entity needs to apply IFRS 10 retrospectively,” according to an IASB release. The proposals should also “allay the concerns of some who thought that the transition provisions were more burdensome than originally intended.” The board hopes to align the effective date of the proposed amendments with the effective date of IFRS 10; public comments are due by March 21. For more information, visit the Comment on a Proposal section of the IASB/IFRS website.
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