November 17, 2010 | Issue #98-3 Forward to a Friend

Will proposed DOL regulation drive firms to drop ESOP appraisals?

In the October 22, 2010 Federal Register, the DOL issued a proposed regulation that would expand the definition of “investment advice” fiduciary under ERISA. Under the proposed regulation, “the types of advice and recommendations that may result in
fiduciary status under ERISA section 3(21)(A)(ii) are: Advice, appraisals or fairness opinions concerning the value of securities or other property.”

BVWire worries that, in its efforts to protect beneficiaries of pension plans, it will have a negative effect on the market. We recall the example of the trust firms like U.S. Trust which abandoned the ESOP market after being exposed to lawsuits.  Will the larger valuation firms (such as Duff & Phelps and Houlihan Lokey) that perform ESOP fairness opinions and appraisals similarly decide to forgo these generally low-margin engagements in order to protect themselves from the increased liability exposure?   This would mean that the new DOL regs, if approved, would potentially reduce the quality of ESOP work.

There is already a backlash against the proposed regulation, at least from the ESOP Association, and we won’t be surprised to hear of further responses from other related groups including the ASA BVC. BVWire will continue to report on the issue.

You can’t be too thin…but you can have too large a size premium

Mike Crain is doing some interesting research on the size premium...or lack thereof.  He presented his research last week at the AICPA National Business Valuation Conference, and an analysis of his conclusions will appear in the December Business Valuation Update.

One conclusion he's drawing is that the size premium has all but disappeared since 1981. This by itself is obviously a radical concept for appraisers who are used to taking on several hundred basis points for small stocks.

Mike also makes a strong point based on a Pastor & Stambaugh (2003) analysis that finds that “illiquidity seems to subsume all or part of the size effect.” This is because illiquid public firms tend to be small, so it may suggest that the size effect comes from an underlying liquidity effect. Liu (2006) agrees with this, but Chen, Ibbotson & Hu (2010) have a somewhat different finding—the liquidity effect does not completely capture the size effect, though it is “highly correlated with firm size.”  (Note:   For those interested in this research, Ibbotson’s work on this topic is summarized in an 10/21/10 post on called “You Can’t be too Thin.”)

DON’T do this when estimating DLOM

“Don’t use averages,” Roger Grabowski told a packed room of attendees at the Advanced Summit on Business Valuation: Resolving Tax & Legal Issues, co-sponsored by BVR and the Georgetown School of Law in Washington, D.C. last week. Grabowski should know—he was the taxpayer’s expert in the 1995 Mandelbaum case (Mandelbaum v. Comm’r, T.C. Memo 1995-255, available at BVLaw), what many analysts consider the defining decision on discounts for lack of marketability (DLOM) in the Tax Courts, as authored by Judge David Laro, whose organizing efforts have also shaped this third incarnation of the Tax Conference.

“I can’t say it enough—don’t just average the data from the restricted stock studies and slap on the discount,” Grabowski said. “We don’t use averages when we match multiples from public companies” in the market approach, he added. There is similarly no analytical support for using averages of any data, from the restricted stock studies or the pre-IPO studies, in cases of the DLOM. As Mandelbaum made clear, what’s far more important is to match the characteristics of your subject company to those in the data. “Match up the characteristics of rate of return with the discounts,” Grabowksi said, especially when considering pre-IPO data. Ask about your subject company, “Do you have one that’s really attractive to someone to take public?”

The only tool for matching company data. The FMV Restricted Stock Study is the only database that allows you to match company characteristics to over 65 data fields and verifiable details on each restricted stock transaction. And the calculations just got more efficient with the introduction of the FMV DLOM Calculator. To find out how to use this unique new DLOM tool, purchase the on-demand pack including CD, transcript, and ancillary reading materials from yesterday’s teleconference featuring Kyle Vataha (FMV Opinions).

Appraiser penalties: IRS relaxes rigid notice procedure

The IRS caused quite the alarm among business appraisers when it announced more than a year ago that it would allow IRS examiners and agents—even those without BV credentials—to issue Sec. 6695A penalty citations via a “Valuation Misstatement Letter,” what since became known as Letter 4477 (see BVWire #85-3). The BV professional community immediately responded, led by Jay Fishman (Financial Research Associates), member of the IRS Advisory Council and chair of the ASA’s Government Relations Committee, who secured a meeting with Service reps last February (BVWire #90-1). “We pointed out—yes, hold appraisers accountable,” Fishman said, while moderating the “IRS Valuation Managers Roundtable” at the recent BVR/Georgetown Advanced BV Summit. “But do it in a better way. Take the emotion out of the issue.”

The IRS listened to appraisers’ comments—and revised the notice requirements. Now the Service will make two phone calls to the subject appraiser before sending Letter 4477, which is now called an “Appraiser Appointment Letter,” said panelist Susan Kurzweil, IRS National BV Issue Coordinator. The letter will ask to set an appointment with the appraiser to discuss the matter—not to invoke a penalty citation. More importantly, an experienced IRS professional will be involved in the process, to review the work file and interview the appraiser “to get the full picture of the case and give the appraiser an opportunity” to respond, Kurzweil said.

More hot buttons and red flags: What aspect of an appraisal will flag the attention of an IRS examiner? What are the top-ten valuation mistakes the Service most often sees? Where will the Service focus its resources—and its increasingly credentialed agents? The IRS panel answered these and more hot-topic items during the Summit roundtable. Be sure to read the full report in the Jan. 2011 Business Valuation Update

Yeanoplos further secures place for LEAPS in DLOM repertoire

In his session last week at the AICPA National BV Conference  "Look Before You LEAPS: Using Collars and LEAPS to Determine DLOMs," Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos) shared key tips for practitioners using Long-Term Equity Anticipation Securities (LEAPS) in their DLOM calculations.  First, there are 770 companies with associated LEAPS available as comparables­– the entire list can be found and downloaded at the Options Industry Council web site.

Yeanoplos pointed out "if you can't use the Guideline Public Company Method, then you probably can't use LEAPS." Talking to BVWire after the session, he expounded on the importance of adding LEAPS to the DLOM toolbox.  "Everybody should be familiar with all the tools because the tax courts are encouraging us to find more definitive ways of quantifying our conclusions and to look at more market-derived data.  And with the growing importance of fair value, the reality is that the quantitative models are easier to audit."  Yeanoplos also reminded the audience about the importance of using more than one model or study when calculating the DLOM.

When valuing stock options remember the six inputs…and consider going beyond Black-Scholes

David Dufendach  (Grant Thornton) provided a detailed analysis of “ASC Topic 718 (FAS 123R) -- Valuation of Share-Based Payments” last week at the AICPA National BV conference. Before going into the details that impact stock option valuation, Dufendach reminded the audience of the “six inputs into a model into three buckets”:

  • Contractual features: exercise price, maximum term, and possibly a market condition.
  •  Market features: stock price (if publicly traded), risk-free interest rate.
  • Estimated features: stock price (if closely-held), dividends, volatility, expected term. 

“The third bucket is “is where all the valuation work is…and you can’t make it up,” added Dufendach.  However, sometimes the inputs just don’t fit with Black-Scholes, the most commonly used model in option pricing. “So it’s is a good idea to get outside the world and try the Lattice model, which can accommodate volatility assumptions that change over time; something the B-S-M cannot do.”

Financial issues in divorce: additional opportunities to make arguments for the right case

Last week at the AICPA National BV conference, Kalman Barson (Barson Group) advised the audience to consider “concepts that go far beyond pushing a pencil or keying in data” in divorce cases.  He suggested practitioners consider the following questions when determining a value:

  • How do improper actions impact value?  What if those improper actions are common within that specific business or industry?
  • Should the existence of unreported income create a difference in value?  
  • Is there logic that a PTE is inherently worth more than a C corp?
  • The public markets dropped 40% in 2008 –were private companies impacted similarly?
  • Are either age or heath relevant to value? To what extent does relative power structure of the company and personal contribution make a difference in the value of the interest?

Look for Barson’s insight to these questions in an upcoming issue of Business Valuation Update

“Objective” data is biggest advantage for Guideline Public Company Method (GPCM)

Last week at the AICPA National BV Conference Linda Trugman (Trugman Valuation Associates) shared the fact that “we used to use the term ‘comps’ but there are so many intangibles with guidelines companies that the term really isn’t accurate.”  She urged audience members to read the management notes associated with the financial documents and to look for anything abnormal, like such as non-recurring expenses.  She described several sources practitioners can use to find guideline companies, many of which are free – but certainly the most robust of which are paid.  She specifically emphasized the difficulty of finding historical data (it is worth noting that the Pitchbook/BVR Public Company Comps Tool does include delisted companies, certainly a differentiating feature) and walked attendees through her list of 24 criteria for similarity.  Trugman also shared her GPCM methodology in which she compares key ratios for guidelines companies year by year and simply circles those most like her subject company.

Experts address ambulatory surgery centers valuation issues

The following “10 Stories on Current ASC Transaction Trends and Issues” were recently published in Becker’s ASC Review:

For additional expert guidance on valuing ASCs and other healthcare entities, turn to the AHLA/BVR Guide to Healthcare Valuation 2010 edition, edited by Mark O. Dietrich.  Co-published with the American Health Lawyers Association (AHLA), the new edition of includes the latest industry specific information and insight along with eight all new chapters, written by top healthcare appraisal experts.

Robin Taylor inducted into AICPA BV Hall of Fame

In last week’s piece on the two new members inducted into the AICPA BV Hall of Fame we misspelled Robin Taylor’s (Dixon Hughes) name. So we’d like to congratulate him again on the honor—rather than the stranger we celebrated last week! 

Two save-the-date notices from ASA Business Valuation Committee…

ASA announces date and venue for its NYC Fair Value Conference, and it’s 30th annual advanced BV conference.  The first is at the offices of PWC on January 11, 2011.  The Annual BV Conference later in the year is October 10-12, 2011 – save the dates!  The annual conference will be held at the beautifully renovated Palmer House Hilton in downtown Chicago. The ASA BVC doesn’t have lot of info on these events posted yet, but asks that you monitor to keep up with their conference planning.

Encore performance of Show Me the Money!

A highlight of the 3rd Annual Summit on Business Valuation in Divorce was Kevin Yeanoplos (Brueggeman and Johnson Yeanoplos) and Edward Rataj’s (CBIZ Human Capital Services) presentation, “Show Me the Money! The Exploration, Examination and Dissection of Reasonable Compensation.”  On Thursday, December 2, BVR welcomes Yeanoplos, the other newest inductee into the AICPA Hall of Fame, and Rataj for a special encore webinar presentation of their session at this year’s Summit.  Follow their presentation, ask them the hard-hitting questions you’ve been mulling, earn CPE, and receive a special discount on the BVR guide Reasonable Compensation: Application and Analysis for Appraisal, Tax and Management Purposes.  For more information on this webinar click here.

Just in time for your 2011 planning – BVR’s new product catalog available for download

As you get your shop in order for the new year, you’ll definitely want to take a read through BVR’s newest product catalog.  Complete with a special offer and thorough updates on all BVR products and services, the catalog is your chance to learn what’s new with the most well respected and most widely used business valuation tools available.  Go to BVR’s homepage at and click on the “View our Complete Product Brochure” link at the top of the page.

Chris Mellen to speak at Babson College

If you are in the Boston area on December 9th, attend Chris Mellen’s (Delphi Valuation Advisors) presentation “Building Value in Private Companies” at the Exit Planning Exchange breakfast meeting.  During the session Mellen will discuss “the metrics needed to maximize our clients’ companies’ value, how we can help them determine their return on investment in their company as part of their overall investment strategy, and how value depends on the many exit options available to business owners.”  Mellen and Frank Evans (Evans and Associates) recently published the second edition of Valuation for M&A: Building Value in Private Companies. An excerpt of the book appears in the upcoming December issue of Business Valuation Update

Software company exit valuations up sharply

“The software industry’s benchmark median exit valuation increased markedly in 3Q10 to its highest multiple since 2006,” according to the Software Equity Group. To find out what’s behind the multiple, read their recently published 3Q 2010 Software Industry Equity Report. The free report contains an analysis of the software industry and deal data such as public market valuations and statistics by product category.


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December Events

Show Me the Money! The Exploration, Examination and Dissection of Reasonable Compensation
December 2, 2010, 10:00am - 11:15am PT

The Use and Application of Option Pricing Modeling
Thursday, December 16, 2010, 10:00am - 11:40am Pacific Time
Featuring: Scott L. Beauchene and James Walling

Valuations for IRC 409A Compliance
New Date: Wednesday, December 22, 2010, 10:00am - 11:40am Pacific Time
Featuring: Neil Beaton and David Dufendach


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