Majority of BV unites behind single standards

“Ray is right,” says Steve Reiss, CPA, CVA, responding to last week’s online survey regarding the need for the BV community to develop a single set of standards.  “If we let the FASB dictate, they will drive valuators crazy in trying to satisfy the auditors with fair value concepts.  If we can’t regulate ourselves, the SEC and IRS will step in more than they already have.”

The vast majority (79.8%) of respondents agrees.  “Our clients and the marketplace deserve a common set of principles,” says John Grant, CPA.  The current diversity of standards among the ASA, IBA, AICPA, etc. leads to diverse methodology, language, and content in valuation reports, he believes.  “As a result, three quality reports on the same subject interest may not be comparable, though accurate and fulfilling the organizational ‘standards’ [of the appraiser].” 

Some comments do betray the “balkanization” of BV.  “If we miss this opportunity,” says one anonymous commentator, “the standards will be ceded to the AICPA, which is already flexing its muscle into this arena, albeit inappropriately and without substantial understanding of the BV practice.”  A newcomer to BV decries the “multitude of different appraiser organizations and their proprietary standards” and adds, “I would have liked to see more unity. The political, partisan infighting [over] key BV standards is disappointing.”
To add your comments to the ongoing survey, click here.  A complete compilation will appear in the next issue of the Business Valuation Update™. 

California becoming battleground for goodwill valuation

Just about three years ago, the Agency for the City of Inglewood, California began condemnation proceedings of an auto lube business.  At trial, the Agency’s valuation expert applied the “excess profits” test to determine the absence of compensable goodwill, arguing that in the previous five years the business had posted a profit only in the last one (2003).  But the owner attributed the downturn to the construction of a major shopping development across the street, including a Target and Home Depot.  Once the construction was complete, he said, the business returned to profitability and its future looked bright.  His expert, Chris Pedersen, CBA (Affiliated Business Appraisers), agreed, using the “cost to create” method to conclude $239,000 of goodwill.  A potential buyer would pay that “within a matter of days,” Pedersen believed, based on what the owner spent “over the five…difficult years to place the business in the enviable position it enjoyed upon completion” of the shopping development.

The trial court agreed—as did the California Court of Appeals, which published the portion of its opinion deeming the “cost to create” approach permissible to value goodwill, “where, as here, a nascent business has not yet experienced excess profits but clearly has goodwill within the meaning of the [California] statute.”  Attorneys for the Agency have filed a letter with the state Supreme Court to “de-publish” the opinion, citing Shannon Pratt for the general definition of goodwill as “the ability to earn a rate of return in excess of a normal rate on…net assets.”  Click here for a copy of the letter and the case. 

Attorneys for the auto business assert the definition is taken out of context, and enlisted Dr. Pratt to write to the California Supreme Court in the fight to keep the case published.  “[T]he quotes from my books do not support the request to depublish the case,” Pratt writes.  “In fact, I believe that publishing the case is very useful as guidance to attorneys and business appraisers for future cases with similar facts and circumstances.”

The Agency’s efforts, especially if they lead to an appeal, could help create “bad case law…one of the biggest obstacles to applying sound appraisal methodology,” Pedersen says.  “That is why it is so important to get involved, as it takes years to overturn or clarify bad law.”  Email any comments, on one side of the battle or the other, to the editor.

Valuing the invisible: advocacy groups join movement
to develop intangible asset valuation standards

“Eighty percent of a corporation’s market capitalization is intangible—assets that are not understood, and definitely not protected by traditional insurance [valuations],” said NASDAQ’s William McGinty in his keynote address to the Intangible Asset Finance Society’s (IASF) Fall Conference last week in Syracuse, NY.  Intangible assets—brands, reputations, patents, trademarks, and other intellectual property—now comprise between 60% and 85% of the market value of the average S&P 500 company.  But they are not easily insurable, McGinty said, because “they’re not easily predictable.”

Because appraisers, accountants, and insurers have found it “impossible” to determine the value and risk of intangibles with any certainty, according to Nir Kossovsky, IASF Executive Secretary, “official accounting rules give intangibles a wide berth.  In all cases, there is little relationship to market value.”  As reported in a recent New York Times article, the IASF is just one advocacy group working to develop new standards and practices for “monetizing” these otherwise invisible assets.  Another is the Social Venture Technology Group (SVTG).  Its “Social Return on Investment” analysis seeks to develop a systematic method for identifying, measuring, and reporting the full spectrum of business value, environmental as well as social and economic.  The SVTG site also offers “SocialMetrics,” a tool for those just starting on such assessments as well as “the expert seeking to share or get input on your metrics and methodologies.”

Reminder: comments to IVSC on intangibles due soon On a related note, comments to the Discussion Paper, Determination of Fair Value of Intangible Assets for IFRS Reporting Purposes, recently issued by International Valuation Standards Committee (IVSC) are due October 31, 2007.  (See BVWire™ # 59-2).  A copy of the Discussion Paper is available at the IVSC website.

Questions remain re: S Corp valuations

In response to last week’s item on S Corp valuations, Mark Leicester, CPA/ABV, JD, LLM writes that his analysis in Bernier was based solely on the facts and circumstances of the case.  “I did not assume that ‘retained net income is as valuable as distributed income.’ Any ‘retained net income’ was taken into consideration, particularly in regard to cash expenditures.  Nor did I assume that ‘there are no detriments to operating as an S Corp compared to a C Corp.’  My calculations assumed that all other factors between the subject S Corp and the hypothetical C Corp were equivalent. Otherwise, adjustments may be necessary and appropriate.”

Moreover, “I did not assume that ‘the same tax rates apply to capital gains as to ordinary income,’” he says, “and neither did the Court in Del. Open MRI Radiology v. Kessler.  In Bernier, the dividend tax rate and ordinary income rate were the same.  In Del. Radiology, they were not.  However, both my calculation and the Court’s in Del. Radiology were correct.  Where the tax rates are different, so are the results.”  We appreciate Mr. Leicester’s comments and apologize for confusing any assumptions in Bernier with the assumptions made by the Delaware Chancery Court in Del. Radiology.

Questions remain regarding Del. Radiology.  In particular—and within the confines of the Del. Radiology model of S Corp valuation—it is still important to ask the following questions:

• How does the Del. Chancery model distinguish between retained income (after CapEx) and distributed income?
• How does the model account for the differences between operating as an S Corp and a C Corp ?
• Does it account for any possibility but that the S Corp will continue as such into perpetuity?

For the answer to these questions and more, look for Fannon’s Guide to the Valuation of Subchapter S Corporations, by Nancy Fannon and published by BVResources; to pre-order your copy, click here.

Sarbanes-Oxley ‘wrong, evil, and ill-intentioned’

“People are simply fed up with being held hostage by the accounting profession, and the big accounting firms are clearly hurting the process of going public,” wrote David Weild, former NASDAQ vice chairman and executive vice president, in a recent letter to the SEC, and posted at PEHub (copies available to subscribers only): 

In the view of many seasoned professionals, the cost and time required to clear the accounting profession post Sarbanes-Oxley has undermined the process of going public and accessing the public markets. Many issuers now avoid the public markets altogether. Many venture capitalists now avoid making investments where they must rely on the public markets for an exit. Is this the balance that we want?

Some industry bloggers are saying that Weild tread too lightly on his own opinions.  “He makes some sober remarks,” comments Karen De Coster in a September 26th posting.  “But at the same time he walks on coals, unwilling to admit that Sarbanes-Oxley (SOX) was wrong, evil, and ill-intentioned from the start.”  SOX has indeed made companies probe, test, and improve the operating effectiveness of their internal controls, De Coster adds, “but don't blame public accounting firms for being too bureaucratic.”  Blame the legislators, the lobbyists, the regulators, and the “political hacks who contributed to this nightmare…. Generally, the guys doing the grunt work and signing away their professional reputation [on the letter rendering the opinions regarding management's assessment of internal controls and their operating effectiveness] are putting much at stake in order to earn their paychecks.”    

Forensics the ‘fastest growing’ area of accounting

In the current auditing and regulatory climate, it’s no wonder that forensic accounting is the “fastest growing area of accounting,” according to Aswath Damodaran (Stern School of Business, NYU), “because people don’t trust financial statements.”  Damodaran spoke at the 2007 BV Conference for the NY State Society of CPAs, adding that, ”bias in the process is the biggest enemy of valuation,” especially in the M & A context.  “We need to make sure our values are not only legally defensible but also fundamentally sound.”

As it happened, Darrell Dorrell, CPA/ABV, MBA, ASA, CVA, CMA, DABFA, spoke at the same conference—and tomorrow will be leading BVR’s teleconference on “Valuation & Forensics: Why and How™.”  Dorrell will discuss forensic accounting as a core capability, its tools and methods, examples of balance sheet and income statement analyses, and representative valuation cases.  For more information and to register, click here.

ABA publishes ‘mini-issue’ on new E-Discovery rules

The current issue of Business Law Today, published by Business Section of the American Bar Association, takes on the new Federal rules regarding electronic discovery as its “mini theme.”   Articles range from an overview of electronic discovery and spoliation in business litigation to “the privilege issues created by the constant use of e-mail in business and legal communications.”   The importance of smooth communications among lawyers, business people, IT staff, and litigation experts is the focus of a final piece. To access the complete issue, click here.