At the NACVA 2024 Business Valuation & Financial Litigation conference last week in Las Vegas, Roger Grabowski, now retired from Kroll, gave an update on the upcoming valuation advisory from The Appraisal Foundation that will address the complex and often contentious topic of company-specific risk premiums (CSRP). This advisory, developed after years of deliberation and input from valuation experts, seeks to standardize the approach to assessing and quantifying company-specific risks. These risks arise from factors that differentiate the subject company from its industry or benchmarked peers, such as operational leverage, customer concentration, or geographic limitations.
Need to compare: Grabowski noted that one of the key challenges highlighted in the advisory is the lack of uniform terminology or understanding of CSRP. Historically, company-specific risk adjustments have faced criticism for being arbitrary, with limited evidence or methodology supporting the chosen premiums. This issue has been underscored in legal cases, such as those in the Delaware Chancery Court, where appraisals have been scrutinized for lacking rigor or objectivity. The advisory emphasizes the necessity for thorough comparisons and evidence-based methodologies when applying CSRP. That is, it’s not enough to just pick from one of the lists of risk factors because what are you comparing them to?
The advisory also advocates for a deeper analysis of guideline public companies’ disclosures, annual reports, and segment information to understand industry risk comprehensively. Grabowski observed that some analysts have stopped reading annual reports and 10-K filings, which is a mistake—those documents can reveal some valuable information that can inform the analyst about company or industry risk factors. He also discussed several academic research papers that can help analysts substantiate their CSRP estimates.
Ultimately, the new advisory will provide a framework for appraisers to systematically identify and justify company-specific risks. Grabowski’s parting remark: “Take care in applying CSRP—do not be arbitrary—pricing risk is difficult.”