“I feel like using the IPCPM and abandoning BUM and not referring to BUM at all in my report.” This startling comment summed up one BV professional’s feeling after listening to the debut presentation of the new implied private company pricing model (IPCPM). This is the first income approach method to valuing private companies that relies on private company data—eliminating the need to make lots of adjustments to public company data.
IPCPM’s developers, Robert Dohmeyer (Dohmeyer Valuation Corp.), Peter Butler (Valtrend), and Rod Burkert (Burkert Valuation Advisors), conducted a recent webinar to explain how this new model estimates cost of capital for companies with revenues of less than $150 million. They also authored an article explaining IPCPM that was featured in the March issue of Business Valuation Update. That article is now being made available by BVR as a free download.
Builds on IPCPL: Last year, the IPCPM developers introduced the implied private company pricing line (IPCPL) as a new tool for estimating the cost of capital for small private companies. IPCPL uses two sets of data: (1) transaction prices of 500 small private businesses from the Pratt’s Stats transaction database (the “IPCPL 500”); and (2) the cost of capital, adjusted for the cost of going and staying public, of micro-cap publicly traded companies that are in the range of $150 million in revenues.
Feedback from the BV community was positive, but some commenters pointed out that, while IPCPL is fine for average companies, what if the subject company is not average—and what if it’s not in the same industry? How do you adjust for these factors? The new IPCPM model facilitates adjustments from the IPCPL size-based indication for comparable differences in: (1) systematic risk (i.e., beta); (2) diversifiable and total risk (i.e., total beta); (3) liquidity; and (4) debt capacity.
BUM’s rush? The build-up model would not probably be used by appraisers today if it had just been invented—not that it hasn't been the core of methods to achieve a cost of capital conclusion. Various experts, including Prof. Aswath Damodaran (Stern School of Business, New York University), have expressed concerns. During their webinar presentation, the IPCPM developers presented some notable outside comments about the flaws of the build-up method, such as Damodaran’s observation: “The build-up approach is a recipe for disaster.”
One valuation expert in the audience took issue with the mere mention of these disparaging comments. “I certainly hope lawyers for cases in which I have testified do not quote (in future cases) these melodramatic comments in an attempt to discredit my work for all the years I've been using a build-up method,” he says. “These comments sound like a total indictment against the majority of business valuation professionals. I wish we could exclude these comments from CPE programs.”
Burkert pointed out that these comments (from Damodaran and Dr. John Paglia, one of the authors of the Pepperdine Private Capital Markets Project) are out there in public, so lawyers can come across them just as easily as they did. "It's better to know that attacks on BUM are coming, and prepare for them, rather than to be surprised," he says. "The more information the better."
To listen to the archive of the webinar, “Utilizing the Implied Private Company Pricing Model: The Cost of Capital Wizard,” click here.