RESEARCH UPDATE - Featured Paper: “Expert Guide to Navigating Forensic Accounting and Valuation Professional Standards”
A monthly roundup of research papers of interest to valuation experts. The featured paper discusses the standards put forth by the AICPA, ASA, NACVA, and the CFA Institute, including USPAP. While they may be “complex and confusing,” they do not conflict, but there are differences. It’s up to the practitioner to determine the appropriate standards to follow based on the nature of the engagement. Other papers covered include financial forecasting, bias in ESG ratings, and whether the market puts a value on corporate culture.
ESOP group happy over withdrawal of DOL valuation regs
The ESOP Association is pleased that the proposed regs the Department of Labor issued in draft form regarding ESOP valuations last week have been withdrawn due to the new administration’s regulatory freeze.
Sigh of relief—somewhat—over proposed DOL regs on ESOP valuations
“Not as bad as expected.” “Could have been worse.” That’s the gist of initial comments we’ve heard over the long-awaited proposed regs the Department of Labor issued in draft form last week.
Bush v. Crystal
This contract case dealing with the value of collateral for a defaulted loan took issue with the use of a business plan that did not have any foundation and was nothing more than based on “conjecture, assumption and generalization” to value a minority stock interest in an operating entity under the income approach. Forecasts or projections used in valuing an entity must be reasonable and reliable. The court affirmed the use of the net asset value approach. The opinion also affirmed that it was appropriate to have art used as collateral for a loan be valued by testimony from an art expert.
Nevada Supreme Court Affirms Exclusion of Testimony Based on a Speculative Business Plan
This contract case dealing with the value of collateral for a defaulted loan took issue with the use of a business plan that did not have any foundation and was nothing more than based on “conjecture, assumption and generalization” to value a minority stock interest in an operating entity under the income approach. Forecasts or projections used in valuing an entity must be reasonable and reliable. The court affirmed the use of the net asset value approach. The opinion also affirmed that it was appropriate to have art used as collateral for a loan be valued by testimony from an art expert.
BV News and Trends December 2024
A monthly roundup of key developments of interest to business valuation experts.
Oakes v. Oakes David C. Oakes & Leadwise, Inc.
Once again, a court, in this case a state appellate court, questioned the efficacy of projections used to determine the value of a business using the income approach. The appellate court remanded the issue to determine whether a major assumption of the projections “failed.” Additionally, because of the size of the equalization payment, likely to be paid over a number of years, the appellate court ordered that the husband provide security for the equalization payment. This case highlighted the complexity of divorce proceedings involving high-value assets, the importance of credible valuations, and the need for appropriate safeguards in financial obligations.
Ohio Appellate Court Remands for Determination of Efficacy of Projections in Determining Value and Orders Security From Husband for Equalization Payment to Wife
Once again, a court, in this case a state appellate court, questioned the efficacy of projections used to determine the value of a business using the income approach. The appellate court remanded the issue to determine whether a major assumption of the projections “failed.” Additionally, because of the size of the equalization payment, likely to be paid over a number of years, the appellate court ordered that the husband provide security for the equalization payment. This case highlighted the complexity of divorce proceedings involving high-value assets, the importance of credible valuations, and the need for appropriate safeguards in financial obligations.
Endless River Techs., LLC v. TransUnion, LLC (II)
The U.S district court denied the defendant’s motion to exclude the testimony of Dr. Malec, who had used an unreliable valuation, during the trial. The jury awarded the plaintiff $18.3 million in damages. Post-trial, the defendants filed a motion for judgment as a matter of law, challenging Endless River’s recovery on multiple grounds. The district court granted the motion and vacated the award. In so doing, it pointed out that the report and testimony of Dr. Malec was speculative and based on projections of management that Malec had not vetted and were unreliable. The appellate court affirmed the vacatur of the jury award. Once again, this pointed out that projections from management cannot be taken at face without some vetting as to reliability. The trial court also determined, among other things, that Dr. Malec’s testimony was not relevant to the damages nor was it reliable and his testimony was therefore stricken under Rule 702.
U.S. Appellate Court Affirms Vacatur of Jury Award—Witness Should Not Have Been Allowed to Testify
The U.S district court denied the defendant’s motion to exclude the testimony of Dr. Malec, who had used an unreliable valuation, during the trial. The jury awarded the plaintiff $18.3 million in damages. Post-trial, the defendants filed a motion for judgment as a matter of law, challenging Endless River’s recovery on multiple grounds. The district court granted the motion and vacated the award. In so doing, it pointed out that the report and testimony of Dr. Malec was speculative and based on projections of management that Malec had not vetted and were unreliable. The appellate court affirmed the vacatur of the jury award. Once again, this pointed out that projections from management cannot be taken at face without some vetting as to reliability. The trial court also determined, among other things, that Dr. Malec’s testimony was not relevant to the damages nor was it reliable and his testimony was therefore stricken under Rule 702.
Appellate court affirms decision regarding overstated projections
A big red flag when using financial projections in a DCF is relying on ones that were prepared for some other purpose, especially if there was a tendency to paint a rosy picture.
Delaware’s Surprising and Inexplicable Appraisal of FairXchange
This appraisal decision has echoes of Edgar Allan Poe: a well-written story with a surprise ending. The sale of a private company was negotiated and forced through by a management that had no relevant experience but failed to use any professional financial advisors. The court expressly stated that the sellers left money on the table but nonetheless ruled that fair value was the deal price.
Jacobs v. Akademos, Inc.
The controlling shareholder of this nearly bankrupt company, which operated online bookstores for colleges and universities, finally threw in the towel and accepted a last-ditch merger, which still left it under water. Some common shareholders asked for a fair value valuation of their common shares, which the court determined to be zero dollars per share. The case emphasized the problems with unreliable projections (i.e., forecasts) and criticized the use of 409A valuations in determining fair value. The case is an excellent tutorial of issues to be considered in determining fair value.
Delaware Chancery Court Determines a Zero Value for Common Stock Shares and Determines That the Merger Triggering the Fair Value Determination Was Fair
The controlling shareholder of this nearly bankrupt company, which operated online bookstores for colleges and universities, finally threw in the towel and accepted a last-ditch merger, which still left it under water. Some common shareholders asked for a fair value valuation of their common shares, which the court determined to be zero dollars per share. The case emphasized the problems with unreliable projections (i.e., forecasts) and criticized the use of 409A valuations in determining fair value. The case was an excellent tutorial of issues to be considered in determining fair value.
BV Myth Busters tackle exit multiple vs. Gordon growth
Is an exit multiple preferable to the Gordon growth model (GGM) for calculating the terminal-year value in a DCF model?
Navigating ESG: The Evolving Landscape and Its Impact on Business Value
Join us to understand the evolving landscape of ESG, including ESG financial reporting developments in the United States and the state of California, as well as some international disclosure requirements impacting U.S. companies. Attendees will also learn how the new International Valuation Standards (IVS) effective January 2025 will address the integration of ESG factors in business valuations. The discussion extends to the significant impacts of ESG on M&A, projected cash flows and the cost of ...
Matthews critiques Delaware’s surprise-ending opinion in FairX
Edgar Allan Poe was a master of the surprise ending, but Judge Laster of the Delaware Chancery Court is giving him a run for his money in his recent decision in the FairXchange (FairX) case.
FairX valuation: from bad to worse
In a statutory appraisal case, the Delaware Court of Chancery rejected two valuation approaches in favor of its own method, which had “seriously flawed” underpinnings.
Hyde Park Venture Partners Fund III L.P. v. FairXchange, LLC
This was a case that, once again, adopted the deal price in a shareholders’ dissent appraisal proceeding. The judge was not satisfied with the experts’ methodologies. He noted the difficulty in valuing a startup in a business model that had not been tried before. Absent compelling evidence of value from either side, the court fell back on the deal price.
Chancery Court (Delaware) Adopts Deal Price—Deplores Valuation Methodologies
This was a case that, once again, adopted the deal price in a shareholders’ dissent appraisal proceeding. The judge was not satisfied with the experts’ methodologies. He noted the difficulty in valuing a startup in a business model that had not been tried before. Absent compelling evidence of value from either side, the court fell back on the deal price.
ECB USA, Inc. v. Savencia, S.A.
This case was an example of the application of Rule 702 as to witness acceptance or exclusion. In this case, the same witness was allowed to testify in part and excluded in part.
U.S. District Court Allows Testimony in Part of Expert Witness on Certain Damages
This case was an example of the application of Rule 702 as to witness acceptance or exclusion. In this case, the same witness was allowed to testify in part and was excluded in part.
A Channel Analysis Is Key When Valuing a Fast-Food Restaurant
There has been a seismic shift in the operations of limited-service restaurants since the pandemic—and there’s no sign of reverting. Channels of revenue have been upended. Therefore, an analysis along these lines is important when valuing these entities, advises an expert in this space.
The CEIV Is Gone But the MPF Will Endure—Here’s an Example
The Certified in Entity and Intangible Valuations (CEIV) credential has been discontinued, but the Mandatory Performance Framework (MPF) will continue to be used. In fact, a revision is expected to make it more streamlined. Here are its guidelines for documenting management projections that are worthy of repurposing.
Barnes v. Barnes
The trial for this divorce case was extended almost eight months because the parties had assured the court it would be a three-day trial and it took four days. The fourth day was almost eight months after the end of the third day of trial. As a result, the husband argued that the value of his business should have been updated and consideration given to the effect of splitting the business’s real estate from the operations of the business. The appellate court noted that this issue had not been raised at trial and was, therefore, not appealable. Other issues not related to the business were issues for the appellate court.