BVR Update 200903

B V
USINESS
From the developers of Pratts Stats
ALUATION
BVR PDATE
What Its Worth
Timely news, analysis, and resources for defensible valuations
Vol. 15, No. 3, March 2009
Wrestling with Guideline Public Market Evidence: What You Need to Know
Turbulence in public markets is wreaking havoc on unprepared appraisers. Thankfully, the Guideline Public Company Method (GPCM) is one of the tools to capture the effect of todays volatile economy on the value of an appraisal target. Given the importance of this topican growing interest by BV expertswe recently sat down with Robert Schlegel ASA, MCBA with Houlihan Valuation Advisors Indianapolis ofce, for insights on the GPCM and a preview of our upcoming workshop in Miami Beach, Florida. The interview: Q: Lets begin with a fundamental question: why should we do Guideline Public Company research? A: Public company trades are the best fundamental barometers of market conditions that we have. Valuation implies an appraisal opinion at a date in time, which reects, as IRS Revenue Ruling 59-60 points out, the economic outlook in general and the condition and outlook of the specic industry in particular. Common standards of Fair Market Value and Fair Value (for nancial reporting) imply our examination of market transactions and intentions of market participants. Therefore, an appraisal that ignores market evidence really is not an appraisal. Q: Is Guideline Public Company research appropriate only for the large and fast-growing companies that may be capable of going public? A: The answer is both yes and no. If a subject company is a likely candidate for an IPO, conditions in public markets are extremely relevant. However, there is merit in avoiding direct comparison of the corner hardware store on Main
Continued to page 4...
There is a New Beta in Town and its Not Called Total Beta for Nothing!
By Keith Pinkerton, ASA, CFA, and Peter J. Butler, ASA, CFA When presenting the Butler Pinkerton Model (BPM) at various conferences across the counContinued to page 6...
INSIDE THIS ISSUE

Special Report ..............2 Appraisals for Tax PurposesCollateral Damage of the Pomeroy Bill With the introduction of H.R. 111-436 (the Pomeroy Bill), on January 14, 2009, the valuation of fractional interests in family owned investment entities is threatened with extinction. Legal & Court Case Updates....................11 Grelier v. Grelier Kaminsky v. Herrick Feinstein, LLP. Fluor Enterprises, Inc. v. Conex International Corp. Funai Electric Co. v. Daewoo Electronics Corp. Russo v. Ballard Medical Products Medical Stafng Network, Inc. v. Ridgeway Kingsway Financial Services, Inc. v. PricewaterhouseCoopers LLP Data & Publication Update........................20 Valuation analysts are often called on to provide litigation support and expert testimony services. BVRConferences.......................................23 Calendar......................................................23 Cost of Capital ..........................................24 Discount Metrics ......................................24
BVResources.comsm
SPECIAL REPORT
Appraisals for Tax Purposes: Collateral Damage of the Pomeroy Bill
By William Frazier, ASA With the introduction of H.R. 111-436 (the Pomeroy Bill), on January 14, 2009, the valuation of fractional interests in family owned investment entities is threatened with extinction. Valuations requirements for family owned operating businesses would also be reduced. If the Pomeroy Bill becomes law, many people who depend upon such appraisals for their livelihoods will be out of work. All professionals who perform these types of assignments as part of their overall practice will see their revenues decline. This is not limited to appraisers. Attorneys, accountants, nancial planners and other nancial service providers will be affected as well. At the heart of the valuation provisions of the Pomeroy Bill is the reestablishment of the family attribution doctrine, which had been largely discredited since a1981 U.S. appeals court decision (Estate of Mary Frances Smith Bright v. U.S.) repudiated this doctrine. Family attribution means that all fractional interests in family-controlled entities are deemed to be controlling interests. The IRS formally abandoned this notion with the publication of revenue ruling 93-12 in 1993. The Pomeroy bill is an end run around the judicial and regulatory prohibitions against family attribution. The seeds of this legislation are found in the January 27, 2005 report of the Joint Committee on Taxation:
Under present law, valuation discounts can signicantly reduce the estate and gift tax values of transferred property. Minority and marketability discounts in particular often create substantial reductions in value. In some cases, these reductions in value for estate and gift tax purposes do not accurately reect value. For example, a taxpayer may make gifts to a child of minority interests in property and claim lack-of-control discounts under the gift tax even though the taxpayer or the taxpayers child controls the property being transferred. A taxpayer also may contribute marketable property such as publicly-traded stock to a partnership (such as a family limited partnership) or other entity that he or she controls and, when interests in that entity are transferred through the estate, claim marketability discounts even though the heirs may be able to liquidate the entity and recover the full value by accessing the underlying assets directly (p. 399).
Continued to next page...
BUSINESS VALUATION UPDATE

Executive Editor: Legal Editor: Contributing Editors: Publisher: Production Manager: President: Customer Service: Sales: Chair and CEO: Lisa Isom Sherrye Henry Jr. Paul Heidt & Adam Manson Doug Twitchell Laurie Morrisey Lucretia Lyons Stephanie Crader Linda Mendenhall David Foster
Editorial Advisory Board

NEIL J. BEATON, CPA/ABV, CFA, ASA Z. CHRISTOPHER MERCER, ASA, CFA
Grant Thornton, LLPSeattle, Wash. Mercer CapitalMemphis, Tenn.
JOHN A. BOGDANSKI, JD
Lewis & Clark Law SchoolPortland, Ore.
JOHN W. PORTER
Baker & Botts, LLPHouston, Texas
NANCY J. FANNON, ASA, CPA/ABV, MCBA

Fannon Valuation GroupPortland, Me.
JAMES S. RIGBY, ASA, CPA/ABV

IN MEMORIAM (1946 2009)
JAY E. FISHMAN, FASA, CBA

Financial Research AssociatesBala Cynwyd, Pa.
RONALD L. SEIGNEUR, MBA CPA/ABV CVA

Seigneur Gustafson LLPLakewood, Colo. Young, Conaway, Stargatt & Taylor, LLPWilmington, Del.
LYNNE Z. GOLD-BIKIN, Esq.

Wolf, Block, Schorr & Solis-Cohen, LLPNorristown, Pa.
BRUCE SILVERSTEIN, Esq. JEFFREY S. TARBELL, ASA, CFA
LANCE S. HALL, ASA

FMV Opinions, Inc.Irvine, Calif.
HOULIHAN LOKEYSan Francisco, Calif.
JAMES R. HITCHNER, CPA/ABV, ASA

The Financial Valuation GroupAtlanta, Ga.
JARED KAPLAN, Esq.

McDermott, Will & EmeryChicago, Ill.
Trugman Valuation Associates, Inc.Plantation, FL
GARY R. TRUGMAN, ASA, CPA/ABV, MCBA, MVS KEVIN R. YEANOPLOS, CPA/ABV/CFF, ASA
GILBERT E. MATTHEWS, CFA

Sutter Securities IncorporatedSan Francisco, Calif.
Brueggeman & Johnson Yeanoplos, P.C.Tucson, AZ
Business Valuation Update (ISSN 1088-4882) is published monthly by Business Valuation Resources, LLC, 1000 SW Broadway, Suite 1200, Portland, OR, 97205-3035. Periodicals Postage Paid at Portland, OR, and at additional mailing ofces. Postmaster: Send address changes to Business Valuation Update, Business Valuation Resources, LLC, 1000 SW Broadway, Suite 1200, Portland, OR, 97205-3035. The annual subscription price for the Business Valuation Update is $339. Low cost site licenses are available for those wishing to distribute the BVU to their colleagues at the same address. Contact our sales department for details. Please feel free to contact us via email at customerservice@BVResources.com, via phone at 503-291-7963, via fax at 503291-7955 or visit our website at BVResources.com. Editorial and subscription requests may be made via email, mail, fax or phone. Please note that by submitting material to BVU, you are granting permission for the newsletter to republish your material in electronic form. Although the information in this newsletter has been obtained from sources that BVR believes to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. This newsletter is intended for information purposes only, and it is not intended as nancial, investment, legal, or consulting advice. Copyright 2009, Business Valuation Resources, LLC, (BVR). All rights reserved. No part of this newsletter may be reproduced without express written consent from BVR.
Business Valuation Update
march 2009
The Pomeroy Bill

...continued
It is clear from the foregoing statement that the proponents of the bill are ignoring the requirement that fair market value be determined based on a hypothetical buyer and seller. This is a fundamental part of the meaning of fair market value and an issue with an extensive judicial and regulatory history. It is interesting that the bill does not really seek to ensure that FLPs are properly valued only that more taxes are raised, fairly or not. If the elimination of valuation discounts is based on the theory that such discounts do not accurately portray what happens in an actual market transaction of a fractional interest, then this rule should apply broadly to all tax-related valuations. However, this is not the case. If an FLP interest is gifted to a charity, full valuation discounts will be required. Therefore, we know that the argument is not based on the economic veracity of valuation discounts. The JCT report echoes the complaints of the IRS that FLP valuation discounts are determined on a hypothetical willing buyer-willing seller concept but, in reality, the taxpayers are abusing the construct, making the FLP nothing more than a device to escape estate taxes. This is the recycling of dollars argument. Proponents of the recycling of dollars theory assume that the family recipients of the discounted, gifted partnership interests will liquidate the entity as soon after the death of the donor as possible, thereby receiving their pro-rata share of the partnerships assets (undiscounted). In this way, the monetary cycle has been completed and the assets have been successfully placed in the second generations hands with a tax expense far below the statutory rates. Since we know, the FLP is designed to be a very longterm investment vehicle, those knowingly participating in such a plan to liquidate a partnership prematurely are gaming the system and are subverting the use of the FLP into a tax avoidance device. We know that such abuses exist but, we believe these abuses exist far more often in smaller transactions in which the taxpayer was not represented by truly qualied professionals. For example, a Qualied Appraiser1 would be in violation of generally accepted appraisal guidelines if
march 2009
she were to determine a signicant valuation discount for an FLP, which is soon to be liquidated. As we will later suggest, there are less draconian ways to solve the problem than the bills heavyhanded measures. The valuation discount provisions of the Pomeroy Bill are an over action to the problem and its proposals to far more harm than good. In addition, the tax dollars it seeks to recover for the Treasury are now illusory. The Joint Committee on Taxation, in its January 27, 2005 report (the JCT Report), Options to Improve Tax Compliance and Reform Tax Expenditures, claimed that the elimination of valuation discounts for transactions involving family-controlled entities would raise $500 - $600 million per year in additional estate taxes for the years 2011 and beyond. The JCT based its estimates on the Congressional Budget Ofces 2004 baseline projections for the years 20052014. The projections with respect to estate and gift taxes assumed that the tax laws existing in 2004 would remain operative. At the time JCT made the projections, this was an understandable assumption. Now, however, we know that assumption is wrong and, therefore, the projections of the JCT Report are no longer valid. It is known now that the Federal estate and gift tax laws will change. The Pomeroy Bill itself seeks to increase the lifetime exemption amount to $3.5 million per person.2 This equates to $7 million for a married couple--$5 million higher than was available when the JCT revenue analysis was made. These facts will cause the estate and gift tax increases touted by the JCT Report to be far overstated and unreliable. The Pomeroy Bill will deprive taxpayers of the right to have the assets transferred (i.e., limited partnership interests) properly valued in accordance with the Tax Code (i.e., fair market value). The bill proscribes the use of valuation discounts but is silent on how this can be accomplished within the context of the meaning of fair market value as dened in the Tax Code. If implemented the valuation rules of the bill would violate numerous sections of the Internal Revenue Code and many Revenue Rulings. The bills valuation
The Pomeroy Bill

...continued from previous page
rules are in conict with Treasury Reg. Section 20.2031-1(b)) which govern estate taxes and Treasury Reg. Section 22.2512-1, which governs gift taxes. In addition, the bill is counter to Revenue Rulings 59-60, 77-287 and 93-12, among others. Will Congress repeal all of these rulings for the sake of one bill? The practical effect of this tax inequity is that it will cause taxpayers to avoid making gifts. Money not gifted will stay in estates but with a $7 million exemption, much of this will escape taxation. This would certainly thwart the tax-raising goal of the bill. The argument boils down to one of public policy. Because of perceived abuses, the proponents of the bill see FLPs as tax avoidance loopholes for the wealthy. Their question is: Why should the wealthy be able to reduce their estate tax burden by clever and sophisticated planning whose only purpose is to avoid taxes? Suggested solutions to FLP abuses. Without getting into a public policy debate, there are practical, appraisal-based solutions to the abuses that obviate the need for the valuation provisions of the Pomeroy Bill. First, require that all tax-related valuations be done by Qualied Appraisers preparing a Qualied Appraisals.3 This will go a long ways towards eliminating inexpertly done appraisals or outright cheating. Next, In order to validate that an FLP is indeed a long-term investment vehicle designed to promote capital appreciation, professional asset management, and intergenerational family wealth retention, we recommend that a valuation assurance clause be added to the partnership agreement.4 The clause will ensure that, if the FLP is liquidated before the tenth year of the date of a gift transfer, the transferee limited partners will not receive their full pro-rata share of the partnerships net asset value (NAV). During the 10-year period, any amount distributed in liquidation that exceeds the discounted value received at transfer would be subject to a tax surcharge unless donated to a qualifying charity. The two measures described above would eliminate most of the currently perceived abuses. Furthermore, and more importantly, these suggested changes would avoid the introduction of new valu4
ation rules, which would massively conict with the existing Tax Code and Treasury regulations.
About the author: William Frazier, ASA of Howard Frazier Barker Elliott, Inc. is vice-chairman of the American Society of Appraisers Government Relations Committee 1. As that term is dened under the proposed nal regulations governing Substantiation and Reporting Requirements for Cash and Noncash Charitable Contribution Deductions (REG-140029-07). 2. This is the exemption amount currently in place but, in 2011, the combined exemption amount is set to revert to $2 million. At this level, the elimination of valuation discounts would give rise to the projections suggested in the JCT report. However, it is a virtual certainty this assumption is wrong. A $7 million joint spousal exemption would make a large number of previously taxable estates non-taxable. 3. Again, see proposed nal regulations governing Substantiation and Reporting Requirements for Cash and Noncash Charitable Contribution Deductions (REG140029-07). 4. William Frazier, Valuation Assurance Clauses, Trusts & Estates. December, 2007.
Guideline Public Company Method

...continued from front page
Street with valuation multiples The Home Depot. Obviously, there are substantial differences in size, markets served, risk, access to capital, and depth of management, just to name a few distinctive issues. Rob Slee has done some excellent work in distinguishing the factors between public and private capital markets, and we are going to spend some time on that in the March 26-27 Miami seminar (call 888-BUS-VALU for registration information.) In contrast, Peter Butler and Keith Pinkerton suggest that public market evidence provides support for quantifying company-specic risk in the closely held company. I would say that public market research is vital to understanding the economics surrounding small companies. Access to debt capital is more difcult now, which would potentially limit the type and capacity of buyers. Generic market evidence of industry trends and economic patterns are valid considerations for valuation choices of growth, forecast, selection of multiples, and capital structure.
march 2009

...continued
Non-controlling, minority interest values are relevant to public markets, if we can establish similarity of risk and reward. There are few pieces of evidence appraisers can point to regarding non-controlling, fractional interest trades on an arms length basis. The issue becomes one of choice of the multiple and application of a discount for lack of marketability (or liquidity). Ashok Abbott has done some interesting research here, particularly that market volatility amid decreasing cash ows reduces price, but also widens the bid/ask spread. Q: We hear the term active market as a requirement for reliance on trades between buyers and sellers. How does an appraiser decide if the market is active and the data is any good? A: We have common benchmarks, such as volume of shares traded on a single day, oat measures, and skepticism of pink sheet trades, but there are risks of non-activity in our present environment. This is another factor of appraisal judgment. The latter half of 2008 has seen unprecedented turmoil throughout the U.S. and International markets, which most appraisers have not had to struggle with . . . ever. Toxic assets are usually seen as debt securities backed by subprime mortgages or complex derivatives. Most have not traded since last Fall; hardly a sign of an active market. Yet the M&A market is not dormant, and the declining stock indexes show there are more sellers than buyers these days. The public markets give us an insight into risk tolerance and liquidity for buyers making a pure investment decision. Another central appraisal decision concerns the time frame for calculation of the market multiple. Most us tend to default into the Latest Twelve Months (LTM) mentality. We get the latest four quarters of reported data from the public company, divide it by the Market Value of Equity (or the Market Value of Invested Capital), and apply the multiple to the LTM results of our subject company. Could we use a four or ve year average? YES. . . How about a six or ninth month period? SURE. . . How many buyers of closely held companies would only request nancial data for one year? A true guideline company is one where we can see depth in performance to assess growth and aberrations, particularly in use of the operating assets and limarch 2009
abilities. Although some transaction databases are attempting to gather longevity data, Guideline Public Company analysis is about the only form of market evidence to offer such depth. Q: What are the market inputs in using an Income Approach? A: The Market Approach and the Income Approach are linked, so to speak. Essentially, in valuing equity we are considering a CAP rate (or a discount rate less long-term growth) against some level of earnings. Value is deduced from either a single period capitalization model or a multi-period discounting model of future cash ows. CAP rates are either derived from direct market evidence, as in a Market Approach, or constructed from a build up of individual variables, which we call an Income Approach. Relying on the Capital Asset Pricing Model (CAPM) is like a build-up method, because we still have to assess risk-free rates, Equity Risk Premiums, Betas, and other factors. All of the key Income Approach elements are based on public market evidence. That is why we commonly apply a discount for lack of marketability to the value conclusion. Too many appraisers fall into the trap of mistrusting the market evidence in a Market Approach while blindly, and somewhat mechanically, adopting an Income Approach without understanding the market dynamics and underscore the valuation assumptions. Many discounted cash ow models are educated guesses with considerable margin for error. The devil is in the assumptions. There has been some recent interesting research on the Equity Risk Premium component and faulty Betas by Roger Grabowski and others, which we are going to explore. Volatility in the markets may give rise to Equity Risk Premiums higher than the 4% or 5% many of us have used in the past, and actually closer to the Ibbotson derived calculations over the long term. However, our Miami seminar is less on theory and more on practice. A second key market variable in an Income Approach is the weight given to the debt and equity components in constructing a Weighted Average Cost of Capital (WACC). Ideally, we

are looking at the percentage market value of interest bearing debtwhich may not be book valueand market value of equity within capital structure. Where do we get this? Most commonly, from publicly traded market participants in the industry of the subject company! The turbulent economic conditions of 2008 and 2009 have shaken the stability of accepted notions of preferred capital structure, particularly with the urry of drawdowns in lines of credit during economic contractions. Current leverage ratios may not be sustainable in the long-term amid higher risk, liquidity needs, and industry contractions. Q: What should participants bring to the seminar? A: Bring a healthy dose of valuation experience and suspicion about examining our wild and crazy public markets. Bring your laptop computer, because we are going to install the FetchXL program on everyones laptop to examine, real time, public market evidence. A wireless feature is key: attendees will play with the variety of other data sources available. Dont expect to just sit and take notes here. Ill going to be more of a shepherd among colleagues, and less a professor. I would say that our 12 or so hours would not be for the casual appraiser or part-time faintof-heart analyst. Come to get your hands dirty.
culation that so many of us thought, or think, beta performed. What is Total Beta? The basic concept underlying any beta (Market Beta, Sum Beta, Total Beta, etc.) is that it measures the sensitivity of a change in the return of a security to the change in return of the market portfolio. Total Beta has been in existence since at least 19812. We have relied upon Total Beta as part of a process to quantify empirically both total cost of equity (TCOE) and company-specic risk premiums (CSRPs) for guideline publicly traded companies since 2005. By using Total Beta, we can specically, and more objectively, compare private companies with our guidelines to better defend and support the selection of a discount rate. Indeed, we believe Total Beta is the most important tool that analysts can use to develop an appropriate cost of capital for privately held companies (see the accompanying sidebar, Why Total Beta Trumps all Other Betas.) Professor Damodaran of New York Universitys Stern School of Business was, presumably, the rst to apply Total Beta in an equation that should look vaguely familiar. Rather than applying a Market Beta in the standard capital asset pricing model (CAPM), Professor Damodaran applies Total Beta in its spot: TCOE = risk-free rate + (Total Beta x Equity risk premium) Because Market Beta does such an awful job of describing total risk, two important questions must be considered. Question: Other than this relatively new concept known as Total Beta, what, if any, other betas are needed to value privately held companies? Answer: None, if you so choose3. Question: Intuitively, doesnt it make sense to use Total Beta to perform the function that so many of us assumed beta performed? Answer: Yes, it does make a lot of sense. We explore these two potentially controversial questions and answers by comparing Total Beta
For more information: Rob Schlegel, ASA, MCBA a highly-rated instructor for the ASA, IBA, and accounting organizationswill offer a one-time intensive seminar in current application of the GPCM on March 26-29 in Miami Beach, Florida. Rob promises a dynamic, hands-on workshop that will bring newer business appraisers fully up to speed, allow established professionals to hone their skills, and earn 12 CPE credits in Miami Beach! For registration details, visit www.bvresources.com or call 888-BUS-VALU.
Total Beta
...continued from front page
try, we often ask audience members to dene beta. Typically, a brave attendee responds that beta, Measures the volatility of the stock relative to the volatility of the market. This is the common perception of beta1. Yet in reality, it does not adequately capture the relationship. To do this, you need the new beta in town Total Betawhich fortuitously performs the cal-
march 2009
Total Beta
...continued
with some of the more popular beta measurements used in the business valuation industry. First, however, we dene Total Beta as: Market Beta divided by R; or Total Beta = /R and equivalently as the: Standard deviation of a stock divided by the standard deviation of the market; or Total Beta = s/m Importantly, please note the identity: Total Beta = /R = s/m Total Beta is concerned with volatility of returns, so it captures total risk4all systematic risk, size risk, and company-specic risk not just market risk which OLS Market Beta purports to capture5. For appraisal purposes, this makes Total Beta very appealing; this is the reference point we use to value privately held companies most of the time. One calculates Market Beta by ordinary least squares regression (OLS), and R is the resulting correlation coefcient between the stock and the market dened as: R = s,m/s*m Where s,m represents the covariance of the stock with the market. Covariance is a statistical measure of the degree to which variables move together. OLS Market Beta is dened as: Covariance of the stock and the market divided by the variance of the market; or symbolically as: = s,m/2m Thus, OLS Market Beta is dependent upon covariance. OLS Market Beta is also the slope of the best-t linear regression line between the returns of the stock and the returns of the market. As we will nd out, the slope of this line and the relative volatility of the stock and the market may have very little in common. Importantly, OLS Market Beta can also be dened as: = R*s/m This equation is critical to understanding the difference between Market Beta and Total Beta. As one can see, OLS Market Beta combines the correlation coefcient, R, with relative volatility.
Thus, Market Beta is not a pure measure of relative volatility. Total Beta, on-the-other-hand, is the pure measure of relative volatility we as a group thought we had in beta. Please see the relationship again in the following identity: Total Beta = /R = s/m Consequently, it should now come as no surprise that a low correlation coefcient could result in a low beta and simultaneously conceal a highly volatile stock. We believe some investors have been kidding themselves by falsely believing that they have selected a defensive stock because its Market Beta has been well less than 1.0 when in fact the stocks volatility could be ve times as high as the markets volatility6, for example. Total Beta will always be greater than the OLS Market Beta since R will never equal 1.0 (indicating a perfect, positive linear relationship between a stock and the market). From the other side of the identity: the standard deviation of any one particular stock7 will almost always be greater than the standard deviation of the market, often times dened as the S&P 500, for example. Dividing the Market Beta by R effectively removes the guideline stock from a well-diversied portfolio perspective. This action takes the correlation coefcient out of the OLS Market Beta; the stock stands alone, which fortuitously happens to be the perspective from which we value privately held companies most of the time. Why else have we traditionally added a CSRP to the discount rate to value privately held rms? No other type of beta has this perspective. Total Beta trumps all other betas on this point. Total Beta also captures 100% of a companys total risk when all risks are properly disclosed and the market for the particular stock is efcient.8 No other measurement of beta comes remotely close to this ability, including modications to OLS Market Beta measurements such as Sum Beta. Total Beta, therefore, trumps all other betas on this point too. Now lets compare Total Beta to the other contenders. Comparing OLS Market Beta to Total Beta: To calculate Total Beta, we dened and used the OLS Market Beta. We disappointingly observed
march 2009
Total Beta
that OLS Market Betas, depending upon the stock, have extremely poor abilities to capture stocks total risk. In fact, most OLS Market Betas explain substantially less than 30% of stocks total risk9, leaving more than 70% to other forces, such as size, unsystematic risk, and possibly other reasons10. Despite its faults, we use OLS Market Betas inside the CAPM to measure systematic risk in the Butler Pinkerton Model in a process to provide empirical data on CSRPs as shown below: CSRP = (Total Beta OLS Market Beta) x Equity risk premium Size premium CSRP is dependent upon both Total Beta and OLS Market Beta. If you want to separate the CSRP from systematic risk you need both beta measuresa step the authors like to perform even though it is admittedly a moderately subjective exercise. If you want to directly key in on the guidelines TCOEan approach some appraisers prefer because they then only have to explain one number to a client, judge, or jurythen you only need to look at Total Beta as shown in this formula: TCOE = risk-free rate + (Total Beta x Equity risk premium) As implied above, appraisers who choose to directly observe the TCOE do not need to estimate a beta, a size premium or, for that matter, a CSRP for a privately held company. Theoretically, if you have only one number to defend, it could make a deposition and/or cross examination a bit easier. Therefore, Total Beta trumps all other betas on this point too. Keep in mind, if you directly focus on TCOE, you must compare and contrast your guideline companies with your subject company on every single risk factorsystematic as well as unsystematic. Conversely, if you separate the two measures (systematic and unsystematic) and take a measure of central tendency for beta, or some other potentially logical representation of systematic risk, you only need to key in on CSR factors when comparing and contrasting your guidelines with your subject company. (We will leave it up to other analysts on how they approach the discount rate and whether to key in on TCOE directly, or attempt to allocate the risk via the BPM and build-up the risk and then
8
compare the private company TCOE against the public companies TCOE benchmarks.) One point is certain: we believe all appraisers should not only put Total Beta in their toolbox now, but also reach for it every time they perform an income approach to valuation. The benets of Total Beta continue to show themselves. It also has been empirically shown that Total Betas are historically much more stable than OLS market betas or sum betas for that matter. We see this even during the same look-back period where we use different days of the trading week to calculate Total Betas, OLS Market Betas, and CSRPs via the BPM. In other words, there is generally much less volatility in Total Betas than OLS Market Betas. Thus, this is another very important reason that Total Beta trumps all other betas. A comparison of OLS Market Beta and Sum Beta. Many small public companies (based on market capitalization) have small OLS market betas. Excluding the troubling ramications of market inefciency11, Sum Betas allegedly capture the lagged response of a companys reactions to movements in the overall stock market. This modication effectively increases the beta measurement and the calculation of the stocks systematic risk. Instead of using OLS regression, Sum Beta uses multiple linear regression to calculate a beta. Instead of only using current market movements to calculate beta, Sum Beta calculations also use the returns of the market in a prior period. Sum Beta is merely the addition of the two beta coefcients arrived at using current, as well as prior period, market movements in a multiple linear regression. We have no criticism of what Sum Beta attempts to doother than the implied inefciency in the market for many stocks, which may or may not be the case (see footnote 11.). We do, however, question if it has become obsolete, given the introduction of Total Beta?12 Consider the following quote from Morningstars Beta Book, 2006 ed.: Because of non-synchronous price reactions, the traditional betas estimated by ordinary least squares are biased down for all but the largest companies. (Emphasis added)
march 2009
Total Beta
...continued
The non-synchronous price reactions referred to above are company-specic; Total Beta captures all of these price reactions. Since Total Beta captures these along with every other disclosed risk, business appraisers need not be concerned that some small guideline companies have potentially low measurements of systematic risk. Total Betas inclusion of CSR (as well as all systematic risks) picks up the OLS Market Betas slack in the measurement of total riskour reference point when we value privately held companies. As a result, there is no need to correct market risk if our reference point is total risk and the benchmark is an efciently traded stock. Its precisely why the aforementioned quote does not say: Because of market inefciency, the traditional betas estimated by ordinary least squares are biased down for all but the largest companies. The market for many smaller stocks is efcient in the semistrong form.13 Their total risk just happens to be dominated by CSR, rather than systematic risk. If the market for a particular stock is efcient, regardless of its low measure of systematic risk, its corresponding Total Beta never needs corrective action. This is yet another benet to the Total Beta measurement. Why bother with a Sum Beta adjustment if the stock trades in an efcient market? While the OLS Market Beta may be low, the use of Sum Betas apportions more of the total risk to systematic risk. The natural result is a smaller and articially low CSRP because the total risk of the company should not change for an efcient stock14. Consequently, we believe that the calculation of Sum Beta is an unnecessary and subjective step for efcient stocks after the introduction of Total Beta. Having made the argument above that Total Beta never needs correction; let us now introduce the proverbial wrench. If a guideline is thinly tradedas in an inefcient marketthen appraisers need to explore the possibility that there may be an implicit illiquidity discount in the calculation. By noting when there is a gap in trading volume and/or when the statistical signicance of the linear regression is below 80%, the BPM helps alert appraisers to this possibility. We subjectively chose 80% as a demarcation
line between the ability/inability to allocate total risk among its various components. We do not believe that there is much condence in the calculation of beta (systematic risk), and hence any other component of total risk as these percentages fall below 80%. If there is an implicit illiquidity factor in the TCOE of a guideline company, then appraisers must consider it when assigning a lack of marketability discount to their subject company, or if they want to use the guideline at all. Whether one labels the allocation of risk (systematic or company specic) is not really that important for business appraisers15 as long as all of the risks are accounted for with Total Beta, and you are consistent among your guidelines and your subject company. While the BPM attempts to allocate the risk when subjectively deemed possible, as previously mentioned, focusing on TCOE is another viable approach16. If you decide to allocate the risk, you can use the TCOEs as reasonableness checksanother benet to Total Beta. What about forward-looking betas? Forwardlooking betas, such as Smoothed Betas, supply interesting information. Yet, as we have alluded previously, why not use a forward-looking Total Beta if you are interested in using a forward-looking perspective, when available? Remember: Total Beta is the only beta that views risk from a stand-alone perspective and captures 100% of the disclosed systematic and unsystematic risks. Remember as well that you calculate Total Beta by one side of the identity with the following formula: Total Beta = s/m If a guideline has publicly traded options, you can calculate implied forward-looking volatilities (standard deviations) for the guideline and the marketthe only two inputs into Total Betato get to a forward-looking TCOE. Adjustments to forward-looking OLS Market Betas are inherently guesses. Then again, forward-looking total betas are based on empirical data (option prices).
About the authors: Keith Pinkerton and Peter J. Butler are Directors of Valuation at Hooper Cornell, PLLC in Boise, Idaho. Continued to next page...
march 2009
Total Beta
...continued from previous page 1. Some textbooks describe beta as a relative volatility measure. 2. Please see The Beta Quotient: A New Measure of Portfolio Risk by Robert C. Camp and Arthur A. Eubank, Jr. published in the Summer 1981 edition of the Journal of Portfolio Management, pages 53 - 57. (Note: This article refers to Total Beta as the Beta Quotient.) 3. The authors still rely upon market betas to capture CSRPs in the BPM. However, you do not have to isolate CSRPs if you do not want to. Moreover, Total Beta is so powerful, that you never again have to look at a size premium unless you want to. In the interest of full disclosure, the authors still look at size premiums to calculate benchmark CSRPs. 4. It has long been accepted that volatility, or standard deviation, is an appropriate measure of risk for standalone assets. 5. Models other than the CAPMsuch as the Fama French Three Factor Modelmay capture other systematic risks rather than just market or single factor beta risk. Despite its faults, we have modeled the BPM off CAPM theory since the CAPM remains today the most widely used cost of capital model. 6. In this example, the stocks Total Beta would equal 5.0. 7. Not including closed-end mutual funds that often times have more than 500 stocks in their portfolios. 8. Total Beta will not capture surprises or risks not previously disclosed. 9. Ibbotson SBBI, 2008 Valuation Yearbook, p. 112. 10. As stated above, the BPM depends on standard CAPM theory. Analysts who use a different underlying modelsuch as the Fama French Three Factor Model or otherswill arrive at different conclusions regarding CSR, for example. 11. It seems that if OLS Market Betas historically and consistently fail to measure systematic risks for smaller publicly traded stocks, and everyone knew it, then this phenomenon would eventually be arbitraged away. 12. Sum Beta does not appear to be widely used on Wall Street anyway. For example, we could not nd any mention of it in the most recent (2009) CFA required reading materials. On the other hand, OLS Market Beta is quite prevalent. 13. A market is semistrong form efcient if prices incorporate all publicly available information. 14. Using the same assumptions for the risk-free rate, the equity risk premium, the look-back period, the valuation date, and the market proxy. 15. Note that we did not say for portfolio managers. 16. In our presentations, given the inherent subjectivity of CSRP calculations (because they are potentially dependent upon unstable beta calculations), we have referred to the BPM as a value-add and commented that the signicant contribution behind the Total Cost of Equity and Public Company Specic Risk Calculator available at www.bvmarketdata.com to be the Total Beta (developed in 1981) and TCOE calculations, which were developed by Professor Damodaran. In fact, we have developed templates (written reports), available to subscribers, describing each approach (TCOE-focused versus CSRP-focused.)
Why Total Beta Trumps all Other Betas

Total Beta is the best and most complete measurement of risk for business appraisers to focus on to value privately held companies. Why? In our estimation, Total Beta: 1. Has the same perspective that we use to value private companiesnamely as a stand-alone asset. All other measures of beta represent systematic risk as part of a well-diversied portfolio that is most appropriate if you are a money manager or stock analystnot a business appraiser. Captures 100% of historical (disclosed) risks. Such is the case, whether they are systematic or unsystematic risks, if the stock trades in an efcient market. No other measurement of beta, including Sum Beta, comes remotely close to this percentage. Is generally much more stable than any other beta measurement, providing more condence in the measure of risk to compare and contrast risk factors between guidelines and your closely held company. Allows for direct comparison to public companies rather than relying upon averages of publicly 5. traded data. For example: industry risk premiums used in the build-up approach capture all of the companies in an industry. Some of these companies may have little comparability to your private company. Gary Trugmans book, Understanding Business Valuation: A Practical Guide to Valuing Small and Medium Sized Businesses, which provides analyses of the BPM: Now, instead of using the entire industry, we can choose better guideline data as a starting point. Captures all of the disclosed risks; one does not need to subjectively correct for any perceived low measurement of systematic risk unless possibly the stock traded in an inefcient market. Provides a means to defend and support one metricTotal Betarather than Market Beta, the size premium and the CSRP to a judge, jury, or client. Moreover, all three of these inputs are generally more subjective (read: more volatile) than Total Beta. Source: Keith Pinkerton, ASA, CFA, and Peter J. Butler, CFA, ASA.
2.
6.
3.
4.
10
march 2009
LEGAL & COURT CASE UPDATE

Wife Loses Discounts in Divorce Battle, Tries to Win the War on Appeal
Grelier v. Grelier, 2008 WL 5265056 (Ala. Civ. App.)(Dec. 19, 2008) The Greliers spent the last two years of their twelve-year marriage in divorce proceedings. Their primary dispute: how to allocate the husbands 25% interest in a consolidation of closely held real estate development companies, which he owned with his father, his brother, and a family friend. In response to the wifes requestand an order drafted by her attorneythe trial court appointed a special master to audit and examine the books and records of the business, plus its physical assets, for the purposes of identication and determination of the fair market value of all business entities in which the [husband] possesses any interest. One expert turns to three. At trial, the husband testied that all of his various interests had suffered more than ve years of nancial difculties, including poor sales, overdue construction loans, and forced debt. Because of these liabilitiesand despite nding that the business owned real estate worth $59 millionthe special master ultimately valued the husbands 25% interest at just over $1 million, without applying any minority or marketability discounts. Each of the parties contested the valuation. The wife presented a nancial expert, who testied that the special master had seriously undervalued the interests by relying on outdated real estate appraisals, but he agreed that discounts were not applicable. By contrast, the husbands nancial expert argued that by neglecting to apply discounts, the special master failed to comply with his court-ordered directive to determine fair market value. The husband had never owned a majority interest in any of the underlying businesses that formed the consolidated business; and he did not have the right to act independently from the majority-interest holders. Moreover, the husband could not convert his interest easily into cash, as all of the operating agreements required prior approval by the other owners before the husband could sell. Thus, his expert applied a 25% discount for lack of marketability and 25% minority interest discount, which, when combined, would have reduced the value of the husbands interest to just over $350,000. After hearing the testimony from all three experts and soliciting legal briefs on the subject, the trial judge accepted the special masters $1 million valuation for the husbands 25% interest, but applied a combined discount of 40%. Wife argues fair value. The wife appealed, arguing as a general matter that discounts were inappropriate when valuing business interests in the context of a divorce. The Alabama Civil Court of Appeals acknowledged that the question regarding which standardfair market value or statutory fair valueapplied in divorce cases would be a matter of rst impression in the state. However, it did not need to reach the issue in this case, for several reasons: 1. Through her attorney, the wife drafted the order appointing the special master, specically instructing him to determine fair market value of the husbands minority interests. 2. During the trial, both parties presented expert opinions and legal briefs regarding the application of discounts. 3. In her legal memorandum, the wife challenged only the application of discounts to a proper determination of fair market value; she did not challenge the use of the fair market value standard, but waited until the appeal to raise the issue for the rst time. Having instructed the special master to determine the fair market value of the husbands business interest, the wife cannot now assert on appeal that the trial court should have applied a different standard, the appellate court held. [A] party may not induce an error by the trial court and then attempt a reversal based on that error, it said, and upheld the trial courts valuation in all respects, including the 40% combined discounts.
11
march 2009
LEGAL & COURT CASE UPDATE Denied Pre-IPO Shares, Investor Sue Attorneys For Lack of Expert Valuation
Kaminsky v. Herrick Feinstein, LLP., 2008 WL 5245901 (N.Y. A.D. 1 Dept.)(Dec. 18, 2008) In hindsight, the bursting of the dot-com bubble seems like a minor blip compared to todays economic turmoil. Investors, however, are still litigating their losses more than a decade later, now turning to secondary sources of recovery, including attorneys and their nancial and valuation analysts. An IPO denied. In 1998, the plaintiff entered into a verbal agreement with a broker with Spenser Trask Securities to invest $100,000 in return for an interest in Next Level Communications, a leading broadband equipment company back. On the eve of Next Levels IPO, however, the brokerage rm rejected the plaintiffs check for $100,000 and instead offered him an unspecied cash settlement together with the right to purchase additional Next Level shares at the IPO price. The plaintiff rejected the offer and sued for breach of contract and specic performance, seeking $5 million in damages. Next Levels IPO took place shortly thereafter, in November 1999, and plaintiff claimed that his $100,000 investment would have been worth tens of millions of dollars. The brokerage rm offered to settle the case for approximately $3.25 million, but the plaintiff rejected this overture as well. The brokerage agreement compelled arbitration, at which the parties focused primarily on determining damages. The brokerage rm argued that the proper measure of any damages was at the time of the breachmeaning shortly before the Next Level IPO. The plaintiff, of course, wanted to use a post-IPO value. His nancial expert calculated damages as of two dates, February 9, and May 10, 2000, or three and six months after the company went public. However, the brokers expert testied that statutory and contractual restrictions would have prevented the plaintiff from selling his shares within 6 months of the IPO. The plaintiff tried to introduce a rebuttal witness, to testify regarding the various options that he could have used to overcome the restrictions. The arbitrators refused to hear this witness because the plaintiff should have presented the evidence in his direct case and/or by cross examining the brokers expert. The panel awarded plaintiff $294,000 in compensatory damages plus $50,000 in punitive damages. The plaintiff challenged the arbitrators ndings, but the New York Supreme Court (Appellate Division), upheld the award, noting that that plaintiff gambled on the panel adopting [his] post-breach analysis, and lost. Plaintiff turns against attorneys. Having exhausted his claims against the brokers, the plaintiff sued his attorneys for malpractice, claiming that the presented an insufcient case to the arbitration panel, resulting in unreasonably low damages. In particular, the attorneys failed to: 1. Introduce evidence to support an award based on the post-IPO value (or market value) of his stock; 2. Adduce testimony from plaintiffs primary damages expert to show he could have circumvented the stock restrictions by using options or a private placement; and 3. Provide a pre-IPO expert valuation of his Next Level share, in case the panel adopted a date of breach theory and assessed damages before the shares began trading. The law rm moved to dismiss the claims, saying that they had presented ample evidence to support plaintiffs damages, including the availability of option strategies as well as expert testimony regarding the pre- and post-IPO values of the plaintiffs shares. The trial court granted the motion, nding no causal link between the alleged malpractice and the harm. The plaintiff once again took his case to the New York appellate division. The court began by noting that calculation of damages was central to his original case and his appeal. Nonetheless, the plaintiff didnt present
12
march 2009
Denied Pre-IPO Shares

...continued
any legal basis for the panel to award damages on a post-IPO basis (the price at which Next Level shares traded during the lockup period or thereafter) or on a pre-IPO basis (expected return from his investment.) The bottom line: he needed to show how his attorneys failure to provide additional expert testimony would have supported a higher arbitration award. By contrast, the court noted substantial evidence supporting the panels award, including the plaintiffs own testimony on his expected position in Next Level shares at the time of the IPO ($500,000); and his experts testimony that concluded roughly the same return based on the share price set forth in the IPO prospectus. An agent from the brokerage rm testied that at the time of the breach, there was a 70% likelihood that the IPO would go through; applying this 30% discount to the plaintiffs expected return resulted in a $420,000 value for the shares. Finally, the attorney for the brokerage rm suggested yet another 30% discount would be appropriate, due to the restrictions on the stock. This yielded a net return of $294,000, or precisely the amount awarded by the arbitration panel. Although this portion of the award (the second 30% discount) appeared to have been at least partially based on facts not in evidence, the court said, the question of arbitral misconduct was not at issueimplying, perhaps, that the plaintiff missed a possible ground for overturning or increasing the award during his prior appeal. The court also noted that during the arbitration, plaintiffs attorney objected to the damages estimation, claiming that the discounts were based on made up assumptions. Moreover, plaintiffs attorney alerted the arbitrators to an alternative valuation method, based on a Massachusetts case, which used the closing price on the rst day of trading to measure damages in a breach of contract to deliver IPO shares. The arbitrators apparently rejected this measure for damages without citing the legal foundation for their conclusion. While the court acknowledged that there was no New York decision on point, it cited Boyce v. Soundview Tech. Group,
Inc., 2d Cir. 2007, for the rule that the proper measure for breach of an option to purchase shares in a corporation on the eve of a public offering is at the time of the breach. (For an abstract of the Soundview case, see the March 2007 BVU.) Thus, the appropriate time to assess the value of [the brokers] performance to plaintiff was at the time of breach, and the arbitrators properly rejected evidence of the value of Next Level shares after trading began, the court held. A post-IPO valuation was not warranted because, had plaintiff wished to own shares and prot from their appreciation in subsequent trading, he could have purchased them on the open market. Given his attorneys objection to the arbitration award and his offer of an alternative valuation method, with supporting case law, the court found no evidence of any malpractice by which the plaintiff received an inadequate damage award, and it dismissed his claims.
LEGAL & COURT CASE UPDATE Mixed Methodologies Render Experts Opinion On Lost Prots Unreliable
Fluor Enterprises, Inc. v. Conex International Corp., 2008 WL 5860048(Tex. App.)(Dec. 18, 2008) A petrochemical company hired a mechanical contractor to perform certain heat and welding work on a large Turnaround Project (the Project) at one of its Texas reneries in 2001. The company also hired a consultant, Fluor Enterprises, to provide engineering guidelines and advice on the Project, including the welding work done by its mechanical contractor. After completion, the company failed to pay the contractor for nearly $2 million of extra work on the Project. The parties settled that dispute for less than $400,000, apparently because that was all the company could afford to pay. The contractor also sued the consultant, claiming business disparagement and interferContinued to next page...
march 2009
13
Mixed Methodologies
ence with its contractual relations, costing it not only payment for the extra work but also future work (lost prots) from the company on the Project and others. A jury awarded the contractor over $98 million in damages. The consultant appealed. The court devoted the rst portion of its opinion to considering whether there was sufcient evidence to support the contractors claims for business disparagement. Although it found some evidence from which the jury could have concluded that the consultant made malicious statements about the contractors work, ultimately the court ruled that the record was too weak to support the verdict, which was clearly wrong and unjust. Similarly, the court found that the consultant failed to produce sufcient evidence to support the jurys ndings for tortious interference with contract, and ordered a new trial on all liability issues, including the contractors claims for unpaid work on the Project. The also court addressed whether the contractor failed to provide legally sufcient proof to support the jurys damages award, including $8.5 million for past lost prots, $8.5 million for future lost prots (other than those connected with the one project) and $50 million for lost prots connected with the Project. Because it ordered a new trial on all liability issues, the court needed only to determine whether the consultant had provided enough proof to support the fact of lost prots damages, not the [specic] amount. (Emphasis added) The consultant had to show more than it suffered some losses, the court said. At a minimum, opinions or estimates of lost prots must be based on objective facts, gures, or data from which the amount of lost prots [may] be ascertained. The bare assertion of lost contracts does not demonstrate a reasonably certain objective determination of lost prots, it added. Expert valuation is mixed. The contractor presented an economics professor as its damages expert, who limited his opinion to lost protsnot causation. (The court does not comment on this limitation in its review of the experts evidence.) He analyzed the contractors average
yearly billings with the petrochemical company during an eight-year prior to and a ve-year period following the Project, and then assumed a 21% prot margin on the difference between the two averaged gures. Apparently, the expert did not consider the contracts that the company actually awarded the contractor during the ve-year post-Project period, nor does it appear that he considered the contracts actually awarded to [other] contractorsfor the period that preceded the [Project], the court said. He also did not consider whether there was a downturn in business at the renery during the relevant periods, or whether the contractor made competitive bids following its work on the Project. In other words, [the expert] provides no evidence of specic lost sales required to recover for business disparagement. The court observed additional problems with the experts lost prots analysis: 1. The expert was not familiar with what the normal prot margin for a mechanical contractor would be. 2. He did not analyze or evaluate the job cost analysis provided by the contractor. 3. He did not include any overhead component in his calculations. 4. He included the contractors prots earned through an exclusive maintenance contract that was in effect during the 1990s but terminated three years prior to the Project. 5. The expert failed to apply his methodology consistently and with objectivitythe most notable shortcoming. Although the expert included both the turnaround work that the contractor did on the Project and large capital expenditures, he based his opinion on lost future prots on past performance only when it benetted [the contractor], and he eschewed historically-based averaging when it came to the [Project]. He used the prot margins from his previous calculations but not the averaged income and costs, the court said. Thus,
14
march 2009
Mixed Methodologies
...continued
he did not supply one complete calculation, but provided piecemeal computations based on different methods of calculation. Employing mixed methodologies renders his opinion on lost prots unreliable, the court held. Still, because the company offered some testimony (from management) that it suffered some amount of lost prots, the court ruled that the consultant was not entitled to a take nothing judgment, and remanded the lost prots damages claims for a new trial. One judge on the panel published a strong dissent. Judge Gaultney asserted that there was sufcient evidence for the jury to return a verdict for special damages related to the contractors unpaid work on the project. However, the dissent would have reversed the remainder of the verdict and render a take nothing judgment against as to all other damages. Generally, lost prots not tied to a specic contract are not recoverable in a business disparagement claim, because they are not the type of special damage for which this tort action provides a recovery.
patents as a matter of law. As to the defendants challenge of the damages award, the court described the two alternative models that the plaintiffs expert presented at trial: 1. A mixed framework that included a lost prot and a reasonable royalty component. The expert based his lost prot calculations on evidence that the defendants sold 1.14 million of the patented units to a major retailer (Target) and .24 million units to other customers, sales that the plaintiff said it would have made but for the defendants infringement. To derive his other sales gures, the expert used a market share analysis, estimating that the plaintiff accounted for 30% of all U.S. sales of VCRs. Under this hybrid approach, damages totaled $11.3 million. 2. A reasonable royalty calculation that resulted in $2.5 million total damages. In reconstructing what reasonably royalty the parties would have agreed to, in a hypothetical negotiation, the expert used a four-year period beginning in the fall of 2002 and continuing through the end of 2006; he also assumed a rate of 10 cents per unit. Defendants contended that both damages models failed to provide adequate and reliable evidence, sufcient to sustain the jurys award of $9.5 million. The court considered these claims in turn. Market reconstruction requires sound economic proof. To recover lost prots, a patent holder must demonstrate that there was a reasonable probability that, but for the infringement, it would have made the infringers sales, the court observed. This causation inquiry requires a reconstruction of the market as it would have developed, absent the infringing product. Specically:
Reconstructing the market, by denition a hypothetical enterprise, requires the patentee to project economic results that did not occur. To prevent the hypothetical from lapsing into pure speculation, this court requires sound economic proof of the nature of the market and likely
LEGAL & COURT CASE UPDATE Keeping Market Share Reconstruction From Lapsing into Speculation
Funai Electric Co. v. Daewoo Electronics Corp., 2008 WL 5057408 (S. D. N.Y.)(Nov. 26, 2008) After a fteen-day trial, a jury found that various entities of the Daewoo Electronics Corporation (the defendants) infringed on three valid patents held by the plaintiff in connection with videocassette recorder technology. The jury awarded over $9.5 million in lost prots damages, and the defendants moved for a judgment as a matter of law and a new trial. In reviewing the record, the court found substantial evidence to support the jurys verdict and rejected the defendants request for a nding that they had not infringed the plaintiffs three
march 2009
15
Keeping Market Share Reconstruction

outcomes with infringement factored out of the economic picture.... Within this framework, trial courtsconsistently permit patentees to present market reconstruction theories showing all of the ways in which they would have been better off in the but for world, and accordingly to recover lost prots in a wide variety of forms.
der a two-year condentiality agreement. Ballard agreed to pay a 3% royalty rate for licensing the new design, but it rejected the inventors request for a guaranteed minimum annual payment of $50,000, and the parties broke off their negotiations. The inventor asked Ballard to return his prototype and related design materials. The company was unable to locate them and used the inventors work to secure two patents and develop a catheter that contained his essential design innovations. Ballard began selling the new, improved catheter in 2001. The inventor sued for breach of the condentiality agreement and unjust enrichment. At trial, the inventor claimed that the only material differences between the companys old catheter and the new stemmed entirely from his innovations and exploitation of his trade secrets. Thus, he was entitled to the entire present value of the companys expected net prots from the new devices over the 17-year life of the patents, which his expert estimated at $32.3 million. In addition, applying a 3% royalty rate and $50,000 minimum annual payment, the expert also testied that the inventor would have received royalties worth $2.75 million (present value) over the life of the patents. This estimate was conservative, according to the expert, because he used a 5% annual growth rate when the company achieved 42% growth from 2001 to 2005, and 17% growth in 2004-2005. Moreover, the expert calculated royalties only through the life of the patentseven though he testied that similar medical products have a very long life. Lastly, the expert told the jury that any changes to his assumptions could yield damages in excess of $3 million. The jury found the company liable on both counts, and awarded the inventor $17 million for his unjust enrichment claim and $3 million for breach of contract, for a total of $20 million in damages. The company appealed. The truth lay between the extremes. The company asserted that the inventors contribuContinued to next page...
The court found that the plaintiff provided substantial evidence that there was market demand for the patented features of their products, and that non-infringing alternatives were not available. Moreover, it presented substantial evidence of the products that it would have sold to Target, but for the defendants infringement; and the defendants failed to rebut the expert testimony regarding the plaintiffs 30% market share. As a general model of market share, the plaintiffs evidence had sufcient basis in fact to prove reliable, the court said. Additionally, the court considered the plaintiffs reasonable royalty analysis, which envisioned the terms of a hypothetical licensing agreement between the parties. The defendants took over sales of the infringing products in the fall of 2002the point at which plaintiffs analysis began. Further, through his own investigations, plaintiffs expert concluded that 10 cents per unit was a reasonable royalty rate, taking into account the various factors that inuence cost (supplier, quantities ordered, delivery schedule, etc.). The court found that substantial evidence supported the plaintiffs reasonable royalty analysis, and upheld the jurys damages award in its entirety.
LEGAL & COURT CASE UPDATE Conservative Growth Estimates Help to Sustain Damages Award
Russo v. Ballard Medical Products, 2008 WL 5247934 (C.A. 10 (Utah))(Dec. 18, 2008) A medical device inventor created a tracheal catheter that more than tripled the useful life of a prior design. In 1998, he marketed his invention to Ballard Medical Productsthe worlds largest manufacturer of closed tracheal systemsun16
march 2009
Conservative Growth Estimates

...continued
tion added nothing or very little of value to its independent making and marketing of the new device. At trial, the inventor argued that the new device was entirely dependent on misappropriating his trade secrets. As if often the case, the jury found the truth to lie somewhere between the extremes, the court said. The damages award represented only 53% of the inventors original request; in addition, the experts use of conservative growth rates was another indication that the jurys assessment fell within the range of evidence. The company urged the court to limit the damages to the two-year span of the parties condentiality agreement. After all, the inventor could have patented and licensed his device to a different company. This argument was a strain, the court said. The parties agreement did not any limit damages for its breach. Further, the inventor testied that he did not market his device elsewhere because the condentiality agreement protected his ideas, and he was certain that the parties would eventually reach an arrangement. Plainly, the jury was free to conclude on the basis of these facts that [the inventor] had a valid reason for waiting to patent his idea, the court ruled. The award of only 53% of the inventors original claims was also consistent with some of the companys argumentse.g., that at most, the trade secrets merely lent it a head start on what it would have achieved on its own. The company argued that unjust enrichment damages are appropriate only when the defendant usurps a trade secret to compete with a plaintiff, and the court should limit the inventors damages to reasonable royalties. However, one of the functions of trade secret law is deterrence, the court said, and to ensure that industrial espionage is [not] condonedor made protable. Unlike a standard breach of contract claim, misappropriation involves an element of theft, which requires the thief not only to return the stolen goods but also any resulting prots. The company must assume the risk for its wrongful acts, the court held, including paying the inventor much larger sums than it would have if the par-
ties had entered a lawful licensing arrangement. It conrmed the $20 million damages award.
LEGAL & COURT CASE UPDATE Courts Void Non-Compete and Remands $1.1 Million in Damages
Medical Staf ng Network, Inc. v. Ridgeway, 2009 WL 21056 (N. C. App.)(Jan. 6, 2009) Two competitors in the healthcare stafng industry vied for the Raleigh, North Carolina, market. One company succeeded in luring the others top-producing manager, despite knowing that he was bound by a non-compete agreement. Shortly before he left, the employee accessed a number of condential les from his former companys computer network, including its market action plan and personnel lists. He also tried to recruit several of his former staff to follow him. In the year after his departure, his old stafng company saw revenues decline while his new employer enjoyed signicant revenue boosts, due in part to capturing one of its competitors major customers. The former sued the latter and its former employee for breach of the non-compete agreement, misappropriation of trade secrets, and tortuous interference with contractual relationship. A jury returned a $1.1 million verdict for the plaintiff, and the defendants appealedclaiming that the non-compete was invalid and overbroad and the damages were speculative. The enforceability of non-compete turns on balancing act. In examining a covenant not-to-compete, courts generally consider the reasonableness of its time and geographic restrictions by balancing the employers right to protect its legitimate business interests versus the employees right to work. In this case, the plaintiffs non-compete prohibited its employee from working in any business within a 60-mile radius that not only competed with the plaintiff, but also any of its divisions, subsidiaries, afliContinued to next page...
march 2009
17
Courts Void Non-Compete

ates, predecessors, or assignees, even if [his] employment dutieshad nothing to do with that business. Likewise, its non-solicitation clause prevented the employee not only from engaging in business with the plaintiffs current and former clients, but also precluded him from soliciting the business of any of its clients, which included clients of its afliates and divisions outside of the medical stafng business. We conclude that on its face, this bar extends beyond any legitimate interest [plaintiff] might have in this case, the court held. The restrictive covenants were overbroad and unenforceable, and the court reversed the jurys decision with respect to the breach of contract and interference with contract claims. The defendants similarly challenged the misappropriation of trade secrets claim. Although evidence showed that the employee accessed marketing information, business strategies, and other condential client les during his nal days with his former employer, there was no evidence the defendants actually used this information once the employer came on board, they said. But the court disagreed, nding that the plaintiffs offered proof not only that the employee had access to its trade secrets, but that he used them as wellin particular in making calls to nurses to recruit them to join the defendants. There was also evidence that he accessed the condential computer les shortly before having a dinner with defendants to conrm his new employ. Finally, there was evidence of a substantial turnaround in the defendants business at the same time plaintiffs business declined, the court said. Viewing all of these circumstances together, there was sufcient evidence to sustain a nding that defendants knew of [plaintiffs] condential information, had an opportunity to acquire it, and did so, causing [plaintiff] harm. Economic damages require most reliable measure. According to applicable state statute, the proper measure of damages for the misappropriation claim is the economic loss or the unjust enrichment that the misappropriation of trade
secrets causedwhichever is greater. However, the trial courts award did not specify which portion of the $1.1 million damages was attributable to the misappropriations claim. Thus, the court of appeals remanded the case for a new calculation of damages that would award plaintiffs the greater of: 1) its economic losses or 2) the extent to which the defendants unjustly beneted from the use of plaintiffs marketing strategies and nurse contact information. The court noted that the plaintiff would still bear the burden to show that its damages could be calculated with reasonable certainty. The calculations that it presented at trial were based on the defendants revenues, and the court said these were too speculative because: 1) they used an arbitrary midpoint; and 2) they assumed that the plaintiff would have gained all of the defendants revenues but for the wrongful conduct. We conclude that [the defendants] revenue could have increased for a number of reasons unrelated to defendants conduct, the court held. For example, if any of the defendants former clients simply expanded their operations and began placing larger nurse orders, then their revenues would have increased, a boost that would have no relation to their bad conduct. A more reasonably certain measure of the plaintiffs economic lossor the unjust enrichment that defendants caused by misappropriating the marketing informationwould be the prot that the defendants gained from the ten nurses that they acquired from the plaintiffs list. On remand, the trial court should also consider whether the parties respective market shares changed since defendants misappropriation, and if so, it should measure the prots attributable to such changes. In calculating prot with reasonable certainty, the trial court must take into account all relevant factors, the court of appeals said, which in this case would include, for instance, the rate paid by the parties clients as well as the rates paid to the nurse employees during the relevant period.
18
march 2009
LEGAL & COURT CASE UPDATE Bafing Hide the Ball Tactics in Economic Damages Discovery
Kingsway Financial Services, Inc. v. PricewaterhouseCoopers LLP, 2008 WL 5336700 (S. D. N.Y.)(Dec. 22, 2008) A law suit is not a game but a search for the truth. The ends of justice are served, not by giving one side a vested right to exhaust the other, but by affording both an equal opportunity to a full and fair adjudication on the merits. Polaroid Corp. v. Casselman, 213 F. Supp. 379, 381 (S.D.N.Y. 1962) The Kingsway court highlighted this quote from an older case when deciding whether to impose discovery sanctions on the plaintiffs in their suit against PricewaterhouseCoopers (PwC) for security fraud and conspiracy. The plaintiffs claimed that from 1999 to 2002, the defendants fraudulently inated the stock price of company to induce their purchase of the same. During this long litigationspanning at least four years the plaintiffs have refused or resisted providing a detailed description of the precise methodology they and their disclosed experts used to calculate damages, which they allege to be worth over $205 million. The case highlights costly, contentious discovery disputes. For example, in PwCs rst set of interrogatories, they asked the plaintiffs to identify: 1) each category of damages sought; 2) a computation of each category of damages; 3) the person(s) most knowledgeable regarding the damages and their calculations; and 4) the documents that support the calculations. In a conference with the court, the plaintiffs explained that they did not want to disclose the methodology by which they calculated damages because they were concerned the calculations might change during discover; and they might give defendants a road map by which to plan their trial strategy. The court nevertheless directed the plaintiffs to respond to the discovery requests pursuant to the Federal Rules of Civil Procedure. Their response provided signicantly more detail regarding the computation of damages, including a breakdown of nine categories of damages (e.g., $50.4 million lost due to materially understated reserves; $107.4 million lost due to increased cost of capital). They also designated three persons with knowledge of the damages computations. Nonetheless, when the defendants deposed one of the identied witnesses, she turned out to know nothing about the damages component; at one point, for example, she stated that she did not realize the plaintiffs suffered any adverse consequences to its capital reserves. The plaintiffs moved for sanctions against the defendant, including a request for the ultimate penalty of default judgment. The court expressed some clear frustration with the unnecessary costs and conict that the plaintiffs caused:
The defendantsshould not have been forced to spend hours at a deposition attempting to discover which specic transactions out of the larger universe of facts underlying the nine damage categories were within [the witnesss] knowledge. The proper course would have been for plaintiffs to identify those categories of damages or those transactions which [the witness] had knowledge and identify any other witnesses who contributed to the damages calculations, or if noemployee had any knowledge ofdamages, that fact should have been disclosedBy naming [the witness] as one of three witnesses with the most knowledge regarding each component of these damage calculations, when she lacked any knowledge regarding several of the damage categories, plaintiffs made it impossible for defendants to tailor their deposition question to [the witnesss] expertise and therefore unnecessarily and vexatiously delayed discovery.
As an appropriate sanction, the court ordered the plaintiffs to pay the defendants fees and costs in taking the deposition.
march 2009
19
DATA & PUBLICATION UPDATE

Expert Testimony: Simple Suggestions Help BV Analysts Bring their A-Game to Court
Valuation analysts are often called on to provide litigation support and expert testimony services. Below are 20 recommended procedures for the valuation analyst who provides expert testimony services abridged and adapted from the recently released Guide to Property Tax Valuation by Robert F. Reilly and Robert P. Schweihs. The procedures relate specically to ad valorem tax disputes, including real estate appraisal, tangible personal property appraisal, business (i.e., unit) and intangible asset appraisal, and other appraisal practice areas. However, they apply equally to all valuation disciplines. The authors note that the recommended valuation analyst procedures are not presented in any particular order of relative signicance. Moreover, these valuation analyst procedures are merely recommendations. As with all valuation analyst procedures, expert testimony procedures are ultimately a matter of the individual analysts reasoned judgment and professional experience. The suggestions: Understand that the valuation report is your best friend. This statement is true on the witness stand it is also true during deposition testimony. Accordingly, always bring the valuation report to the courtroom witness stand or to the deposition. It is appropriate to refer to the property valuation report as often as possible and to read from the report from time to time. Expert testimony is not a memory test. Be fully prepared to present your expert testimony. Review valuation engagement work papers just before offering expert testimony and any analyst eld notes just before offering expert testimony. In addition, review the property valuation report just before offering expert testimony. Of course, you should be familiar with the facts of the matter. Moreover, be familiar withand be prepared to explainthe property valuation report, the taxpayer property valuation analysis, and the value conclusions. Always tell the truth, as you believe it. Expert witnesses, and valuation witnesses in particular, win if they honestly and factually assert their valuation opinions. Believe in the truth of your valuation analysis and value conclusions and demonstrate to the trier of facts that you a fundamental (almost religious) conviction in the truth of your value conclusions. Never trust memory and/or guess the answer to a question, either in direct examination or in cross-examination. When necessary, it is always appropriate to answer a factual question, to refer to a specic document to refresh your recollection about a document, a work paper, data source, or any other matter, or when being examined in a deposition, take all of the time needed to read all documents asked about. However, when it is the truthful answer, the valuation analyst should not hesitate to admit: I dont recall or to admit: I dont know. Do not feel compelled to agree with short quotes that are taken out of context. You may be confronted with short quotes from the subject valuation report, the opposing valuation analyst report, valuation professional organization course materials, learned valuation textbooks and treatises, and other sources. In addition, you should not feel compelled to readand should not allow the examining attorney to readonly partial quotes from the property valuation report, or a valuation treatise, or any other document. The valuation analyst should read the entire quote to him or herself and into the recordbefore answering the question being asked. In fact, it may be appropriate for the valuation analyst to read several paragraphsor even an entire pagebefore answering a question regarding a quotation. Never let them see you sweat. It is inappropriate for a valuation expert to argue
20
march 2009
Expert Testimony
...continued
during expert testimony, either with the examining attorneys or with the trier of fact. Remember, your role in the courtroom is to educateit is not the role of the valuation expert witness to litigate the dispute. That is the job of the trier of fact. It is usually inappropriate for a valuation expert witness to advocate for the position of the client, although it is entirely appropriate for the valuation expert witness to advocate for the truth of his or her value conclusion opinion. Admit mistakes and any omissions. Intellectually honest valuation experts can change their value opinions, based on new information. It is true that even the best valuation experts sometimes make mistakes. However, it is also true that the very best valuation experts admit their mistakes, correct their mistakes, and continue with their expert testimony. Acknowledge any material methodological or conceptual inconsistencies. If it is relevant to any apparent inconsistencies, it is appropriate for the expert witness to explain how the facts and circumstances are different than in previous litigated cases, previous valuation reports, and so forth. It is also appropriate to admit if your methodology, research, or opinions have changed over time. It is intellectually honest for the valuation analyst to admit, Ive changed my opinion on that issue. Remember: the thinking of most professionals (including valuation analysts) evolves over time. Note any inconsistencies in your analysis with (and departures from) the Uniform Standards of Professional Appraisal Practice (USPAP), other valuation profession standards, generally accepted valuation practices, authoritative valuation reference treatises, and so on. Of course, it is equally appropriate to explain why these analytical inconsistencies and departures are, in fact, appropriate under the facts and circumstances of the subject taxpayer valuation. Confront questions intended to imply that you do not have the appropriate experience or expertise thoughtfully. You may be asked the following type of voir dire
question: Are you an expert in the taxpayer industry? One appropriate answer to such a voir dire question may be: I am an expert in analyzing and valuing taxpayer corporations (or operating assets or properties) in the subject taxpayer industry. My testimony is based on my professional valuation experience and expertise and not on any operational experience in the taxpayer industry. Explain what procedures you performed and why those procedures were relevant. You should be condent when noting why the valuation procedures that were performed are adequate and appropriate under the circumstances. If you believe that you have performed a thorough and rigorous valuation analysis, then there is no need to be defensive about the subject valuation work. In addition, readily admit to: 1. 2. 3. 4. analytical procedures that were not performed, if any; management interviews that were not conducted, if any; taxpayer documents that were not reviewed, if any; and industry or economic research that was not completed, if any.
Do not be defensive about your experience or credentials. Rather, be proud of whatever experience and credentials you have. Of course, it is appropriate to admit forthrightly any deciencies in professional experience or valuation credentials. Likewise, it is equally appropriate for valuation analysts to stress all the positives about his or her professional experience and credentials. Never underestimate the importance of the redirect examination phase of expert testimony. The redirect examination period is the valuation experts opportunity (a) to expand on those areas of direct examination testimony that were questioned during cross-examination, (b) to clarify any confusion that may have occurred during the questions and answers in cross-examContinued to next page...
march 2009
21
Expert Testimony
ination, and (c) to complete any otherwise incomplete answers to questionssuch as answers that were cut off by the opposing counselduring the cross-examination. Come prepared to defend your valuation. A valuation expert witness sometimes encounters such typical cross-examination follow-up questions as: Where does it say that in your valuation report? or It doesnt say that in your valuation report, does it? These questions are intended to imply one or all of the following conclusions: the experts valuation report is inadequate or incomplete; you changed the value conclusion between the time the report was issued and the occasion of the analysts expert testimony; or some aspect of the valuation analyst testimony is inconsistent with what the analyst wrote in the valuation expert report. Your response to this type of cross-examination question may be: I endeavored to make my valuation report as comprehensive as possible. In my previous answer, I was simply expanding on the description (or the conclusion, or the data, or whatever is being questioned) presented in my valuation report. Do not answer multiple (or compound) questions, either during direct examination or during cross-examination. While none of these recommended procedures is an absolute rule, the experienced expert witness knows that multiple or compound questions tend to obfuscate the ofcial record of the judicial proceeding, confuse the trier of fact, and exacerbate confusion. When presented with a multiple or compound question, it is appropriate to state the problem with the question and to keep the record clear, politely ask the examining lawyer to rephrase the question into a simple sentence before providing an answer. Never attempt to sort out or answer vague, ambiguous, leading, or imprecise questions, during either direct examination, or cross-examination. Similarly, you should not answer (1) questions that you do not understand or (2) questions that include the incorrect or imprecise use of jargon. For the benet of the trier of fact,
clearly and concisely state the problem with the question and politely ask the examining lawyer to rephrase the question before providing an answer. Remember the audience for your testimony. The valuation expert witness may want to talk directly to the judge (or to the jury). If the layout of the courtroom permits, the valuation analyst may want to turn to face the judge (or the jury) when answering questions. The evaluation analyst should remember that the experts job is to educate, enlighten, and convince the trier of fact. It has been said that the role of a testifying valuation expert is somewhere between that of a professor and that of a preacher. Answer all questions completely. This procedure may not be as easy as it sounds. Sometimes, examining lawyers will cut off an experts answers, either deliberately or unintentionally. For the benet of the trier of fact, do not allow your answers to be cut off. If the examining lawyer cuts the witness off with Youve answered the question, the witness may respond to the trier of fact, No, I have not completely answered the question. When necessary, you may directly address the trier of fact with a statement such as: I didnt answer the last question completely and I would like to ensure that the record is complete in that regard. You may encounter a lawyer who admonishes: Answer this question with a yes or no. For the benet of the trier of fact and to ensure the completeness of the record, an appropriate response may be: A yes or no answer would not completely answer that question and may be misleading to the court.
For more information: The Guide to Property Tax Valuation by Robert F. Reilly and Robert P. Schweihs outlines presents practical advice to solve specic ad valorem tax valuation problems. This book explores (and, when possible, resolves) the practical ad valorem tax issues facing corporate taxpayers, valuation analysts, state and local tax lawyers, and state and local tax administrators. This book summarizes the consensus of the current thinking of ad valorem tax valuation practitioner. To order, visit www.bvresources.com/ PropertyTax or call 888-BUS-VALU. Cost: $59.95
22
march 2009
BVR audio & live conferences

To register for any of our conferences, or for more information, visit our website at BVResources.com/conferences (teleconferences), BVResources.com/training (live events) or call (503) 291-7963. March 5, 2009, 10:30am - 12:10pm PDT Lost Prot Damages: Lessons Learned from Motions to Exclude Financial Experts Featuring: Nancy Fannon and Jonathan Dunitz March 26-27, 2009, Miami Beach, FL Deauville Beach Resort Applying the Guideline Public Company Method Featuring: Rob Schlegel, ASA, MCBA April 2, 2009, 10:00am - 11:40am PDT Valuing Professional Practices Featuring: Kevin Yeanoplos April 30, 2009, 10:00am - 11:40am PDT Developing Capitalization and Discount Rates Featuring: Ron Seigneur & Don DeGrazia May 18 19, 2009, New York, NY New York Marriott Marquis Times Square 11th Annual FAE/BVR Business Valuation Conference Featuring: Aswath Damadoran, Jim Hitchner, Mel Abraham, Darrell Doyle, Ashok Abbott, and Vincent Love =Telephone Conference =Live Event =Webinar
Calendar
New New item added or changed this issue April 26 29 CFA Institutes Annual Conference Orlando, FLDisneys Contemporary Resort (434) 951-5500 www.cfainstitute.org May 6 7, 2009 ESOP Associations 32nd Annual Conference Washington, DCRenaissance Washington Hotel (202) 293-2971 www.esopassociation.org May 12 14 ACG InterGrowth Conference Las Vegas, NV (877) 358-2220 www.acg.org May 27 30 NACVAs 2009 16th Annual Consultants Conference Boston, MAThe Westin Boston Waterfront (800) 677-2009 www.nacva.com May 27 30 IBAs 2009 Business Valuation Conference Boston, MAThe Westin Boston Waterfront (954) 584-1144 www.go-iba.org
June 7 13 IBBA Conference for Professional Development Atlanta, GA (888) 686-4222 www.ibba.org June 18 19 CICBV Eastern Regional Conference Niagara Falls, Ontario (416) 204-3461 July 12 15 ASA International Appraisal Conference Orlando, FLRenaissance Orlando Resort at SeaWorld (703) 478-2228 www.appraisers.org October 1 - 2 CICBV Western Regional Conference Kelowna, British Columbia (416) 204-3461 www.cicbv.ca October 19 21 ASA Advanced BV Conference Boston, MAMarriott Copley Place (800) 272-8258 www.appraisers.org November 14 20 IBBA Conference for Professional Development Reno, NV (888) 686-4222 www.ibba.org
November 15 17 AICPA National Business Valuation Conference San Francisco, CAMarriott San Francisco (888) 777-7077 www.aicpa.org 2010 May 4 7 ACG InterGrowth Conference Miami Beach, FL (877) 358-2220 www.acg.org July 25 29 ASA International Appraisal Conference Las Vegas, NVJW Marriott Las Vegas Resort & Spa (703) 478-2228 www.appraisers.org 2011 August 14 17 ASA International Appraisal Conference Washington, DCJW Marriott Hotel Pennsylvania Avenue (703) 478-2228 www.appraisers.org
For an all-inclusive list of valuation-related Seminars and Conferences, BV Education classes and credentialing programsplus BVR Conferences, go to BVResources.com, and click on the Calendar menu.
march 2009
23
COST OF CAPITAL
Treasury yields1 30-day: 0.24% 5-year: 1.82% 20-year: 3.94% Duff & Phelps 2008 Premiums Over Long-Term Risk-free Rate 2 Historical Equity Risk Premiums: Averages Since 1963 Data for Year Ending December 31, 2007 Measure Used for Size 3 1st 13th 25th 5-Year Average EBITDA 4.5% 9.0% 12.7% 5-Year Average Net Income 4.1% 8.9% 13.0% Sales 5.6% 9.1% 12.0% Total Assets 4.5% 8.8% 12.4% IBBOTSONS 2008 Arithmetic mean equity risk premium4 Historical equity risk premium (S&P 500) for 30-day horizon, 1926-2007 8.48% Historical equity risk premium (S&P 500) for 5-year horizon, 1926-2007 7.51% Historical equity risk premium (S&P 500) for 20-year horizon, 1926-2007 7.05% Micro-cap size premium (S&P 500), 1926-2007 3.65% 10th decile size premium (S&P 500), 1926-2007 5.82% Supply side equity risk premium (S&P 500) for 20-year horizon, 1926-2007 6.23%5 Prime lending rate:1 Dow Jones 20-bond yield:1 Barrons intermediate-grade bonds:1 3.25% 6.45% 12.48%
High yield estimate:1 Mean 51.04% Median 13.60% Dow Jones Industrials P/E ratios:1 On current earnings: On 08 operating earnings est.: On 09 operating earnings est.: Long-term ination estimate:6 Long-term rate of growth GDP:6
1 2
19.59 14.60 16.50 2.50% 2.60%
Barrons, Febraury 9, 2009. Source: Risk Premium Report 2008 Duff & Phelps LLC. All rights reserved. Report includes premiums where size is measured by market value of equity, market value of invested capital, book value of equity, and number of employees. We highly recommend that analysts using Duff & Phelps data for cost of capital have the current years Report and thoroughly understand the derivation of the numbers used. Complete current and historical Duff & Phelps cost of capital data available at BVResources.com. Each measure for size is organized by Duff & Phelps, LLC into 25 portfolio ranks, with portfolio rank 1 being the largest and portfolio rank 25 being the smallest. Smoothed average premiums are presented here because they are considered a better indicator than the actual historical observation for most of the portfolio groups. Source: 2008 Ibbotson Stocks, Bonds, Bills and Ination (SBBI) Valuation Yearbook, 2008 Morningstar. All Rights Reserved. Used with permission. We highly recommend the use of SBBI valuation data for cost of capital and related fundamental analysis work. Copies of the Yearbook may be acquired directly from Morningstar. While Morningstar makes every effort to provide high quality data, Morningstar does not guarantee the accuracy, timeliness or completeness of these data. Represents the historical equity risk premium adjusted downward to remove historical price to earnings growth. 10-year forecast; Federal Reserve Bank of Philadelphia, Livingston Survey, December 9, 2008.
BVR
DISCOUNT METRICS
ABBOTT LIQUIDITY FACTOR The Discount for Lack of Liquidity (DLOL) database compiled by Dr. Ashok Abbott, from which the Abbott Liquidity Factor is derived, provides the rst complete tool for quantifying discounts for lack of liquidity specic to size of the block and the valuation period. It is based on directly observable, publicly available data. The reported results are representative of the small rm, publicly traded stock pool with an average market capitalization between $14 and $21 million during 2006-2007. The data represent the mean DLOL for the last month of the quarter and ignore SEC Rule 144 restrictions. If you are interested in using Abbott Liquidity Factor consulting services for a specic DLOL assignment, please contact Linda Mendenhall at lindam@bvresources.com.
What Its Worth Business Valuation Resources, LLC 1000 SW Broadway, Suite 1200 Portland, OR, 97205-3035
Discount for Lack of Liquidity 2006 Block size 10% 20% Q2 18.83% 22.86% Q4 12.59% 15.74% Q2 14.63% 19.79% 2007 Q4 19.69% 25.83%
The information contained in this Liquidity Factor is current as of December 31, 2007, and subject to change without notice. Ashok Abbott and BVR are not responsible for any damages, direct or indirect, caused by any error or omission in this Liquidity Factor.
24
march 2009

BVR Update 200903

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

BVR Update 200903

Uploaded by

Copyright:

Available Formats

B V

What Its Worth

Timely news, analysis, and resources for defensible valuations

Vol. 15, No. 3, March 2009

INSIDE THIS ISSUE

BUSINESS VALUATION UPDATE

Editorial Advisory Board

NANCY J. FANNON, ASA, CPA/ABV, MCBA

JAMES S. RIGBY, ASA, CPA/ABV

JAY E. FISHMAN, FASA, CBA

RONALD L. SEIGNEUR, MBA CPA/ABV CVA

LYNNE Z. GOLD-BIKIN, Esq.

BRUCE SILVERSTEIN, Esq. JEFFREY S. TARBELL, ASA, CFA

LANCE S. HALL, ASA

HOULIHAN LOKEYSan Francisco, Calif.

JAMES R. HITCHNER, CPA/ABV, ASA

JARED KAPLAN, Esq.

Trugman Valuation Associates, Inc.Plantation, FL

GILBERT E. MATTHEWS, CFA

Brueggeman & Johnson Yeanoplos, P.C.Tucson, AZ

Business Valuation Update

The Pomeroy Bill

Business Valuation Update

The Pomeroy Bill

Guideline Public Company Method

Business Valuation Update

Guideline Public Company Method

Business Valuation Update

Guideline Public Company Method

Business Valuation Update

Business Valuation Update

Business Valuation Update

Business Valuation Update

Why Total Beta Trumps all Other Betas

Business Valuation Update

LEGAL & COURT CASE UPDATE

Business Valuation Update

Business Valuation Update

Denied Pre-IPO Shares

Business Valuation Update

Business Valuation Update

Business Valuation Update

Keeping Market Share Reconstruction

Business Valuation Update

Conservative Growth Estimates

Business Valuation Update

Courts Void Non-Compete

Business Valuation Update

Business Valuation Update

DATA & PUBLICATION UPDATE

Business Valuation Update

Business Valuation Update

Business Valuation Update

BVR audio & live conferences

Business Valuation Update

19.59 14.60 16.50 2.50% 2.60%

Business Valuation Update

You might also like