Subsequent Events in Business Valuation
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Subsequent Events in Business Valuation

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Presentation on things that happen AFTER the valuation date. This is a thorny issue for appraisers and courts.

Presentation on things that happen AFTER the valuation date. This is a thorny issue for appraisers and courts.

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Subsequent Events in Business Valuation  Subsequent Events in Business Valuation Presentation Transcript

  • “ Valuation and Financial Forensics – Educate, Communicate, Preserve” NACVA and IBA’s Annual Consultants’ Conference Subsequent Events Academic Track and Z. Christopher Mercer, ASA, CFA present May 27-30, 2009 Boston, MA
    • Please set pagers, cell phones, etc. on vibrate mode or turn them off.
    • Please complete and hand in the Presenter Evaluation forms.
    • Don’t forget to complete your CPE Attestation Form. Add your NACVA# (located on your name badge) and sign it. Keep the white copy for your records. Turn in the yellow copy at the NACVA Registration Desk.
  • Subsequent Events Z. Christopher Mercer, ASA, CFA
  • Definitions
    • Subsequent
      • : following in time, order, or place < subsequent events> <a subsequent clause in the treaty>
    • Event
      • : something that happens : occurrence
    • Occurrence
      • 1 : something that occurs <a startling occurrence >
      • 2 : the action or instance of occurring <the repeated occurrence of petty theft in the locker room>
  • Subsequent Event
    • Subsequent event
      • Something that happens following in time after a particular date
    • Valuation date
      • The specific point in time as of which the valuator’s opinion of value applies – also referred to as “Effective Date” or “Appraisal Date” or “as of” date ( ASA Business Valuation Standards, Glossary)
  • Subsequent Events
    • Subsequent events are … any events that occur after the valuation date…
    • Bottom line
      • Relative to any valuation date, a subsequent event has not happened yet
  • Valuation Date Perspective Valuation Date Timeline Company history Industry condition Public market conditions Management team Economic conditions Competitive situation Company situation Company outlook The past is the window through which we view the uncertain future – Your Speaker Valuation is a prophecy – RR 59-60, Judge David Laro The future is hard to predict. It hasn’t happened yet – Yogi Berra
  • Valuation Date Perspective Investment Date (Funds are committed) Timeline Company history Industry condition Public market conditions Management team Economic conditions Competitive situation Company situation Company outlook Regardless of what happens after the investment, the investor gets the results that the market provides What will be the investment result? Price will go up Price will go down Price will stay about the same
  • Revenue Ruling 59-60
    • Valuation of securities is, in essence, a prophesy as to the future and must be based on facts available at the required date of the appraisal .
      • Clear recognition of the veil hiding the future after the valuation date
  • Definitions
    • Prophesy
      • 1 : to utter by or as if by divine inspiration
      • 2 : to predict with assurance or on the basis of mystic knowledge
    • Predict
      • to declare or indicate in advance ; especially : foretell on the basis of observation, experience, or scientific reason
  • Fair Market Value
    • Hypothetical transaction between
      • Hypothetical willing buyer(s)
      • Hypothetical willing seller(s)
      • Both are fully (reasonably) informed about the investment
      • Neither is acting under any compulsion
      • Both have the (financial) capacity to engage in a transaction
      • Engage in a hypothetical transaction
      • On a specific date
    This is the standard of value in all gift and estate tax matters as well as many other matters
  • Future
    • 1 : that is to be ; specifically : existing after death
    • 2 : of, relating to, or constituting a verb tense expressive of time yet to come
    • 3 : existing or occurring at a later time <met his future wife>
  • Future Events From the Perspective of a Valuation Date
    • Unexpected events
      • Market crashes or surges
      • Unexpected failure of a competitor
      • Unexpected loss of a key supplier or manager
      • Terrorist actions (September 11, 2001)
      • Unexpected regulatory changes
      • Natural disasters
    Unexpected events can change value relative to that which existed at a given valuation date
  • Future Events From the Perspective of a Valuation Date
    • Possible events
      • Reflecting risks of an enterprise
        • Customer concentrations
        • Product concentrations
        • Management concentrations
      • Reflecting risks related to future actions of a company’s management or directorate
        • Changes in dividend or distribution policies
        • Recapitalizations
        • Stock repurchases
        • Engaging in IPO
        • Offering company for sale
  • Future Events From the Perspective of a Valuation Date
    • Reasonably foreseeable events
      • At the valuation date
        • Losses due to concentrations?
          • Not usually considered reasonably foreseeable
        • Change in dividend or distribution policy?
          • Perhaps, in particular circumstances
        • Expectations of recapitalizations or stock repurchases
          • Perhaps, in particular circumstances
    No one, particularly the appraiser, knows when a “reasonably foreseeable” event might occur
  • Uncertain
    • 1 : indefinite, indeterminate <the time of departure is uncertain >
    • 2 : not certain to occur : problematical <his success was uncertain >
    • 3 : not reliable : untrustworthy <an uncertain ally>
    • 4 a : not known beyond doubt : dubious <an uncertain claim> b : not having certain knowledge : doubtful <remains uncertain about her plans> c : not clearly identified or defined <a fire of uncertain origin>
    • 5 : not constant : variable, fitful <an uncertain breeze>
  • Uncertainty
    • 1 : the quality or state of being uncertain : doubt
    • 2 : something that is uncertain
  • Future Events From the Perspective of a Valuation Date Valuation Date Timeline Company history Industry condition Public market conditions Management team Economic conditions Competitive situation Company situation Company outlook Unexpected events??? Possible events??? Reasonably foreseeable???
  • Reasonably Foreseeable (at a Valuation Date)
    • Enterprise level
      • Many concentration risks are binary
        • Risk condition exists or else it is triggered
        • Triggering of risk impacts cash flows
      • Concentration risks usually considered in the discount rate (or multiple selection) as opposed to the expected cash flows
    Appraiser must reach conclusions in face of uncertainty
  • Reasonably Foreseeable (at a Valuation Date)
    • Shareholder level
      • Usually relate to sales of enterprises ( Estate of Jung) or stock buy-backs ( Estate of Noble)
      • Valuation impact of future events considered
        • Estimate future price(s) at which liquidity may occur
        • Estimate the risk associated with a particular event happening (or not) among other possible events
        • Estimate when over a range of possible holding periods the liquidity event might occur
        • Consider valuation impact through possibilities and probabilities across a range of potential future time periods
    Appraiser must reach conclusions in face of uncertainty
  • Two Kinds of Appraisals
    • Current appraisals
      • Contemporaneous with valuation date
      • The future has not yet happened
      • The appraiser must consider the unknown future through the filter of possibilities and probabilities
    • Historical appraisals
      • After or long after a given valuation date
  • Historical Appraisals Historical Valuation Date Timeline Company history Industry condition Public market conditions Management team Economic conditions Competitive situation Company situation Company outlook Unexpected events??? Possible events??? Reasonably foreseeable??? Report Date
  • Historical Appraisals
    • Rendered at a current date but as of a date in the past
    • Uses information “available as of the valuation date”
    • Appraiser must attempt to place self in position of another appraiser (or investor) who would be valuing concurrent with the valuation date
  • Known or Reasonably Knowable
    • Known information
      • Fairly obvious – known at the valuation date
    • Reasonably knowable
      • A more difficult standard
    • What can be “reasonably knowable” at a valuation date?
      • Potential for new business based on contract that is close to being signed
      • Potential for a sale – but when is not knowable
      • Potential for stock repurchases – but when is not knowable
  • Reasonable Knowledge
    • Fair market value
      • Both parties assumed to have reasonable knowledge of the relevant facts
      • Both parties assumed to be “fully informed”
      • Both parties have similar negotiating abilities
      • Reasonable knowledge is from the perspective of the valuation date
  • Reasonable Knowledge
    • Real life transactions based on facts and circumstances known up to the minute of their closings
      • Consider reasonable outlooks for the future
    • Reasonable knowledge does not mean having a crystal ball that predicts the future with certainty
    • Reasonable knowledge is attained in the face of uncertainty regarding the future
  • Reasonable Knowledge
    • The fact that an event might occur in the future is often known at a valuation date
      • What not known is when or with what probability event might occur
    • Appraisers assess probabilities and incorporate risks and potential benefits, as appropriate, in appraisals
      • That’s what real life investors do
  • Investments and Uncertainty
    • All investments are made in the face of uncertainty
    • Fact that some uncertainties are resolved after a valuation or investment date does not change their existence or reality at that date
  • Reasonably Foreseeable
    • Reasonably foreseeable events are just that, reasonably foreseeable
      • Not known
    • From perspective of a valuation date, many things may be reasonably foreseeable
      • Range of future events
      • Any of which are, in greater or lesser degree, reasonably foreseeable
    • Hypothetical investors must consider the range of possibilities and reach their decisions
      • Hypothetical transaction (defined by the appraiser) is the result
      • Transaction occurs on the valuation date
      • Settled in money or money’s worth (i.e., cash)
  • Business Valuation Standards and the Future
    • Institute of Business Appraisers
      • Business Valuation Standards
    • NACVA
      • NACVA Professional Standards
    • The Appraisal Foundation
      • Uniform Standards of Professional Appraisal Practice (“USPAP”)
    • American Society of Appraisers
      • ASA Business Valuation Standards
    • AICPA
      • Statement on Standards for Valuation Services No. 1
  • Institute of Business Appraisers
    • 1.20 Eligibility of Data. An appraisal shall be based upon what a reasonably informed person would have knowledge of as of a certain date.
    • This shall be known as the appraisal's &quot;date of valuation&quot; or &quot;effective date&quot; and accordingly reflect the appraiser's supportable conclusion as of that date.
    • Information unavailable or unknown on the date of valuation must not influence the appraiser or contribute to the concluding opinion of value.
    • a. Imminent Change. The appraiser is sometimes faced with the knowledge of a material imminent change in the business; a change not known of on the &quot;date of valuation&quot;, but known as of the appraisal's &quot;report&quot; date.
    • In such an event, the imminent change (positive or negative) should not affect the valuation conclusion , unless a reasonably informed person could have anticipated the imminent change. However, it is not uncommon for an appraiser to disclose such a change within the narrative portion of the report.
    • b. Data on Guideline Companies.
      • Suggests using data available at valuation date
  • NACVA
    • Clearly distinguishes between “report date” and “valuation date”
    • Provides definition of valuation date from International Glossary of Business Valuation Terms
    • Inference is that information is based on that available at the valuation date, but this is not explicit
  • USPAP
    • Standard 3: Appraisal Review, Development and Reporting
      • SR 3-1(c) Comment
        • The appraisal review must be conducted in the context of market conditions as of the effective date of the opinion in the work being reviewed. Information available to the reviewer that could not have been available to the appraiser as of or subsequent to the date of the work being reviewed must not be used by a reviewer in the development of an opinion as to the quality of the work under review
  • USPAP
    • Standard 9: Business Appraisal, Development
      • SR 9-2(d)
        • In developing an appraisal of an interest in a business enterprise or intangible asset, an appraiser must identify the effective date of the appraisal
  • USPAP
    • SR 9-4
      • In developing an appraisal of an interest in a business enterprise or intangible asset, an appraiser must collect and analyze all information necessary for credible assignment results
      • Implication – for current appraisals this would only include information that would be available at that time
        • Would/could a different standard apply at a later time for an historical or retrospective appraisal?
  • USPAP
    • SR 10-2(a)(vii)
      • The content of an Appraisal Report must be consistent with the intended use of the appraisal and, at a minimum
        • State the effective date of the appraisal and the date of the report
      • Comment
        • The effective date of the appraisal establishes the context for the value opinion , while the date of the report indicates whether the perspective of the appraiser on the market or property as of the effective date of the appraisal was prospective, current, or retrospective
  • USPAP
    • Statement on Appraisal Standards No. 2 (SMT-2), Discounted Cash Flow Analysis, Real Property
      • To avoid misuse or misunderstanding when DCF analysis is used in an appraisal assignment to develop an opinion of market value,
      • it is the responsibility of the appraiser to ensure that the controlling input is consistent with market evidence and prevailing market attitudes .
      • Market value DCF analyses should be supported by market derived data, and the assumptions should be both market and property specific.
      • Market value DCF analyses, along with available factual data, are intended to reflect the expectations and perceptions of market participants . They should be judged on the support for the forecasts that existed when made, not on whether specific items in the forecasts are realized at a later date.
      • An appraisal report that includes the results of DCF analysis must clearly state the assumptions on which the analysis is based and must set forth the relevant data used in the analysis.
    Difficult to follow this guidance using post-valuation date information
  • USPAP
    • Statement on Appraisal Standards No. 3 (SMT-3), Retrospective Value Opinions, Real Property, Personal Property
      • A retrospective appraisal is complicated by the fact that the appraiser already knows what occurred in the market after the effective date of the appraisal
      • Data subsequent to the effective date may be considered in developing a retrospective value as a confirmation of trends that would reasonably be considered by a buyer or seller as of that date
      • The appraiser should determine a logical cut-off because at some point distant from the effective date, the subsequent data will not reflect the relevant market. This is a difficult determination to make
      • Studying the market conditions as of the date of the appraisal assists the appraiser in judging where he or she should make this cut-off. In the absence of evidence in the market that data subsequent to the effective date were consistent with and confirmed market expectations as of the effective date, the effective date should be used as the cut-off date for data considered by the appraiser
      • Use of direct excerpts from then-current appraisal reports prepared at the time of the retrospective effective date helps the appraiser and the reader understand market conditions as of the retrospective effective date
    A little “loose” but it is clear that the preferable vantage point is that of the effective date of the retrospective appraisal
  • American Society of Appraisers
    • ASA Business Valuation Standards, General Preamble, Para. II
      • The American Society of Appraisers, in its Principles of Appraisal Practice and Code of Ethics, and The Appraisal Foundation, in its Uniform Standards of Professional Appraisal Practice (“USPAP”) have established authoritative principles and a code of professional ethics. These Standards incorporate the Principles of Appraisal Practice and Code of Ethics and the relevant portions of USPAP , either explicitly or by reference, and are designed to clarify them and provide additional requirements specifically applicable to the valuation of businesses, business ownership interests, securities and intangible assets
  • American Society of Appraisers
    • ASA Business Valuation Standards, BVS VI, Reaching a Conclusion of Value, Para. II.A.
      • The conclusion of value reached by the appraiser shall be based upon the applicable standard of value, the purpose and intended use of the valuation, and all relevant information available as of the valuation date in carrying out the type of engagement for the assignment
      • This general guidance considered adequate to ground all the standards to information available as of the valuation date (known or reasonably knowable)
  • AICPA
    • Statement on Standards for Valuation Services No. 1, Subsequent Events
      • 43. The valuation date is the specific date at which the valuation analyst estimates the value of the subject interest and concludes on his or her estimation of value. Generally, the valuation analyst should consider only circumstances existing at the valuation date and events occurring up to the valuation date
      • An event that could affect the value may occur subsequent to the valuation date; such an occurrence is referred to as a subsequent event . Subsequent events are indicative of conditions that were not known or knowable at the valuation date, including conditions that arose subsequent to the valuation date. The valuation would not be updated to reflect those events or conditions
      • Moreover, the valuation report would typically not include a discussion of those events or conditions because a valuation is performed as of a point in time—the valuation date—and the events described in this subparagraph, occurring subsequent to that date, are not relevant to the value determined as of that date. In situations in which a valuation is meaningful to the intended user beyond the valuation date, the events may be of such nature and significance as to warrant disclosure (at the option of the valuation analyst) in a separate section of the report in order to keep users informed (paragraphs 52(p), 71(r), and 74). Such disclosure should clearly indicate that information regarding the events is provided for informational purposes only and does not affect the determination of value as of the specified valuation date
  • Valuation Texts
    • Pratt/Niculita, Valuing a Business, 5 th Edition (pp. 39-40)
      • The date, or dates, on which the business is being valued is critically important because circumstances can cause values to vary materially from one date to another, and the valuation date directly influences data available for the valuation . Every day, observers of the public stock markets see sudden and substantial changes in the value of a particular company’s stock. In many court cases, especially those involving tax litigation, significant changes in value over very short time spans have been justified because of changes in relevant circumstances
  • Valuation Texts
    • Pratt/Niculita, Valuing a Business, 5 th Edition (pp. 39-40) [cont.]
      • Many internal and external factors can cause changes in the value of an interest in a company. Obviously, a sudden change in a company’s earnings, especially if unanticipated, can have a substantial effect on value. Also, the value of a business interest varies with the cost of capital, a factor over which individual businesses have little control. Major events, such as the signing or termination of a major customer contract, can also have a dramatic, immediate impact on value
      • In most business valuation, the opinions of value will be based at least partly on other, similar transactions, such as the prices at which stocks in the same or a related industry are trading in the public markets relative to their earnings, assets, dividends or other relevant variables, if such data are available. It is important to know the valuation date when using guideline companies in the valuation so that the guideline transaction data can be compiled as of the valuation date, or as near to it as practically possible
  • Valuation Texts
    • Trugman, Understanding Business Valuation, 3 rd Edition (p. 80)
      • Effective Date(s) of the Valuation
        • Appraisals are similar to balance sheets in that they are as of a specific point in time. Both internal and external factors affect the value of a company, and therefore, the valuation date is a critical component of the appraisal process . Changing values are easily illustrated in the public stock market. The constant movement of the price of a share of stock illustrates the potential volatility of the value of the stock. Think about what happened to the stock market on September 11, 2001. What a difference a day makes!
  • Valuation Texts
    • Trugman, Understanding Business Valuation, 3 rd Edition (p. 602)
      • Subsequent Events
        • Although valuation, for the most part, is normally performed based on the events that were known or would have been knowable by the willing buyer and willing seller, there are many times that subsequent events can act as either your friend or your foe. The Tax Court has been known to look at transactions after the valuation date to test the reasonableness of what the valuation analyst has done. While I do not agree with the notion of playing Monday morning quarterback, sometimes it is necessary. For example, getting away from the pure standard of fair market value, sometimes the courts are concerned with doing what is fair and equitable . If a subsequent event will assist in that regard, the courts have taken advantage of the information.…
        • All I am saying is that in some circumstances, it may be appropriate to consider the subsequent event, and in other circumstances, while you may not choose to rely on it, you may want to present it to the court. Be prepared to discuss the factors that might have caused the subsequent event, like a transaction, to be more or less because of other factors that may have affected the subsequent price that was reached between the parties. Sometimes we just don’t know!
    In my opinion, Gary leaves too much wiggle room for comfort. I’m not willing to make valuation decisions based on what I think might be “fair and equitable” in the context of a fair market value determination
  • Valuation Texts
    • Fishman/Pratt/Morrison, Standards of Value: Theory and Applications , (pp. 62-63)
      • Postvaluation-Date Information and Subsequent Events
        • Since valuation is as of a particular point in time, practitioners are required to reach their conclusions based on information that is known or knowable (or reasonably foreseeable) at the valuation date. Typically, in a retrospective valuation, postvaluation-date information may be available. Subsequent events that were foreseeable at the valuation date may be considered in a valuation. However, if an event was completely unforeseen at the date of valuation, it is generally not considered. Although the practitioner might want this information to have been available at the valuation date, the possibility of occurrence is not the same as a recognizable probability, and it is important for the practitioner to use judgment in determining that information was truly knowable as of that time . A court may go to great lengths to determine what was known or knowable at the valuation date regarding information or factors affecting value
  • Other Texts
    • Laro/Pratt, Business Valuation and Taxes: Procedure, Law, and Perspective
      • The valuation date is important for determining fair market value. Fair market value requires that we value property at the price at which it would change hands between a willing buyer and seller, both having reasonable knowledge of relevant facts. To ascertain what facts the willing buyer/seller would know, we need to establish the valuation date as the focal point for determining the knowledge relevant to our valuation. Events subsequent to the valuation date, in most cases, are not known by the hypothetical buyer/seller and therefore are not relevant to the valuation
      • The Court of Federal Claims (in Grill v. U.S ) stated the rule this way:
        • [T]he valuation for income tax purposes must be made as of the relevant date without regard to events occurring subsequently
  • Ithaca Trust v. United States 279 U.S. 151 (1929)
    • The estate so far as may be is settled as of the date of the testator’s death. The tax is on the act of the testator not on the receipt of the property by the legatees…[T]he value of the thing to be taxed must be estimated as of the time when the act is done …[It] depends largely on more or less certain prophecies of the future; and the value is no less real at that time if later the prophecy turns out to be false than when it becomes true. Tempting as it is to correct uncertain probabilities by the now certain fact, we are of [the] opinion that it cannot be done , but that the value of the wife’s life interest must be estimated by the mortality tables
  • Other Texts
    • Laro/Pratt, Business Valuation and Taxes: Procedure, Law, and Perspective
      • According to Laro/Pratt, the seemingly “neat conclusion” in Ithaca Trust Co. is “undone by the word relevant .”
      • … the logic of permitting subsequent events to affect valuation is that they may be helpful and therefore relevant in proving that the hypothetical buyer/seller did reasonably foresee such events. In this manner, the later-occurring events are to be given consideration in the valuation. The weight to be given such evidence may, however, be negligible (p. 19)
  • Definition
    • Relevant
      • a : having significant and demonstrable bearing on the matter at hand
      • b : affording evidence tending to prove or disprove the matter at issue or under discussion < relevant testimony>
  • Per Laro & Pratt, subsequent events should not be taken into account unless at least one of the following is true:
    • The subsequent events were reasonably foreseeable at the valuation date
        • An event that is “reasonably foreseeable” at a valuation date is considerably different than one that has, subsequently, happened
        • “ Reasonably foreseeable” events as of a valuation date should be considered in terms of probabilities and possibilities – and not with the certainty, at a later date, that they have happened
  • Per Laro & Pratt, subsequent events should not be taken into account unless at least one of the following is true:
    • The subsequent events are relevant to the valuation, and appropriate adjustments are made for the differences between the valuation date and the date of such subsequent events
        • To consider a subsequent event in a current valuation and then to attempt to “adjust” for changes (like in previous slide) between valuation date and event is the height of folly and futility
        • The list does not include the riskiness of owning the business interest from the valuation date until the (then unknown) subsequent event occurs
        • There is no indication of just how long after a valuation date a subsequent event might be considered
        • Such an adjustment process effectively assumes that the valuation process will never be completed
        • What about the poor appraiser who was valuing at the valuation date and who had no idea when or if any subsequent event – whether “reasonably knowable” or not – might occur and developed his valuation accordingly?
  • Per Laro & Pratt, subsequent events should not be taken into account unless at least one of the following is true:
    • The subsequent events are not used to arrive at the valuation, but to confirm the valuation already concluded
        • This suggests it is okay to consider a subsequent event if it confirms a valuation conclusion
            • - What if it does not confirm the conclusion?
            • - What if there are multiple subsequent events? How are they to be considered?
            • - What if the considered subsequent event was actually predicated on another subsequent event happening prior to it?
  • Per Laro & Pratt, subsequent events should not be taken into account unless at least one of the following is true:
    • The subsequent events relate to property that is comparable to the property being valued, and the subsequent events are probative of value
        • Such subsequent events do not even relate to the subject property, but perhaps to a similar business that is “comparable”
        • Probative:
          • 1 : serving to test or try : exploratory
          • 2 : serving to prove : substantiating
        • If there were no events with “comparable” properties prior to the valuation date, how is it relevant to consider events after the valuation date?
  • Per Laro & Pratt, subsequent events should not be taken into account unless at least one of the following is true:
    • Subsequent events may be evidence of value rather than as something that affects value
        • Applying the hypothetical willing buyer/willing seller tests, how can something that happens after a valuation date “affect value” as of an earlier date?
  • Subsequent Events per Laro/Pratt
    • IIWIBISIS
    It Is What It Is Because I Say It Is! Fair Market Value?
  • Formula for “Time Adjustments”
    • Laro/Pratt, Business Valuation and Taxes: Procedure, Law, and Perspective
      • “ Starting point” formula for adjusting subsequent events:
        • + Inflation
        • +/- Industry changes, or in expectations regarding industry
        • +/- Societal changes (technology, macroeconomics, tax law)
        • +/- Actual occurrence (or lack thereof) of an event included (excluded) from original valuation, if relevant in time/type
        • +/- Occurrence of nonoccurrence of any other events or facts that an arm’s length buyer could have reasonably foreseen had she purchased the business in the year of valuation
        • = Adjusted valuation
  • Looking at the “Time Adjustment” Formula
    • Inflation
      • That is merely one portion of an investor’s required rate of return. What about the rest of the return and the reward for risk?
    • Industry changes (or changes in expectations)
      • It is difficult enough to ground an appraisal in the industry conditions as of a valuation date. Are appraisers responsible for continually updating every appraisal based on subsequent industry conditions?
    • Societal changes
      • This category includes the macroeconomy, technology and even tax law. Will the valuation ever end?
  • Looking at the “Time Adjustment” Formula
    • Actual occurrence of an event included in the original valuation, if relevant in time or type
      • Presumably the event was “reasonably foreseeable” at the valuation date; however the appraiser did not know whether or when it actually might occur
      • Does the actual occurrence of an event, subsequent to a valuation date, increase its probability of occurrence at the valuation date ? No
  • Looking at the “Time Adjustment” Formula
    • Occurrence of nonoccurrence of any other events or facts that an arm’s length buyer could have reasonably foreseen had she purchased the business in the year of valuation
      • This has little limit in terms of time and relates to “any other event or fact” that might be known by buyers and sellers acquiring the business “in the year of valuation”
      • So non-specific as to be inoperative
  • Looking at the “Time Adjustment” Formula
    • What is missing from the Laro/Pratt analysis?
      • Any consideration of the risk of ownership between valuation date and subsequent event
      • Any consideration of investor’s required return
      • Any consideration that the analysis applies a totally different standard appraisers valuing concurrent with the valuation date and a court (or appraisers, presumably) valuing long after a valuation date
      • “ Common sense, informed judgment and reasonableness” as required to be employed by appraisers in fair market value determinations by Revenue Ruling 59-60
  • Looking at the “Time Adjustment” Formula
    • Michael Paschall, “Back to the Future, Part II,” Business Valuation Review, Fall 2008
      • ...[F]urthermore, according to Laro and Pratt, only one of these conditions must be met for the subsequent event to enter. This is a circus tent so vast and expansive that nearly any subsequent can come in. In fact, my above analogy of doors through which a subsequent event may enter is not accurate. In reality, there are no doors to this tent, and subsequent events may enter at will and with virtually no opposition. In effect, the above “conditions” are really window-dressing. It would have the same effect for Laro and Pratt to state that any and all subsequent events are allowed
    Or, that the appraiser (or the court) can pick and choose from among the many subsequent events that surely have happened between the valuation date and a later report date
  • Estate of Noble
    • Subject of valuation
      • 11.6% of the common stock of Glenwood State Bank, Glenwood, Iowa
    • Valuation date
      • September 2, 1996, the date of death of Helen M. Noble
    • Standard of value
      • Fair market value
    • Level of value
      • Nonmarketable minority
  • Estate of Noble
    • Glenwood State Bank
      • Owned 88.4% by Glenwood Bancorporation, a one-bank holding company
      • Bancorporation was owned by Dean family
      • Bank in Mills County, a small rural county with limited growth potential
      • Bank heavily capitalized and a low earner
        • Average ROE about 5% for last five years
        • Average ROE for 84 similar sized banks in Iowa was 12%
      • Asset growth of less than 2% per year for last five years
        • Iowa peer group growing at 6%
  • Estate of Noble
    • No history of dividends in many years
      • Bancorporation had stated policy of no dividends
      • Iowa peer group paid 53% of earnings as dividends
      • Outlook for future dividends slim (as reported in a contemporaneous valuation report)
  • Estate of Noble
    • Recent Transactions
      • July 1996, 7 shares, $1,500 per share, 11% of book value
        • Seller was daughter of long-time shareholder
      • June 1995, 10 shares, $1,000 per share, 8% of book value
        • Seller was an unrelated bank director
      • Buyer in both transactions was Glenwood Bancorporation
  • Estate of Noble
    • The Subsequent Event focused on by Court
      • Estate sold its block of stock to Glenwood Bancorporation
      • October 24, 1997
      • Price was $9,483 per share, or $1.1 million
    Additional Facts – Estate sold block prior to filing of Form 706 – Estate filed Form 706 at $7,793 per share, or $903,982 for block
  • Noble – Appraisals Cued up for Court to examine Marketability Discount?
  • Noble – Court’s “Valuation”
    • Subsequent value was $1,100,000 at October 1997
    • Court discounted back one year (not 1.14 years to valuation date)
      • 3% inflation rate used
      • This rate not found in record
    • Court’s conclusion was $1,067,000 for block, or $9,276 per share
  • Noble – Court’s “Analysis” of Appraisals
    • Shenohon report was briefly described
    • Mercer Capital report was briefly described
    • Relative analysis of two reports
      • Marketable minority values – none
      • Marketability discounts – none
  • Business & Valuation Perspectives
    • Appraiser is determining fair market value as of a specific date using information available at that time (for estate) and gift is made
    • Example 1. One or two or three years later, a transaction occurs at a higher price
      • IRS argues transaction was “reasonably foreseeable” or probative or confirming of value at the valuation date
        • Argues for higher fair market value for estate and higher estate taxes
      • Taxpayer says, “we did everything we could have done at the time” and it isn’t “fair” to change fair market value for the estate
  • Business & Valuation Perspectives
    • Example 2. One or two or three years later a transaction occurs at a lower price
      • IRS argues that value should have been determined as of the date of death, so no adjustment is appropriate
      • Taxpayer, in reliance on Noble , says, in retrospect, the transaction was “reasonably foreseeable” and therefore indicative of value at the date of death
  • Conclusion
    • It is difficult to think of any standard other than “valuation as of the valuation date” that provides the following:
      • Symmetry
      • Fairness
      • Fair market value
        • For taxpayer
        • For IRS
    • Thank you for joining us.
    • Please remember to turn in your evaluation forms.
    • Plan to join us next year for our Seventeenth Annual Conference.