Current Topics in Valuation

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Current Topics in Valuation

  1. 1. Current Topics in Valuation <ul><li>Franz Fleischli, JD </li></ul><ul><li>Managing Director </li></ul><ul><li>The Mentor Group, Inc. </li></ul><ul><li>Direct – 707-473-4747 </li></ul><ul><li>Brad M. Cashion, CFA </li></ul><ul><li>Managing Director </li></ul><ul><li>The Mentor Group, Inc. </li></ul><ul><li>Direct - 760-898-3334 </li></ul><ul><li>February 12, 2008 </li></ul>
  2. 2. Agenda <ul><li>Discounts </li></ul><ul><li>IRC 409a </li></ul><ul><li>FAS 123(r) </li></ul><ul><li>FAS 141(r) </li></ul><ul><li>FAS 157 </li></ul><ul><li>Monte Carlo Simulation </li></ul>
  3. 3. Application of Discounts <ul><li>Benchmarking – using empirical market data for studies </li></ul><ul><li>Quantitative Methods </li></ul><ul><li>Guideline Transaction Methods </li></ul><ul><li>Discounts must be supported through qualitative and quantitative analysis </li></ul><ul><li>Discounts must be supported by a “sanity check” using an internal rate of return calculation </li></ul>
  4. 4. Discounts for Lack of Control <ul><li>Must match source of market data with the type of asset held by the entity </li></ul><ul><li>Closed End Funds – Must use specific CEFs that match type of assets owned </li></ul><ul><li>RELP – good for entities that own real estate </li></ul><ul><li>Income Method – Discounted cash flow and capitalization of earnings </li></ul>
  5. 5. Discounts for Lack of Marketability <ul><li>Benchmarking – using market studies and apply the “Mandelbaum factors” </li></ul><ul><li>Quantitative Methods </li></ul><ul><ul><li>Put Option Calculation </li></ul></ul><ul><ul><li>LEAPs </li></ul></ul><ul><ul><li>QMDM </li></ul></ul><ul><ul><li>Guideline Transactions – 2 step process </li></ul></ul>
  6. 6. Presumptive IRS Valuation Methods Under 409A <ul><li>Under a illiquid start up presumption: </li></ul><ul><li>Valuation must be evidenced by a written report </li></ul><ul><li>Performed by a qualified person </li></ul><ul><ul><li>Must have significant knowledge, experience, education & training </li></ul></ul><ul><ul><li>A reasonable person would rely on such a person’s advice in transacting in the stock. </li></ul></ul>
  7. 7. The AICPA Practice Aid – Valuation of Privately Held Equity securities Issued as Compensation <ul><li>Sets forth three “allocation methodologies” </li></ul><ul><li>Current Method </li></ul><ul><li>Option Pricing Method </li></ul><ul><li>Probability – Weighted Expected Return Method (“PWERM”) </li></ul><ul><li>These are not valuation methods, but rather allocation methods for computing the value of different classes of equity </li></ul>
  8. 8. Standard of Value and Purpose <ul><li>Tax Compliance – 409A FMV </li></ul><ul><li>Financial Reporting – 123R & 141 Fair Value </li></ul><ul><li>Typically discounts are applied under FMV and no discounts are applied under Fair value. </li></ul>
  9. 9. SFAS 123(R) Issues <ul><li>Financial Report – 157 Fair Value definition applies </li></ul><ul><li>Black-Scholes Model </li></ul><ul><li>Binomial Model </li></ul><ul><li>Volatility - How is this calculated? </li></ul>
  10. 10. SFAS 141 Issues <ul><li>Under SFAS 157 – definition of fair value: </li></ul><ul><li>“ Fair value is price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” </li></ul><ul><li>Fair Value is Market Based rather than Entity specific Based </li></ul><ul><li>Important Question: “How to handle synergies?” </li></ul>
  11. 11. SFAS 141 Issues <ul><li>Level of Inputs under SFAS 157 </li></ul><ul><li>Level 1 – Quoted prices in active markets for identical assets & liabilities (example: NYSE prices for identical equity or debt securities). </li></ul><ul><li>Level 2 – Quoted prices for similar assets or liabilities in active markets where factors affecting the price are observable (example: matrix pricing for loan instruments). </li></ul><ul><li>Level 3 – Unobservable inputs where a hypothetical market must be structured. (This is the level that most of our work is done) </li></ul>
  12. 12. SFAS 141(R) Changes <ul><li>Some of the Changes: </li></ul><ul><li>Assembled Workforce – should not be recognized as a separate intangible asset, but included in contributory asset charge. </li></ul><ul><li>IPR&D – Will not be written off immediately, but will be amortized once completed, or written down if impaired. </li></ul><ul><li>Acquisition Costs – Accounted for as expenses, not capitalized. </li></ul><ul><li>Contingent Consideration – Measured and recognized at fair value as of acquisition date. </li></ul>
  13. 13. Evolution of Valuation Models <ul><li>Use of Static Models – DCF, Single point valuation multiples </li></ul><ul><li>Use of Dynamic Models – Monte Carlo Simulation </li></ul><ul><li>Example of Monte Carlo Simulation </li></ul>

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