subsequent events in business valuation

“Valuation and Financial Forensics – Educate, Communicate, Preserve”

“Valuation and Financial Forensics – Educate, Communicate, Preserve”

NACVA and IBA’s Annual Consultants’ ConferenceNACVA and IBA’s Annual Consultants’ Conference

Subsequent EventsSubsequent Events

Academic Track

and

Z. Christopher Mercer, ASA, CFA present

Academic Track

and

Z. Christopher Mercer, ASA, CFA present

May 27-30, 2009Boston, MA

May 27-30, 2009Boston, MA

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Please complete and hand in the Presenter Please complete and hand in the Presenter EvaluationEvaluation forms. forms.

Don’t forget to complete your CPE Don’t forget to complete your CPE Attestation Form.Attestation Form. Add your NACVA# (located Add your NACVA# (located on your name badge) and sign it. Keep the on your name badge) and sign it. Keep the white copy for your records. Turn in the yellow white copy for your records. Turn in the yellow copy at the NACVA Registration Desk.copy at the NACVA Registration Desk.

Please set pagers, cell phones, etc. on Please set pagers, cell phones, etc. on vibrate modevibrate mode or turn them off. or turn them off.

Please complete and hand in the Presenter Please complete and hand in the Presenter EvaluationEvaluation forms. forms.

Don’t forget to complete your CPE Don’t forget to complete your CPE Attestation Form.Attestation Form. Add your NACVA# (located Add your NACVA# (located on your name badge) and sign it. Keep the on your name badge) and sign it. Keep the white copy for your records. Turn in the yellow white copy for your records. Turn in the yellow copy at the NACVA Registration Desk.copy at the NACVA Registration Desk.

Subsequent EventsSubsequent Events

Z. Christopher Mercer, ASA, CFA

2009 NACVA and IBA’s Annual Consultants’ Conference“Valuation and Financial Forensics – Educate, Communicate, Preserve”

4

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>


5

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)


6

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


7

Valuation Date Perspective

Valuation DateTimeline

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


8

Valuation Date Perspective

Investment Date(Funds are committed)Timeline





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 upPrice will go down

Price will stay about the same


9

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


10

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


11

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


12

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>


13

Future EventsFrom 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


14


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


15


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


16

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>


17

Uncertainty

1 : the quality or state of being uncertain : doubt

2 : something that is uncertain


18


Valuation DateTimeline





Company outlook

Unexpected events???

Possible events???

Reasonably foreseeable???


19

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


20

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


21

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


22

Historical Appraisals

HistoricalValuation Date

TimelineCompany history

Industry conditionPublic market

conditions Management team

Economic conditions Competitive situation

Company situation Company outlook

Unexpected events???

Possible events???

Reasonably foreseeable???

ReportDate


23

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


24

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


25

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


26


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


27


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


28

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


29

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)


30

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


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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 "date of valuation" or "effective date" 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 "date of valuation", but known as of the appraisal's "report" 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


32

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


33

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


34

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


35

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?


36

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


37

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


38

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


39

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


40

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)


41

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


42

Valuation Texts Pratt/Niculita, Valuing a Business, 5th 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


43

Valuation Texts Pratt/Niculita, Valuing a Business, 5th 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


44

Valuation Texts

Trugman, Understanding Business Valuation, 3rd 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!


45

Valuation Texts

Trugman, Understanding Business Valuation, 3rd 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


46

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


47

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


48

Ithaca Trust v. United States279 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


49

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)


50

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>


51

Per Laro & Pratt, subsequent events should not be taken into account unless at least one of the following is true:

1. 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

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


52


2. 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?

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?


53


3. 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?

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?


54


4. 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?

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?


55


5. 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?

Applying the hypothetical willing buyer/willing seller tests, how can

something that happens after a valuation date “affect value” as of an

earlier date?


56

Subsequent Events per Laro/Pratt

IIWIBISISIt Is What It Is Because I Say It Is!

Fair Market Value?


57

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


58

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?


59


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


60


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


61


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


62

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


63

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


64

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%


65

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)


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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


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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


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Noble – Appraisals

$ MillionsMercer Capital Shenahon Difference

Marketable Minority Value ($mm) $12.70 $13.50 6.3%Marketabilitly Discount 43% 30% -30.2%Nonmarketable Minority Value ($mm) $7.25 $9.48 30.8%Per Share (1,000 shares) $7,251 $9,483Value of Estate's 116 Shares $841,113 $1,100,000 $258,887Date Prepared 31-Mar-04 14-Jun-01

Updated 2004Knowledge of Subsequent Event? Yes YesConsidered in Valuation No No

Cued up for Court to examine Marketability Discount?


69

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


70

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


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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


72

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


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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

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Please remember to turn in your Please remember to turn in your evaluation forms.evaluation forms.

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subsequent events in business valuation

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