topics in valuation that nobody is talking about gscpa nacva
DESCRIPTION
My discussion of interesting valuation topics at the NACVA-GSCPA Atlanta Chapter meeting on August 21, 2012TRANSCRIPT
![Page 1: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/1.jpg)
Michael S. Blake, CFA, ASADirector of Valuation ServicesHabif, Arogeti & Wynne, [email protected]@unblakeablewww.unblakeable.com
Topics in Valuation that Nobody is Talking About – Predictions of Future
Hot Topics
![Page 2: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/2.jpg)
Disclaimer
The intent of this discussion is to provide guidance to non-appraisers to perform internal valuation analyses. Applying the concepts and data contained herein is in no way a substitute for an analysis performed by a qualified appraiser.
Use at your own risk. Legal counsel should be consulted before
doing anything whatsoever.
![Page 3: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/3.jpg)
Disclaimer #2
The opinions expressed in this presentation are my own and do not necessarily represent those of HA&W, NACVA, the GSCPA or the Government of Freedonia.
The intent of this speech is to provoke thought – not provide easy answers.
Disagreement leads to enlightenment.
![Page 4: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/4.jpg)
What Won’t Happen Here
Discussion of discounts and court cases Discussion of tax-affecting for S corporations Discussion of loss of US AAA Credit Rating Discussion of dueling BV standards Talk about Facebook
![Page 5: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/5.jpg)
WHAT HAPPENED TO THE MARKET APPROACH?
![Page 6: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/6.jpg)
The Disappearing Market
Every major set of BV standards requires consideration of market approach
ASC 820 implies consideration of market approach (Level 1/2 inputs)
Rev. Rul. 59-60 indicates consideration of market approach
![Page 7: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/7.jpg)
Kicked to the Curb?
Laziness Effort to conserve hours Poor training at the association level (ASA) Collective professional don’t-ask-don’t-tell Genuine disbelief in market data or
information
![Page 8: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/8.jpg)
The Market Approach is Important
Professional standards require it
Abandoning the market approach undermines credibility of other valuation techniques
Often the only piece of information that is interesting to the client
![Page 9: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/9.jpg)
SAS 73: WHAT DOES IT REALLY MEAN?
![Page 10: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/10.jpg)
What Reviewers Need to Do is Clear
Perform tests of the data Assess valuation
methodologies in terms of acceptability
Validate qualifications of the specialist
![Page 11: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/11.jpg)
Or is it…?
No FASB or AICPA guidance on how much review is enough
No clear best practices from industry leaders
No checklists Client experience varies
from auditor to auditor
![Page 12: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/12.jpg)
Our Take
Tie all assumptions to something verifiable Management representations viewed with
healthy skepticism Test probability-driven models with statistics,
simulations, option theory Replicate the valuation (do the math) Complete analyses in conformance with
professional standards
![Page 13: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/13.jpg)
Summary of PCAOB FV Comments
37/89 or 42% of criticisms of the Big 4 were related to fair value
Hard-to-Value securities seemed to generate most frequent criticism
Failure to challenge/support projections figured prominently
Overreliance on third parties Too much “black box”
![Page 14: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/14.jpg)
HOW THE FED IS MESSING WITH THE M&A MARKET
![Page 15: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/15.jpg)
The Fed Punishes Savers
2008-08
2008-11
2009-02
2009-05
2009-08
2009-11
2010-02
2010-05
2010-08
2010-11
2011-02
2011-05
2011-08
2011-11
2012-02
2012-050.00.51.01.52.02.53.03.54.04.55.0
20-year Treasury Yield (%)
![Page 16: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/16.jpg)
Selling a Business Turns you into a Saver
Your income goes from active to passive
Your available risk-free return to replace income is cut in half
Usually prevented from going into same business
![Page 17: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/17.jpg)
Where Fair Value Meets Alternate Reality
Fair Value – Buyer and Seller Agree
Investment Value – Seller – Low return on funds received.
Investment Value – Buyer – Low return on funds invested
Bid-ask spread
![Page 18: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/18.jpg)
Do Owners Have to Sell?
Myth Aging owners must sell Foreign competition will
scare owners out of business
Banks calling loans will force sales
Owners will adjust to the new normal and capitulate
Buyers can wait owners out
Reality They can work longer and are getting better at succession See Clint Eastwood and Halftime for America Owners are winning games of chicken with the banks Entrepreneurs are by definition hopeless optimists Buyers only make money if they actually buy the business
![Page 19: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/19.jpg)
Activity in Small M&A on Decline
2007 2008 2009 2010 2011 20120
200400600800
100012001400160018002000
16261730
10811219
1001
32
Number of Closed Transactions*
*2012 data through 4/24/12
![Page 20: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/20.jpg)
Closing Time
2007 2008 2009 2010 2011 20120
50
100
150
200
250
201225 219 229 226
160
Average Days to Transaction Close
![Page 21: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/21.jpg)
Money on the Table
2007 2008 2009 2010 2011 20120%
10%
20%
30%
40%
50%
60%
70%
80%
90%
69%74% 71%
78% 79%
64%
% Cash Down at Closing
![Page 22: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/22.jpg)
A Buyer’s Market
2007 2008 2009 2010 2011 20120%
10%20%30%40%50%60%70%80%90%
100%
73%
85% 86% 84% 82%88%
% of Sales as Asset Sales
![Page 23: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/23.jpg)
M&A Takeaways
Very much a buyers’ market
Likely increase in distressed sales
Sellers are digging in Tax policy not likely
driving the M&A market M&A should continue to
be slow into next year
![Page 24: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/24.jpg)
BLACK-SCHOLES DOESN’T WORK
![Page 25: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/25.jpg)
A Review of Black Scholes
There is no arbitrage opportunity (i.e., there is no way to make a riskless profit)
It is possible to borrow and lend cash at a known constant risk-free interest rate
It is possible to buy and sell any amount, even fractional, of stock (this includes short selling)
The above transactions do not incur any fees or costs (i.e., frictionless market)
The stock price follows a geometric Brownian motion with constant drift and volatility
The underlying security does not pay a dividend The option is European in style No counterparty risk
![Page 26: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/26.jpg)
So What’s Wrong?
Most options are not European style
Counterparty risk not contemplated
Dividends increasingly common
Private securities not in a frictionless market
Black Scholes only appears to work with low-volatility stocks
![Page 27: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/27.jpg)
Possible Solutions
Move away from option models to simulations
Adopt more complex option models (Hull-White, EPV, Whaley models)
Real options theory Current value methods Accept the bad model
![Page 28: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/28.jpg)
APPRAISERS AND ACCOUNTANTS PLAYING NICELY
![Page 29: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/29.jpg)
Mars and Venus
Accounting Profession is externally
regulated and licensed Highly rules-driven Math is limited to
arithmetic Views BV as a necessary
evil Right vs. wrong relatively
defined
Business Valuation Profession is largely self-
policing Heavily reliant upon
judgment Unlimited complexity to
math Views CPAs as referral
source Hard to be definitively
“wrong”
![Page 30: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/30.jpg)
We Need to Educate
Good reports = improved transparency
Audit procedures don’t always match up with credible value
Surprises = friction Overreliance of CPA on
the appraiser
![Page 31: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/31.jpg)
5th CPA Exam?
AICPA should consider adding a 5th exam to cover valuation
Every CPA must be able to critically read a valuation report
CPA’s must help their clients understand the work product
![Page 32: Topics in valuation that nobody is talking about gscpa nacva](https://reader036.vdocuments.site/reader036/viewer/2022062511/54c326f74a79596c478b458b/html5/thumbnails/32.jpg)
Thanks! Questions?