Valuation Articles

Hodgkin article in October 2009 BVR Update

Tue, 06 Oct 2009 11:47:35 -0700

Alex Hodgkin, CFA, recently authored a thought-provoking piece about the challenges in reconciling multiple valuations for different purposes, often by different providers, for the same entity. The article was published in the October issue of BVR update. But you can read it by clicking here. BVU_2009_Oct_Hodgkin.pdf

Hodgkin Cited

Wed, 11 Mar 2009 16:19:38 -0700

An article written by Alex Hodgkin, co-founder and Managing Director at Arcstone, was recently published in the Thunderbird Global Private Equity Center's inaugural White Paper Series. The article addresses the changing regulatory environment for 409A/123R valuation work and offers readers Hodgkin's valuable insights on how to navigate, successfully even, the increasingly complex and always evolving valuation landscape. To visit the TGPEC site and read the article, click here Staying on Top

Latest SEC doc helps clear the murky waters of public disclosures

Sun, 18 Jan 2009 15:39:26 -0700

Financial executives received a new year's bonus from the SEC with the release of a document designed to help them navigate the murky waters of public disclosures. Last updated way back in 2000, this latest document has more than doubled in size in its latest iteration. For financial services professionals this is a must (if not almost overwhelming) read. For the full text of the report click the link in the box to the right.

Arcstone Rising

Tue, 13 Jan 2009 15:20:00 -0700

If you are a true finance nerd, you are indeed in luck: valuation is enjoying a rising tide and, as our colleagues across the industry agree, finding good people that do good work is no easy task. That's good for you; if you are good, that is.

Look, we get it -- like you, we wanted a great job at a firm comprised of superlative people in a growing industry. So we built Arcstone. And now we need more of us, which is where you come in.

If you think you might be a good fit for us, and vice versa, click on the download link to the right. Check it out, and be in touch.

Brustkern to Keynote FEI Event

Fri, 09 Jan 2009 15:21:31 -0700

On Thursday, January 15, Arcstone Managing Director, Bo Brustkern will present the keynote address at the January meeting of FEI. Mr. Brustkern will be speaking on a subject near and dear to his heart as co-founder of Arcstone - a Colorado-based valuation shop: The Fourth Service Provider. The meeting commences at 4 pm with a professional development session, followed by networking, dinner and Mr. Brustkern's presentation, scheduled to start at 7:30 pm.

Brustkern to speak at Kauffman's Global Entrepreneuship event

Mon, 17 Nov 2008 07:44:22 -0700

Arcstone co-Founder and Managing Director, Bo Brustkern, will participate in a panel discussion on entrepreneuship. The event, part of the Kauffman Foundation's Global Entrepreneurship Week, will take place at the University of Denver on Monday, November 17. More information can be found at Unleashing Ideas, and the Daniels College of Business.

Arcstone Articles: re-organized, made better!

Wed, 01 Oct 2008 11:00:17 -0700

At long last, we've reorganized the Arcstone Articles to read much more like they ought to: that is, ordered by topic instead of by date. We'll keep tinkering. Heck, we may completely remodel. But for now, you'll want to know that all of our articles are organized into the following general categories:

Valuation 101: Common Stock Articles

Valuation 101: Purchase Price Allocation Articles

Fair Value (FAS 157) Articles

Common Stock articles: archives

Announcements

SEC & FASB clarify 157

Tue, 30 Sep 2008 23:19:18 -0700

This afternoon the Chairman of the SEC, together with FASB staff, released a short document to clarify the application of FASB Statement No. 157, "Fair Value Measurements." The guidance provides clarification on the use of broker quotes and financial models, application to illiquid markets, and additional information relating to impairments.

(Download the PDF in the box to the right.)

The FASB is soon expected to issue further interpretive guidance on the application of fair value.

Reed and Brustkern to speak at Thunderbird

Tue, 02 Sep 2008 22:32:29 -0700

Chuck Reed and Bo Brustkern will participate in two interactive classroom discussions at the Thunderbird School of Global Management tackling the two-part issue of modeling and valuing volatile enterprises in uncertain conditions.

The discussions will take place Friday, September 5th in the classroom of Dr. John Mathis; and Saturday, September 6th in the classroom of Steven Stralser.

Excellent CFO.com article on 157

Tue, 02 Sep 2008 20:34:42 -0700

Alrighty, folks. Here's a great article on SFAS 157.

Now, if all we did was link to the myriad pieces relating to SFAS 157, we'd have little time to value companies. In the words of David Katz, Fair Value has "achieved the improbable feat of making front-page news." Sensationalism aside, occasionally we do run into a great analysis of the issues. When we do, it's worth a link. So here you are.

Katz's article runs about five web pages in length, and covers the current sentiment relating to 157, the probable future life of the regulation, and some details relating to its far-reaching nature.

Dan Primack puts 157 on trial

Tue, 05 Aug 2008 12:42:35 -0700

Dan Primack of PE Hub / PE Week Wire fame recently put FAS 157 on trial. Read his short account here. I'm afraid we've been to (and participated in) too many sessions with the same topic and nowhere near the entertainment value. Cheers to Dan for making a sobering topic at least fun to debate.

Hodgkin to speak on valuation

Wed, 16 Jul 2008 09:27:02 -0700

Alex Hodgkin, Managing Director of Arcstone Partners, will participate in a panel discussion alongside co-panelist Tom Miller, Managing Director of Quist Valuation, to tackle issues of Fair Value and financial reporting. James Beck of the Mayfield Fund will moderate the discussion.

The panel will take place Friday, July 18 at the Private Equity CFO and COO Conference in the Rockies, in Beaver Creek, Colorado.

1. Empirics and Analytics

Tue, 01 Jul 2008 21:37:48 -0700

At Arcstone, quantitative analysis is balanced with qualitative reasoning.

Data, reason and logic: the lodestars of at least one Silicon Valley CEO. So it should be with a responsible valuation practitioner.

I’ll stop and mention for the record that we at Arcstone have no illusions about our place in the world. Cypress Semiconductor builds things that do stuff, which is magnificently more valuable to the world at large than we simple financial service providers. But still we can draw a comparison to the way TJ Rodgers looks at his universe and the way Arcstone analysts look at our own idiosyncratic universe of financial valuation. Data, reason and logic reign in both.

Data: Quantitative data. In writing this, it seems just too obvious to mention, but the art of valuation is indeed constructed by quantitative measures. But perhaps it’s not too obvious: one recent client was surprised that his company’s common stock valuation had taken a jump, despite the fact that qualitatively not much seemed to have changed in the past year. I suppose this sentiment can be caused by not seeing the forest for the trees. At any rate, it was surprising to us that we had to point out that changes in quantitative data weighed heavily in our analysis. Their projections had jumped several-fold. Projections, we explained, are the kind of quantitative data upon which valuation analyses depend quite significantly.

Reason: There’s reason and there’s reasonable, and we must employ both. We’re not tackling problems of physics, so our reasoning does not have to be stretched by PhDs in mathematics. However, ask any practiced valuation analyst and they’ll tell you there’s a great deal of art that balances out the science of valuation. So reason is key. And reasonableness as well, which leads us to…

Logic: How does it all hang together? That’s a critical question that the valuation analyst must ask. An unsophisticated analyst may derive some wacky numbers, figures that just don’t make sense given the nature and maturity of a given company. The sophisticated analyst will balance quantitative methodologies with a qualitative sensibility to answer the question, “does it all hang together?”

We don’t pretend to be solving the world’s mysteries or pushing the limits of physics. Would that we could! We do, however, hope to solve a small but nagging mystery for you, the client: what’s this thing worth? It turns out that adhering to the sensibilities of TJ Rodgers is as beneficial to his art as it is to ours.

Tip of the hat to Joseph Rago writing in the WSJ on 02 September, 2007.

1. Protecting Yourself from the Pitfalls of 409A: An Appraiser’s View

Tue, 01 Jul 2008 13:11:00 -0700

Over the last few years, both public and privately-held companies have struggled with the complexity of incorporating equity participation into compensation plans for employees. Terms like 409A, Practice Aid, qualified appraiser, and safe harbor methods are suddenly part of the everyday lexicon of most compensation professionals. At the same time, debate still rages and confusion abounds about just how companies achieve compliance in developing their compensation policies and practices.

Internal Revenue Code section 409A created a wave of discussion as companies scrambled to implement equity compensation policies that comply with the new regulation. Finalized in April 2007, 409A applies to discounted stock options and stock appreciation rights (SARs) defined as deferred compensation. Under 409A, stock options that have an exercise price less than the fair market value of the underlying stock as of the grant date could result in adverse tax consequences for the option recipient. The gain is subject to taxation at the time of option vesting rather than the date of exercise, with potentially devastating penalties and interest charges. In short, the consequences for noncompliance, which affect the individual who holds the options and not the issuing company, are significant.

Section 409A, while lengthy and complex, does outline some reasonably clear approaches on how to develop compliant policies. These presumptive methods, known as safe harbors, shift the burden of proof of noncompliance to the IRS if implemented properly. That simply means that if a company employs a safe harbor method to value the price of its stock options, the IRS must show that the company was grossly unreasonable in calculating the fair market value of the underlying security before wrongdoing may be claimed.

There are a number of these safe harbor methods, including: the illiquid start-up, binding formula, and independent appraisal approaches. In order for any of the safe harbors to comply, however, the method must incorporate evaluation of a number of factors, including: (i) the value of tangible and intangible assets of the company, (ii) the present value of future cash flows, (iii) the public trading price or private sale price of comparable companies, (iv) control premiums and discounts for lack of marketability, (v) whether the method is used for other purposes, and (v) whether all available information is taken into account in determining value.

Needless to say, many compensation professionals employ the services of a third-party firm to perform valuations for regulatory purposes such as 409A. The theory is that an independent appraisal offers the most effective protection. However, even this poses its own challenges, since identifying competent professionals and understanding the standards to which 409A valuations will be held remain difficult. Why? Simple: What constitutes a competent and capable valuation professional? Even though a number of professional organizations provide valuation training and credentials, there is no single universally accepted governing body. Moreover, the valuation community has not yet fully developed a robust body of knowledge concerning valuations performed for these purposes. Finally, as the regulations are quite new, no companies have yet had to defend their 409A valuation conclusions with the IRS.

Still, there is good news. Valuations for tax purposes are not new. As a result, there is a reasonable amount of information available on how to conduct a valuation suitable for presentation to the IRS, as well as how the IRS currently assesses the competency of valuation professionals. What is clear is that it’s not sufficient to get the simple safe harbor compliance of an independent appraisal. Instead, to fully enjoy the additional protections offered by shifting the burden of proof, the wise compensation professional should procure a qualified appraisal from a qualified appraiser as those are defined in tax documents and recent court rulings.

Guidance on where to turn for meeting those requirements comes from a variety of sources, such as legislation and IRS position statements. For example, Section 1219 of the Pension Protection Act of 2006 provides that a qualified appraisal must include certain details and methodologies that someone adept in finance – but not necessarily practiced in the art of valuation – may not comprehend. These details include specifics about the actual entity and its value, qualifications of the appraiser, and the valuation analysis itself. As to the specific methodologies, there are in fact many to choose from. According to the IRS, the requirements specific to 409A were initially developed after a review of generally accepted valuation methodologies, as well as the Uniform Standards of Professional Appraisal Practice (USPAP), a valuation benchmark. The list of accepted valuation methodologies has expanded as innovative practitioners create new ways to examine vexing problems.

The quality of appraisal is critical, but it’s only one part of the overall insurance package you are buying when you get an independent appraisal. Another piece of the puzzle is the qualifications of the appraiser him- or herself. Thankfully, additional legislation has tightened the definition of just what constitutes a qualified appraiser. The current set of standards encompassed by the definition include the following:

• An appraisal designation from a recognized professional appraiser organization;
• Regular performance of appraisals for which the individual receives compensation;
• Demonstration of education and experience in valuing the type of entity subject to the appraisal.

Currently, there are essentially four recognized professional appraiser organizations, each offering its own valuation credential. These include: 1) American Society of Appraisers (ASA), offering an ASA or AM; 2) American Institute of Certified Public Accountants (AICPA), offering an ABV; 3) National Association of Certified Valuation Analysts (NACVA), offering an AVA, CVA; and 4) Institute of Business Appraisers (IBA), offering a CBA, BVAL, or AIBA. While there is some debate regarding which credential is best, all of these currently provide sufficient evidence of minimum education in the profession for purposes of satisfying the qualified appraiser requirement under current IRS regulations.

Recent court rulings shed additional light. In Herbert V. Kohler, Jr. v. Commissioner of Internal Revenue, United States Tax Court, T.C. Memo 2006-152, July 25, 2006, the court clarified the instances in which the burden of proof shifted to the IRS. In Kohler, the court ruled that the burden of proof shifted to the IRS because the petitioner introduced credible evidence, substantiated material claims, maintained required records, and cooperated with the IRS. In deciding for the taxpayer, the court stated that it was impressed with the valuation methodologies utilized by the taxpayer’s experts, as well as the fact that the expert was a certified appraiser.

In the end, we are struck by the importance of two key pieces relevant to 409A compliance: appraiser and appraisal. Clearly, not only is it important to use reputable, qualified appraisers, but it is also critical that such professionals follow generally accepted valuation standards to craft robust appraisal reports. Without both, you are not fully protected from the perils and pitfalls of noncompliance with 409A.

FAS 157 reckoning in TheDeal.com

Mon, 21 Apr 2008 08:59:12 -0700

Today, at last, FAS 157 made its splash in the private equity scene as it was granted an appropriately-sized article in The Deal. As Dan Primack says (separately, in PE Hub), it's "the most important private equity issue that not enough of us are reporting on."

Our thoughts:

FASB 157 is here to stay, and PE firms are beginning to debate the merits of its implementation.

Recent volatility in the markets and controversies regarding valuation over illiquid investments have brought the issue to the forefront.

There is uncertainty over who will take on the new duties of developing the valuations and defending them in front of the audit community. Some firms are have created groups or positions internally, while others have gone to independent professionals. Regardless of what they do, it's a substantial commitment of time and effort.