Hitchner rebuts Damodaran’s attacks on cost of capital inputs

Just keep on doing what you’re doing with cost of capital, advises Jim Hitchner (Valuation Products and Services), despite what academics say. During a recent webinar, he responded to some severe criticisms Aswath Damodaran (New York University Stern School of Business) made during a recent BVR webinar about certain inputs to the cost of capital. Damodaran rejects some concepts that most valuation practitioners use, such as the historical ERP, the company-specific risk premium, and the size premium. Other academics have also questioned cost of capital models and inputs practitioners typically use.

The two-hour webinar was very comprehensive and went into great detail on how analysts can support their cost of capital estimates. Hitchner offered his list of best practices, and he conducted some polls of the large audience about the use of certain models and inputs. Yes, there are different opinions about many elements, but it’s a healthy dialogue. And it’s important to understand the framework you are using, whether it’s the Kroll Cost of Capital Navigator, BVR’s Cost of Capital Pro, or Damodaran’s data.

Be reasonable: Getting deep into the weeds of cost of capital can be mind-boggling, so, at the end of the day, you need to see whether your overall rate is reasonable. Hitchner advised that a good check on this is to show where your subject company falls in the spectrum of rates out in the market, starting with the U.S. 30-day T-bill (0.06% in 2021) all the way up to venture capital for first stage/early development (40% to 60%). Hitchner showed this as a listing of rates, but you can also depict it in some other form. We’ve seen it done as a gauge, like the gas gauge in your car, with a needle going from low risk to high risk.

During the BVR webinar, Damodaran had made some remarks about total beta that, when taken out of context, lead you to believe that he rejects that concept also. During the Hitchner webinar, he provided the full remarks made about total beta, a concept Damodaran does not criticize in the same vein as he does some of the other concepts. Damodaran publishes total betas and includes the concept in his teachings and writings.

A recording of the July 21 webinar will be made available on the VPS website. The title is: Cost of Capital Dispute: Damodaran vs. Kroll Cost of Capital Navigator vs. BVResources Cost of Capital Professional. What Is Right and What Is Wrong?

Healthcare whistleblower case regarding FMV can proceed

The CFO of a healthcare provider blew the whistle on his former employer, alleging it overpaid for a surgery center in order to induce it to refer future business. Paying for future referrals is in violation of the federal anti-kickback statutes, which prohibit healthcare providers from exchanging remuneration in return for referrals of federal healthcare program business. The overpayment issue hinges on the acquisition being at fair market value. The CFO had done a “high level” valuation of $8 million to $10 million for the center, but the acquisition price ended up being $25 million. The defendants moved for summary judgment, but it was denied. The court ruled that the CFO’s valuation was enough to create a “triable issue regarding the fair market value of the [center]. Summary judgment is not appropriate on this issue.”

The case is Kuzma v. N. Ariz. Healthcare Corp., 2022 U.S. Dist. LEXIS 106969, and a case analysis and full opinion are available on the BVLaw platform.

Extra: The federal physician self-referral law (the Stark Law) incorporates a similar principle by prohibiting certain physician referrals to entities with which physicians have compensation arrangements. FMV is a key matter in this context also, and the rules recently changed. See the soon-to-be-released Complete Guide to Fair Market Value Under the Stark Regulations.

Divorce spotlight: valuing a family business with complex ownership

When a family business caught up in divorce is not a simple 100% ownership, things can get complicated—from both a valuation and legal perspective. In a short video, family law attorney Kevin Segler (KoonsFuller Family Law) points out that dealing with complicated ownership structures is like peeling back an onion, with each layer revealing more issues for investigation.

Valuation expert Karolina Calhoun (Mercer Capital) notes that it’s important to understand complex entity structures and the flow through of that ownership—as well as the qualitative and quantitative characteristics of that ownership. Other issues to consider include multilayering with discounts, tracing marital versus separate asset ownership, and how related parties in the business impact ownership, valuation, and division of assets.

Calhoun and Segler will co-present a session on this very topic at the 2022 AAML/BVR National Conference, September 18-20, in Las Vegas. To see the full agenda and to register, click here.

Paper investigates patent valuation methods

A new paper investigates the underlying knowledge structure and the evolution of patent valuation methods under two main topics: quantitative and qualitative. The authors (all from Bahçeşehir University in Turkey) searched for peer-reviewed journals that resulted in a review of 129 documents between 1981 and 2021. The paper, “Qualitative and Quantitative Patent Valuation Methods: A Systematic Literature Review,” is in the June 2022 issue of the journal, World Patent Information. An abstract is available if you click here.

DealStats users spark enhancements to the database

BVR's Market Data Team recently surveyed DealStats users, and their suggestions have prompted some enhancements. For example, users indicated that it would be important to know whether the buyer in a transaction financed the cash purchase price through an SBA or bank loan. Now, the DealStats platform includes the following searchable fields:

• “SBA/Bank Loan Included” (whether an SBA or bank loan was included in the transaction);

• “SBA/Bank Loan Amount” (if a loan was included in the transaction, you can now see the exact amount);

• “SBA/Bank Loan % of Amount Down” (exactly how much of the cash paid to the seller was financed through an SBA or bank loan); and

• “Bank Name—If Available” (the name of the bank that provided the SBA loan or other financing).

More enhancements are in the works based on the feedback from users. BVR thanks all of those who participated in the survey.

Global BV News

IVSC launches Asia office in Singapore

The International Valuation Standards Council (IVSC) has selected Singapore as its first base outside Europe to drive its advocacy efforts in the adoption of International Valuation Standards (IVS) in Asia. “The launch of the IVSC Asia office comes at a time when demand for professional valuers is growing rapidly worldwide due to financial reporting and audit requirements; and new drivers of company value are rising such as IA, and Environmental, Governance and Sustainability (ESG) factors,” the IVSC said in a statement.

What’s in the August 2022 issue of Business Valuation Update

Here’s what you’ll see:

• “Conference Recap: ESOP Valuations at a Crossroads” (BVR Editor). A key takeaway at the inaugural ESOP Virtual Conference hosted by the American Society of Appraisers was that we may be at a crossroads with regard to valuations of employee stock ownership plans (ESOPs). Topics covered included ESOP valuation basics, key issues from recent litigation, ESOP stock purchase transactions, and advanced topics (such as control premiums, repurchase obligations, and synthetic equity).

• “Damodaran on How Inflation Plays Out in Company Valuations” (BVR Editor). Professor Aswath Damodaran (New York University Stern School of Business) presents a simple framework for assessing the impacts of inflation on the value of a private company. He also made some explosive remarks about certain inputs to the cost of capital.

• “The 2022 Cannabis Reset: A Redux of 2019?” (Ron Seigneur and Ryan Cram, Seigneur Gustafson LLP). Comments on the impacts to the cannabis industry in the wake of COVID-19 and related economic stimuli and amid inflation, interest rate increases, legislative reforms, and labor and supply-chain disruptions.

• “ASA Ramps Up Efforts to Attract and Retain Young BV Pros” (BVR Editor). Ray Moran (FON Valuation Services), marketing director with the iiBV, interviews Johnnie White, CEO of the American Society of Appraisers, who outlined the ASA’s efforts in dealing with the ripple effects of the great resignation in the valuation profession.

• “Probing Questions Valuers Will Face About Their Guideline Transaction Analysis” (BVR Editor). Here are the questions a trier of fact (or other reviewer) will ask the analyst about his or her guideline transactions method. A worksheet judges use to compare the work of two opposing experts is included.

• “Key Lesson to Be Learned From Valuing a Strip Club” (BVR Editor). A strip club may bare all, but not when it comes to every bit of information an analyst needs to do a valuation. The trick is knowing the right questions to ask to discover these hidden factors that may impact value, and that goes for other types of businesses as well.

The issue also includes:

• A full section of “BV News and Trends/Global BV News and Trends”;

• Regular features: “Ask the Experts” and “Tip of the Month”;

• BV data spotlight: “DealStats MVIC/EBITDA Trends,” “ktMINE Royalty Rate Data,” “Economic Outlook for the Month,” and the “Cost of Capital Center”; and

• BVLaw Case Update: The latest court cases that involve business valuation issues.