Michelle Gallagher, Z. Christopher Mercer, and James Hitcher

Three Experts Convene to Answer and Discuss Pressing BV Issues

On March 1, 2022, Jim Hitchner hosted a webinar that featured Michelle Gallagher and Z. Christopher Mercer. While the respective speakers provided some questions in anticipation of the webinar, the audience sent questions and these were answered. The unscripted webinar provided attendees an opportunity to assess what was foremost in the mind of BV professionals.

On March 1, 2022, Jim Hitchner hosted a webinar that featured Michelle Gallagher and Z. Christopher Mercer. While the respective speakers provided some questions in anticipation of the webinar, the audience sent questions and these were answered. The unscripted webinar provided attendees an opportunity to assess here from business valuation thought leaders and hear questions of what was foremost in the mind of BV professionals. This article summarizes the questions and impressions shared by the speakers and is based on the notes taken; there were no hand-outs for this presentation.

Issues Discussed

• Two to three areas where experts disagree the most.
• Whether to apply a discount (lack of liquidity) on a 100% Control Value?
• Continuing with the second point above, what about when one is valuing a 51% ownership interest?
• Is there an S corp premium while the Tax Cuts and Jobs Act of 2017 (TCJA) is in effect? What about post TCJA?
• Are the panelists using the DCF or market approach as their primary method?
• What are panelists views on the use of Calculation Reports?
• What are the panelists views on the use of DealStats?
• If a company will take a long time to sale, when is a DLOM justified?
• When a business owns real estate, how should the real estate component be valued?
• If a financial forecast or budget is requested, but it is not available, should the BV appraiser develop the projection? If that is permissible, how does it become a management projection?
• The aging of the BV profession, what impact will that have on clients?

Two to three areas where experts disagree the most.

Michelle Gallagher: Establishing (1) reasonable compensation, (2) WACC components, and (3) company specific risk premium.

Christopher Mercer: Establishing reasonable compensation and basis for any upward or downward adjustment. Finds that when a compensation expert is hired, the expert is hired to bolster the argument for the higher pay.

Hitchner: Agreeing on reasonable compensation.

The panelists use the ERI database, RMA ratios, and will look for proxy statements of comparable companies.

Whether to apply a discount (lack of liquidity) on a 100% Control Value?

Christopher Mercer: No discount; what matters is cash flow and growth potential. Believes that a good analogy is found when one looks at real estate transactions, where there is no discount.

Michelle Gallagher: Seconds, Christopher Mercer’s view.

Hitchner: Adds that the owner still owns the company, can take the money.

Continuing with the second point above, what about when one is valuing a 51% ownership interest?

The panelist agree that this change in scenario, does not warrant the use of a discount.

Is there an S corp premium while the Tax Cuts and Jobs Act of 2017 (TCJA) is in effect? What about post TCJA?

Michelle Gallagher: Pre-TCJA: yes. During TCJA, she has “ditched” the S corp adjustment. Post-TCJA: no S corp adjustment. She uses S corp tax rates where a controlling interest is being valued.

Christopher Mercer: If there is going to be a premium, it must be justified on the basis of expected cash flow, risk, or growth. Does not believe an S corp premium is warranted in most cases and makes the point that his firm still tax effects S corp earnings.

Hitchner: Does not believe an S corp premium exists. He adds that Fanning and Treharne show a C corp premium in some cases, something he does not believe is warranted. Hitchner values the corp as though it was a C corp and considers the VanVleet approach.

Are the panelists using the DCF or market approach as their primary method?

Michelle Gallagher: Uses DCF for most valuations, except in divorce actions where the court has a preference for the capitalization of earnings.

Christopher Mercer: 100% DCF.

What are panelists views on the use Calculation Reports?

Michelle Gallagher: Does not provide this service.

Christopher Mercer: Does not provide this service.

Hitchner: Calculations can provide a preliminary estimate, but it is not a substitute for a full appraisal.

What are the panelists views on the use of DealStats (formerly Pratt’s Stas), used as a primary source of value? As a corroborating source?

Christopher Mercer: States he may not use the method at all but may. Mr. Mercer is not a “fan” of the Guideline Transaction Method—with the exception of institutional banking valuations—in part because he has questions regarding whether EBITDA has or has not been adjusted, and where the data was pulled from.

If a company will take a long time to sell, when is a DLOM justified?

Michelle Gallagher: Agrees with Christopher Mercer’s assessment.

Christopher Mercer: If a company being sold has unique assets and it may take longer to sell, that does not warrant a discount or a premium. The holding period has occurred and what matters is value, price, and proceeds.

Hitchner: Agrees with Christopher Mercer’s assessment.

When a business owns real estate, how should the real estate component be valued?

Michelle Gallagher: When an entity has real estate, including a building, she may either use a rent equivalent or treat the real estate as a nonoperating asset.

Christopher Mercer: If using a transaction database, treat the real estate or building as an excess or non-operating asset.

Hitchner: Cautions that real estate needs to be valued at the highest and best use, and that when he has been pressured not to include that he makes a statement that the valuation does not reflect the highest and best use.

If a financial forecast or budget is requested, but it is not available, should the BV appraiser develop the projection?  If that is permissible, how does it become a management projection?

Michelle Gallagher: An area of caution since the appraiser is viewed as an outsider and there also may be questions about the experience the appraiser has with the industry. Best for management to prepare.

Christopher Mercer: Thinks that an appraiser can go over past financials and performance, discuss with management, and get management to make changes and approve. Once approved, it is a management projection.

Hitchner: Agrees with Christopher Mercer.

The aging of the BV profession, what impact will that have on clients?

Panelists View: The panel sees an aging profession and the need for firms to quickly prepare a succession strategy. Some advised that the clients are beginning to ask who will take over the appraisal services and this is a cause of concern for those clients. The panelists also encourage firms and attendees to get involved writing articles, doing presentations, and meeting with less senior executives at the client firms to establish a relationship and continuity.

Conclusion

Although the panelists submitted several questions ahead of time, the bulk of the questions addressed came from attendees. Hence, this was unscripted and provided valuable feedback to those pressing questions raised by the audience. The responses to the six polling questions also revealed a variety of practices; while the panelists agreed on most points, the poll results underscore that there are many unsettled practices. One can learn the hard way, but it is best to learn by asking and listening, and this was, as such, an opportunity.

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Roberto H Castro, JD, MBA, MST, CVA, is the Legal Compliance counsel for Equilus Capital Partners, LLC, a closely held Real Estate Limited Partnership Fund. He is also Technical Editor of QuickRead and a member of NACVA’s CUV team.

Mr. Castro can be contacted at (509) 679-3668 or by e-mail to rcastro@rcastrolaw.com.