Litigation Advisory Services

This month's issue of Valuation & Litigation Advisory Insights includes the following articles:

• New Expert Discovery Rules Should Reduce Litigation Costs
• Zubulake Revisited: New Guidance on E-Discovery
• How the Recession Has Impacted Business Valuation

New expert discovery rules should reduce litigation costs         

This article discusses proposed amendments to the Federal Rules of Civil Procedure that will likely have a big impact on the attorney-expert relationship. One of the most significant changes is amended Rule 26, which will extend attorney work-product protection to draft reports by testifying experts and, with certain exceptions, to communications between experts and retaining counsel. It’s hoped that this will avoid needless discovery costs.

Click here to read this article.

Zubulake revisited: New guidance on e-discovery

A recent court case shows that sanctions can not only be awarded for deliberate destruction of discoverable data, but also when a party is grossly negligent. The court found that "failure to issue a written litigation hold constitutes gross negligence…." A sidebar to this article lists specific examples of gross negligence.

Click here to read this article.

How the recession has impacted business valuation

Should businesses that were valued on the eve of the economic downturn be revalued in light of subsequent events? This article looks at a Florida marital dissolution case in which a restaurant valued in December 2007 lost value during the recession that followed. This case confirms that, when valuing a business, appraisers generally shouldn’t consider events that take place after the valuation date. A sidebar examines Financial Accounting Standards Board standards regarding the treatment of subsequent events for accounting purposes.

Click here to read this article.

Prior issues are available in the E-Newsletter Archive of our Valuation & Litigation Advisory Services Resource Center. If you would like to subscribe to this free, monthly, business valuation and litigation support e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, post a comment below or please contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

This month’s issue of Valuation & Litigation Advisory Insights includes the following articles:

• Nonqualified Deferred Conpensation: Independent Appraisals Offer Protection Against 409a Challenge
• Damage Control: Surviving a Business Interruption
• Fair Value in a Troubled Economy
   

Nonqualified deferred compensation: Independent appraisals offer protection against 409A challenge         

Businesses that provide employees with stock options, stock appreciation rights (SARs) and other types of nonqualified deferred compensation have been subject to Internal Revenue Code Section 409A for years. As you can imagine, compliance is particularly challenging in the current economic environment. To avoid Sec. 409A problems, options and SARs must be issued at or above fair market value, so accurate valuations are critical. It’s important to know what Sec. 409A requires and how to establish fair market value. Three "presumptive" valuation methods are discussed.

Click here to read this article.

Damage control: Surviving a business interruption

Whether it’s minor, such as a lightning strike that shuts down production for a day, or major, such as a lengthy labor strike, a business interruption not only reduces income, but also simultaneously creates new expenses. The key to surviving a business interruption is to restore normal operations as quickly as possible. Insurance plays a critical role. This article explains business interruption insurance, how to file a claim, what to do to mitigate loss, and how to establish a loss period. A sidebar addresses scope-of-coverage issues.

Click here to read this article.
 
"Fair value" in a troubled economy

Last year, Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 157 took effect. The statement, entitled Fair Value Measurements, provides guidance on measuring fair value for purposes of several accounting standards, and establishes a "fair value hierarchy" that emphasizes market-based valuation methods. This article explains how it works. A sidebar discusses a few opportunities to explore in this down economy.

Click here to read this article.


Prior issues are available in the E-Newsletter Archive of our Valuation & Litigation Advisory Services Resource Center. If you would like to subscribe to this free, monthly, business valuation and litigation support e-newsletter, send an email to info@skodaminotti.com.

With apologies to all of you non-basketball fans out there, this blog entry will once again focus on LeBron James and his impending free agency.  After all, it is the primary (only?) sports story in Cleveland this summer.  As my colleague wrote in a previous entry, LeBron’s decision to stay or go this summer will have a dramatic impact the value of the Dan Gilbert’s investment in the Cavaliers.  Here’s another perspective on how LeBron’s decision might be illustrative of the value of your business. 

The concept of the “key person discount” is often bandied about in valuation circles.  The idea is that a certain employee of the subject company, typically the owner-operator and founder, creates value due to his or her unique ability to run the business, enhance performance, or generate revenue.  One might ask, "Why would that be considered a reason to discount the company’s value?"  It seems as though such an individual creates a competitive advantage, and thus, a higher value.  The key person discount contemplates the impact of the potential exit of that individual from the business, and the resulting sustainability (or lack thereof) of the business after that exit.  In other words, the key person discount is a component of risk due to the fact that the success of the company is inordinately tied to a single person. 

To get back to the LeBron analogy, think of the “stay” or “go” scenarios and the impact on the Cavaliers’ ability to perform with or without him.  Take it one step further, and consider what the odds makers in Vegas are thinking right now as LeBron’s future is in question.  One thing is certain – whichever team is able to sign LeBron will see a significant uptick in its likelihood to win the NBA Championship next year (i.e., improved odds).  This volatility and uncertainty is simply an added risk associated with Cavaliers’ ability to win basketball games in the future. 

In business valuations, we handle volatility through the discount rate.  Therefore, an additional component of risk would be included in our discount rate for a key person, such as LeBron is for the Cavaliers.  In the valuation world, this would drive a lower value due to the added risk of the related investment.

Of course, many subscribe to the “Ewing Theory” which was popularized by Bill Simmons.  A summary of the theory is linked above, but the basic idea is a team may be better off without its superstar and, under the right circumstances, will actually perform better if the superstar gets injured, is traded, or leaves through free agency.  In other words, it is a scenario of addition by subtraction.  Simmons offers some very compelling examples of this notion.  It is common for valuators to encounter this situation (e.g., an owner taking excessive compensation) from time-to-time, but we will hold that back for a later entry.

For more information on the key person discount, post a comment below or contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

Click here to view Part 1 of our series and learn more about the stock option landscape or Part 2 to learn more about the accounting and tax ramifications of issuing stock options.

What To Do?

As discussed above, there are significant risks that a company brings upon itself if it decides to issue stock options without properly valuing the options and the equity of the company. Rather than issuing stock options, if a company wants to offer an employee the opportunity to obtain an ownership interest, the most efficient and “clean” method may be to allow the employee to purchase shares from the company or from existing owners. There is no valuation requirement in this case (unless a party wants to hire an expert to ensure that they the transaction price is fair and reasonable) which also eliminates the out-of-pocket cost for the employer. In fact, a business actually recognizes a cash inflow when an employee purchases shares directly from the company. 

I am a valuation expert and I directly benefit from work associated with the valuation of stock options, so why am I telling you to consider alternative routes of compensation? Too often, the companies that issue stock options without having them professionally valued are the same companies that will fight against having their options valued at all due to the cost associated with the valuation. I simply want to spread awareness that there are other avenues of compensating employees and giving them opportunities for equity ownership that may be more cost efficient for companies that are under the illusion that issuing stock options does not require a cash outlay.

If you take anything away from this article, remember that issuing stock options is not a “cashless” expense. Consider that there are other alternatives for compensating employees other than using stock options. Remember that there are transaction costs associated with issuing stock options, specifically, hiring a valuation expert, that will create real out-of-pocket cost for any company. Unless you are ready to comply with the valuation requirements associated with issuing stock options, you may be better off simply not using them and compensating employees in another manner. Finally, just like selling a home, if you are going to issue stock options make sure that you bring in an expert to ensure that the value of the company and options are determined and documented appropriately – and be prepared to pay the “commission” for these services.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.

Accounting and Tax Ramifications of Issuing Stock Options

 Click here to view Part 1 of our series and learn more about the stock option landscape.

To give you more perspective, first let us review the accounting treatment for the issuance of stock options (rest easy - this will not be too painful). When stock options are issued, an expense must be recorded based on the value of the option. A stock option’s value is derived from a variety of factors, two of which are the value of the stock as of the date of the option grant and the exercise price of the option (the price at which the option holder can purchase a share of stock). Determining the value of a company’s stock is not difficult when it is publicly traded, but privately-held companies do not have readily available market prices, which necessitates the services of a valuation expert. Unless the option is properly valued, a company cannot correctly record the associated compensation expense. If a company is unable to correctly record the results of its operations, it may find obtaining a clean audit opinion to be a difficult, if not impossible, task.

Now that I have warned you about the headaches that you may encounter on the “accounting” side of issuing stock options, let me further alarm you with the tax ramifications. If a company sets the stock option exercise price lower than the fair market value of its stock on the grant date, the stock option could be deemed to be deferred compensation according to Internal Revenue Code 409A. Under 409A, such deferred compensation would be immediately taxable to the employees receiving the grant and subject to regular income tax rates plus 1%. Perhaps even more distressing, a 20% penalty plus interest would also be triggered. In addition, employers would be responsible for withholding income taxes for employees on these types of option grants, which if not done, could result in additional tax penalties. The immediate taxability, penalty and withholding requirements do not apply when the stock option exercise price is equal to or greater than the fair market value of the company’s stock on the grant date. It is impossible to compare the exercise price of a stock option to the fair market value of a company’s stock unless a valuation of the company’s stock has been performed. In addition, when a valuation has been performed to establish the fair market value of a company’s stock, the burden of proof shifts to the IRS to disprove the appraised value. Therefore, unless there is documentation to support the fair market value of a company’s stock near the option grant date, there could be significant tax issues in addition to the accounting issues alluded to earlier.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit us tomorrow for Part 3: What to Do?

In the meantime, visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.
 

When selling your home, it is common to use an agent to list, promote and show the property. In exchange, you pay a portion of the sales price as a commission to the agent. The benefits of using an agent include: 1) the listing of your home in a database so that homebuyers can access information about it; 2) the agent acting as your middleman during the negotiation process; and 3) the incentive it gives the agent to sell your home quickly (so that her or she can earn their commission). 

Some people choose to sell their home by owner and forego using an agent. These are typically the homes that have “For Sale” signs in their yards for many months, sometimes even years (you know the ones), before they are actually sold. These people often believe that the benefit of not having to pay an agent commission on the sale of their home is worth the prolonged period it will likely take to sell the property. 

What does the choice of hiring a real estate agent or selling your home by owner have in common with private companies issuing stock options? The strange answer is: Much more than many of us realize. 

The Stock Option Landscape

More and more private companies are issuing stock options as part of their key employees’ compensation plans. This may be driven by the ideas that: 1) stock options don’t “cost” anything to the company; 2) stock options will positively influence employees’ performance; or 3) since public companies issue stock options, it must be a good idea and private companies should follow suit. Regardless of the motivation, what most private company owners and executives do not realize is that accounting for stock options, for both tax and financial reporting purposes, may actually have an out-of pocket cost that is greater than the value of the options themselves.

In order to value stock options issued by private companies, there are two major steps that must be undertaken:

1. Determining the value of the company’s equity (which is a key input to valuing a stock option)

2. Determining the value of the stock option

There are not many privately-held companies with the in-house resources or expertise necessary to perform either of the requirements above, both of which are essential in accounting for the issuance of stock options. This often puts accountants in the awkward position of trying to explain to business owners the “unseen” costs and accounting ramifications associated with issuing stock options.

Back to our analogy, hiring a valuation expert to determine the value of stock options is much like hiring a real estate agent to sell your home. A valuation expert is able to perform both of the tasks identified above that are necessary to value the stock options issued by a private company, much like a real estate agent takes care of the necessary steps to sell your home. This work is not free, however, and depending on the complexity of the company and the options issued, the cost to value a private company’s stock options can range in cost from thousands to tens of thousands of dollars. When private companies issue stock options, they often do not consider the “commission” that they will have to pay to a valuation expert to ensure that the options are properly valued. Unlike real estate agent commissions, however, which are based on the sale price of the home, valuation fees are relatively fixed. 

Just like selling a home “by owner,” some companies will issue stock options and try to determine the value themselves (or even worse, not value them at all). By not using a real estate agent, homeowners often find themselves making no headway in the sale of their home. Similarly, by not hiring a valuation expert to value the stock options that they have issued, private companies create the risk that their auditors will not sign off on their financial statements. Maybe even more importantly for business owners and employees, unsubstantiated option values leave both companies and their employees in danger of stiff tax consequences.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit us tomorrow for Part 2: The Accounting and Tax Ramification of Issuing Stock Options

In the meantime, visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.

Advisor Insights

With the passage of the the Patient Protection and Affordable Care Act both businesses and individuals will be feeling major effects of this bill in the coming years. To help you better understand how this bill impacts you and your business, we have put together several resources that you should find useful.

Health Care Reform Webinar

On May 5th, our own Jim Sacher participated in a Smart Business Live webinar presentation on health care reform. You can view the outline from his presentation here or you can view the webinar here.

Health Care Reform Blog Posts

Earlier this year, we covered many of the effects of health care reform in our blog:

• Effects of Health Care Reform on Small Businesses
• Effects of Health Care Reform on Employers
• Effects of Health Care Reform on Individuals
• Offsetting the Cost of the Health Care Package: Revenue Raisers
• Health Care Reform & Medical Expense Deduction
• Health Care Reform & FSAs and HSAs
• Health Care Reform & Market Sector Fees
• Health Care Reform & High-Cost Plans
• Health Care Reform & Additional Medicare Tax

For more information on the tax treatment of healthcare coverage for adult children under age 27, please click here.

Healthcare Reform Article

Finally, keep an eye out for the June issue of CPA Voice where my article on the tax implications of health care reform on individuals will appear. We will provide a link to the article in the June Special Delivery e-newsletter.

If you have any questions on how health care reform may affect you or your business, please contact me at 440-449-6800 or jsacher@skodaminotti.com. 

Six Ways to Improve Debt Collection

In the current economy, it is not enough to generate sales. It is just as important to ensure that your business is actually paid for your services or products. That is why debt collection is increasingly becoming a concern of small-business owners.

When pursuing debt collection activities, be careful to avoid violating any federal laws designed to protect debtors, including the Fair Debt Collection Practices Act and related legislation. In brief, you may be fined or forced to pay damages, or both. State law may also restrict these practices. In addition, debtors may be able to initiate civil actions.

The key is to maximize collections for your business without exposing it to liability.

Click here for six practical suggestions.

Are You in the AMT Danger Zone?

The alternative minimum tax (AMT) was originally designed to ensnare only the wealthiest individuals. But this "stealth tax" has been steadily hitting a far wider group of taxpayers than initially intended. If you are in danger of incurring AMT liability, you should familiarize yourself with the rules.

Basic premise: The AMT runs on a separate track beside your regular tax liability. After you have figured out your regular taxable income, your AMT liability must be computed.

Click here for the four basic steps.

Aurum Capital Markets Summary 

Please click here for a summary from Aurum Wealth Management Group on the performance of the major market indices through the end of April as well as a recap of the significant events influencing the markets.

Worker's Compensation: Reminder to Businesses Participating in Group-Rating Programs

The Ohio Bureau of Worker's Compensation Board passed a rule that requires group participants that have experienced a workers' compensation claim in the past two years (2007 and 2008) to complete two hours of safety training by 6/30/2010. If you have not completed your training by June 30, 2010, you will lose your group discount. 

For more information on how you can comply with this training requirement, including a low-cost and easy to use on-line training system, please contact Roger Gingerich at 440-449-6800 or rgingerich@skodaminotti.com.
 

This month’s issue of Valuation & Litigation Advisory Insights includes the following articles:

• Lucent Sheds Light on Patent Infringement Damages
• Valuing Pass-Through Entities vs. C Corps
• What’s Behind the Veil? Digging for the Truth in Alter-Ego Cases

Lucent Sheds Light on Patent Infringement Damages

Courts are generally loath to disturb a jury’s verdict on damages. But an appeals court threw out a $350 million patent infringement award that wasn’t supported by substantial evidence. This case illustrates the need for detailed expert testimony, which will establish credible evidentiary facts and conclusions and, thus, support a claim for patent infringement damages.

Click here to read this article.

Valuing Pass-Through Entities vs. C Corporations  

Valuing interests in pass-through entities can be deceptively complex. This complexity stems from a mismatch between the data commonly used to value privately held companies and the tax benefits associated with pass-through entities. But, in recent years, several analytical models have been developed which provide a more accurate picture of a pass-through entity’s economic benefits.     

Click here to read this article.

What’s behind the veil? Digging for the truth in alter-ego cases 

When a plaintiff can’t collect a judgment from a corporation and seeks to obtain it from the corporation’s owners, it may try to show that the corporation and its shareholders lack separate identities — that is, the corporation is the owners’ alter ego. Key factors in determining an alter-ego relationship include not only this lack of separateness, but also financial dependence of the corporation upon its shareholders or parent, and undue influence upon a corporation.

Click here to read this article.

Prior issues are available in the E-Newsletter Archive of our Valuation & Litigation Advisory Services Resource Center. If you would like to subscribe to this free, monthly, business valuation and litigation support e-newsletter, send an email to info@skodaminotti.com.

2010 Real Estate and Construction Survey

Skoda Minotti is conducting our 3rd annual survey of the Northeast Ohio real estate and construction industries. Every participant who completes the questionnaire will receive a free copy of the survey results and analysis and have a chance to win a $50 gift card to Dick's Sporting Goods.

The goal of the survey is to provide professionals in the real estate and construction industries in Northeast Ohio with the invaluable insight into their industries.

As an added bonus, one out of every 20 survey participants will be randomly selected to receive a $50 gift card to Dick's Sporting Goods. Note that only the first 100 survey participants will be eligible for the gift cards, so act quickly.

Click here to complete the real estate or the construction survey.

Please feel free to contact Bob Goricki at bgoricki@skodaminotti.com or 440-449-6800 with any questions related to the survey.

Green Building & Green Leasing: What is it, and why should I care?

By Peter D. Brosse, Esq., Meyers, Roman, Friedberg & Lewis

Since the establishment of Earth Day, the creation of the Environmental Protection Agency (EPA), and issues brought to public light by the Oil Embargo in the early 1970's, Americans have become more sensitive to the environment and use of resources, including petroleum. However, we still continue to use many of the same chemicals, gasoline and other resources as we did before, subject, however, to regulation.  Recently, a revolution has begun with new attention to conserving energy and resources. This new "green revolution" is evident with the use of a new vernacular that has entered into our common language. Only a few years ago, such words as "green","sustainable," "renewable energy," "greenwashing," "LEED" and "Energy Star" were rarely, if ever, used.  Today, these are part of everyday speech. Nowhere has this "green revolution" been more evident than in the real estate industry.  Such words as "building green" and "green leasing" are commonly heard and many articles are written about the subject. When discussing green building and green leasing, the question that owners, developers and tenants typically ask is "What is it, and why should I care?"

Is there a difference between "green" and "sustainable?"

Yes, there is a significant difference.  When one considers green building or green leasing, it is really sustainability and not "green" that is the focus. "Green" generally means to be environmentally friendly. To be "sustainable" means more. When one refers to sustainability, it takes into consideration the life cycle of a product or a building. To say a product is sustainable, one needs to look at processes, procedures, materials, how the product is manufactured, and whether the product can be reused or ultimately finds its way to the landfill.

Click here for more of this article.

Residential Real Estate: Making Modifications Work
By Brian Bader

Lew Ranieri, often credited with creating the mortgage-backed securities industry when he was at Salomon Brothers in the early 1980s, has returned to try to save America from the worst effects of that accomplishment. In 2008, Ranieri established the Selene Residential Mortgage Opportunity Fund, raising money primarily from foundations and pension funds, to buy and restructure failed mortgages created to feed the securitization process. In doing so, he is showing how mortgage modifications can work - and why the federal home-owners modification program (HAMP) has done so poorly by comparison.

Click here for more of this article.

CMBS: Special Servicers
By John Tax

Special servicers are the firms trying to correct mortgage loans in the later stages of delinquency or in actual default. Their role has become increasingly important as a result of the tremendous number of troubled loans According to a report by Standard & Poor's (S&P), servicers have been training their staffs to address the unique aspects of these loans, packaged as commercial mortgage-backed securities (CMBS). Almost 50 percent of these unresolved assets are loans originated in 2006 and 2007. Many of the loans are more complex than older ones, which mean it takes longer to resolve them, either by a full workout, a discounted payoff or foreclosure sale. Because of the time period in which they originated, many of the newer loans lack some of the safeguards present in the commercial loans originated before 2004.

Click here for more of this article.

Securitization: Covered Bonds
By Anthony La Malfa

The use of covered bonds as a source of home-mortgage funds is being encouraged by the U.S. Treasury Department and the Federal Deposit Insurance Corporation (FDIC) because they offer much greater certainty for the bondholders with respect to damages and rights.

Covered bonds contain a key element that is missing in many commercial mortgage backed securities (CMBS), i.e., a double layer of protection for investors, with the asset being backstopped by the issuer of the securities. The key difference between CMBS and covered bonds is that the latter requires lenders to retain the default risk. On the other hand, covered bonds fail to provide a good option for private labels because they require a capital base to retain loans on balance sheets and do not provide the higher level of leverage that was available with CMBS.

Click here for more of this article.

Leases: Subordination Clause Could Harm Tenants
By David Tevlin

Commercial lease agreements often are long and complex, with clauses neither party may expect will ever be triggered by events. But sometimes they are. One such is the lease subordination clause, by which the tenant agrees the lease is subordinate to any present or future mortgage that the landlord may put on the property. Accordingly, foreclosure of a mortgage (depending on the law of the state involved) either will automatically terminate the lease or entitle the lender, at its option, to terminate the lease.

Click here for more of this article.

Legal View: Second Circuit Rejects Champerty Defense
By Alvin Arnold

Champerty is not a word often heard these days, even though it is a living doctrine in modern law and on occasion has real bite. In a recent case, the Second Circuit Court of Appeals reversed a trial court ruling that had dismissed a mortgage trust's suit for indemnification for loan losses from the originator. Trust for Certificate Holders of Merrill Lynch Mortgage Investors v. Love Funding Corp., 391 F.3d 116 (C.A.2, N.Y.). However, the reasoning of the decision leaves some room for the distressed debt markets to be concerned.

Click here for more of this article.

Migration: Major Shifts
By Andrew Dalecki

Every type of real estate - housing, business, retail, and office - is impacted by population movements across the U.S. and across its borders. In its most recent report, based on new Census numbers, the Brookings Institution says the past ten years saw the greatest migration slowdown since the end of World War II. Significant events were the housing bubble and the worst recession in more than half a century, as well as major storms and terrorist attacks.

Click here for more of this article.

Cleveland Market Overview

Signs are pointed towards recovery for commercial real estate in Cleveland.  The vacancy rate was down over the previous quarter, with net absorption totaling positive 293,238 square feet in the first quarter.  In fact, with the exception of the Southwest and Downtown's Financial and Warehouse submarkets; all markets posted a positive overall net absorption for the first quarter of 2010.  The Cleveland office market ended 1st Quarter with a slight decrease in the overall vacancy rate, 21.8%, as sublease space outperformed direct deals.  Another good sign; rental rates are stabilizing, ending the first quarter at $17.90 per square foot. 

Nationally, as job losses abate and turn into employment gains across various industries and geographies, more markets are moving towards recovery.  This includes Cleveland because we lacked the high stock of inventory that plagued more developed markets (Las Vegas, Phoenix, Florida).  Cleveland should be in a good position to rebound quicker than other markets and continue to see an increase in activity and deal flow.

More information on the real estate markets in North America is available courtesy of Jones Lang LaSalle .  For questions on this information, please contact Andrew Coleman or J.R. Fairman at (216) 861-7171.

This month’s issue of Valuation & Litigation Advisory Insights, includes the following articles:

• Struggling Economy Presents Business Valuation Challenges
• Nonpublic Information Considered in Valuing Securities
• Are Valuations Recyclable?

Struggling Economy Presents Business Valuation Challenges     

In bad times, appraisers may face a disconnect between the income and market approaches, creating a wide gap between valuations. The challenge becomes reconciling these differences. This article explains how to approach valuation for both profitable and distressed companies, and notes that the purpose of a business valuation can have a big impact on the valuation methods that are used. A sidebar looks at one case in which a court rejected the uses of the discounted cash flow method by both the creditors’ and the debtors’ experts.

Click here to read this article.

Nonpublic Information Considered in Valuing Securities

In one recent case, a district court held that it was reasonable for a jury to conclude that material nonpublic information possessed by the defendants affected the fair market value of certain securities. The case is significant because it seems to offer a novel interpretation of the phrase "reasonable knowledge of relevant facts" in the definition of fair market value. The decision suggests that even nonpublic information can be a "relevant fact."     

Click here to read this article.

Are Valuations Recyclable?

The paper a valuation report is printed on may be recyclable, but in most cases the content is not. This article points out that recycling valuations poses two major problems: First, the value of a business or other asset can change dramatically over time — in some cases, overnight. Second, a valuator’s methods depend to a large extent on the valuation’s purpose.  The article discusses the problems that can ensue when business owners are tempted to stretch their valuation dollars by using a single valuation for several different purposes.

Click here to read this article.

Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free monthly e-newsletter, send an email to info@skodaminotti.com.

The Tax Court has held that, under the regs, a land surveying firm is treated as performing engineering services even though it employed no engineers. As a result, the Tax Court found that the firm was a qualified personal service corporation subject to a flat 35% tax rate.

Background. C corporations generally are subject to tax at graduated rates on their taxable income. (Code Sec. 11(b)(1)) The benefits of the graduated rates phase out after taxable income reaches a specified amount. By contrast, qualified personal service corporations are subject to a flat 35% tax rate. (Code Sec. 11(b)(2))

A corporation is a qualified personal service corporation if it meets the function and ownership tests: 

• Substantially all of its activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting. “Substantially all” means that 95% or more of the time spent by the corporation's employees, serving in their capacity as employees, is devoted to performing such services. Brokerage services, including commission-based financial services, are exempted from consulting services.
• Substantially all (95% or more) of the stock (by value) is held directly or indirectly by: employees performing the services or retired employees who had performed such services; or the estates of such employees, or any other person who, during the two-year period starting with the date that such an employee died, acquired that individual's stock because of his death. (Code Sec. 448(d)(2); Reg. § 1.448-1T(e)(4))

Facts. Kraatz & Craig Surveying Inc. (Firm) is engaged in land surveying in Tennessee. Land surveying is Firm's only activity. It does not employ any licensed engineers, is not associated with any firm that employs licensed engineers, and does not provide any services that State law requires to be performed only by a licensed engineer.
IRS determined a deficiency of $9,762 in Firm's Federal income tax for its tax year ending Dec. 31, 2005. In the notice of deficiency, IRS determined that Firm is a qualified personal service corporation under Code Sec. 448 subject to a flat 35% tax rate under Code Sec. 11(b)(2).

Parties' arguments. Firm argued that it did not meet the function test because it was not engaged in any of the types of services specified in the statute. Firm did not dispute the ownership test.

IRS argued that Firm's land surveying constituted the performance of services in the field of engineering pursuant to Reg. § 1.448-1T(e)(4)(i), which specifically treats land surveying and mapping as engineering.

Firm argued that the reg was invalid. Alternatively, it argued that if the reg is valid, it means that surveying and mapping services, if performed by an engineer, would qualify as services in the qualifying field of engineering. Under this argument, the reg would not apply in Firm's situation since it has no engineers.

Firm said that the Court should look to State law to decide whether surveying is in the field of engineering. Firm also contended that land surveying in Tennessee can be performed only by a licensed land surveyor and that it is not licensed to perform any activity which State law requires to be performed by a licensed engineer.

Court sides with IRS. The Tax Court held that whether a service is performed in a qualifying field under Code Sec. 448(d)(2) is to be decided by examining all relevant indicia and is not controlled by State licensing laws. It found that Reg. § 1.448-1T(e)(4)(i) is supported by the legislative history, by the ordinary meaning of the term “civil engineering,” which encompasses surveying, and by other indicia that surveying is regarded as within the field of engineering. As a result, it concluded that the reg is valid. Accordingly, it held that Firm's land surveying is a service performed in the field of engineering under Code Sec. 448(d)(2) and Firm is subject to the flat 35% income tax rate under Code Sec. 11(b)(2).

The Moral of the Story.  Professional service firms that may provide personal services that subject the Corporation to the flat 35% income tax rate should consider all viable options for organizing the business.  Other options of business organization may allow the stakeholders to take advantage of graduated rates.

References: For the tax rate for qualified personal service corporations, see FTC 2d/FIN ¶  D-1006 et seq.; United States Tax Reporter ¶  114.02; TaxDesk ¶  600,901 et seq., TG ¶  650. Information Courtesy: Thomson Reuters

International Financial Reporting Standards (IFRS) exist as an alternative to U.S. generally accepted accounting principles (GAAP) as issued by the Financial Accounting Standards Board (FASB).  Designed to replace the “rules based” GAAP with a more principles based approach, FASB has been working with the international standard setters to conform and converge GAAP to IFRS.

The SEC has recently signaled their support for a switch to IFRS by 2015, so long as progress continues to be made in a number of areas.  For private companies, there is actually an IFRS–lite version (called IFRS-SME for Small and Medium sized Entities) that came out in 2009 and is a mere 230 pages, as contrasted to the 10,000+ pages of today’s GAAP.

CPA’s are now able to issue reports on either IFRS or GAAP. 

During 2010, the FASB has signaled that proposals will be forthcoming to continue the convergence in the following key areas:

• All leases, including operating leases, will likely be capitalized onto the balance sheet
• Financial reports will need to be comparative, not just show a single year
• The cash flow statement will need to be presented on a “direct” method to provide more information about operational cash inflows from customers, and cash outflows to vendors and employees

So, what are the differences between GAAP and IFRS-lite?  Here is our short list:

• Prepaid insurance and other expenses: Will be shown within trade and other accounts receivable under IFRS.
• LIFO inventory method: Will not be permitted under IFRS as a way to save on taxes.
• Deferred loan and other financing fees: Will no longer be spread over the life of the loan under GAAP’s matching concept, but rather would be expensed in the year paid under IFRS.
• Intangible assets, such as customer lists acquired in a business combination: Will no longer be stated separately from goodwill, but rather would be included as one category, subject to both amortization over a maximum of 10 years AND subject to an annual impairment test.  This may be attractive to some companies, as it avoids the expense of having an outside financial valuation consultant perform a study to allocate business combination consideration into buckets.
• Costs of a business combination: The former GAAP rule to include these costs as a part of the combination has been retained by IFRS.  Under current GAAP since 2009, these are period expenses.
• Internally developed software: Would always be a current period expense under IFRS.
• Fixed assets: Large assets would be separated into individual components, something that is only rarely done under GAAP.

Other, less common areas where there could be differences include revenue recognition in certain areas (including the completed contract method), some elements of balance sheet presentation, accounting for restructuring costs, lease escalation clauses, and pending litigation matters.  Under IFRS, there is greater flexibility in valuing stock options and doing asset impairment evaluations.  There is little or no industry specific guidance. 

We think having options is a good thing.  If you would like more information, post a comment below, call Pete Metzloff at 440-449-6800 or take a look at the IFRS web site at www.iasb.org.
 

This month's issue of Valuation & Litigation Advisory Insights includes the following articles:

• IP Valuation Using the Relief From Royalty Method
• Valuation Critical Under New M&A Rules
• Putting a Price on Technology

Click here to read this article.

Valuation Critical Under New M&A Rules  

Sweeping changes to the accounting rules for mergers and acquisitions (M&A) will start affecting many companies that are closing deals this year. FASB SFAS No. 141(R), Business Combinations, was issued in late 2007, but it applies to deals closing on or after the first day of the first annual reporting period beginning after Dec. 15, 2008. This article explains how many of the changes prescribed in this 358-page document increase the importance of having accurate valuations.      

Click here to read this article.

Putting a Price on Technology

Valuing technology-related intellectual property (IP) can be an enormous challenge for lawyers and valuation experts. It considers the degree of legal protection associated with technology IP as well as the economic benefits a company is expected to derive from that protection. Typically, valuation experts analyze the various economic benefits associated with a technology IP asset separately, and will use different approaches depending on whether  a patent is associated with developed technology, in-process research and development, or future technology. There are a variety of contexts in which the need to value technology IP can arise.

Click here to read this article.

Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free monthly e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, post a comment below or please contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

Investment banking fees are one of the biggest costs in any acquisition.  Since the 263(a) regulations were issued in December, 2003, the documentation requirements for deducting such fees under Treasury Regulation §1.263(a)-5(f) have resulted in significant controversy between taxpayers and the IRS.

In general, under Treasury Regulation §1.263(a)-5(a), a taxpayer must capitalize amounts paid to facilitate an acquisition of assets that constitute a trade or business and stock acquisitions.  An amount is paid to facilitate a transaction if it is paid in the process of investigating or otherwise pursuing the transaction.  With respect to an amount paid that is contingent on the successful closing of a transaction, Treasury Regulation §1.263(a)-5(f) provides the documentation requirements to support a deduction for fees allocable to activities that do not facilitate the transaction.  In short, the documentation, which must be completed contemporaneously with the tax return for the taxable year in which the transaction closes, must consist of more than merely an allocation between the activities that facilitate the transaction and activities that do not facilitate the transaction.  The documentation must consist of supporting records such as time records, itemized invoices, or “other records.”

Under a recent Technical Advice Memorandum’s (“TAM”) facts, a taxpayer hired a private equity firm and investment banker to assist with a potential sale of the Company.  The Company agreed to pay the private equity firm and investment banker a lump-sum contingent fee if a sale was consummated within a certain time frame.  After the successful transaction, the private equity firm and investment banker invoiced the Company, but neither provided a detailed breakdown of the services rendered by time or fee.  The Company then hired an accounting firm to conduct a transaction cost study to determine what portion of the fees was deductible or capitalizable.  At issue were spreadsheets created in connection with the study, based on discussions and correspondence with representatives of the private equity firm and investment bankers. 

The IRS said the Company was required to capitalize costs incurred to facilitate the transaction.  To the extent the Company could demonstrate that some activities provided by the private equity firm and the investment banker were allocable to activities that did not facilitate the transaction, the Company could deduct a portion of the fees paid.  The IRS argued that the Company failed to provide sufficient documentation that a portion of the success-based fees was attributable to non-facilitative activities and thus amounts were to be capitalized under §263(a).  The Company argued that the spreadsheets prepared by the accounting firm qualified as “other records” and hence were sufficient to meet the documentation requirements even though the documentation did not include time records or detailed invoices.  Since private equity firms and investment bankers do not keep time records or provide itemized invoices like law firms and accounting firms, the Company was unable to provide time records or itemized invoices to support its allocation.

The TAM acknowledges that the term “other records” is not defined, and there are no limitations on the type or source of documentation that can qualify for such.  Thus, any document, whether or not labeled a “time record” or “itemized invoice,” can serve to establish the deductible portion of success-based fees, and this is true even where the document was not produced directly by the service provider (i.e., private equity firm or investment banker) but was based on interviews of employees who had worked for the service provider.

The TAM is favorable to taxpayers because it makes it easier to support a deduction for success-based fees.  The IRS National Office has clearly stated that Treasury Regulation §1.263(a)-5(f) should not be read in a manner that would automatically preclude the deductibility of non-facilitative costs simply because the taxpayer is unable to provide time records or itemized invoices.

For more information on fees related to mergers and acquisitions, post a comment below or contact our Transaction Advisory Services Group at 440-449-6800.

This issue of Construction Connections includes the following articles:

• 2010 Construction Outlook
• Ten Steps to Safety
• Lost Productivity Damages
• Surety Market Update

The construction market ended 2009 in as bad a shape as it has been in for almost two decades, with non-residential construction plummeting and housing construction at record post-World War II lows. For the overall economy, however, the year ended with a host of indications that recession was morphing into recovery.

Some of the boldest pronouncements came from the National Association of Business Economists (NABE).  NABE conducted its annual meeting in October in St. Louis, and made headlines by declaring that the Great Recession was over. On the heels of their annual meeting NABE published its 2010 outlook. The forecast contained a number of major points:

• Gross domestic product will grow at a 3.2% rate for all of 2010 (this is an upward adjustment from NABE's earlier forecast).
• The jobless recovery will turn to a recovery adding jobs in the first quarter of 2010. NABE's economist panel predicted a decline in unemployment to 9.6% by fourth quarter 2010.
• Household spending will remain sluggish but the housing will gain momentum. Experts forecast a 38% jump in housing starts and an 8% increase in residential investment in 2010 due to low prices and low interest rates.
• Business investment will be the main engine of growth in 2010
• Corporate profits will climb 12.4% in 2010
• The dollar will remain weak. Short-term interest rates will remain below one percent and inflation will not be a problem in 2010.

Click here for more of this article.

Ten Steps to Safety
By Joseph Ventura, Safety Controls Technologies

The construction industry has struggled for many years with the answer to the question, "Can Management Prevent Accidents or Are Workers Responsible for Their Own Actions?" In the litigious society that we live, it has become more important to find someone "at fault" for an accident than it is to find out how we can prevent it from ever happening again.  Consider this:

• 20% of the nation's workplace fatalities occur in the construction industry
• The construction industry has the highest number of occupational injuries - 10% of all industries
• The cost of accidents accounts for approximately 6.5% of all construction dollars spent
• Construction companies with an effective written safety program have 36% lower accident rates, on average
• Maintaining a good safety record for at least two or three years can reduce a company's workers' comp and general liability insurance (GLI) premiums by as much as 40%

Most successful companies subscribe to the theme that "all accidents can be prevented." They institute training and qualification programs, safe performance incentives, and culture change; yet we still see construction accidents that result in lost time, and occasionally death, which is extremely costly in the shortsighted measure of money and, in real terms, impact to the worker's family.

Click here for more of this article.

Constructing a Claim for Lost Productivity Damages
(as seen in our Valuation & Litigation Advisory Insights e-newsletter)

Quantifying the cost of lost productivity when a construction project is disrupted through no fault of the contractor is a difficult challenge. An unanticipated disruption of the project typically causes the contractor to work less efficiently, which can lead to additional labor, equipment and material costs. This article explains that appraisers can use several methods when quantifying lost productivity damages, depending on the particular job's facts and circumstances and also notes that lawyers and damages experts need to work together closely to establish lost productivity and measure it appropriately.

Click here to read this article.

Surety Market Update

In early fall 2009 the National Association of Surety Bond Producers (NASBP) held it national seminar in Washington DC and, as you might imagine, the mood was less than cheery.

The association released its mid-year and 2009 projected results, which showed a 28.9% loss ratio, more than double the loss ratio for 2008. Beyond the negative results, the prevailing feeling that losses will continue to mount throughout the coming year influenced the mood. After five straight years of significant profits the surety industry is bracing for a difficult year in 2010; and it's making the kinds of adjustments that usually accompany a recessionary cycle.

Click here for more of this article.

Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free quarterly e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, post a comment below or please contact our Real Estate & Construction Group at 440-449-6800.

This month's issue of Valuation & Litigation Advisory Insights includes the following articles:

• Constructing a Claim for Lost Productivity Damages
• Marketability Discounts
• Clues Abound

Constructing a Claim for Lost Productivity Damages           

Quantifying the cost of lost productivity when a construction project is disrupted through no fault of the contractor is a difficult challenge. An unanticipated disruption of the project typically causes the contractor to work less efficiently, which can lead to additional labor, equipment and material costs. This article explains that appraisers can use several methods when quantifying lost productivity damages, depending on the particular job’s facts and circumstances and also notes that lawyers and damages experts need to work together closely to establish lost productivity and measure it appropriately.

Click here to read this article.

Marketability discounts: Appraisers relying less on empirical study averages 

With the widespread availability of public market databases, spreadsheet software and other analytical tools, valuators are no longer relying solely on empirical study averages to determine marketability discounts. They’re now placing greater emphasis on how to identify what truly affects marketability and how to better match empirical data to the specific attributes of each subject company. However, though pre-IPO and restricted stock studies may be somewhat under siege, their data is still worthwhile. Research has generated several insightful hypotheses.     

Click here to read this article.

Clues abound: The tax return as an investigative tool

Tax returns can be a highly effective investigative tool in fraud and divorce cases, shareholder litigation, and other situations in which a defendant may have hidden assets. In fact, virtually every page of a tax return can provide clues to hidden assets. Income from wages, taxable refunds of state or local taxes, and retirement plan distributions are just a few of the items on a 1040 that a valuator will review.
 
Click here to read this article.

Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free monthly e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, post a comment below or please contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

If you asked my Grandpa what the rate of return on his investments is, he would probably scratch his head and say, “Huh?” The only return that he knows (even though he doesn’t necessarily understand it) is the .5% that he earns on his savings account with the local bank. If you asked my Dad the same question, he might say that he earns a few percentage points per year. His investments are being allocated in a more conservative fashion as he nears retirement. In my case, most of my retirement investments are in equities. My investments have much greater risks than my Dad and Grandpa’s, but they also present opportunities for much greater returns.

Out of my family’s three generations of investments, the “safe” savings account investment of my Grandpa (which could be debated in light of the wave of bank failures over the past year), has the lowest levels of both risk and return. My Dad’s investments have a higher level of risk, but a correspondingly higher rate of return. Finally, my investments have the highest rate of return out of the group, but also the most risk that the return will not be realized (leaving me with less money than I invested).

The concept of risk vs. return is important in the valuation of any business. The lower the risk associated with an investment, the lower the required returns. In contrast, the riskier that an investment is, the higher the return it should provide to an investor. The value of an ownership interest in a company typically moves opposite of the level of risk and required return, as summarized below:

High Risk = High Required Returns = Lower Company Value

Low Risk = Low Required Returns = Higher Company Value

One of the abilities that a valuation analyst brings to the table is his or her ability to determine an appropriate rate of return for an investment in a company. As discussed above, once the rate of return is determined (as a function of the level of risk), it plays a key role in concluding on the value of a business. Keeping in mind the general relationship between risk and return can help anyone better understand the value of a business, regardless of their level of valuation experience. 

Looking for business valuation assistance in Cleveland or Akron? Contract our Business Valuation Group at 440-449-6800 for more information.

Often times when negotiating financing terms for commercial real estate, prospective buyers assume that simply classifying the debt on a building as “Non-Recourse” debt will remove the personal liability of the owners.  As many potential investors have come to realize, banks and other lending institutions are becoming increasingly savvy in the wording of their lending documents with the use of “Carve Out” clauses.  Carve out clauses attempt to protect that lending institutions rights, as well as the value of the property.  In most cases, the carve out clause ultimately forces the borrower to either (1) continue paying the mortgage or (2) forfeit the property to the bank.  In either case the Carve Out clauses protect the bank from costly litigation.

Below is a list of popular carve out clauses that recently appeared in our Real Estate Monitor e-newsletter (click any of the clauses for a link to the full article with further detail):

• Initial term recourse
• Top-of-the-loan recourse
• Property taxes and mechanics liens
• Fraud or misrepresentation
• Milking the property

If you are interested in receiving our Real Estate Monitor on a regular basis, please click here to send us an email with “Real Estate Monitor” in the subject line and we’d be glad to add you to our list. You can also contact our Real Estate and Construction Group at 440-449-6800.

With the recent declines in the real estate market, it is important that you ensure your commercial property is valued correctly for real estate tax purposes. In 2009, many Ohio counties reappraised or updated their real property values for the tax year. These new valuations apply through 2012.

Despite the declining real estate market, it is our understanding that most tax values for commercial properties were not lowered for the 2009-2011 tax years in many Ohio counties. Owners of commercial property have until March 31, 2010 to contest the new valuations.

If you own high value properties (office; industrial; apartments) we encourage you to review these updated tax values. We would be glad to discuss with you if a challenge makes sense and also refer you to legal professionals who are equipped to handle these matters.

Please contact our Litigation Advisory Services Group at 440-449-6800 if you have any questions regarding this matter.
 

This month's issue of Valuation & Litigation Advisory Insights includes the following articles:

• Finding the Appropriate Valuation Standard
• How Valuators Assess the Rising Risk of Fraud
• Lost Profits or Lost Value?

Finding the Appropriate Valuation Standard           

Valuation isn't static and can change depending on the purpose of the valuation. This article looks at the three most common standards of value: fair market, investment and fair. It briefly defines each standard and discusses the circumstances in which one standard may be more appropriate than another. The article points out that identifying the appropriate valuation standard up front can minimize confusion down the road. The goal is to arrive at a reasonable and supportable value conclusion in light of all the surrounding facts and circumstances.

Click here to read this article.

 
How Valuators Assess the Rising Risk of Fraud

The current economic downturn has produced an upswing in incidents of occupational fraud, so it's imperative for businesses to step up efforts to deter and detect it. An important part of the valuation process is identifying potential risks and gauging whether management has taken appropriate action to mitigate those risks. This article explains how valuators evaluate internal controls and corporate culture, tailoring their analyses of fraud risks based on the subject company's size, complexity, industry and goals.    

Click here to read this article.
 

Lost Profits or Lost Value?

Lost profits and lost business value are common measures of damages in commercial litigation. They're also a common source of confusion. What do they have in common? How are they different? Can a plaintiff recover both? This article addresses these questions. A basic understanding of the similarities and differences between lost profits and lost business value can help build a case for business damages or challenge an opponent's calculations.

Click here to read this article.


Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free monthly e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, please contact our Valuation & Litigation Advisory Services Group at 440-449-6800.