< PreviousA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 30 MARCH | APRIL 2020 t h e v a l u e e x a m i n e r 2. Critical access hospitals (CAHs) are no longer required to (a) limit the number of beds to 25 or (b) limit patient length of stay to 96 hours. 3. The requirement that acute care hospitals house acute care patients and psychiatric patients in distinct units separate from the rest of the hospital has been waived. 4. Lost or damaged durable medical equipment (DME) may be replaced without a face-to-face patient encounter. 5. Providers already licensed in one state may now practice in another state without a license. 6. Providers (both physicians and nonphysician practitioners) may receive expedited temporary Medicare billing privileges, waived application fees, and waived background checks. 7. States may apply for section 1135 waivers, which would allow their Medicaid programs to relax various restrictions, allowing them to: a. Reimburse out-of-state licensed providers under the state’s Medicaid program; b. Authorize providers to provide care in alternative settings; and c. Suspend prior authorization requirements.11 Recent Federal Reserve Actions In response to the economic instability, the Fed (a governmental agency) has also made a number of drastic moves to offset the greater market panic resulting from COVID-19: 1. On March 15, 2020, the federal funds rate was reduced 1 percent to between 0 and 0.25 percent.12 2. On March 15, 2020, the Fed directed the Open Market Trading Desk (the Desk) to increase holdings to $500 billion in Treasury securities and $200 billion in mortgage-backed securities in the coming months.13 11 “CMS Approves Medicaid Section 1135 Waivers for 11 Additional States in Response to COVID-19,” Centers for Medicare & Medicaid 12 “Transcript of Chair Powell’s Press Conference Call,” Federal Reserve Board, March 15, 2020, FOMCpresconf20200315.pdf (accessed 3/17/20). 13 “Statement Regarding Treasury Securities, Agency Mortgage-Backed 3. On March 17, 2020, a lending facility was established to support short-term commercial debt markets (similar to what was used during the Great Recession).14 These unprecedented measures are the most aggressive since the Great Recession, the most significant economic downturn since the Great Depression, which lasted from December 2007 to June 2009.15 Subsequently, on March 23, 2020, the Fed announced additional, broader measures, including: 1. Removal of the March 15 limit on the purchase of treasury securities and mortgage-backed securities. The Desk will make purchases in “the amounts needed” to support smooth market functioning and effective transmission of monetary policy to the broader economy. 2. Establishment of new credit programs to support up to $300 billion in financing to employers, consumers, and businesses. 3. Establishment of two facilities to support credit to large employers—the Primary Market Corporate Credit Facility, to provide new bond and loan issuance, and the Secondary Market Corporate Credit Facility, to provide liquidity for outstanding corporate bonds. 4. Establishment of the Term Asset-Backed Securities Loan Facility to support credit to consumers and businesses. 5. Expansion of the Money Market Mutual Fund Liquidity Facility to include additional securities, including municipal variable rate demand notes and bank certificates of deposit, in order to facilitate the flow of credit to municipalities. 6. Expansion of the Commercial Paper Funding Facility to include high-quality, tax-exempt commercial paper and reduction of facility pricing.16 Securities, and Repurchase Agreement Operations,” Federal Reserve Bank of New York, March 15, operating_policy_200315 (accessed 3/17/20). 14 “Federal Reserve Board announces establishment of a Commercial Paper Funding Facility (CPFF) to support the flow of credit to households and businesses,” Federal Reserve Board, March 17, 2020, federalreserve.gov/newsevents/pressreleases/monetary20200317a.htm (accessed 3/17/20). 15 Jim Chappelow, “The Great Recession,” Investopedia, March 10, 2020, 16 “Federal Reserve announces extensive new measures to support the A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r MARCH | APRIL 2020 31 Despite these measures, financial market conditions have remained volatile:17 1. As of March 16, 2020, the Dow Jones Industrial Average, the Standard and Poors 500 (S&P 500), and the Nasdaq indices have all entered bear market territory (a fall of more than 30 percent from recent highs).18 2. Selloffs in the S&P 500 have triggered multiple trading halts. 3. All 11 sectors of the S&P 500 have seen considerable stock price declines. 4. Stocks of airline and cruise industries have tumbled more than 20 percent. 5. International financial markets have seen precipitous declines. 6. Most multinational corporations project a decline in earnings due to the pandemic. 7. The U.S. dollar has surged against all major currencies, an indication of stressful market periods.19 8. A record number of Americans, 5.25 million, filed for unemployment benefits the week ending April 11, 2020.20 The total number of Americans filing for unemployment benefits exceeds 22 million, the greatest since the Great Depression.21 Valuation Implications The financial market conditions above will impact valuations performed on or after December 31, 2019.22 Previous Black Swan Events, i.e., an unpredictable event that is beyond economy,” Federal Reserve Board, March 23, gov/newsevents/pressreleases/monetary20200323b.htm (accessed 3/26/20). 17 Caitlin Ostroff, Joanne Chiu, and Caitlin McCabe, “Stocks Plunge 10% in Dow’s Worst Day Since 1987,” The Wall Street Journal, March 12, 2020, (accessed 3/12/20); William L. Watts, “Stocks Plunge at Opening Bell, Triggering Trading Halt,” Marketwatch, March 16, marketwatch.com/story/stocks-plunge-at-opening-bell-triggering-trading- halt-2020-03-16 (accessed 3/16/20). 18 Caitlin McCabe, Anna Hirtenstein, and Chong Koh Ping, “Dow Plummets Nearly 3,000 Points as Virus Fears Spread,” Wall Street Journal, March 16, 19 Caitlin Ostroff and Joe Wallace, “Dollar Surges as Investors Seek Shelter From Market Disruption,” Wall Street Journal, March 17, 20 “Unemployment Insurance Weekly Claims,” Department of Labor, April 16, 2020, normal expectations for a situation and has potentially severe consequences (such as the Great Recession),23 as well as evaluation of current events and market conditions, can help provide guidance for the impact upon the valuation of healthcare enterprises, assets, and services. Valuation Approaches for Healthcare Enterprises, Assets, and Services The impact of the financial market conditions above on the valuation of healthcare enterprises, assets, and services will partially depend on the valuation approach utilized. The three general valuation approaches are: 1. Income approach Valuation methods under the income approach seek the present value of anticipated future economic benefits that will accrue to the willing buyer of the business, asset, or service. In addition to estimating the future economic benefits of post-transaction ownership, an appropriate discount rate— risk-adjusted for the property interest—by which the benefits are discounted to present value, must also be developed. 2. Market approach Valuation methods under the market approach are premised on the foundation that actual transactions of similar property interests guide value. The efficient market hypothesis posits that prices derived from well-functioning, publicly traded markets are reflective of all pertinent information available to the participants in the market, i.e., a price derived from market transactions represents the market consensus present value of the expected future economic benefit to be received from the ownership of the enterprise, asset, or service by a willing buyer. 3. Asset/cost approach Valuation methods under the asset/cost approach seek an indication of value by determining the cost of reproducing or replacing an asset or providing a service. No matter which valuation methodology is selected, economic value is quantified as the expectation of future 21 “U.S. now has 22 million unemployed, wiping out a decade of job gains,” Washington Post, April 16, 2020, business/2020/04/16/unemployment-claims-coronavirus/ (accessed 4/17/20). 22 Lari Masten, “Business Valuation Considerations—Living with 23 Jim Chappelow, “Black Swan,” Investopedia, March 11, 2020, investopedia.com/terms/b/blackswan.asp (accessed 3/26/20).A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 32 MARCH | APRIL 2020 t h e v a l u e e x a m i n e r economic benefit to be derived from the ownership or receipt of the property or service, respectively. Impact on the Valuation of Healthcare Enterprises and Assets Hospitals and other healthcare enterprises will see significant financial impacts from the cancellations of financially vital procedures. In a recent survey of orthopedic surgeons, interventional cardiologists, and anesthesiologists, 23 percent of responding physicians noted an increase in deferrals or cancellations of procedures, and 55 percent of responding physicians expected that deferrals and cancellations will continue to increase.24 While cancellations of elective procedures have been primarily initiated by patients, the need for additional inpatient capacity at healthcare facilities could drive a further reduction in elective procedures,25 especially given the direction from the CDC that hospitals in affected regions cancel non-urgent procedures for an indefinite time26 and the recommendation from professional societies, such as the American College of Surgeons, that hospitals be prepared to call off all elective surgeries during the pandemic.27 Cancellations of profitable cardiac and orthopedic elective surgeries will undoubtedly hurt hospital margins. In addition to the loss of revenue from elective procedures, there will also be increased costs related to space, supplies, and staffing needed to respond to COVID-19 cases. According to S&P Global Ratings, hospitals could see up to a 20 percent decline in admissions for up to six months.28 S&P Global Ratings has lowered its financial outlook for hospital companies LifePoint and Tenet Healthcare due to the pandemic and the effects on revenue.29 These factors could lead to a negative impact on the short-term economic benefits that would be derived from ownership in healthcare enterprises and assets, even with current legislative actions. The long-term impact of the COVID-19 outbreak on U.S. economic growth and the U.S. healthcare industry is currently uncertain. This uncertainty may also present significant opportunities for healthcare providers, especially for those providing telehealth services.30 In fact, the temporary rollback of regulations has increased demand for telemedicine services 10- to 20-fold.31 In addition to adoption and provision of telehealth services, there is an increase in the use of additional tools and technologies to help manage patient outcomes, such as remote clinical observation and disease management, improved communication tools, self-service diagnostics and self-care tools, predictive analytics and knowledge management, artificial intelligence, informational chatbots, cross-industry collaborations, and innovative care models.32 Those companies and providers that can make this transition, or already have, may (1) differentiate themselves from their competition and guideline comparables (which may lead to a higher indication of value under market-based methods); or (2) provide enhanced economic benefit of ownership with reduced uncertainty (which may increase value under The long-term impact of the COVID-19 outbreak on U.S. economic growth and the U.S. healthcare industry is currently uncertain. 24 Tara Bannow, “Doctors report canceled procedures amid COVID-19,” Modern Healthcare, March 11, providers/doctors-report-canceled-procedures-amid-covid-19 (accessed 3/16/20). 25 Chad Mulvany, “COVID-19 outbreak will negatively impact U.S. hospital finances,” Healthcare Financial Management Association, March 16, 2020, covid-19-outbreak-will-negatively-impact-us-hospital-finances.html (accessed 3/16/20). 26 Melanie Evans and Anna Wilde Mathews, “Hospitals Push Off Surgeries to Make Room for Coronavirus Patients,” Wall Street Journal, March 16, 2020, 27 “COVID-19: Recommendations for Management of Elective Surgical Procedures,” American College of Surgeons, March 13, org/covid-19/clinical-guidance/elective-surgery (accessed 3/17/20). 28 Sara Hansard, “Coronavirus Outbreak Threatens to Slash Hospital Admissions,” Bloomberg Law, March 26, com/health-law-and-business/coronavirus-outbreak-threatens-to-slash- hospital-admissions?context=search&index=4 (accessed 4/16/20). 29 Ibid. 30 Jonathan Manis, “There’ll be no ‘back to normal’ for healthcare after COVID-19 crisis,” Modern Healthcare, March 25, modernhealthcare.com/opinion-editorial/therell-be-no-back-normal- healthcare-after-covid-19-crisis?utm_source=modern-healthcare-daily- finance-wednesday&utm_medium=email&utm_campaign=20200325&utm_ content=article6-headline (accessed 3/27/20). 31 Erin Brodwin and Casey Ross, “Surge in patients overwhelms telehealth services amid coronavirus pandemic,” Stat, March 17, 32 “There’ll be no ‘back to normal’ for healthcare after COVID-19 crisis” (see n. 29).A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r MARCH | APRIL 2020 33 income-based methods); both of which may have a positive impact on value. In addition, those companies and providers that have already spent the resources, time, and funds may increase value under a cost-based method. Further, it is important to note that when considering income- based valuation methods, up to 75 percent of the value could exist in the terminal period (i.e., the period beyond the short- term discrete projection of economic benefits).33 The long- term impact of the COVID-19 outbreak on the valuation of healthcare enterprises and assets remains to be seen. However, the long-term prospects of those companies that are positioned to deliver care in a high-quality, cost-effective manner in the post-COVID-19 world may outweigh any short-term negative impact on valuations from COVID-19. Impact on the Valuation of Healthcare Services The majority of compensation arrangements have not factored in compensation during extreme public health crises such as the current COVID-19 outbreak. Regulatory guidance will continue to change around compensation arrangements that are revised or entered into during and after the outbreak. Currently, there is strong demand for essential services in the emergency departments and intensive care units at the epicenter of the COVID-19 outbreak, and hospitals are attempting to redeploy specialists who do not typically treat infectious diseases to meet the excess demand.34 There may be a need to change compensation arrangements to provide payment to these providers for working extra hours and facing additional risk. The amount of hazard pay that providers would qualify for would depend upon the selection of an appropriate proxy for the determination of the hazard pay premium and would likely vary on a case-by-case basis as some providers may already work in inherently dangerous environments and some amount of compensation may already be factored into existing arrangements. Certain qualitative factors may also impact the necessity for hazard pay, such as situations where there is insufficient personal protective equipment for providers, which would require providers to reuse equipment and increase risk of infection.35 Physicians and nonphysician providers delivering nonessential services under provider services agreements (PSA) will likely experience a near-term decline in productivity due to the limitation or cancellation of elective procedures. Hospitals may consider converting affected specialists to a fixed salary or stipends to temporarily stabilize their income and minimize the impact to these specialists. On March 30, 2020, CMS published “Blanket Waivers of Section 1877(g) of the Social Security Act,” wherein the HHS Secretary waived certain requirements under the Stark Law (subject to certain conditions), including: 1. Remuneration between an entity and a physician (or the physician’s immediate family member) that is above or below fair market value for: a. “services personally performed by the physician (or the immediate family member of the physician) to the entity”; b. “items or services purchased by the entity from the physician (or the immediate family member of the physician)”; c. The use of premises or for items or services purchased, medical staff incidental benefits; d. Nonmonetary compensation that surpasses the current Stark Law limit of $300 per year; and e. Remuneration resulting from a loan with an interest rate below fair market value. 2. Rental charges between an entity and a physician (or the physician’s immediate family member) that is above or below fair market value for the lease of office space or equipment.36 CMS provided specific examples wherein these blanket waivers may apply, including a hospital compensating a physician above the contracted rate in recognition of “particularly hazardous or challenging environments.”37 33 Shannon P. Pratt and Roger J. Grabowski, Cost of Capital: Applications and Examples,” 4th ed. (Hoboken, NJ: John Wiley & Sons, 2010), 34. 34 Tara Bannow and Maria Castellucci, “Hospitals redeploy specialists to COVID-19 front lines,” Modern Healthcare, March 30, 2020, modernhealthcare.com/hospitals/hospitals-redeploy-specialists-covid-19- front-lines (accessed 3/30/20). 35 Matthew Wetzel, Stephen Bucci, and Jason Ruchaber, “Fraud and Abuse: Impact of COVID-19 on Health Care Fair Market Value,” March 30, 2020, in AHLA’s Speaking of Health Law, podcast, com/221709/3174793-fraud-and-abuse-impact-of-covid-19-on-health-care- fair-market-value (accessed 3/30/20). 36 Note that these waivers are retroactive to March 1, 2020. “Blanket Waivers of Section 1877(g) of the Social Security Act Due to Declaration of COVID-19 Outbreak in the United States as a National Emergency,” Centers for Medicare & Medicaid Services, covid-19-blanket-waivers-section-1877g.pdf (accessed 3/31/20). 37 Ibid.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 34 MARCH | APRIL 2020 t h e v a l u e e x a m i n e r While these waivers provide needed relief to healthcare providers, this does not eliminate the need for a fair market value analysis in order to comply with fraud and abuse laws. Fair market value of these arrangements will vary on an individual basis and adequate documentation for the necessity of these arrangements will reduce regulatory risks should the arrangement be subject to scrutiny in the future.38 Further, documenting the commercial reasonableness of these arrangements may prove vital to substantiating the extraordinary circumstances of the change in compensation, as a commercial reasonableness opinion may serve to set forth the qualitative aspects of such an arrangement and provide the reasoning behind compensation changes. In addition to the above, existing pay-for-performance compensation models may require normalizing adjustments for the period impacted by COVID-19. Future physician compensation arrangements will need to take into consideration normalizing adjustments to industry normative benchmark compensation data for 2020. Some healthcare systems are temporarily reducing nonessential physician compensation, which may impact the compensation reported in that data.39 Conclusion While the focus of healthcare providers and regulators is, appropriately, on the access to and delivery of care to those impacted by the COVID-19 outbreak, the regulatory scrutiny related to fraud and abuse issues will persist. This current uncertainty creates a plausible scenario wherein a valuation professional may be required to deviate from industry normative benchmark data to account for those specific facts and circumstances related to a given transaction. As a result, valuation professionals opining on these transactions should utilize an evidence-driven methodology that includes both qualitative and quantitative assessments of the specific facts and circumstances related to the transaction, document their consideration of these facts and circumstances, and articulate their ultimate applicability to the transaction in support of their opinions. Todd A. Zigrang, MBA, MHA, FACHE, CVA, ASA, is president of Health Capital Consultants, where he focuses on the areas of valuation and financial analysis for hospitals and other healthcare enterprises. Mr. Zigrang has significant physician-integration and financial analysis experience and has participated in the development of a physician owned, multispecialty management service organization and networks involving a wide range of specialties, physician owned hospitals, as well as several limited liability companies for acquiring acute care and specialty hospitals, ASCs, and other ancillary facilities. Email: Jessica L. Bailey-Wheaton, Esq., serves as vice president and general counsel of Health Capital Consultants, where she conducts project management and consulting services related to the impact of both federal and state regulations on healthcare exempt organization transactions, and provides research services necessary to support certified opinions of value related to the fair market value and commercial reasonableness of transactions related to healthcare enterprises, assets, and services. Email: jbailey@ healthcapital.com. VE While these waivers provide needed relief to healthcare providers, this does not eliminate the need for a fair market value analysis in order to comply with fraud and abuse laws. 38 Patsy Powers, “Physician compensation relationships in the time of COVID-19,” Chambers and Partners, March 26, 2020, com/articles/physician-compensation-relationships-in-the-time-of-covid-19 (accessed 4/30/2020). 39 “Intermountain cutting doc pay as COVID-19 impacts service lines,” Modern Healthcare, March 28, physician-compensation/intermountain-cutting-doc-pay-covid-19-impacts- service-lines (accessed 3/30/20).A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r MARCH | APRIL 2020 35 healthcare sessions moderated by Todd Zigrang and Jessica Bailey-Wheaton of Health Capital Consultants. They’ve assembled an amazing panel of experts who will address a wide variety of healthcare valuation issues, including the Valuation Implications of COVID-19. Another great session is Dealing with Cybersecurity Risk in Business Valuation, presented by Raymond Hutchins and Dave Miles. TVE: I can’t help but notice that many of the session topics are especially relevant in light of recent events. Jones: True. One that really blows my mind is Karen Kaseno’s session on The Epidemic of Financial Elder Abuse and How We Can Help—an important issue before that couldn’t be more relevant today. Another interesting one is Mark Norris’s session on Determining Consequential Damages— Lost Business Value vs. Lost Profits. Always an important topic, but especially relevant to our current situation. Also, there are several sessions on how to rebuild and strengthen a firm’s brand, including The New Rules of Marketing— What’s Working Now, presented by Lee Frederiksen. This information will prove to be very valuable for our members as they adjust to doing business in a new world. TVE: Thank you for your time. I look forward to virtually seeing you in June. Jones: Likewise. Thank you. Brien Jones is a seasoned association execu- tive with extensive professional experience in continuing professional education man- agement, online/distance learning, business development, member recruitment/reten- tion, operations management, conference and event planning, marketing, graphic design, public relations, social media strategies, copywriting, and supporting association governance. He has been employed with NACVA and the CTI for over twenty years supporting the organizations and their industry partners in a leadership capacity. 4. No data left behind. Watch out for sensitive data left on personal devices or storage media. Ideally, remote workers would use corporate servers or cloud-based storage. Otherwise, Stephens recommends having them store data on an external hard drive that can be taken to the office when normal operations resume. 5. Enable remote access to office computers. By leaving office computers on, Stephens says, you can take advantage of tools that “[give] you access to all the files on the device and network; it also means that you have access to all the applications installed on the computer.” The downside is that leaving computers on 24/7 increases the risk of unauthorized access. To minimize the security risk, Stephens recommends “asking your IT staff to enable Wake-on-LAN (WoL) on your computer,” which “essentially allows you to turn on your computer remotely.” It is also a good idea to review the security settings in online collaboration tools, such as Zoom, to help ward off embarrassing or damaging intrusions by hackers. An Evolving Situation The COVID-19 landscape is changing on a daily basis. In the coming weeks and months, it will be critical for valuation professionals to monitor the situation, assess the impact on their clients and their practices, and adapt accordingly. Daniel Shiffrin, JD, is editor of The Value Examiner. He is also the owner of Dan Shiffrin Communications, a company that provides legal and financial writing and editing services for professional service firms and other businesses, and vice president and managing editor of CPA Leadership Institute. VE VE Uncharted Territory: Continued from page 11 Navigating the New Reality: Continued from page 7A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 36 MARCH | APRIL 2020 t h e v a l u e e x a m i n e r R.D. Clark and Sons, Inc. et al. v. James Clark, et al. • Court: Appellate Court of Connecticut • Argued: September 9, 2019 • Officially released: December 10, 2019 • Citation: 194 Conn. App. 690 In this case, which involved a dispute over the buyout of a family business’s minority shares, the Connecticut appellate court addressed several important valuation issues. Notably, the court upheld the trial court’s decision not to tax-affect the company’s earnings in determining the fair value of the shares, despite the fact that both the plaintiffs’ and defendants’ experts had done so. The court also upheld the trial court’s findings that (1) the company engaged in shareholder oppression and, therefore, the value of the minority shareholder’s interest would not be subject to a minority interest discount, and (2) the value of the minority interest should not be reduced by a discount for lack of marketability. The appellate court downplayed the impact of its decision on future rulings on these issues, however. Emphasizing that valuation is a factual determination, the court limited its analysis “to the holdings of the trial court and the corporation’s specific challenges to them.” Facts of the Case R.D. Clark and Sons, Inc. was formed in 1984 in Connecticut by Robert D. Clark to operate a specialty freight trucking business. The company, which was organized as an S corporation, was owned in equal one-third shares by Robert Clark and his two sons, John Clark and James Clark. When Robert died in 2011, his daughter, Carolyn Manchester, assumed his shares. The three siblings served as officers and directors of the company until they had a falling out in late 2011, when James was terminated from his position as a driver and occasional dispatcher. In February 2012, James resigned from his positions as officer and director. In 2014, the company and its other shareholders brought an action against James and his new business, Smart Choice, for breach of fiduciary duty, alleging that James had improperly used proprietary information to start a competing venture. James filed a counterclaim seeking dissolution of the company on grounds of shareholder oppression. In lieu of dissolution, the company elected to purchase James’s shares at fair value, pursuant to Connecticut law. In February 2016, the plaintiffs withdrew their complaint. At the same time, James filed an amended counterclaim alleging that the company had a practice for many years of providing shareholders with funds to cover their pass-through shares of the company’s income tax liabilities but that James had not received such payments for the years 2012, 2013, and 2014. James claimed that this conduct was oppressive. The parties were unable to agree on the shares’ fair value or the terms for their purchase, so the matter was presented to the trial court. After a trial and several other hearings, the court determined that the company’s value as of December 31, 2014, was $2,356,719 and that the fair value of James’s shares was $785,573. The court also ruled that: (1) because the company, through its majority shareholders, engaged in oppressive conduct, the value of James’s shares was not subject to a minority interest discount; (2) the shares’ value should not be reduced by a marketability discount; and (3) James was entitled to statutory attorney and expert witness fees and expenses plus post-judgement interest. Ultimately, in June 2017, the court awarded James $983,028.09, including fees and expenses, plus post-judgement interest at 2.25 percent, payable over ten years. LEGAL INSIGHTS Courtside View Valuation Perspectives from the Bench “Courtside View” highlights recent decisions by federal and state courts addressing significant valuation and economic damages issues. These cases offer valuable insights to business valuation and forensic litigation services professionals that can help them develop sound, defensible valuation and damages analyses, and present them more effectively in court. By Kimberly Tavares, CVA /////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// ///////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r MARCH | APRIL 2020 37 Appellate Court’s Analysis On appeal, the plaintiffs challenged the trial court’s valuation of James’s interest, claiming the court erred by: •Not tax-affecting the company’s earnings, •Not applying a minority interest discount, and • Not applying a discount for lack of marketability. Tax-Affecting Expert witnesses for both sides valued the company under an income approach and each decreased the corporation’s normalized earnings to reflect a pass-through tax rate. The plaintiffs’ expert applied a 25 percent tax rate and the defendants’ expert applied a 12.6 percent tax rate. The trial court declined to make any tax-affecting adjustment, and the company argued on appeal that this artificially inflated the company’s value. The appellate court noted that no Connecticut law mandates a specific approach to tax-affecting and the propriety of such tax adjustments is a subject of considerable debate in the courts of other jurisdictions. The court concluded that the trial court did not commit a reversible abuse of discretion by not tax-affecting, for several reasons: 1. The approach has considerable support in tax cases. 2. The trial court was tasked with determining fair value, not fair market value. 3. The issue of tax affecting continues to be a subject of debate among experts. 4. This case “seems particularly ill-suited to tax affecting earnings,” given the company’s practice— which was likely to continue—of extending loans to shareholders to cover their tax liabilities and then retiring those loans through the payment of bonuses. The appellate court emphasized that its decision was based on the facts of the case and “we discern no bright line rule in this area.” Minority Interest Discount In arm’s-length transactions, the value of a minority interest is typically discounted because a willing buyer would pay less for a noncontrolling interest in a closely held business. In this case, the trial court declined to apply a minority interest discount (and also awarded attorney and expert witness fees) because it determined that James had been subjected to oppressive conduct by the company’s majority shareholders. The finding of oppression was based on the fact that after James’s termination, even though he remained a shareholder, the other shareholders excluded him from the company’s long-standing policy of providing shareholders with funds to cover their pass-through tax liabilities. The company challenged the trial court’s finding of oppression on several grounds, arguing that: •It was customary practice to extend loans only to officers and directors, not to shareholders. •The decision to extend those loans was made not by shareholders, but by the company’s advisory board. •James failed to establish his tax obligations for the years in question. •Any alleged oppression occurred only after James petitioned for the company’s dissolution because any tax assistance he may have received for his 2014 tax obligations would not have been awarded until after the valuation date. The trial court rejected all of these arguments because they contradicted the evidence in the record or were based on testimony by witnesses found not to be credible. Marketability Discount The company argued that the trial court’s disallowance of a marketability discount was erroneous because it imposed an “undue financial burden” on the company. The appellate court disagreed. The court explained that the application of a marketability discount is generally disfavored when determining the fair value, versus fair market value, of a closely held corporation’s shares when those shares are to be purchased in lieu of dissolution and there is no actual sale of the shares in the open market. The trial court declined to make any tax-affecting adjustment, and the company argued on appeal that this artificially inflated the company’s value.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 38 MARCH | APRIL 2020 t h e v a l u e e x a m i n e r Although Connecticut law is silent on appropriateness of a marketability discount in valuing a dissenting shareholder’s interest, some courts apply such a discount under “extraordinary circumstances” in order to “promote fairness and equity to all parties.” The trial court noted that such extraordinary circumstances have been found to exist when “the full value of a buyout greatly exceeded certain measures of the corporation’s financial condition,” but that was not the case here. The trial court acknowledged that the company had been struggling financially but found that “the way to deal with this issue is in setting the terms and conditions of purchase not in applying an arbitrary percentage discount.” The appellate court found that the trial court had not abused its discretion by determining, after an examination of the relative finances of the company and the defendant’s shares, that there were no extraordinary circumstances warranting a marketability discount. The trial court addressed the financial burden of its judgment on the company by fashioning a 10- year payment plan to satisfy the judgment. But the company cannot, the appellate court explained, successfully claim an unfair financial burden merely because it might experience difficulty in making the payments. Conclusion The Connecticut appellate court’s decision in R.D. Clark and Sons, Inc. v. Clark addresses important issues regarding the application of tax affecting—as well as minority and marketability discounts—in buyout-related valuations. Although the decision offers little in the way of bright-line rules or other objective guidance for future courts or litigants, it highlights the fact-based nature of many valuation issues. As the appellate court explains: Valuation is a factual determination. In assessing the value of…property…the trier arrives at [its] own conclusions by weighing the opinions of the appraisers, the claims of the parties, and [its] own general knowledge of the elements going to establish value, and then employs the most appropriate method of determining valuation.... The trial court has the right to accept so much of the testimony of the experts and the recognized appraisal methods which they employed as [it] finds applicable; [its] determination is reviewable only if [it] misapplies, overlooks, or gives a wrong or improper effect to any test or consideration which it was [its] duty to regard.... In determining whether the trial court reasonably could have concluded as it did on the basis of the evidence before it, we will give every reasonable presumption in favor of the correctness of [its] action. (Citation omitted; internal quotation marks omitted.) Kimberly Tavares, CVA, is the founder of PacWest Accounting, Inc., a full-service accounting/litigation support firm that provides outsourced CFO advisory services as well as business valuation and forensic accounting services. She has served as an expert witness in San Diego and Orange counties in California, and has more than 18 years of experience preparing valuations in numerous industries, including technology, construction, healthcare, professional services, trucking, and manufacturing. Ms. Tavares graduated from California State University Fullerton with a BA in accounting. She is CFO of the Newport Beach Chamber of Commerce Board of Directors, a 2016 NACVA/ CTI 40 Under Forty honoree, and a nominee for the Connected Women of Influence 2018 President’s Award and the 2016 and 2018 Orange County Business Journal Women in Business Award. Email: VE The trial court noted that such extraordinary circumstances have been found to exist when “the full value of a buyout greatly exceeded certain measures of the corporation’s financial condition,” but that was not the case here. Duff & Phelps Cost of Capital Navigator: U.S. Cost of Capital Module PRICING U.S. Cost of Capital Module Basic (two most recent years) Single User . . . . . . . . . . . . . . . . . . . . . $295 . . . . . . . . . +$129 per Basic additional user U.S. Cost of Capital Module Pro (all years, 1999 to present) Single User . . . . . . . . . . . . . . . . . . . . . $595 . . . . . . . . . . +$299 per Pro additional user *The U.S. Cost of Capital Module Basic subscription has EVERYTHING contained in the regular Basic U.S. Cost of Capital Module, but limits the number of cost of capital analyses/downloads based on your subscription level. The limits are three cost of capital analyses/downloads for Silver, seven for Gold, and ten for Platinum. Data is updated quarterly. Duff & Phelps Cost of Capital Navigator: U.S. Cost of Capital Module (Basic*) NOW INCLUDED IN KeyValueData® Titanium continues to include the U.S. Cost of Capital Module (Pro). Silver, Gold, or Platinum subscriptions. Duff & Phelps Cost of Capital Navigator: U.S. Cost of Capital Module DATA INCLUDED IN THE U.S. COST OF CAPITAL MODULE SIZE PREMIA AND RISK PREMIA g CRSP Deciles 1–10 size premia, plus the 10th Decile split g Risk Premium Report Size Study size premia and “risk premia over the risk-free-rate” g Risk Premium Report Risk Study “risk premia over the risk-free rate” gHigh-Financial-Risk Study size premia and “risk premia over the risk-free rate” g Comparative Risk Study (fundamental risks of companies comprising Risk Premium Report Size Study portfolios) RISK-FREE RATES g Spot long-term risk-free rates (from the Federal Reserve, updated daily) g Duff & Phelps long-term normalized risk-free rate (adjusted for impact of flights-to-quality, actions of the Federal Reserve, and inflation expectations) U.S. EQUITY RISK PREMIA (ERPS) g 1926–present Historical (i.e., realized) ERP g1926–present Supply-side ERP g Duff & Phelps Recommended ERP (reflecting current point in business cycle) “SIZE” TABLES Includes CRSP Deciles Size Study and Risk Premium Report size premia tables that are viewable within the Navigator. ESTIMATE WACC Develop into weighted average cost of capital (WACC) estimates. ENHANCED OUTPUTS Export more robust and comprehensive documentation of the user’s cost of capital assumptions, sources, analysis, and results as PDF or in Excel. EXCEL ADD-IN This powerful new tool enables users to directly import cost of capital data in their own Excel spreadsheets. BETAS g Industry-level betas (Full- Information, Vasicek-Adjusted, Sum, and High-Financial-Risk Betas) gIndustry Risk Premia for use in the Build-up Method g Debt betas (for unlevering and relevering betas) COMPANY LISTS g List of companies used to calculate Full-Information Betas and Industry Risk Premia (updated quarterly) g List of companies used to calculate “Pure-Play” U.S. industry statistics (updated quarterly) The Duff & Phelps Cost of Capital Navigator is an interactive, web-based platform that guides valuators through the steps of calculating Cost of Capital, a key component of any valuation analysis . To learn more, visit www.NACVA.com/store_home.asp or call Member/Client Services at (800) 246-2488. NEW ENHANCED FEATURES NEW! Now Included in KeyValueData Bundles at no additional cost, OR BUY standalone! 1 1 4 5 2 3 2 3 4Duff & Phelps Cost of Capital Navigator: U.S. Cost of Capital Module PRICING U.S. Cost of Capital Module Basic (two most recent years) Single User . . . . . . . . . . . . . . . . . . . . . $295 . . . . . . . . . +$129 per Basic additional user U.S. Cost of Capital Module Pro (all years, 1999 to present) Single User . . . . . . . . . . . . . . . . . . . . . $595 . . . . . . . . . . +$299 per Pro additional user *The U.S. Cost of Capital Module Basic subscription has EVERYTHING contained in the regular Basic U.S. Cost of Capital Module, but limits the number of cost of capital analyses/downloads based on your subscription level. The limits are three cost of capital analyses/downloads for Silver, seven for Gold, and ten for Platinum. Data is updated quarterly. Duff & Phelps Cost of Capital Navigator: U.S. Cost of Capital Module (Basic*) NOW INCLUDED IN KeyValueData® Titanium continues to include the U.S. Cost of Capital Module (Pro). Silver, Gold, or Platinum subscriptions. Duff & Phelps Cost of Capital Navigator: U.S. Cost of Capital Module DATA INCLUDED IN THE U.S. COST OF CAPITAL MODULE SIZE PREMIA AND RISK PREMIA g CRSP Deciles 1–10 size premia, plus the 10th Decile split g Risk Premium Report Size Study size premia and “risk premia over the risk-free-rate” g Risk Premium Report Risk Study “risk premia over the risk-free rate” gHigh-Financial-Risk Study size premia and “risk premia over the risk-free rate” g Comparative Risk Study (fundamental risks of companies comprising Risk Premium Report Size Study portfolios) RISK-FREE RATES g Spot long-term risk-free rates (from the Federal Reserve, updated daily) g Duff & Phelps long-term normalized risk-free rate (adjusted for impact of flights-to-quality, actions of the Federal Reserve, and inflation expectations) U.S. EQUITY RISK PREMIA (ERPS) g 1926–present Historical (i.e., realized) ERP g1926–present Supply-side ERP g Duff & Phelps Recommended ERP (reflecting current point in business cycle) “SIZE” TABLES Includes CRSP Deciles Size Study and Risk Premium Report size premia tables that are viewable within the Navigator. ESTIMATE WACC Develop into weighted average cost of capital (WACC) estimates. ENHANCED OUTPUTS Export more robust and comprehensive documentation of the user’s cost of capital assumptions, sources, analysis, and results as PDF or in Excel. EXCEL ADD-IN This powerful new tool enables users to directly import cost of capital data in their own Excel spreadsheets. BETAS g Industry-level betas (Full- Information, Vasicek-Adjusted, Sum, and High-Financial-Risk Betas) gIndustry Risk Premia for use in the Build-up Method g Debt betas (for unlevering and relevering betas) COMPANY LISTS g List of companies used to calculate Full-Information Betas and Industry Risk Premia (updated quarterly) g List of companies used to calculate “Pure-Play” U.S. industry statistics (updated quarterly) The Duff & Phelps Cost of Capital Navigator is an interactive, web-based platform that guides valuators through the steps of calculating Cost of Capital, a key component of any valuation analysis . To learn more, visit or call Member/Client Services at (800) 246-2488. NEW ENHANCED FEATURES NEW! Now Included in KeyValueData Bundles at no additional cost, OR BUY standalone! 1 1 4 5 2 3 2 3 4Next >