Royalty Rates Part II: A Guide to Finding and Analyzing ... FVS Consulting Digest, we noted that ... 1 Royalty Rates Part II: A Guide to Finding and ... as a patent-only license

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FVS ConsultingIssues, cases, practice

management tips and news for Forensic and Valuation Services

Section members

Issue 17 – October 2013

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Royalty Rates Part II: A Guide to Finding and Analyzing Royalty By David R. Jarczyk

IntroductionIn Part I of this article in the last issue of the FVS Consulting Digest, we noted that until recently, common practice and legal precedent had established the 25% rule of thumb (the “25% Rule”) as an acceptable approach to approximating reasonable royalty rates that licensees would be willing

to pay to licensors, based on profit. On January 4, 2011, the United States Court of Appeals for the Federal Circuit changed that practice irrevocably when it deemed the rule inadmissible in the Uniloc USA v. Microsoft patent infringement case (the “Uniloc Ruling”). The impact of this ruling has been spreading across the world.

Chairman’s CornerAs I wrap up my final year as chair of the FVS Executive Committee, I’m very pleased with the many achievements that the FVS Section can point to during the last three years. One of the great things about this membership section is that it allows us to work together to

make a real difference on issues that are important to CPAs who practice in the FVS niche. Among the standout examples are our activities in the standard-setting process, where we’ve offered incisive comments on a discussion draft from the Appraisal Foundation on the valuation of customer-related assets and on the Appraisal Standards Board’s proposed changes to the communication and reporting aspects of USPAP. On the regulatory front, we worked with AICPA President and CEO Barry Melancon on his letter on a Senate bill that would exempt valuation analysts from the definition of fiduciary under ERISA. Such

efforts ensure our voice is heard and promote our members’ knowledge and competency.

I’m also happy to say that we have also continued to supply members with the resources they need to distinguish themselves in their field, as exemplified by our premier educational offering, the AICPA Forensic and Valuation Services Conference. Of course, our credentials are a significant tool not only for enhancing the competence of our practice area, but also for setting ourselves apart in the marketplace. The 15th anniversary of the ABV credential, which we celebrate this year, demonstrates the success and value of these qualifications.

I want to thank you for the very satisfying opportunity to serve as your committee chair. I hope to see you at the conference next month! g

Thomas F. Burrage, CPA/ABV/CFF, CVA

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WhAt’s InsIde

1 Royalty Rates Part II: A Guide to Finding and Analyzing Royalty

6 how Big data is Being Used and the Opportunity It Offers for CPAs

8 Valuation experts debate Value of a new York deli

10 Marketing a Business Valuation Practice

14 Coming events for FVs Professionals

Contact us

We welcome your comments, questions or article ideas.

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Join our new FVs LinkedIn subgroup!

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thOMAs F. BURRAGe

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In the wake of the Uniloc Ruling, it is clear that analysts will need to be as thorough as possible in performing due diligence to support their estimation of a reasonable royalty rate. Toward that end, a more defensible approach for determining reasonable royalty rates for infringement damages, for intercompany licensing, and for the transfer of intangibles involves the examination of third-party license agreements that are sufficiently similar to the subject situation or tested transaction.

Third-party licensing agreements may provide the most defensible source of fact-based evidence for several reasons. First, there is a substantial, publicly available repository of representative license agreements in the U.S. Securities and Exchange Commission EDGAR database, Canada’s SEDAR and other open information sources due to government regulations calling for public companies to file these material contracts. Second, an adequate percentage of these publicly available license agreements offer unredacted royalty rate information along with other licensing terms that are key factors of comparability, such as licensing parties, product descriptions, territories and exclusivity. Third, the licensing terms within these license agreements can offer arms-length comparable transactions, which can present an unbiased model from which to determine a reasonable baseline royalty rate or set of royalty rates for IP valuations.

Finding Fact-Based evidenceWhen seeking fact-based evidence as the basis for estimating a reasonable royalty rate, defining your search methodology based on the functional profile of the tested transaction is a key factor in performing due diligence.

Defining CriterionA prudent first step in defining the criteria of the search methodology begins with the identification of all

intangibles related to the subject situation or tested transaction. Types of intangibles include:• Manufacturing intangibles, such as

patents, inventions, formulations, recipes, processes, technical information, designs, patterns, or know-how;

• Marketing intangibles, such as trademarks, trade names, trade dress, brand names, or service marks;

• Copyrights and literary, musical, or artistic compositions;

• Franchises (or business systems);• Methods, programs, systems,

procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or training materials;

• Software or source code; and• Intangible generating services:

research and development, engineering, or marketing.

After the appropriate intangibles have been identified and inventoried as the basis for matching comparable transactions, a pivotal next step is to identify what key factors of the subject situation or tested transaction affect comparability and, therefore, the final results. Exhibit 1 on page 3 provides a list of comparability factors that should be considered when selecting royalty rates. These factors include:

• Existence of internal and external market royalty rates;

• The business relationship between licensor and licensee;

• The uniqueness of IP;• The profit potential of the IP; • The functions performed and risks

born by the licensor and licensee; • Exclusivity and restrictions on use;• The territory and field of use for the

granted rights; • The duration of the contract; and • The right to receive updates and

modifications.

These factors of comparability are generally accepted by global analysts, although perhaps not in this exact form. Having a referenceable list

of comparability factors developed beforehand is a useful method for ensuring a consistent critique of each license agreement.

sourcing License AgreementsFact-based evidence in the form of license agreements exists for each type of intangible. However, finding a defensible set of comparable transactions from license agreements can be an arduous process depending on the resource used.

There are a variety of sources for this information, but generally they can be classified into three main categories: government information databases (free), multi-purpose information databases (subscription-based), and royalty rate databases (subscription-based).

Government databases are often the most challenging resource for locating comparables, as these vast repositories were designed to accommodate a diverse audience seeking information for a wide range of purposes. In the U.S. SEC EDGAR database, for example, the available information is indexed very broadly and the key attributes that could help an analyst find comparable transactions in license agreements are not easily searchable. Further, license agreements in EDGAR are not necessarily filed in one intuitive location, such as exhibit 10 material contracts, (as many analysts believe), which increases the risk of missing a pivotal comparable. Not surprisingly, many analysts consider government databases more time-consuming and less reliable than other sources of market comparable data.

Multi-purpose information databases offer another resource for locating comparable license agreements but, in general, are similar to government databases in terms of the broad organization of their data. While most multi-purpose databases will have more sophisticated search tools, both the

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exhibit 1: ktMIne Road Map to Finding & Analyzing Royalty Rates

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manner in which the documents are indexed and the way the results are presented may not provide a clear and comprehensive fact pattern necessary for conducting a thorough comparables analysis.

Specialized royalty rate data providers offer another alternative information source and their tools and outputs tend to be aligned with the analyst’s specific needs when performing a license agreement search. Royalty rate data providers aggregate intangibles information and organize key terms into searchable attributes that can significantly streamline the search process. In addition to offering more sophisticated search filters, most royalty rate data providers will offer a summary of licensing terms and comparable criteria needed for each transaction matched within the defined search methodology. An example summary is shown in Exhibit 2 on page 5, which was provided by the ktMINE Royalty Rate Finder.

While summaries offered by royalty rate providers can offer a helpful snapshot of the license agreement, it is important to note that reading the full agreement text is still a critical step in performing due diligence. In fact, reviewing all licensing terms contained in a license agreement document is the only way to validate that those terms fully support the factual profile of the subject situation or tested transaction. Reading the full text will also provide assurance that the document itself is usable, as some databases occasionally provide royalty rates from trade journals, financial newspapers or magazine articles gathered from unusable sources. Royalty rate comparables from unsubstantiated sources, such as newswire listings, cannot be used in court or with tax authorities unless backed up by a full text, corroborating license agreement.

Analyzing Fact-Based evidenceOnce the search methodology has been employed and a set of potential

comparables has been found, the next steps in a prudent license agreement analysis are:• Perform an initial review of identified

license agreements (i.e., review agreement summaries);

• Perform a detailed review of appropriate agreements (i.e., review actual license agreements);

• Select comparable license agreements and, therefore, royalty rates; and

• Construct an arm’s length range.

Validating ComparabilityAs an analyst reviews potential comparable license agreements, a thorough and savvy examination of all licensing terms is critical. Exhibit 2 provides an example of a license agreement that has been summarized to show key licensing terms that can affect the comparability of one transaction to another.

In Exhibit 2, the synopsis details the rights being granted and for what type of intangible(s). In this case, the license agreement applies to a patented technology associated with medical systems for stents. All are key factors of comparability, as a patent-only license agreement would not be an appropriate comparable to use in benchmarking a trademark-only transaction.

In the next area, parties to the license agreement are captured –Filing Company, Licensor(s) and Licensee(s). This information is useful in ensuring that a transaction satisfies the criteria of being a third-party transaction, as opposed to a transaction between related parties, which will contain an unbiased market royalty rate(s).

The effective date is a key comparability factor, as it shows this transaction to be contemporaneous with market conditions of 2010, which may be quite different from those of previous years depending on the industry, type of IP, and other

relevant factors. Transactions taking place around the same time as the subject situation generally are more comparable than those that are older. Market conditions regularly change and a solid comparability analysis takes this into account.

The term field defines the length of the license agreement and provides necessary insight for an analyst trying to identify comparable agreements that are not expired or do not have a significantly different term than the subject situation.

The Agreement type field lists all applicable category(s) from which intangibles are being licensed in this license agreement. While the Agreement Type field provides good shorthand on the nature of the intangibles being licensed, it is wise to read the full text of the license agreement to see if there are any other conditions that could affect the comparability of this transaction. For example, if an analyst was looking to benchmark a royalty rate for a patent-only transaction and a comparable included licensing terms for both patent and know-how intangibles, this may call for an adjustment with respect to any royalty rates used. This is also an instance where the full license agreement would provide critical context and support for the adjusted calculation.

The Industry and sIC (Standardized Industrial Classification) fields may appear to go hand in hand here, but they are actually quite different in terms of reliability and results. The SIC code represents what was filed with the government database at the time of submission, if one was actually provided. If SIC is used as a search criteria and a means for rejecting transactions, the analyst should take note of the potential risks. First, filing companies do not always supply an SIC code when submitting their documentation.

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Second, the filing company SIC code may have no correlation whatsoever to the intangibles being licensed or the industry in which the licensee can exploit the intangibles, which means an analyst could overlook a pivotal comparable that was filed under a misrepresentative SIC code.

Case in point, in Exhibit 2, the summary shows an SIC code of 1000, which is the code used to designate mining activities. Yet the intangibles being licensed in this agreement are more closely related to the Healthcare: Products and Services industry. In fact, the filing company is in the healthcare industry. This is a perfect example of a mistake by the filing company. If an analyst were seeking intangibles related to the latter industries but only relied on an SIC search, this potential comparable might be missed.

Alternatively, a more reliable criterion to use (if available) when seeking intangibles from a particular vertical market may be Industry. In Exhibit 2, the Industry field documents all applicable industries directly related to the intangibles being licensed therein and the industries in which the licensee has the right to exploit the intangibles. Searching by Industry typically allows an analyst to more precisely, and more comprehensively, identify potential comparable transactions directly related to a particular vertical.

territory and exclusivity are both good indicators of the potential market impact from the agreement based on licensing reach, but territory is often one of the first factors dismissed in a litigation situation as being of lessor importance than other comparability criteria. This happens primarily

when there are relatively few license agreements in total for that geography. For instance, it is nearly impossible to find specific license agreements that exploit an intangible solely in Ireland, so it may be more likely to find a comparable agreement with coverage in Europe or the world than one from specific geographies.

Royalty Rates are key factors of comparability and the detailed summary in Exhibit 2 offers full breakdown of all rates within the license agreement, including tiers. In instances where a license agreement has tiered or multiple royalty rates – which can be for a single intangible, and/or across a group of intangibles – a thorough analysis of how each rate impacts the overall value is critical in approximating a reasonable royalty rate. Once again,

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exhibit 2: License Agreement summary

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reading the full license agreement is a vital step toward ensuring that comprehensive due diligence has been performed as it is the only way one can see, and address, all collateral transactions such as lump sums, milestone payments and other variables, that may impact the results of an analysis.

While there is no guidance on the appropriate number of comparables to choose − comparability could be determined by just one transaction − it is prudent to analyze any and all possibilities and to allow statistical calculations, such as data documenting an interquartile range, to assist in identifying a comparable range.

summaryFinding and analyzing fact-based evidence may provide the most defensible method for approximating reasonable royalty rates in the wake of the Uniloc Ruling. There is a substantial repository of fact-based evidence available in the form of third-party license agreement data and documentation, and specialized royalty rate data providers can provide analysts with an efficient and reliable portal to finding representative transactions. As a result, when comparable transactions are identified and analyzed with a thorough methodology and comprehensive search process, fact-based evidence can support the resulting analysis with proof of thorough

due diligence that can stand up in litigation matters. g

David R. Jarczyk is President and CEO of ktMINE, a global IP intelligence firm focused on delivering IP protection and competitive advantage to IP owners and stakeholders across the globe. This is part two of a three-part series. Part one offered an overview of the anatomy of license agreements and how to best analyze full text agreements. Part three presents market evidence from certain industries to show how different license deal structures and royalty rates can be, even at a high level.

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how Big data is Being Used and the Opportunity It Offers for CPAsBy Dr. Timothy A Pearson, CPA, CFF

Barry Melancon, president and CEO of the AICPA, has blogged that “CPAs are perfectly suited to take a leadership role in deciphering and using big data

to achieve strategic business goals.” Given the large numeric datasets accounting professionals encounter every day, extending our knowledge to understanding big data analytics and algorithms seems to be a necessity.

Using both big data and the cloud, with which it is associated, can be very beneficial to CPAs, forensic accountants and valuation experts, if we learn how to employ it to focus our efforts on critically important business or investigative outcomes. Cloud technology makes it possible to easily access vast stores of data. Big data enables us to pull together the vast amounts of digitized, online, public,

private and transactional data that permeate the digital environment. It is a natural result of living in a world where almost all forms of communication can be captured digitally, stored and retrieved. Electronic storage, memory, processing and bandwidth are becoming cheaper at an accelerating rate, making it more economical than ever for companies to conduct previously unimagined data-intensive approaches to analyzing information. We can include in our analyses “long” (very old) data, “dark” (previously unused incidental) data along with a wide variety of forms of data. If we work to organize and optimize our approach to the data available in digital form we can deal with previously unanswerable questions. Properly executed we can run Google-like searches, “if then” decision trees, and test for correlations that can lead us to better insights for our clients or the perhaps track down the bad guy(s). We need to understand the potential of unstructured data and tools like Hadoop and SQL. This is the future.

Putting It to WorkSome estimates indicate that the amount of data a typical business generates and stores doubles in size every year. One estimate of total data in the world is at 295 exabytes. Gartner, in particular, sees information volume growing worldwide at a minimum annual rate of 59%, with roughly 85% of that as “unstructured” – data such as video clips, RFID tags, and web site logs. This unstructured data is not readily suited for traditional data management systems. In addition, customers are also seeing increasing velocity of data as they now collect new data in real-time in many cases. Given such massive quantities of data at their fingertips, forward-thinking businesses are using it to examine decisions and evaluate patterns. Companies that have used these large data sets identify trends that improve marketing efficiency, spot potential clients and determine what resources can be repurposed to expand services into new markets. The growth in big data usage is directly linked to the development of

tIMOthY A. PeARsOn

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sophisticated and powerful algorithms. Often when people describe big data they take for granted the algorithms that will be used to crunch through the data. Algorithms are programs that test for analytical patterns, may connect qualitative data, and use red flags or trigger points to set new sequences of activity in motion. Right now, algorithms control the majority of equity trades in the U.S. financial markets. Up to 70% of Wall Street trading is now run by so-called black box trading. More directly, these algorithms monitor actions such as credit card use to instantly deny a suspicious transaction and close an account if the card’s use falls outside an algorithmic range.

Big data makes it possible to test hypotheses or make unexpected discoveries. That is the difference between structured data analytics and unstructured data predictions. Big data impacts how we prove who we are, what products are presented to us online and when we spend. It may also influence how we vote, how we learn, how we get health care and how we maintain our privacy.

Big data has been put to work effectively in numerous high-profile ways. One notorious example is its use by the federal government to filter through all sorts of communications metadata to spot potential terrorist activities. Some people have reasonable concerns about potential invasions of individual privacy when all our daily interaction and transactions using digital devices can be separated, deconstructed and reconstructed into patterns that may reveal some behavior we wish to keep to ourselves.

Elsewhere, under Securities and Exchange Commission and Financial Industry Regulatory Association rules, broker-dealers must implement a compliance archiving and monitoring solution to store and evaluate all electronic communications, such as email, attachments, instant messages,

social media and more. This archiving permits the employer and the regulator to evaluate the content and metadata of the communications for inappropriate communications of broker-dealers.

Big data approaches permit very fast and comprehensive analysis of alternative assumptions and algorithms used to narrow down ranges of value. In order to forecast, companies build predictive models, changing various inputs, such as rates for interest and inflation, direction of the market or expansion or contraction of local consumer services. These models rely on enormous data volumes that must then be cross-compared with actual market transaction behavior, often in real time or near real time. Big data approaches include the combing, capturing, cleaning and normalizing of data for decision making and prediction. Invariably big data approaches deal with one or more of the following: volume, velocity and variety. Savvy organizations find this is a critical business competency. Companies can use big data to better serve their customers, understand their risk exposure and reduce exposure to fraud and regulatory scrutiny.

Big data has expanded the reach of retailers. Nordstrom found a way to apply observation and data collection techniques used by online retailers in the physical world. Cellphone signals, smartphone apps and customer movements tracked by in-store software-enhanced cameras are the equivalent of the tracking cookies in Internet browsers. The Transportation Safety Administration also uses similar monitoring tools at airports.

Using Big data in InvestigationsInsider trading cases can incorporate data on an individual’s trading practices and track who they communicated with and when. In a recent case Scott London, a (now former) partner with KPMG, had been passing confidential information about public audit clients

(e.g., Herbalife) to his friend, a non-professional investor, Bryan Shaw. Regulators spotted unusual trading activity in Shaw’s small retail investment account. The SEC sent a civil subpoena to Shaw, asking him to explain his activity. Separately, the investigators were able to combine online trading records, files and metadata from computers, tablets and smartphone activity (including calls, dates, times, GPS, text messages). Using big data-enabled techniques, it was fairly easy to link Shaw and London.

Financial institutions are more susceptible than ever to fraud with the introduction of new access points to financial services offerings and the increased sophistication of the fraud perpetrators. Sometimes, customer behavior makes the fraud easy. Customers commonly create separate accounts for different service offerings without linking them. They may create a checking account for a relative without also giving them access to their savings. With multiple accounts sharing access to the overlapping financial products, a perpetrator can execute complex trades and transfers between apparently independent accounts to mask fraudulent behavior. Much in the same way that social networking companies identify unlinked relationships, anti-fraud teams search for connections that are implied by the detailed traces.

One area that is at the crossroad of big data, algorithms and accounting is electronic discovery. E-discovery is any process in which electronic data is sought, located, secured and searched with the intent of using it as evidence in a civil or criminal legal case. Typically the focus is on email, but any other digital evidence is fair game. E-discovery can be carried out offline on a particular computer or it can be done in a network. Court-ordered or government sanctioned hacking to obtain critical evidence is also a type of e-discovery.

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Valuation experts debate Value of a new York deliBy Sylvia Golden, JD, Legal Editor, Business Valuation Update

Ruggiero v. Ruggiero, 2013 n.Y. Misc. LeXIs 3698 (July 29, 2013) The death of a kosher deli owner set in motion a fierce public fight between his widow and the surviving owner, the decedent’s brother, over the value and rights to the business. To break the impasse, the court and parties turned to business appraisers.

For 25 years, two brothers ran a kosher deli in New York state in which they each owned a 50% interest. In August 2012, one brother died; by the end of the year, his widow sued

her brother-in-law (and the company), claiming he tried to force her and her family out of the business and requesting the appointment of a temporary receiver and an accounting. The surviving brother countersued, alleging the decedent had been stealing from the business and his widow had taken $25,000 from the corporate account without notice. After more charges flew back and forth, the court suggested that the parties engage expert appraisers. Both sides agreed.

Both sets of experts had access to the same documents, including copies of daybooks, the restaurant’s cash receipts,

the general ledger, vendor cards, and cash register tapes. A witness confirmed that the restaurant’s busiest period was between September and April—covering all the major Jewish holidays.

Plaintiff’s expert devises market approach. The expert for the widow rejected the traditional market approach because of his inability to identify similar businesses. He also rejected an income approach: There were inadequate sales data in the records the defendant (surviving brother) kept and gaps in the general ledger related to cash purchases, he was unable to reconcile payroll on the company’s books and records with cash payments,

The nature of digital data makes it extremely well-suited to investigation. For one thing, it can be electronically searched with ease and it is difficult or impossible to completely destroy, particularly once it gets into a network. This is because the data appears on multiple hard drives and because digital files, even if deleted, can be recovered. In fact, the only reliable way to destroy a computer file is to physically destroy every hard drive and demagnetize every piece of media where the file has been stored or may have been stored.

The data involved can include text, images, calendar files, databases, spreadsheets, audio files, animation, web sites and computer programs. Even malware and cookies can be secured and investigated. Email and text messages can be an especially valuable source of evidence in litigation, because people tend to be less careful in these exchanges than in written memos and traditional mail.

What CPAs have to OfferMany CPAs already have many of the skills required to make the most of big data, in particular the ability to capture accurate transactional data. They must

also incorporate and begin to master skills in modeling, multivariate statistics and econometrics. Hadoop and SQL are a part of the technical tools needed for executing big data projects. CPAs can rely on technical experts for data manipulation and retrieval, however most CPAs have some knowledge of basic statistical concepts including sampling, correlation and multiple regressions. Areas such as structural equation modeling to develop causal models or methods of dealing with unstructured data are areas where a CPA can develop to further strengthen their understanding and functionality.

These skills will allow accountants to tell a powerful compelling narrative about the data. Visualization has an amazing ability to make the complex simple, and the latest tools can do much more than give everyone the same view of data. Visualization allows us to take something as abstract as big data and algorithms and turn it into a story with a physical image that has dimensions that our eyes can quickly see and our brains understand. This can benefit our clients and be more convincing to end users of the information. g

Dr. Pearson is Professor and Director of the School of Accountancy at Georgia Southern University. He is a CPA, CFF, and received his BS, Macc, and PhD from the University of Wisconsin at Madison. He is the former Executive Director of the Institute for Fraud Prevention (IFP), a research center founded by the ACFE and AICPA. Dr. Pearson has conducted funded research sponsored by PwC, LexisNexis, the National Institute of Justice, the National Library of Medicine and the National Science Foundation.

Dr. Pearson conducts research in fraud research and education, examination of the supply and demand components in the market for audit and related services, performance measurement for regulated industries including charitable organizations and financial institutions. He also participates in research on identity management, biometrics, privacy & trust in online environments, internal controls and information security. He has made numerous academic and professional presentations on these subjects.

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and the owners had used cash, Amex cards, and barter to pay vendors. The “price to revenue” approach, he said, enabled him to calculate revenues from sales from the company’s daybooks both for the 12-month period before the death and the 12 months preceding his report.

Instead, he normalized revenues from the company’s daybooks for the 12 months before the death and the 12 months before his report on April 13, 2013. He then valued the restaurant at a “price-to-revenue” ratio of 40%, based on his business valuation experience. He made two calculations. First, for the 12 months ending at the death (August 2012), he determined approximately $2.67 million in gross revenue; 40% of this amount yielded approximately $1.1 million. From this figure, he subtracted $360,000 in working capital deficit and arrived at a fair value of $709,000.1 Half of this amount yielded $354,000. Second, for the year ending at his report date (April 30, 2013), he found that gross revenue was $2.97 million; valuing the restaurant at 40% of revenue resulted in an amount of $1.2 million. After adjusting for working capital items, he concluded the fair value for that period was just over $1 million; 50% of that figure resulted in a value of $501,000. He also found there was $297,000 in cash flow available to the owners from August 2012 through April 30, 2013.

He gave several reasons for the increase in value, including a significant pay down in accounts payable between August 2012 and April 2013, an increase in menu prices, and the addition of three new “meals on wheels” programs. He dismissed the impact of debt and of the economy.

The defendants’ expert critiqued aspects of the plaintiff expert’s valuation based on low profits for the meals on wheels program, price decreases on some items, his assessment that seasonality rather than growth explained the increase in the second calculation, and particularly the lack of rationale for the 0.4 multiple.

defendants’ expert prefers income approach. The defendants’ expert was able to compute revenue from the daybook and also determine: (1) accounts receivable balances; (2) accounts payable balances from actual purchases; (3) revenues; (4) payroll that did not appear on the tax returns; (5) cash payouts to vendors and nonvendors; (6) unpaid checks; and (7) the previous year’s sales tax. He included the corporate debt and loans to shareholders in his calculation. He stated that for nine years after the valuation date, there could be no distributions to shareholders out of the company’s net income because there were nine years remaining on an installment loan to the widow and three other loans due to shareholders in the amount of $125,000. He determined a 60-month repayment term for the latter loans and subtracted about $25,000 per year for five years from the estimated net income. Once he had determined income, he used a 4.6% risk-free rate based on the downturn in the economy (the wife’s expert countered this with 2.5%) and arrived at a present value of $273,000 as of the date of death. Finally, he applied a 20% discount for lack of marketability (DLOM) and added $21,800 to account for the pass-through tax advantage the company had as an S corporation. His final figure for 50% of the company value was $120,200.

The court adopted the defendant expert’s valuation. It found the

calculations of the plaintiff’s expert problematic for several reasons:

1) Since both sides had access to the same information, there was no support for the argument that he lacked the necessary data to compute the company’s income;

2) He failed to consider that a large portion of the business came from the meals on wheels program, which had a lower profit margin;

3) Although he brought his figures forward to April 2013, his conclusion that there was an increase in business between the death and the 2013 date was not credible considering the business cycle; and

4) Most important, he did not account for corporate loans and debts even though he acknowledged these factors influenced corporate value.

The court also accepted the defendant’s expert’s rationale for the 4.6% discount rate. The one flaw in his analysis was the insufficiently explained 20% DLOM, the court said. It agreed with the plaintiff’s expert that the restaurant represented a “somewhat unique niche business.” As a result, the court used the $273,000 value the defendants’ expert determined and kept the $21,800 increase related to the favorable tax status but removed the $54,600 DLOM deduction. The correct value for the business was $295,000, 50% of which yielded $147,400. The surviving brother was to continue running the business and buy out the shares belonging to his brother’s estate, the court ordered. g

1 Calculations were provided in the original court documents and there may be inconsistencies due to rounding.

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Marketing a Business Valuation PracticeThe AICPA FVS Section’s Business Valuation Practice Management Toolkit is an exclusive FVS Section member benefit that provides general guidance on the many issues to be considered in operating a successful practice. This excerpt adapted from the Toolkit reviews important marketing recommendations.

The first steps for getting involved in the business valuation arena are to identify your practice’s skill set and determine the areas of BV in which to become involved. Properly scoping and establishing your direction make it possible to market your particular area of competency through the appropriate channels. The next step is to identify the decision makers who hire experts in the types of valuation that you have chosen to offer. Developing marketing momentum is essential to the growth of a practice. In order to begin this momentum, a firm must develop an effective marketing plan through identifying with, and becoming visible to, their target market.

developing an effective Marketing PlanSome of the basic questions to address to ensure success include: • Who pulls the trigger?• What kind of service can you offer?• What is your competitive edge?• What is your desired outcome?

Who Pulls the Trigger?Once you’ve determined your focus, it is very important to identify the people who hire the experts in your area and to focus your marketing efforts on them. In most valuation engagements, the client is loosely associated with the hiring process and relies on the judgment of trusted advisers (such as attorneys, accountants or CPAs or investment bankers). Often, the

decision makers in the larger firms rely on the judgment or recommendation of one of their associates or junior staff, so position titles alone may not be a reliable indicator of the value of client sources. You may also need a working knowledge of their organizations to access the person most influential in hiring a BV expert.

What Kind of Services Can You Offer?Once the target (decision maker) has been identified, you should scope out the kind of service he or she is seeking and whether it matches what you can offer. It cannot be overemphasized that to efficiently and successfully market your services, it is necessary to target the individuals or organizations with whom you are functionally aligned. To market directly to clients and their advisers efficiently, you may need to educate them on:• What a business valuation is. • Why it is necessary.• What is involved in performing a BV

engagement.• The abilities, experience and level of

expertise that qualify you to provide these services.

What Is Your Competitive Edge?Often, it is necessary to analyze your own skills and experience to determine what you can do that many others cannot. Having a competitive edge over your peers (for example, credentials, years and breadth of practical experience, experience testifying in court, articles published, industry knowledge, communication skills) could put you in the spotlight for a particular service type and will result in more referrals.

What Is Your Desired Outcome?Your focus should not only be on obtaining an engagement but on developing relationships so that you

become an organization’s go-to BV expert. We’ll discuss the people and firms who pull the trigger in hiring a BV expert in later sections of this article.

segmentation Within Business ValuationThere are subsets of concentration within business valuation. Most demand falls within estate and gift taxation, marital dissolution, mergers and acquisitions (M&A), financial reporting, litigation, and employee stock ownership plans (ESOPs).

Estate and Gift TaxThe three most important objectives of estate planning for owners of closely held businesses are:1

• Providing liquidity, either for themselves, their heirs, or both.

• Minimizing federal gift and estate taxes and state inheritance taxes.

• Ensuring business continuity.

Referral sources are mainly CPAs involved with filing IRS Forms 706 or 709 for estate or gift tax planning purposes, respectively, as well as attorneys specializing in estates, insurance advisers, investment advisers, and trust officers. It is important to focus on as many of the specialists in these areas as possible because business owners are usually close to or seek the counsel of their advisers and may not otherwise be familiar with your services.

Marital DissolutionDivorce can be the source of a lengthy and emotional engagement. The valuation expert is usually hired by divorce attorneys subsequent to separation or divorce filings by one of their clients. Generally, each party in the divorce hires his or her own valuation expert, but it is not uncommon for parties to mutually agree to hire a

1 Shannon P. Pratt, Robert E. Reilly, and Robert P. Schweihs, Valuing a Business, 4th ed., (New York: McGraw-Hill, 2000), 582.

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neutral valuation expert, particularly in collaborative divorces. Hiring a neutral expert is usually more efficient and can minimize fees. Additionally, the flow of information should be smoother in a joint engagement.

When the parties are not inclined to be cooperative, resolving valuation issues can be extremely challenging. The valuation expert needs to be considerate and understanding of the nature of these engagements and the sensitive issues that can ensue. Valuators should also recognize that the information provided in these circumstances is typically limited. The expert must be efficient and astute enough to derive quality results by making the best use of the obtainable information. Additionally, the expert must be innovative and creative in uncovering pertinent information.

The main business referral sources for these types of BV engagements are divorce attorneys, divorce mediators and judges. The valuation expert should be well-trained and qualified to testify as an expert. The referral sources usually look for a valuation expert who is experienced in the field, known for consistently delivering a quality and objective work product and experienced in giving court testimony.

Mergers and AcquisitionsThe valuation expert is brought into this kind of engagement if the client has received a purchase offer for his or her business or if the client is targeting a company for acquisition. Engagements are time sensitive and, typically, a lot of work needs to be completed in a short period of time. It is a specialized field, and the expert should be well qualified to efficiently perform the valuation within the prescribed time frame. Experts may be hired to value: • Property, plant, and equipment.• Intangibles, such as goodwill and

patents.• Real estate.• Contracts.

• Postemployment benefits.• Trademarks and trade names.• Contingencies.• Research and development.

The leading referral sources for these transactions are business brokers, transactional attorneys, CPAs and the business owners themselves. As with other subdisciplines of BV, these engagements require specialized skills. It is not uncommon for valuation experts to refer this type of work to more experienced peers or collaborate as a group to gather the best resources. This would make it prudent for an expert to market his or her expertise to peers at association meetings.

Financial ReportingThe need for valuation for financial reporting purposes increased dramatically with the issuance of recent Financial Accounting Standards Board guidance on fair value measurements and disclosures. These valuations involve the allocation of a purchase price related to a business combination to tangible and intangible assets and are performed under a fair value standard. They tend to be very complex and are subject to a review by the external auditor under AU section 336, Using the Work of a Specialist (AICPA, Professional Standards).

As such, a BV expert must familiarize himself or herself with these standards and the various nuances of valuation under the fair value standard. CPAs should be aware that guidance in this area continues to evolve. Primary referral sources for these engagements are CFOs or chief accounting officers of the purchasing company. In some cases, these engagements can also come from other CPA firms.

Litigation and Shareholder DisputesThese engagements encompass the preparation of business damages calculations and the valuation of a shareholder’s business interest. They resemble matrimonial litigation in that

they can be lengthy and emotional. The ability to obtain necessary information depends largely on the cooperation of both parties and the expertise of the attorneys. Clients will seek out a valuation expert who is qualified, experienced and who can readily articulate the results of his or her analysis in layman’s terms to a judge and jury. Traditional referral sources for these types of engagements are litigating attorneys, judges and CPAs acting on behalf of their clients.

Employee Stock Ownership PlansThere are approximately 10,000 ESOPs in the United States, according to the ESOP Association, and they must be valued at least annually. A valuation expert hired to conduct this kind of engagement must be knowledgeable in various subdisciplines, including valuation theory, legal and regulatory rulings related to ESOPs, qualified plan administration, general finance and fiduciary concerns. In addition to fulfilling the annual requirement, ESOP valuations are performed for other reasons, including shareholder liquidity, estate planning, management succession planning, employee motivation, privatization, and acquisitions.

Referrals are commonly obtained through other CPAs and their firms, largely because ESOP valuation must be done independently of the accounting firm that performs its audit. It is important to recognize that when performing a valuation for ESOP formation or administration, the valuation professional works for the ESOP trustee, not the selling shareholder. In this regard, networking with peers is an excellent way to market your capabilities. Also, another valuation specialist might refer work to a peer if he or she does not feel comfortable with this type of engagement. Becoming an active member of the ESOP Association is

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another great way to network within this segment.

Other Types of EngagementBV specialists may also perform several other types of valuations for tax and financial planning purposes. It is very important that practitioners keep their eyes and ears open when networking to seek out opportunities and effectively market their services. Advisers may not only be the referral sources but can also be the client. CPAs should focus their marketing efforts on advisers who offer clients tax, financial, and legal advice. Other CPAs can be a significant referral source if they do not have experience in performing valuation services or if they have a conflict of interest; for example, if it is the CPA firm that performs audits for clients, BV specialists should establish trust with the client’s CPA and make it clear that they are not seeking to take their clients.

Methods of MarketingNow that you have identified your skill set and your target audience, you can begin marketing your services to your target audience. The most effective way to do so is to build relationships with potential clients. The first step is to increase your visibility within your target market by using any of a number of vehicles.

NewslettersNewsletters can be distributed through direct mailing or via e-mail and are effective in educating and informing the market about you. They can also be used to deliver breaking news or new developments related to the BV discipline to your target audience. Consistency pays off. If you choose this method, make sure that the artwork is top-notch, and that the content is meaningful. Firms can be hired to write content and customize the newsletter with your company’s specific information. Two companies that provide such services are Practice Development Institute, Inc. and BV Resources.

AdvertisingAdvertise your services in the publications that your referral sources

read most often, including state and local bar association journals, as well as state and national industry journals for legal and accounting professionals, and don’t overlook discipline-specific publications.

Presentations and ReceptionsConducting seminars for referral sources educates contacts and enhances your visibility. Groups and events to consider include: • Chambers of commerce.• Bar associations.• Financial planners.• State CPA society meetings.• Estate planning councils.• Insurance agents.• Law firms.• Continuing professional education

conferences.

Invite referrals (such as attorneys) or other target audience groups to breakfast meetings or cocktail events. Always follow up after the meeting to continue developing a relationship.

NetworkingNetworking and communicating regularly with professional contacts widens your circle of prospective clients and referral sources. The best opportunities for effective networking may include: • Industry trade groups.• Estate planning councils.• Local chapters of your state CPA

society.• Roundtables from local banks and

trust companies.• Valuation organizations.• Professional advisory committees

from various charitable organizations.• Chambers of commerce.• Boards of various charities.• Advisory boards for schools that your

children attend.• Local alumni chapters of your college

or university.

Visibility within a qualified organization is essential. Your interest will be contagious, so make sure that you have genuine enthusiasm for the group.

Collateral MaterialCollateral material represents your business long after you have left someone’s office and should project an image that establishes and communicates your identity. Some examples include:• Handouts and brochures.• Stationery.• Proposals.• Business cards.

It is said often, but needs to be restated and heeded nonetheless, that you only get one opportunity to make a first impression. Perceptions matter, and the materials listed above will help brand you and your business. The image you project should be consistent with the identity you want for your business and the message you wish to convey to your market.

Public RelationsThe overall goal of public relations is to build goodwill and credibility and increase awareness of your business. Maintaining good public relations cultivates long-term client relationships. Public relations activities are an indirect form of marketing your business. If you have the resources, hiring a public relations firm is a good option, but it is not always necessary. Steps you can take on your own include:

• Send out press releases.• Communicate frequently with the

local media to build awareness.• Send out monthly newsletters

highlighting seminars or speaking engagements in which you will be involved.

• Issue organization or achievement award updates about yourself and your firm.

• Actively participate in volunteer organizations.

It is important to keep your good name in the media so that your referral sources see you mentioned or quoted and think of you first when making referrals.

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Teaching and WritingVisibility is important at all levels—locally, nationally and internationally. Teaching BV fundamentals and technical courses, giving lectures and seminars, and writing (for example, articles, course materials, and textbooks) expands your professional presence and increases your likelihood of establishing long-lasting and valuable contacts. This all leads to increased exposure in your profession as well as other related organizations.

CPA Marketing Toolkit and Other Marketing MaterialsThe AICPA and the FVS Section have created a marketing toolkit that BV experts can use in their practices, as well as marketing brochures, press releases and logos and other marketing materials for ABV and CFF credential holders.

Quality Work ProductThe importance of delivering a quality work product in a timely manner that meets a client’s needs cannot be overstated. Setting deadlines that are both realistic and attainable and then delivering on those promises will enhance your reputation and increase your role as a trusted adviser. After delivering a quality and timely work product to a client, do not hesitate to ask for referrals. You will be surprised at how quickly your name and reputation can travel and develop marketing momentum. A recurring client is a great asset to a practice, and the quality of your work product and relationship-building skills will determine how well this asset is developed.

CredentialsWith increased competition, it is becoming more important to differentiate by being qualified. Once specific requirements are met, many credentials are available to the BV practitioner, and you should consider which one(s) are most valuable to you. There are other various valuation credentials in the market other than

the ABV, and each one has different virtues. Obtaining one or, for the stout-hearted, all of them, differentiates the BV practitioner who is serious about the discipline and has spent the time necessary to acquire and demonstrate competency in the field.

For an ABV, the professional requirements are:

Initial certification. As a supplement to the following certification requirements, please see a copy of the ABV Credential Application Kit located at www.aicpa.org/fvs (click on Membership/Learn More About the ABV Credential). However, the FVS website will identify the most recent requirements to obtain the ABV credential and should be the first point of reference.

establish a solid BaseThe greatest resources for potential new clients are your professional relationships, both existing and new. It is your job to fully inform these

resources that you offer BV services. Remember that the client’s adviser is usually the person who will be hiring the BV professional, so you need to establish a solid working relationship with these individuals by educating and informing them about what you can offer. g

Membership AICPA

Experience in business valuation (BV) Attest to a minimum of performance of 6 business valuation (BV) engagements or projects (or 150 hour experience equivalent) demonstrating substantial experience and competence

Other credentials required CPA

Work experience—other than BV Experience required for CPA certificate

References required No

Training requirement Minimum of 75 hours of lifelong learning related to the BV body of knowledge

Proctored exam Yes

Length of proctored exam 6 hours

Case study No

Time to complete case N/A

Submission of client report No

Recertification Requirements (3 year cycle)

Required hours of continuing professional education within recertification period

60 hours

Quality enhancement, quality review, or peer review No

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Register now for the 2013 AICPA Forensic & Valuation services ConferenceBe sure to mark your calendars and register now for the AICPA Forensic & Valuation Services Conference, which provides a unique opportunity to enhance your knowledge and network with other forensic and valuation professionals. The conference, which will take place on Nov. 10 to 12 at Caesar’s Palace in Las Vegas, allows forensic and valuation practitioners to attend sessions from either inter-related area.

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Conferences date Location Why You should AttendAICPA Forensic and Valuation Services Conference

November 10-12 Las Vegas Save $100 on registration if you are an FVS Section member or ABV/CFF credential holders. Participants can learn the latest techniques and developments from experts in interactive sessions. Participants can also choose an online option.

AICPA/AAML Conference on Divorce

April 24-25, 2014 Las Vegas Network with the top professionals in valuation and the legal profession while learning innovative ideas and timely solutions to critical challenges. FVS Section members and ABV/CFF credential holders receive a $100 discount on registration.

Live CoursesABV Exam Review Course November 8-9 Las Vegas FVS Section members save

$100 on registration for this comprehensive program that prepares CPAs to take and pass the ABV exam.

CFF Exam Review Course November 8-9 Las Vegas FVS Section members save $100 on this introduction to the knowledge needed to take and pass the CFF exam.

AICPA Expert Witness Skills Workshop

January 9-11, 2014 New Orleans This interactive workshop features a blend of classroom lectures and instant personal feedback to enable participants to develop the “real life” skills you need to succeed as an expert witness.

Web seminarsAICPA Webcast Series: Intangible Assets: Valuation and Related Topics

Oct. 29: Signed, Sealed, Delivered: Measuring the Fair Value of Contract-Based Intangibles

Nov. 21: Artistic-Related Intangible Asset Valuation

Registration is free for FVS Section members and ABV and CFF credential holders. Access to archived earlier webcasts is available online.

Coming events for FVs ProfessionalsLearn more about FVS Section events and learning opportunities on the FVS site.

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technical Advisory Board

James Ashe, CPA/CFF, CFFAMarcum LLP Melville, New York

Rosanne J. Aumiller, CPA/ABV/CFF, AsABBP Partners LLC Cleveland, Ohio

don Barbo, CPA/ABVDeloitte Financial Advisory Services LLP Dallas, Texas

Brent Bersin, CPA/CFF, CLPIPFC Corp. Houston, Texas

Joseph G. emanuele, CPA/ABV/CFF, CFAEmanuele Valuation San Jose, California

Richard hilliard, CPA/CFF, CFeParenteBeard LLC Pittsburgh, Pennsylvania

hubert Klein, CPA/ABV/CFF, CVA, CFeEisner Amper LLP Hackensack, New Jersey

Karen J. Kaseno, CPA/ABV/CFF, CVA, CFe, CFFA The Kaseno CPA Firm, APC San Diego, California

Michael d. Morhaus, CPA/ABV/CFF, AsA, CVAAnders Minkler & Diehl LLP St. Louis, Missouri

W. Marc schwartz, CPA/CFF, CFeHill Schwartz Spilker Keller LLC Houston, Texas

holly sharp, CPA/CFF, CFeLaPorte Sehrt Romig Hand New Orleans, Louisiana

Glenn spinello, CPA/ABV/CFF, CVATucker & Meltzer Valuation Advisors Owings Mills, Maryland

Peter thacker, CPA/ABV/CFF, AsA, CFeKeiter Stephens Glen Allen, Virginia

Linda B. trugman CPA/ABV, MCBA, AsA, MBATrugman Valuation Associates Plantation, Florida

Alan d. Westheimer, CPA/CFF, CFeAlan D. Westheimer, CPA/CFF, CFE Houston, Texas

Allen Wilen, CPA/CFF, CIRA, CFAEisner Amper LLP New York, New York

Vickie Wolf, CPA/ABV/CFF, CFeBrinig & Company, Inc. San Diego, California

Candice Bassell, CPA/ABV/CFFGrant Thornton LLP Seattle, Washingon

dennis Medica, CPA, CFF, CGMA, CVA, CFeMedica, LLC Cleveland, Ohio