Valuation Reports: Charging by the Page
A few weeks ago, a gentleman called me out of the blue and said he wanted me to value four family limited partnerships that had been part of his father’s estate. He had received a quote of $20,000 from his father’s lawyer and wanted to know if I could do the work for less money. He began to complain that the estate had already paid about $20,000 to value the underlying real estate in the FLPs, each of which contained apartment complexes in the same city with the same management.
After studying the documents, I came up with a lower fee and had him sign the engagement letter. A week later, he called me very apologetically to say that his attorney, a partner with a 1,000 lawyer international firm, insisted on using a valuation firm that he had used for many other engagements and that he felt would be better to have in their corner in case of an audit.
After much persuading, the client stuck with me, even though I was not the attorney’s preferred valuation professional. Why did I overcome the attorney’s objection? The client mentioned to me several times that he liked the fact that I was a CPA and had an MBA from Stanford (time to boost my alumni donations), even though I never took a valuation course there. In fact, he never asked about my valuation credentials. To be sure, he also liked the fact that my fee was about 40% less than the lawyer’s quote. Sure, there were four FLPs, but much of each report would be the same. Why should I charge for cutting and pasting?
I asked to see a sample FLP appraisal from the attorney’s preferred valuation firm to make sure that I covered the same bases. Shortly thereafter, a pdf arrived in my e-mail. It was 142 pages. Now I have been criticized in the past for writing short reports. I’ve had attorneys tell me that if it’s too short, it’s obviously light weight. Never mind that I make sure that my reports comply with SSVS1, the AICPA’s valuation standard. I just don’t believe in padding the document so that I can charge a higher fee. But 142 pages! What am I leaving out?
I always believe that I can learn from other people’s work, especially if the work is generated by a reputable firm, which I believe this is. (For confidentially purposes, the name of the firm is not revealed, nor is the client or the subject properties.) Some of these 142 pages is very good material. But a lot of it is boiler plate and padding. Let’s take a look at this valuation report and see why it’s so big.
First of all, the appraiser is a CPA and an ASA. Therefore, the report must simultaneously comply with USPAP and SSVS1. This adds some documentation, although it’s not clear in the report what part complies with what standard. It just states that it complies. The report is also with generous amounts of white space on every page.
There is a 15-page description of the subject property, most of which appears to be lifted from the operating agreement. I typically attach the operating agreement to the report, and only quote the parts of the agreement that affect the discounts for lack of control or marketability.
Then here comes the economic section – another eight pages with sections on consumer spending and the stock market that don’t have much to do with the subject property. Only one page is devoted to the Florida real estate sector, the germane topic.
Moving on to the valuation section, the report quotes Revenue Ruling 59-60 and lists the eight factors that should be considered when valuing the stock of closely held companies – as do I. The 142 page report also lifts two pages from the revenue ruling verbatim. I’m not sure why that’s needed. I’m already up to page 35.
One glaring omission from the report was a lack of consideration of an income approach. True, in many cases, an income approach will not produce a meaningful result because the distributions from a flow-through FLP merely cover the minority interest holders’ taxes and not much else. The report assumes an asset approach without discussion.
The next section discusses the three components of the FLP, that being cash, real estate and a note receivable. For the cash component, the report discusses the relevance of closed end government bond funds and examines the price discount from net asset values. However, the report takes several pages to describe what’s in a table. I personally thought the table was self explanatory. Then, the author spends several more pages describing a regression analysis to see if the data is sensitive to other variables such as size of the fund, yield and total return. It concluded it wasn’t. It might be interesting, but I think most readers would be thrown off by this detour, especially since it didn’t really tie into the goal, which is to determine a discount for lack of control.
For the real estate portfolio, the author uses data from Partnership Profiles, Inc., which is fine. Again, the report spends several pages describing what’s in a table which to me is self-explanatory. For the five year note, the author uses closed-end equity funds. I’m not sure why he didn’t select closed end bond funds, which could have used some explanation.
Now the fun part begins. Pages 52 through 126 discuss the discount for lack of marketability. It reads like a academic paper. Some of it is interesting and it is completely re-usable on other engagements. But there is very little applicability to the subject FLP. There are six pages on the “Cost of Flotation” method and a discussion of studies “germane to lack of marketability for controlling interests,” even though the subject interest is minority. There’s another ten pages on Leaps Analysis, seven pages on Pre-IPO studies and more than 20 pages on restricted stock studies. You can read several pages on the LiquiStat™ database and another 20 pages on various quantitative methods such as the Black-Scholes Options Pricing Model, the Longstaff Upper Bound Lookback Put Option Model and so on. Most of it is theoretical, and almost none is used to calculate a value for the subject interest.
Here’s how the author determined the discount for lack of marketability:
For the “primary weight indicator,” he averaged a “rate of return method (35.9%) with a LEAPS analysis (0%) to arrive at 18%. This received a weight of 3/6. For the secondary weight indicator, he used the median of pre-1990 restricted stock studies (33%). This received a weight of 2/6. For the tertiary weight indicator, he took an average of Emory and Willamette Pre-IPO studies (48.2%,) the LiquiStat database (34.6%) and the post 1990 to 1997 restricted stock studies (21.6%) which equals 34.8%. This received a weight of 1/6. The weighted average of all of these studies was 25.8%. But he concluded an allowance for lack of marketability of 33%. There was no explanation of why he didn’t use 25.8%.
To conclude, the three asset classes were reduced for their various discounts for lack of control, which in turn was reduced further by a discount for lack of marketability. The rest of the report was the author’s CV, which is impressive, 21 assumptions and limiting conditions, and a copy of USPAP Standard 10 which focuses on business appraisals. Of the 142 pages, perhaps 10% was work unique to this assignment. Let’s be honest about what we’re selling.