CEO from Westchester County convicted in hedge-fund scheme

The co-founder of a Manhattan investment firm and a former trader at the firm were convicted this week of inflating the value of the firm’s investments. Photo by Bill Oxford on Unsplash

The co-founder and CEO of a Manhattan investment firm and a former trader at the firm were convicted Thursday of securities fraud.

Anilesh Ahuja, 51, the co-founder, CEO and chief investment officer of Premium Point Investments LP, which managed a portfolio of hedge funds, and Jeremy Shor, 44, a former trader at PPI, were convicted of scheming to artificially inflate the value of the firm’s holdings by more than $100 million in order to attract new investors and retain existing ones.

Ahuja, of New Rochelle, NY, and Shor, of New York City, were found guilty of all four counts against them: conspiracy to commit securities fraud, which carries a maximum potential sentence of five years in prison, and securities fraud, conspiracy to commit wire fraud, and wire fraud, each carrying a maximum potential sentence of 20 years. The men will be sentenced by U.S. District Judge Katherine Polk Failla at a future date.

Before founding PPI a decade ago, Ahuja was the head of the residential mortgage-backed securities group at a global investment bank. At its peak, PPI managed more than $5 billion in assets.

According to prosecutors, from approximately 2014 to 2016, Ahuja and Shor participated in a conspiracy to defraud PPI’s investors and potential investors by mismarking the value of certain securities held by its funds each month, thereby inflating the net asset value of those funds as reported to existing and potential investors.

Two former PPI employees, Amin Majidi of Armonk and Ashish Dole of White Plains, had already pleaded guilty to their roles in the scheme, as had Frank Dinucci Jr., a former salesman at a broker-dealer.

“Investors in our markets must be able to count on the truth and accuracy of the information they receive from those they entrust with their money,” said Deputy U.S. Attorney Audrey Strauss.

To read the U.S. Attorney’s Office’s press release on the conviction: https://www.justice.gov/usao-sdny/pr/hedge-fund-founder-ceo-and-cio-anilesh-ahuja-and-former-trader-jeremy-shor-convicted

To read the U.S. Attorney’s Office’s press release on the indictment of Ahuja, Majidi and Shor: https://www.justice.gov/usao-sdny/pr/hedge-fund-founder-portfolio-manager-and-trader-charged-manhattan-federal-court

To read the indictment: https://www.justice.gov/usao-sdny/press-release/file/1061281/download

New Standards Released for Forensic Engagements

New standards released Wednesday by the American Institute of Certified Public Accountants provide guidance for member engagements involving investigation or litigation.

The American Institute of Certified Public Accountants on Wednesday issued its first authoritative standards for members who provide forensic accounting services.

Forensic accounting services are described in the document as those involving “the application of specialized knowledge and investigative skills by a member to collect, analyze, and evaluate certain evidential matter and to interpret and communicate findings.” The Statement on Standards for Forensic Services No. 1 focuses on certain types of engagements – litigation and investigation – rather than the specific skill sets used or activities involved in those engagements.

Litigation is described in the statement as “an actual or potential legal or regulatory proceeding before a trier of fact or a regulatory body as an expert witness, consultant, neutral, mediator, or arbitrator in connection with the resolution of disputes between parties.” The category includes disputes and alternative dispute resolution.

Investigation is described as “a matter conducted in response to specific concerns of wrongdoing in which the member is engaged to perform procedures to collect, analyze, evaluate, or interpret certain evidential matter to assist the stakeholders in reaching a conclusion on the merits of the concerns.”

The standards generally do not apply to forensic services performed as part of an attest engagement such as an audit, review or compilation, or to internal assignments made by an employer to an employee not in public practice.

Under the standards, an AICPA member who serves as an expert witness in a litigation engagement is generally barred from providing opinions subject to contingent fee arrangements. A member performing forensic services is also prohibited from issuing an opinion regarding whether a fraud has been committed. A member may provide an expert opinion regarding “whether evidence is consistent with certain elements of fraud or other laws.”

The standards were developed and issued by the AICPA’s Forensic and Valuation Services Executive Committee. They are effective for engagements accepted on or after January 1, 2020, but may be voluntarily implemented earlier. Member forensic services are also subject to the AICPA’s broader “General Standards Rule,” which establishes guidelines such as professional competence, professional care and planning and supervision.

If you have any questions regarding this article or other matters related to forensic accounting, please contact Advent Valuation Advisors at info@adventvalue.com.

Has the Seller’s Market Peaked?

Business Brokers Note Dip in Seller Confidence in First Quarter

Seller sentiment declined during the first quarter in four out of five price segments below $50 million, according to a survey of business brokers and M&A advisors. Photo by rawpixel.com from Pexels

It’s still a seller’s market, but the balance of power in business transactions has begun to shift, according to the latest edition of Market Pulse, the quarterly survey of business brokers conducted by the International Business Brokers Association and M&A Source.

The national survey is intended to capture market conditions for businesses being sold for less than $50 million. It divides that market between Main Street businesses with values of $2 million or less, and lower middle-market ones in the $2 million to $50 million range.

The report for the first quarter of 2019 describes a robust market in which sellers of businesses hold the advantage in all segments except the smallest (under $500,000). But it also notes that seller confidence declined over the preceding year across all market segments except for the $5 million to $50 million value range.

A seller’s market is reflected in seller confidence in excess of 50 percent.“Although it is still a strong seller’s market with strong values, this is the first time in years that we’ve seen four out of five sectors report a dip in seller market sentiment,” said Craig Everett, PhD, who is quoted in the report. Everett is director of the Pepper­dine Graziadio Business School’s Private Capital Markets Project, which compiled the survey’s results. “This is a sign the market has peaked, and more people are expecting a cor­rection in the year or two ahead.”

The first-quarter survey of 292 business brokers and M&A advisors was conducted from April 1-15.

Other takeaways from the report include:

Larger companies are selling at higher multiples than smaller ones. During the first quarter, sales for less than $500,000 carried a median multiple of price to seller’s discretionary earnings of 2.0. Businesses in the $1 million to $2 million range sold for three times SDE. The median EBITDA multiple paid for businesses in the $2 million to $5 million range was 4.3, compared to the median multiple of 6.0 for businesses in the $5 million to $50 million range.

Larger companies tend to sell for a greater percentage of asking price.
Lower middle-market companies ($5 million to $50 million in value) sold for 101 percent of the asking price or internal benchmark. Small Main Street companies (less than $500,000) sold for 85 percent of asking price.

One reason for the difference: Larger companies are more likely to attract interest from private equity or synergistic buyers, according to David Ryan of Upton Financial Group, who is cited in the report.

Smaller businesses also tend to depend more heavily on their owners, which means more value is lost when the owner leaves the business.
For more information on the report, go to: https://www.ibba.org/market-pulse

Businesses Sold at Lower Multiples in the First Quarter of 2019


The relationship between EBITDA and sale price for private business transactions has grown more volatile over the past two years, according to the DealStats Value Index data for the first three months of 2019. Source: DealStats Value Index, 2Q 2019

Bargain shoppers took center stage during the first three months of the year, as EBITDA multiples for sales of private businesses dropped sharply, according to the latest edition of the DealStats Value Index.

The ratio of median selling price to EBITDA (earnings before interest, taxation, depreciation and amortization) fell during the first quarter to 3.2, from 4.6 during the final three months of 2018. It was the lowest level reported since the second quarter of 2018, when the median multiple hit a five-year low of 3.1.

DealStats is a database of private-company transactions maintained by Business Valuation Resources. Those transactions are used by business appraisers when applying the market approach to valuation. Multiples such as sale price-to-EBITDA can be derived from transactions involving similar businesses and used to estimate the value of a company.

Business appraisers use ratios such as price-to-EBITDA in roughly the same manner that home appraisers use price-per-square-foot – to create a ballpark estimate of value, subject to adjustments for unique features of the entity being valued.

Other popular ratios are price-to-sales, price-to-EBIT (earnings before interest and taxes, aka operating profit) and price-to-discretionary earnings. We could spend a full column discussing that last one; for now, think of it as the total benefits available to the business owner.

Rising margins

While the sale price-to-EBITDA multiple declined during the first quarter, another measure tracked by DealStats increased. EBITDA margin – the percentage of revenue represented by EBITDA – rose to 15 percent during the first quarter of 2019, up from 11 percent in the previous quarter. EBITDA margin and the sale price-to-EBITDA ratio tend to move in opposite directions.

In short, companies sold during the first three months of the year were more profitable (as measured by EBITDA) than those sold in the previous half-year, but sold at lower multiples of that enhanced profit level.

Increased volatility

The relationship between selling prices and EBITDA has grown more volatile over the past two years, after moving in a more narrow range from 2014 to mid-2017, according to the DealStats Value Index.

What is driving this increased volatility? Answering that is a little like trying to explain the stock market’s roller-coaster ride of the past year. If we could divine satisfactory solutions to these riddles, we’d be in a different line of work, perhaps reading Tarot cards or playing the ponies.

One factor that can create the appearance of volatility is a shift in the mix of businesses that sell from one quarter to the next. Companies in different industries tend to sell for distinct multiples. The ratio of sale price-to-EBITDA for finance and insurance companies, for instance, was 7.5 during the quarter, according to BVR, while the multiple for retail trade was 3.8. If a wave of consolidation hits retailers, it could skew the overall multiples without implying anything regarding the appropriate multiples for any given industry or business.

Think of it this way: If a developer came to town and built a few dozen pricey Colonials over a year or two, the median sale price for homes in your town might increase substantially. That would not necessarily mean that your humble split-level with its well-manicured lawn and partially obstructed mountain views had increased in value proportionately.

It remains to be seen if the recent drop in the EBITDA multiple and spike in volatility are temporary blips or signals of more sustained change. Stay tuned.

NY developer charged with running Ponzi-type scheme

A developer and landlord in western New York is charged with running a fraud scheme that prosecutors say cost investors millions.

One of the largest landlords in the country has been charged with operating a Ponzi-like scheme that used millions in investor funds to make interest and principal payments to prior investors, and to cover up other fraudulent conduct.

Robert Morgan, Frank Giacobbe, Todd Morgan and Michael Tremiti were indicted May 21 on 114 counts, charged with conspiracy to commit wire fraud and bank fraud for their roles in what prosecutors describe as a half-billion dollar mortgage fraud scheme. The defendants each face various additional charges such as wire and bank fraud and money laundering. Robert Morgan and Todd Morgan are also charged with wire fraud conspiracy to defraud insurance companies.

The charges carry a maximum penalty of 30 years in prison and a fine of twice the loss caused by the crimes, which is currently estimated to exceed $25 million.

In a related civil case, the Securities and Exchange Commission alleges that Robert Morgan, Morgan Mezzanine Fund Manager LLC and Morgan Acquisition LLC, all of Pittsford, NY, made a series of fraudulent private securities offerings that operated in a “Ponzi scheme-like manner” by using new investor funds to repay prior investors.

Robert Morgan was the managing member and CEO of Morgan Management and controlled a large portfolio of properties, according to prosecutors. Morgan and his companies developed residential and commercial real estate projects, with most of its properties located in western New York and Pennsylvania. According to the SEC complaint, between 2013 and September 2018, Morgan and the related entities raised more than $110 million by selling securities directly to investors.

The money was supposed to be used to acquire multifamily residential properties and engage in other real estate development projects. Investors were promised 11 percent returns. More than 200 investors in at least 17 states poured money into Morgan’s notes funds.

According to the criminal complaint, Morgan Management provided property management, accounting and financial reporting services for properties owned by limited liability companies controlled by Robert Morgan. The defendants are accused of conspiring to manipulate income and expenses for properties to meet financial ratios required by lenders.

“The manipulation included, among other things, removing expenses from information reported to lenders and keeping two sets of books for at least 70 properties, with one set of books containing true and accurate figures and a second set of books containing manipulated figures to be provided to lenders in connection with servicing and refinancing loans,” according to the U.S. Attorney’s Office for the Western District of New York.

Prosecutors say that, between 2007 and June 2017, the defendants conspired with others to fraudulently obtain money, securities and other property from financial institutions and government-sponsored entities like Freddie Mac and Fannie Mae. The defendants are accused of providing false information overstating the incomes of properties owned by Morgan Management or certain principals of Morgan Management.

Many of the projects did not generate sufficient cash flow to repay both their secured lenders and the notes funds, according to the SEC. As a result, the defendants used the notes funds as “a single, fraudulent slush fund, repeatedly using the funds for purposes inconsistent with the representations and disclosures made to investors,” according to the complaint. “To conceal their fraudulent conduct, and to mislead their auditors, defendants papered these transfers using sham loan documents designed to make the transfers appear legitimate.”

Investors are owed more than $63 million, according to the complaint, and the notes funds have few if any assets aside from the receivables for the loans they have made to affiliated borrowers.

Both the criminal case and the SEC’s civil case are being heard in U.S. District Court for the Western District of New York.

For more information:

https://www.justice.gov/usao-wdny/pr/robert-morgan-three-others-indicted-multi-million-dollar-mortgage-fraud-scheme

https://www.sec.gov/litigation/complaints/2019/comp24477.pdf

Court Case May Herald Shift in Valuation of S Corporations

A recent District Court decision has implications for the use of tax-affecting in the valuation of S corporations. Photo by Sarah Pflug from Burst

Lorraine Barton
Advent Valuation Advisors

On March 25, 2019, the U.S. District Court – Eastern District of Wisconsin issued an important decision supporting the use of tax-affecting in valuing pass-through entities. In Kress v. United States, Chief Judge William C. Griesbach relied heavily on the taxpayer’s expert in valuing non-controlling interests in a Subchapter S operating company called Green Bay Packaging, Inc. (“GBP”).

In the taxpayer’s expert report, GBP was first valued as a C-corporation equivalent, which included tax–affecting. Next, quantitative and qualitative adjustments were made to address economic benefits attributed to the Subchapter S election.

The valuation community and taxpayers have been fighting the IRS over this issue for years, starting with Gross v. Commissioner (TCM 1999-254) in 1999, which rejected the use of tax-affecting when valuing pass-through entities. Courts have generally sided with the IRS in opposing the tax-affecting of pass-through entities in subsequent cases such as Estate of Gallagher v. Commissioner (TCM 2011-148) in 2011.

In Kress v. United States of America (Case No. 16-C-795, U.S. District Court, Eastern District of Wisconsin), plaintiffs James and Julie Ann Kress sued to recover an overpayment of gift taxes. The court accepted the taxpayer’s valuation report, in which GBP was tax-affected as a C corporation, supporting the point that valuation experts have been arguing for several years. While the District Court’s decision in Kress does not carry the precedential weight of a U.S. Tax Court decision, it should be valuable to other courts considering the issue.

In his report, the taxpayer’s appraiser tax-affected the earnings of the S corporation in appraisals filed as of December 31, 2006, 2007 and 2008. The court accepted the fair market value as filed by the taxpayer, with only minor adjustments to the applied discounts for lack of marketability (DLOM).

In their respective reports, the IRS’s appraiser and the taxpayer’s expert each tax-affected GBP’s S corporation earnings as if it were a C corporation. This is significant, because the IRS has held the position in recent years that earnings of pass-through entities (S corporations, LLCs and partnerships) should not be tax-affected, because they do not pay entity-level taxes. Business appraisers have generally endorsed the practice of tax-affecting pass-through entities, arguing that the tax benefit of pass-throughs should be based on the effective difference in the after-tax income of their owners.

In the Kress case, this was not an issue, as both appraisers tax-affected GBP’s earnings. The IRS’s expert also applied a pass-through benefit in its application of the income approach, while the taxpayer’s expert did not.

After acknowledging the efficacy of tax-affecting, the court went even further, stating, “The court finds GBP’s subchapter S status is a neutral consideration with respect to the valuation of its stock. Notwithstanding the tax advantages associated with subchapter S status, there are also noted disadvantages, including the limited ability to reinvest in the company and the limited access to credit markets. It is therefore unclear if a minority shareholder enjoys those benefits.”

In its decision, the court did not accept the S-corporation premium (pass-through benefit) put forth by the IRS’s valuation expert, resulting in a nearly complete victory for the taxpayer. The decision represents an important point of inflection in the controversy over the tax-affecting of pass-through entities and the application of a premium for pass-through entity status.

Over the past 20 years, the application of a premium to pass-through entities based on their pass-through tax status has been a heavily debated topic. In the Kress case, such a premium was not applied by the court. While not all concur, we believe that today, most valuation experts have concluded that pass-through entities may deserve a premium when compared to otherwise identical C corporations.

It is worth noting that the gifts in the Kress case were from 2006, 2007 and 2008, prior to the pass-through tax benefit gaining full traction in the debate within the valuation community. It will be interesting to see if prevailing thought and application change in the future.

Kress will clearly be an important reference for taxpayers in gift- and estate-tax appraisal cases where the IRS argues against tax-affecting of S corporation earnings and for a premium in the valuation of pass-through entities relative to otherwise identical C corporations. The case should be considered as support for tax-affecting the earnings of a company organized as a pass-through entity for income tax purposes.

Lorraine Barton is a partner with Advent Valuation Advisors. She can be reached at lbarton@adventvalue.com.

Former Business Journalist Joins Advent as Analyst

Michael Levensohn of Monroe, NY, an award-winning business writer and editor, has joined Advent Valuation Advisors.

Advent Valuation Advisors announced that Michael Levensohn has joined the firm as an analyst.

Michael, who lives in Monroe, NY, brings more than a decade of business journalism and editing experience to Advent. He was most recently the metro editor of the Times Herald-Record, a regional daily newspaper and media company serving Orange, Sullivan and Ulster counties in New York.

He has authored more than 1,500 articles on business and financial topics including mergers and acquisitions, residential and commercial real estate, the economy and bankruptcy. His writing and investigative skills garnered more than a dozen awards from the New York State Associated Press Association, the New York News Publishers Association and other journalism organizations. 

Michael is a graduate of Princeton University and is completing a master’s degree in accountancy from the University of Illinois. He can be reached at mlevensohn@adventvalue.com.

Protect Your Business from Employee Fraud

Installing a safe and securing cash and other valuables are among the many steps employers can take to fight workplace fraud. Photo by Nicole De Khors from Burst

The bookkeeper for a small Sullivan County business is charged with making $3,000 in personal purchases on the company credit card.

An employee of an Ulster County restaurant is charged with stealing $12,000.

The longtime office manager of an Orange County propane dealer pleads guilty to embezzling more than $1.3 million – the equivalent of four years of profits – by disguising thefts as payments to vendors.

Experts estimate that organizations lose 5 percent of their annual revenues to fraud. Organizations with fewer than 100 employees are more likely to be victimized by occupational fraud – acts committed against an organization by its own officers, directors or employees – than are larger ones. And the losses for small organizations, which are more likely to lack internal controls, are typically twice as large, according to the Association of Certified Fraud Examiners’ Report to the Nations 2018 Global Study on Occupational Fraud and Abuse.

The path to a more secure workplace

Organizations need strong internal controls to prevent theft and fraud. What can a small organization with limited resources do to protect itself? Consider these steps to help reduce risk:

  • Have a written code of conduct, documentation of policies/processes, and anti-fraud policies in place. Have staff review these documents each year.
  • Segregate duties when possible, bearing in mind the potential for collusion.
  • Conduct background checks on all potential hires. If red flags are detected, do not hire the applicant without a confirmed (hopefully, in writing), sound explanation.
  • Rotate job responsibilities when possible.
  • Require employees to use vacation days, and have their job duties covered by another employee who can discover any questionable activity. Follow up with the covering employee. Ask about job-efficiency suggestions, and if they identified any concerns.
  • Provide separate user names and passwords for all authorized IT users, with information-access rights limited to required users.
  • Use a safe and security cameras. Safeguard cash, checks, credit cards and inventory.
  • Take a physical inventory at least once a year.
  • Require authorizations, receipts and recording of all petty cash transactions.
  • Have copies of bank and credit card statements sent to the home of a key manager or board member who can review them.
  • Require detailed receipts for all credit/debit card charges shortly after they are incurred.
  • Require two signatures or written authorization for expenditures over a material dollar amount.
  • Require detailed invoices from vendors that clearly outline goods and/or services provided, related locations/job names, etc.


Give your organization a checkup

Conducting regular reviews of key checkpoints in your organization can help you detect fraud early. If maintaining a schedule is difficult, try random, unpredictable reviews as frequently as possible.

Here are a few ways to get started:

  • Review monthly bank statements. Ensure checks paid were properly authorized and signed. Test large checks to the related underlying documentation. If checks are out of chronological order, determine why, and locate any missing ones. Confirm total deposits match accounting records and investigate any discrepancies. Compare the bank statement to the bank reconciliation and note if any payee name differences exist. If payroll checks are issued, examine any payroll checks with two endorsements.
  • Investigate unexplained differences in monthly cash flows from prior periods.
  • Review monthly or quarterly payroll reports. Investigate unexplained compensation increases, overtime and/or unusual reimbursements. Verify that new employees exist and former employees are no longer being compensated. Investigate any employees with no withholdings.
  • For point-of-sale transactions, reconcile closeouts to bank deposits. Note if discrepancies regularly occur with a specific employee.
  • Investigate unexplained changes in sales from prior periods. Identify missing invoice numbers, unusual credits and potential over- or under-billings.
  • Review software audit trails and access logs to identify any questionable activity or patterns.
  • Compare financial statements to the former period and clarify any unexplained discrepancies.

Here’s a final piece of advice. To limit workplace fraud, build a fair organization. Avoid situations that promote fraud, such as unrealistic goals, poorly designed incentive compensation plans or unfair workloads. Encourage an atmosphere of open communication where problems can be identified and resolved.

If you think your organization may have been victimized by occupational fraud, contact Advent Valuation Advisors at info@adventvalue.com.

Meet Our New Partner, Lorraine Barton

Lorraine Barton

Advent Valuation Advisors, LLC, takes great pleasure in announcing that Lorraine Barton, CPA/ABV/CFF, CIRA, CVA, MAFF, MBA, has been admitted to the partnership. 

Lorraine joined Advent, an affiliate of accounting and advisory firm RBT CPAs, LLP, in 2015. She has an extensive and varied accounting, valuation and litigation-support background in private industry and public accounting.

Lorraine has provided bankruptcy-support services since 2002 and business valuation services since 2004. She previously served as interim chief financial officer of a $125 million credit card processing company operating in Chapter 11 bankruptcy, helping to facilitate the sale of the business and saving more than 100 jobs.

At Advent, she and her team provide valuation and litigation-support services to closely held businesses and their advisors for purposes including mergers and acquisitions, buy-sell agreements, divorce, estate and gift-tax planning and corporate reorganizations.

Lorraine has completed a 40-hour divorce mediation training program that meets the requirements of the New York Association of Collaborative Professionals. She and the firm have wide-ranging experience in matrimonial finance, including asset tracing, lifestyle analysis and forensic examination.

Lorraine lives in Fishkill and has two sons. She is a graduate of Leadership Orange and serves on the NYSSCPA Business Valuation Committee.

She is also a member of the American Institute of Certified Public Accountants (AICPA), the National Association of Certified Valuators and Analysts (NACVA), the Association of Insolvency and Restructuring Advisors (AIRA) and the Hudson Valley Collaborative Divorce & Dispute Resolution Association (HVCDDRA).

“We are so pleased to welcome Lorraine as the newest partner in Advent Valuation Advisors,” said Michael Turturro, managing partner of RBT CPAs. “Lorraine is a crucial part of our continued growth. I wish her congratulations and many years of continued success!”

The New York Court of Appeals’ Ruling on Congel v. Malfitano and Its Implications

On March 27, 2018 the New York Court of Appeals applied effective discounts and deductions amounting to 81.22%, or $3,938,928 on a 3.08% minority partnership interest in a partnership wrongful dissolution matter. The partnership, Poughkeepsie Galleria Company, owns, operates and manages a shopping mall, the Poughkeepsie Galleria Mall. We were not provided with any of the valuation reports related to the matter, and you know what they say about assuming. The standard of value utilized by the Court was going concern value, with a reduction for goodwill and discounts for a minority interest and lack of marketability.

Background

The case involves a minority partner who the court determined wrongfully dissolved their partnership. The remaining partners continued the partnership’s business. NY Partnership Law § 69(2)(c)(II) was applied to the case, which states that when a partner dissolves a partnership in contravention of the partnership agreement, and the remaining partners continue the business in the same name, the dissolving partner has “the right as against his copartners . . . to have the value of his interest in the partnership, less any damages caused to his copartners by the dissolution, ascertained and paid to him in cash . . . but in ascertaining the value of the partner’s interest the value of the goodwill of the business shall not be considered.”

In Congel v. Malfitano, the Court of Appeals applied the following deductions and discounts: 15% for goodwill, 35% for DLOM, and 66% for DLOC; resulting in effective deductions of 81.22%. No details were provided regarding how the business value (before deductions) was derived. The Plaintiffs’ valuation expert testified that the value of the Partnership included goodwill of 44%, and that a marketability discount of 35% and a minority discount of 66% applied to the matter. The Defendant’s valuation expert testified that the Partnership, a real estate holding company, did not possess goodwill, that a minority discount was not applicable when determining fair value, and that a 25% marketability discount applied to the matter.

New York Business Corporate Law §623(h)(4), which pertains to the procedure to enforce a shareholder’s right to receive payment for shares (for corporations and not partnerships), states “if the corporation fails to make such offer within such period of fifteen days, or if it makes the offer and any dissenting shareholder or shareholders fail to agree with it within the period of thirty days thereafter upon the price to be paid for their shares…The court shall determine the fair value of the shares without a jury and without referral to an appraiser or referee.  Upon application by the corporation or by any shareholder who is a party to the proceeding, the court may, in its discretion, permit pretrial disclosure, including, but not limited to, disclosure of any expert’s reports relating to the fair value of the shares whether or not intended for use at the trial in the proceeding”.

The Appellate Division relied on Anastos v. Sable for guidance on its decision. Anastos v. Sable is a Massachusetts wrongful dissolution of a partnership by a minority shareholder case. The related Company was a real estate holding company located in a jurisdiction possessing a similar regulation excluding the value of the goodwill of the business in the settlement. In the Anastos v. Sable matter, the value of the net assets of the partnership were $2,494,005, indicating utilization of a cost approach in valuing the entity. The judge applied a discount of 40% to obtain what was termed “a minority interest going concern value” for a 33.33% partnership interest, with no mention made of a deduction for goodwill.

Goodwill and Going Concern Value

Lynda J. Oswald, in her article “Goodwill and Going-Concern Value: Emerging Factors in the Just Compensation Equation”[1] sheds light on the goodwill and going concern topic. Her article originated from eminent domain proceedings and the related recovery of business losses. Oswald identifies goodwill and going concern value as closely-related, but separate, components of business value. With goodwill relating to the value which inheres in the fixed and favorable consideration of customers, rising from an established, well-known, well-conducted business that create an expectancy of earnings in excess of the normal returns on the tangible assets, and going-concern value created by such factors as avoidance of start-up costs, increased operating efficiency, and increased marketing and administration efficiencies. Goodwill reflects the existence or expectation of excess earnings, while going-concern value reflects the ability of an ongoing business to realize a higher rate of return than a newly established one. The Appellate Division decision appears to relate strongly to these concepts.

In addition to the legal foundation previous mentioned, my research on this topic identified that the SBA requires (in specified cases) going concern special purpose property appraisals be obtained from experienced and qualified appraisers.[2] Special purpose properties are limited market properties with unique physical designs, special construction materials, or layouts that restrict their utility to the specific use for which the property was built. Their appraisals allocate separate values to the individual components of the transaction including land, building, equipment and intangible assets. Paul R. Hyde, EA, MCBA, ASA, ASA, MAI has written similarly on the topic in his article “Valuing Real Property Going Concerns”[3], and Mark T. Kenney, MAI, SRPA, MRICS, MBA in his article “Shopping Mall Valuation: Is There Intangible Value to Extract?”[4] discusses the issue of intangible assets related to shopping mall real estate. If you haven’t guessed it by now, going concern special purpose property and real property going concern appraisals are a complex area of valuation, requiring real estate appraisal as well as business valuation competencies.

Implications

Without copies of the Congel v. Malfitano valuation reports, we are unable to determine with certainty whether they were going concern special purpose property or real property going concern appraisals. Based upon the history of the matter, my hypothesis is they were not. The Congel v. Malfitano decision underscores the importance of fully understanding the purpose of a valuation assignment and the applicable laws relating to the matter, as well as in seeking guidance on the appropriate appraisal for your case.

This article was intended to provide commentary on a controversial, recently decided valuation matter and does not constitute legal advice. If you have any questions or comments relating to this topic, please contact me at eonischuk@adventvalue.com.

[1] Lynda J. Oswald, Goodwill and Going-Concern Value: Emerging Factors in the Just Compensation Equation, 32 B.C.L. Rev. 283 (1991), http://lawdigitalcommons.bc.edu/bclr/vol32/iss2/1.

[2] SOP 50 10 5(H), SBA, https://www.sba.gov/sites/default/files/sops/SOP_50_10_5_H_FINAL_FINAL_CLEAN_ 5-1-15.pdf.

[3] Paul R. Hyde, EA, MCBA, ASA, ASA, MAI, Valuing Real Property Going Concerns, American Society of Appraisers, http://www.appraisers.org/docs/default-source/discipline_rp/hyde-valuing-real-property-going-concerns.pdf?sfvrsn=0.

[4] Mark T. Kenney, MAI, SRPA, MRICS, MBA, Shopping Mall Valuation: Is There Intangible Value to Extract?, American Society of Appraisers, http://www.appraisers.org/docs/default-source/discipline_rp/shopping-mall-valuation-is-there-intangible-value-to-extract-.pdf?sfvrsn=0.