Articles By Michael Levensohn

Landmark Compensation Case Turns 25

Photo by Pepi Stojanovski on Unsplash

When is no compensation considered reasonable compensation?

When an officer of a business is an officer in name only. That is one of the key takeaways of Davis v. United States, one of the landmark cases in the canon of compensation law.

This is the 25 anniversary of Davis v. United States, and Paul Hamann and Jack Salewski recently penned a new analysis of the decision. While the case is held out as the only reasonable compensation case the IRS has lost, the authors argue that a nuanced analysis produces a more balanced view of the decision.

Then they offer some practical advice on putting the lessons of Davis to work in assessing your firm’s – or your client’s – compensation.

You can read their analysis on RC Reports’ website: https://rcreports.com/resources/reasonable-compensation-blog/did-the-irs-really-lose-lessons-from-the-davis-case

Divorce Decision Reversed After Judge Double Dips

Divorce cases involving family businesses can pose unique challenges. Photo by Kelly Sikkema on Unsplash

A Connecticut appellate court recently delivered a resounding rebuke to a trial judge for “double-dipping” in a divorce case.

The court hearing the appeal in Oudheusden v. Oudheusden determined that the trial judge acted unfairly in dividing the couple’s assets and setting alimony, despite warnings from the lawyers for both sides regarding the risk of double-dipping.

According to the appellate decision, Mr. Oudheusden built two businesses during the couple’s decades-long marriage, and they represented his only sources of income. The trial judge awarded Mrs. Oudheusden $452,000, representing half the fair market value of the two businesses, as well as lifetime alimony of $18,000 per month.

In its decision, the appellate court stressed that the lump sum award and the stream of alimony payments were drawn from the same source.

“We agree with the defendant that, under the circumstances of this case, the court effectively deprived the defendant of his ability to pay the $18,000 monthly alimony award to the plaintiff by also distributing to the plaintiff 50 percent of the value of his businesses from which he derives his income,” the decision reads. “The general principle is that a court may not take an income producing asset into account in its property division and also award alimony based on that same income.”

Second bite of the apple

In divorce cases where the assets include a business, the value of the business and its profitability are key considerations in dividing the estate. In Oudheusden v. Oudheusden, the judge sided with the wife’s valuation expert in determining that the businesses were worth a total of $904,000, and that the husband’s annual gross income from them was $550,000.

Under the income approach to valuing a closely held business, the valuation is derived by calculating the present value of future benefits (often cash flow or some variant thereof) that the business is expected to generate. First, the business’s operating results are adjusted, or normalized, for nonrecurring or unrealistic items. In many small, closely held businesses, it is not unusual for the amount of compensation the business pays to its owner-operator to be motivated by tax considerations. In such a case, a business appraiser should normalize the owner’s compensation to reflect a fair market salary for the owner’s job duties. This formalizes the distinction between the reasonable compensation for the owner’s efforts and the business’s return on investment after deducting that compensation.

Next, a multiple of the normalized earnings is calculated based on the perceived risk to the company’s future performance and the expected growth rate of its earnings. The result of that calculation represents the present value of the future benefits to be generated by the business.

When a couple gets divorced, a judge who awards the nonowner spouse half the value of the family business has in essence given that spouse half of the future benefits to be generated by the business, discounted into today’s dollars. Awarding alimony based on a percentage of the same future benefits to be generated by the business would be taking a second bite from the apple, since that stream of benefits has already been divided.

Mrs. Oudheusden’s attorney explained the concept nicely in his closing statement, when he warned the judge of the perils of double-counting a single stream of income:

“Whatever value the court attributes to the business, the court has to, and should back out a reasonable salary for the officer and owner of the company. Because if the court is going to set a support order based on his income, it would not be fair and equitable to also ask that he pay an equitable distribution based on that as well,” he said. “That would be double-dipping.”

Decision reversed

After the trial court issued its decision, Mr. Oudheusden filed a post-judgment motion for clarification, asking if the judge considered $550,000 to be his income from his businesses, or his earning capacity if employed elsewhere. The judge responded that the figure was not a measurement of earning capacity, but rather of income from the two businesses.

The appeals court found that the trial judge “failed to take into account that the defendant’s annual gross income was included in the fair market value of his businesses.”

The appeals court also took issue with the trial court’s award of non-modifiable, lifetime alimony, because it barred Mr. Oudheusden from seeking a modification if he became ill or decided to retire, or if his businesses saw a reduction in their earning capacity. But that is a topic for another day.

The appeals court reversed the trial judge’s financial orders in their entirety and returned the case for a new trial on those issues.

The doctrine against double-dipping is largely settled law in many states, including New York, where a substantial body of case law has refined its application to various scenarios, such as the acquisition by one spouse of a professional license during the marriage. Notable cases include McSparrow v. McSparrow (Court of Appeals, 1995) and Grunfeld v. Grunfeld (Court of Appeals, 2000). That said, attorneys and valuation professionals who work in the matrimonial arena should be aware of the potential for a poorly executed valuation, or a misguided judge, to tilt the scales of justice.

Advent Valuation Advisors has a wealth of experience and a variety of research tools and resources at its disposal to help determine the value of a business and a reasonable salary for its owner-operator. For more information, contact Advent at info@adventvalue.com.

Read the appellate decision in Oudheusden v. Oudheusden here: https://www.jud.ct.gov/external/supapp/Cases/AROap/AP190/190AP283.pdf

Westchester Restaurateur Charged with Cooking the Books

The owner of a French restaurant in Westchester County faces multiple fraud charges. Photo by Jez Timms on Unsplash

The owner of an upscale French restaurant in Westchester County has been charged with multiple counts of fraud, accused of falsifying bank records and running up an $80,000 tab on a customer’s credit card.

Barbara “Bobbie” Meyzen, owner of La Cremaillere Restaurant in Banksville, faces a litany of fraud charges, the culmination of a five-year spree of brazen acts of theft and fraud detailed by the U.S. Attorney’s Office for the Southern District of New York.

Meyzen has owned the restaurant since 1993. From August 2015 to July 2016, Meyzen submitted applications for credit on behalf of the restaurant to at least nine lenders and factors. According to the U.S. Attorney’s Office, Meyzen provided the potential lenders with business bank statements that she had altered, changing negative balances to positive balances, removing references to bounced checks and reducing service fees. When one lender discovered that the bank statements had been altered, authorities say Meyzen created an email account in the name of a bank officer and sent an email to the lender stating that the bank statements were genuine.

Authorities say Meyzen falsely represented to the same lender that the second mortgage on the restaurant had been paid off. She is accused of forging a satisfaction of mortgage document, filing it with the Westchester County Clerk’s Office and sending a copy to the lender. Meyzen later denied filing the false document, telling FBI agents that she believed a loan broker with whom she had previously worked had done it.

Meyzen is also accused of charging more than $80,000 in food and restaurant supplies to the American Express card of one of the restaurant’s customers. When the customer discovered the charges, authorities say Meyzen claimed the charges were a mistake and promised to resolve them. She later gave the customer two checks totaling $32,000. The checks bounced.  She told the FBI that she knew nothing about the unauthorized charges and denied giving the customer any checks, according to the U.S. Attorney’s Office.

In September 2018, Meyzen Family Realty Associates, LLC, the company that owns the property where La Crémaillère operates, filed for bankruptcy in U.S. Bankruptcy Court in White Plains. In April 2019, La Crémaillère Restaurant Corp., which operates the restaurant, followed suit. Meyzen is a part owner in both businesses. Two days after the second filing, Meyzen opened a bank account in her name and diverted more than $40,000 of the restaurant’s credit card receipts to that account, authorities said. The funds were used to make payments to a food distributor and to an in-home nursing service.

That bank account was closed on May 1. Six days later, Meyzen opened an account at another bank under Honey Bee Farm, LLC, and diverted La Crémaillère’s credit card receipts, as well as $20,000 in advances on the eatery’s future credit card revenue, to that account, according to the U.S. Attorney’s Office. Authorities say Meyzen used some of that money to make a payment on Meyzen Family Realty’s mortgage and to pay food distributors, wine wholesalers, a commercial trash service, a tableware and china company, and a restaurant employee.

Meyzen, 57, of Redding, Connecticut, has been charged with aggravated identity theft, wire fraud, mail fraud, credit card fraud, two counts of making false statements and one count of concealing a debtor’s property.

Read the complaint here: https://www.justice.gov/usao-sdny/press-release/file/1186206/download

Size Premiums: Fact or Fiction?

Photo by Matthew Henry from Burst

Which of these businesses do you think is riskier: A pizzeria on a busy street in some village’s downtown business district, or a company with five pizzerias at similar locations in five villages?

Chances are, the single-location business faces more risk. Think of the effect a broken water main would have on the day’s receipts, or the impact a new competitor might have on foot traffic. Larger businesses tend to have more diversified products, suppliers and customers, all of which mitigate risk.

Why is risk important in business valuation? Because there is an inverse relationship between risk and value. The greater the risk, the lower the value. That’s why business valuation professionals often apply a size premium, also known as a small-company risk premium, to capture the risks and the corresponding additional returns investors expect to earn from the stock of small companies versus larger ones.

How does this principle apply to small-business valuations? In order to shed some light on this question, we analyzed data for small, private-company transactions from 2003 to 2017 provided by Pratt’s Stats Private Deal Update for the second quarter of 2018 (also known as Deal Stats Value Index). Valuation professionals commonly employ these transactions to derive benchmark ratios, or multiples, for use in the market approach to valuation.

One such earnings multiple is MVIC/EBITDA. This is the ratio of the market value of invested capital (think “sale price”) to earnings before interest, taxes, depreciation and amortization, where invested capital equals equity plus debt. A business with $250,000 of EBITDA that sells for $1 million has an MVIC/EBITDA multiple of 4.

Private Deal Update provides median MVIC/EBITDA data by year from 2003 to 2017 for companies in three net sales ranges: up to $1 million, $1 million to $5 million, and greater than $5 million.

The chart clearly shows that companies with the lowest net sales garnered significantly lower EBITDA multiples than did companies in the middle and upper sales ranges. Companies in the highest revenue range tended to sell at the highest multiples, with the distinction more pronounced since the end of the Great Recession. In 2017, the most recent year available, the largest companies sold at a median of 6.7 times EBITDA, compared to 4.5 times EBITDA for the middle range and 3 times EBITDA for the smallest companies.

Consider a scenario in which those MVIC/EBITDA multiples are applied to three fictitious companies, each of which has a 20 percent EBITDA margin:

All three companies exhibit the same degree of profitability as measured by EBITDA margin, but the small company’s implied value is just 60 percent of annual sales, while the large company’s implied value is 134 percent of annual sales.

The data provides a strong endorsement for the application of a size premium in transactions involving small businesses. As is often the case with sweeping pronouncements, however, there are caveats to bear in mind. We’ll leave you with a few:

  • The smallest companies in the dataset – those with up to $1 million in annual sales – tended to be more profitable than larger companies. This might mitigate, to some degree, the effect of their lower multiples.
  • There are many other factors beyond size – and beyond the scope of this article – that can affect a company’s valuation multiples.
  • And finally, the Private Deal Update data includes a melting pot of transactions in a variety of industries, from manufacturing to retail to IT. Each of these industries is made up of numerous subdivisions, each with unique characteristics, financial and otherwise.

Here at Advent, we won’t casually apply a broad analysis, but will drill down into the data to consider these unique characteristics and their impact on risk, and therefore value.

For more information, contact Advent Valuation Advisors at 845-567-0900 or info@adventvalue.com.

What Drives the Value of Unicorns?

Photo by Wilmer Martinez on Unsplash

Ever wonder why a startup company that hasn’t turned a profit and may not even have a clear path to generating one can command a billion-dollar valuation?

What drives the value of these unicorns? Why are early investors so eager to pour money into them? Antonella Puca talks about the challenges of unicorn valuation and the importance of intangibles at aicpa.org.

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