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In This Issue:

Premium Gap Closes Between Strategic and Financial Acquisitions

The difference between the premium strategic buyers pay for acquisitions versus what financial buyers pay has decreased, according to recent data in the Factset MergerStat/BVR Control Premium Study. The study has 23 years of data from over 14,000 transactions across many different industries, and more than 60 different data fields are available per transaction.

The data fields include “transaction purpose,” which identifies the transaction as either strategic or financial. The study defines the two transaction types as follows:

  1. This type indicates the acquirer in the transaction operates in the same business or industry as the target company. Unlike financial buyers, strategic buyers are often looking to find synergies with the target company and generally want to acquire the target and hold on to it, whereas financial buyers generally want to exit their investment in the target company within a relatively short time frame after the acquisition.
  2. This type indicates the acquirer is making the acquisition for investment purposes and not for strategic business purposes. Financial buyers frequently include private equity firms, buyout funds, or any other finance company whose principal line of business is not directly related to that of the target company.

Overall, based on its 23 years of data, the study shows approximately 80% of all transactions involve strategic buyers, while 20% are financial. In general, you will see higher premiums on average for the strategic than the financial buyers. As Exhibit 1 reveals, historically, there’s a 4% to 6% differential between the two types of premiums paid.

One thing to keep in mind is that, although the vast majority of acquisitions involve positive premiums, there is a meaningful number of transactions where the premium was below 0%. Restricting the data to the last five years (2016 to 2020) narrows the differential gap even further across all industries, as shown in Exhibit 2.

As you can see in the two exhibits, the proportion of strategic to financial buyers is still largely the same (roughly 82% to 18%), but the tighter differential could be due to the influx of financial buyers—private equity funds and financial sponsors with access to greater funds and lower interest rates—paying slightly more on average than they have in the past, while, on the strategic side, the premium has decreased slightly. Essentially, the two differentials are converging, and, if you look strictly at the equity acquisition premium, you can see where it has actually flipped (from a +4.7% mean premium to a -4.8% in recent years).

As the exhibits show, the study, which is an online database, now provides an invested capital premium as well as the corresponding implied minority discount. Subscribers to the study receive free access to a PDF copy of a new publication: BVR Briefing—Control Premiums: A Deep Dive Into the New Data on Invested Capital Premiums (nonsubscribers may purchase the briefing).

Good News: Key Research on Private Cost of Capital Is Back

Are you comfortable using public-market data when estimating a cost of capital for a small private company? Shannon Pratt says that the discount rate is “a market-driven rate. It represents the expected yield rate—or rate of return—necessary to induce investors to commit available funds to the subject investment, given its level of risk.” He put this in italics for emphasis because it’s important to use the relevant market when deriving a rate. Would the relevant market for private companies be the public capital market or the private capital market? For those who say the latter, an important ongoing research project that was on the verge of shutting down has been rescued.

Up and running. On the brink of ending its long run, the Private Capital Markets Project from Pepperdine University has secured funding to continue its ongoing survey of expected rates of return of providers in the private capital market. A BVWire poll in 2019 found that 40% of respondents use the Pepperdine reports. Some practitioners use the reports as a sanity check on more traditional methods, and some use them as a primary method for estimating small private-company cost of capital.

“I am very pleased to announce that we are back up and running due to generous underwriting from the ESOP Association and Employee Ownership Foundation,” says Dr. Craig R. Everett, the project’s director. This has enabled the project to launch a new cost of capital survey. “We know how important this study is to the ESOP and valuation communities, and we are pleased to ensure that this important independent source of data will continue to be provided to ESOP companies and valuation experts alike,” says Patrick Mirza, director of communications for the ESOP Association and Employee Ownership Foundation.

Pepperdine’s project, which produces the annual “Private Capital Markets Report,” provides an analysis based on an ongoing survey of expected rates of senior lenders, asset-based lenders, mezzanine funds, private equity groups, venture capital firms, angel investors, privately held businesses, investment bankers, business brokers, limited partners, and business appraisers.

2021 results. The 2021 survey reveals that loans have the lowest average rates (banks require a median return of 3.3% to 5.5% depending on loan size) while capital obtained from angels has the highest average rates (ranging from a median of 23% for later-stage financing to 43% for seed money). The full report contains details on each type of funding.

Of course, the cost of capital for privately held firms varies by capital type, size, and risk assumed. Pepperdine’s findings in the 2021 report on the median cost of capital rates appear in the exhibit. There is much more detail in the report itself, including first and third quartiles by different criteria such as amount of financing, EBITDA levels, and financing stage.

Private Capital Market Required Rates of Return

Type of Private Capital Funding

Pepperdine Median Rate of Return (Range)



Asset-based lenders 3.8%-16.0%
Mezzanine financers 10.0%-14.0%
Private equity groups 25.0%-30.0%
Venture capital groups 23.0%-38.0%
Angel investors


The survey also asks privately held business owners what they believe is their cost of equity. Over half (58%) of privately held business owners believe their cost of equity is less than or equal to 12%.

Approximately 21% of respondents indicated their business cost of equity capital is in the range of 9% to 10%, the range most cited. These low figures indicate that there may be a misunderstanding among business owners about the returns that investors require. We note that the majority of private firms that responded had 20 employees or fewer, with 46% having no more than five employees. Also, over half of them had annual revenues less than $1 million.

In practice. Pepperdine’s model for identifying a specific private cost of capital (PCOC) requires adjustments, of course, just like any other method for deriving cost of capital. These adjustments are:

  1. Determine which of the types of private capital match your subject company (all six may apply, or some subset).
  2. Since a subject company is unlikely to meet the optimum requirements potential funders set, the median expected returns above need to be subjected to a risk adjustment. For example, if a manufacturer has a lower EBITDA, its cost of capital from the private capital markets might be closer to the upper quartile rather than the median figures from the Pepperdine results.
  3. Each source of capital for the subject company must be valued so that a percentage of the total capital structure for each source can be derived.
  4. The PCOC is the sum of the individual percentages for each capital source.

For more details, the program’s founders, John Paglia (Pepperdine University) and Robert Slee (Robertson & Foley), have an article, “Using the Private Cost of Capital Model,” that was published in the Value Examiner.

How to get it. The report had been free in the past, but, because of an ongoing funding gap, a small fee of $100 will be charged. However, respondents to the 2021 survey will receive the report for free and were sent coupon codes for this and other reports. The 2021 annual report is available here.

How COVID-19 Has Impacted Insurance Agencies and Brokerages

By now, all valuation experts should know that the pandemic has not had the same impact on all industries. The importance of industry research in this regard is crucial when doing a valuation. Fortunately, industry research sources act as a clearinghouse in assembling this type of information.

This article excerpts some recent information from Vertical IQ for insurance agencies and brokerage firms and how COVID-19 has impacted them. Analysts should bring this information up-to-date as necessary and consider any other similar issues that may be new and emerging. Vertical IQ (which covers over 500 industries) updates its information regularly, which allows you to be as current as possible.

‘Covicane’ risk scores. Hurricane season, rising COVID-19 cases, and low vaccination rates in some states could add up to a major superspreader event that would slow recovery after a storm and increase costs, according to catastrophe modeler Property Claims Services (PCS). PCS has created a “Covicane risk score” for 31 US states and territories that takes into account tropical storm risk, vaccination rates, and population density. States with the highest Covicane risk scores are Florida and Louisiana, followed by Texas, Alabama, and Mississippi. PCS urged insurers to prepare for a combined hurricane-COVID-19 disaster by ensuring adjusters are outfitted with adequate personal protective equipment (PPE). Firms could also face a shortage of adjusters in the event of a major catastrophe that high rates of infection have made worse.

Business interruption. Financial experts play a key role in supporting or disputing damages and valuation claims. As coronavirus-related losses piled up, small-business owners who thought business disruption insurance would cover them have mostly discovered otherwise. A few years after the SARS outbreak, some insurers inserted clauses excluding coverage for “loss due to virus or bacteria,” according to the Philadelphia Inquirer. Several states—including New York, Oregon, Pennsylvania, Rhode Island, and Washington—have introduced legislation to prevent insurers from denying business interruption claims resulting from COVID-19-related losses. However, none of the proposed state-level legislation passed, according to Moody’s Investor Service.

As of July 26, 2021, 1,980 COVID-19-related business interruption insurance lawsuits have been filed in the US, according to a litigation tracker the University of Pennsylvania’s Carey Law School maintains. In early July, the US Court of Appeals for the 8th Circuit ruled the lower court did not err in dismissing a business interruption claim lawsuit because the insured failed to prove physical alteration to the property in question. Legal experts suggest the ruling is a bad sign for insureds’ business interruption suits that are working their way through the courts. Insurers have won more than 90% of federal court cases, according to a litigation tracker by the University of Pennsylvania’s Carey Law School. Including dismissals without prejudice, insurers have won 70% of cases in state court.

Additional guidance the Centers for Disease Control and Prevention (CDC) issued regarding COVID-19 in early April 2021 may further undermine business interruption claim arguments that assert physical damages due to the coronavirus clinging to surfaces. The CDC guidance suggests the virus primarily spreads through the air. The agency said, “It is possible for people to be infected through contact with contaminated surfaces or objects (fomites), but the risk is generally considered to be low.” However, some attorneys have filed suits that allege airborne viral contamination does cause physical damages. Such arguments, including in cases involving mold, have been successful for plaintiffs in the past.

Credit issues. The COVID-19 pandemic has not had a material effect on the creditworthiness of the property and casualty (P&C) insurance industry, according to a report by Moody’s Investor Service in late May 2021. Legislation stemming from the pandemic has had little impact on the P&C industry. Moody’s cited the fact that most of the business interruption claims policyholders filed have been decided in favor of insurers. COVID-19-related workers’ compensation claims have only had a “moderate” impact on claims costs; total workers’ compensation losses related to the pandemic were $260 million in the US, and 95% of claims were for less than $10,000. Moody’s also noted that most states passed legislation that protected businesses from coronavirus liability claims, which is a “credit positive” for insurers.

Auto insurance. Early in the pandemic, some auto insurers offered customers rebates and discounts as the number of miles driven in the US—and, therefore, the number of accident claims—declined. While miles driven have since crept upward, they are generally below normal, according to Federal Highway Administration Statistics. In August 2021, consumer advocacy groups the Consumer Federation of America (CFA) and the Center for Economic Justice (CEJ) released a report alleging that insurers collected $42 billion in excess premiums while only refunding $13 billion. The CFA and CEJ report is based on their analysis of financial statements of insurance firms and research by AM Best. The American Property Casualty Insurance Association (APCIA) countered that the joint report by the CFA and CEJ was inaccurate on a number of issues, including miscalculation of industry profits, and not recognizing that, despite fewer miles driven, speeding and other dangerous driving habits increased the severity of crashes.

Despite $18 billion in pandemic-related premium relief, auto insurance companies’ levels of customer satisfaction remained unchanged, according to the J.D. Power 2021 US Insurance Study released in June 2021. The 2021 results marked the first time since 2017 that satisfaction showed no year-over-year improvement. Various communication channels were the chief drivers of dissatisfaction. Satisfaction with assisted online channels including chat and email fell 12 points compared to a year earlier. Other communication touchpoints that saw declines in satisfaction included contact center (-5), website (-3), and local agent (-1). Just over half of survey respondents said they were aware of their insurer’s pandemic premium relief programs. Brand perceptions were significantly better among consumers who were aware of premium relief, and that awareness also had a positive effect on policy renewal intent.

Remote work/meetings. Even before the pandemic, in-person meetings between insurance agents and clients were on the decline. The pandemic hastened the use of web-based meeting tools as agents worked from home. As insurance companies move to reduce fixed costs, some firms are rethinking their real estate footprints. Nationwide has said it will close some of its offices as its shift to more remote work increased efficiency.

Supply chain issues. As the economy and consumer spending rebound, supply chains have often not been able to keep up with surging demand. Some employers that curtailed factory activity earlier in the pandemic have not been able to find enough workers to ramp production back up. The resulting imbalance in supply and demand has triggered inflation in many parts of the economy. US consumer prices in June 2021 were up 5.3% compared to the same month in 2020. Increased prices for cars and housing are affecting property and casualty insurance firms in the form of higher loss costs, according to the American Property Casualty Insurance Association.

For more information. A new guide, What It’s Worth: Valuing Insurance Agencies, draws upon industry and benchmarking data from DealStats, Vertical IQ, and the Business Reference Guide. It also includes perspectives and insights from a valuation practitioner who has developed a specialty in insurance firms. Note: You already have access to this new guide if you are a subscriber to the BVResearch Pro platform.

“Survey Says” for FMV of Physician Compensation Is on Its Last Legs

The use of compensation surveys to determine the fair market value of physician compensation is seriously flawed, a position Mark Dietrich has long maintained. Speaking during the New Jersey CPA Society’s Business Valuation and Litigation Services Conference on September 21, Dietrich, a nationally known healthcare valuation expert, points out that even the provider of a major compensation survey (the Medical Group Management Association) does not support the use of its data for determination of fair market value.

Alternate method. During the session, Dietrich explained an alternate method he developed along with Tim Smith (TS Healthcare Consulting LLC) based on the resource-based relative value scale (RBRVS). This is a fee schedule that uses a complex formula to determine the payment due a physician for patient services and takes into account such factors as the resources used, practice expenses, malpractice expenses, geographic location, and others. It measures direct compensation and benefits for physicians and excludes other costs or revenues unrelated to the physician’s personally performed clinical services. RBRVS reveals how much of what is collected should go toward paying doctors instead of overhead. The amount of collections could be allocated to physicians based on compensation vis-à-vis overhead and insurance, which allows the provider to set compensation based on conditions in the local market.

During the conference session, a question came in from the audience: Do you see the new CMS regs to be good news with respect to your position and methodology on the FMV of physician compensation? “Definitely,” says Dietrich, who pointed out that he is working with Smith on a paper for BVR that will serve as a guide to the development of the new CMS regs and their interpretation

New regs. This past December, the Centers for Medicare & Medicaid Services (CMS) released a final rule that modernizes and clarifies the regulations that implemented the Medicare physician self-referral statute (the Stark Law). The new rule, effective Jan. 19, 2021, is designed to make it easier for hospitals and physicians to maintain compliance with the statute in the era of value-based care. The rule impacts healthcare valuations and includes guidance on how to determine whether the compensation being given to physicians is at fair market value.

The new regs align the definition of FMV with the appraisal profession’s body of knowledge, which is rooted in basic valuation texts, professional standards, and existing guidance. Healthcare-specific valuations are covered primarily in several texts, including: the BVR/AHLA Guide to Valuing Physician Compensation and Healthcare Service Arrangements (2nd edition), the BVR/AHLA Guide to Healthcare Industry Finance and Valuation (4th edition), and BVR’s Guide to Physician Practice Valuation (3rd edition). Dietrich and Smith are the authors and editors of these texts, which include contributions from other experts in healthcare valuation. The guides contain a detailed explanation of the RBRVS methodology. They have also written numerous articles on this matter.

During the CMS rule-making process, Smith and Dietrich provided extensive comments to the agency before and after the proposed rules were issued. Dietrich credits Smith with taking the lead on this effort. An exclusive analysis by BVR of the hundreds of comment letters reveals that a good deal of their comments ended up being incorporated into the final rules. As a result, the determination of FMV of physician compensation is now consistent with the valuation profession’s body of knowledge. The analysis will be included in the upcoming paper.

Dietrich concluded his conference session by remarking: “What I’ve shown you here today and what those new regs demonstrate is that this survey ‘junk’ is really on its last legs.”

An Inside Look at the Landmark ESOP Valuation Case

For over a decade, the Department of Labor has carried out a controversial and aggressive enforcement effort targeting valuation issues in employee stock ownership plans (ESOPs). The DOL did not lose a major ESOP case on a valuation issue until the recent case of Walsh v. Bowers. The case involves many key valuation issues, and BVR was fortunate enough to have two of the testifying experts for the defense give the inside story of the case during a recent webinar. It is hoped that this case will open the door for the valuation profession and the DOL to work together on some meaningful guidance surrounding valuations for ESOP purposes.

Background. The case involves Bowers + Kubota, an architecture and engineering firm based in Hawaii that decided to form an ESOP in 2012. After the two owners (Bowers and Kubota) obtained independent valuations and consulted with legal counsel, they sold 100% of their shares to an ESOP for $40 million. According to deposition testimony, in 2015, DOL investigators were told by their superiors to “sniff around” Hawaii ESOP transactions. In 2018, the DOL filed civil actions against a number of parties, including the ESOP trustee and the company owners. The allegations were similar to those the DOL has made in past cases (e.g., breach of fiduciary duty, prohibited transactions), and the central contention was that the ESOP paid more than fair market value for stock of the sponsor company.

Valuation experts have long maintained that the DOL has been playing by its own valuation rules—rules that are not consistent with accepted valuation standards. The American Society of Appraisers (ASA) has filed amicus briefs in several of these past cases, expressing strong support for the ESOP trustees and appraisers. The ASA briefs also pointed out how the DOL was not following accepted valuation standards and practices, notably with regard to the definition of fair market value, control issues, and the DOL’s continued use of an underqualified expert who did the valuations in support of the agency’s allegations. But the DOL had a long track record of success using its own rules, a record it hoped to extend with the Bowers case.

Trial experts. The defense engaged Ken Pia (Marcum LLP) and Ian Rusk (Rusk O’Brien Gido + Partners LLC) to review the prior valuations, rebut the DOL’s valuation, and provide their own valuations for the ESOP transaction. Pia has a national reputation for working on complex valuations; Rusk is also a valuation expert and has a strong focus on the architecture and engineering industry. They worked independently of one another and never actually met until the trial. Interestingly, they both came up with very close valuations—$43 million and $43.2 million—which were also similar to the previous valuations done for the ESOP trustee.

They pointed out that the DOL used a different valuation expert than the agency had used in previous cases. In the Bowers case, the DOL expert was a CPA and credentialed in business valuation from the ASA, led the global valuation practice at a Big Four firm, and was involved in several organizations, including the International Valuation Standards Council and the ESOP Association. In prior cases, the DOL used an individual who was not a credentialed business valuation expert.

During the BVR webinar, Pia and Rusk also noted that the judge in the case was very well versed in financial matters and clearly understood business valuation concepts. The court considered four principal issues: (1) the DOL appraiser’s responsibility to follow USPAP and other valuation standards; (2) the use of information not known or knowable; (3) the weight to be accorded to a nonbinding letter of interest (the sponsoring company had received an offer to acquire the company for $15 million); and (4) the level of control ESOP participants possess.

Standards. The court recognized that the DOL’s valuation expert’s “failure to follow Uniform Standards of Professional Appraisal Practice (USPAP) introduced substantial errors into [his] analysis.” For example, the expert did not do a management interview, which violates USPAP’s scope of work and competency rules. True, it is sometimes difficult to do an interview in the context of litigation, but there are other ways of collecting the needed information. Pia and Rusk noted that management can answer questions in a deposition. Also, the court can order the other side to submit to a management interview.

Known or knowable. The DOL’s expert adjusted the forecasts used for the DCF analysis, but the adjustments were based on information not known or knowable as of the date of the valuation. The expert used bonuses paid in later years to apply a “limited control” discount of 10% to the controllable, nonmarketable value. The DOL expert also used these future bonuses to adjust the forecasts for the DCF. He also adjusted the forecast for subconsultant fees the company might have to incur (these fees get passed on to clients). His “reliance on matters occurring after the sale to apply the limited control discount [and forecast adjustment for employee bonuses] appears to the court to have contravened the appraisal standards limiting the facts to be considered” to those known or knowable at the valuation date. Interestingly, if you eliminate these improper adjustments, the DOL’s valuation almost matches the $40 million purchase price.

Offer to buy. In 2011, before the decision to form an ESOP company, Bowers + Kubota considered a “non‐binding indication of interest” from a potential buyer for $15 million (cash free/debt free), and the DOL expert took the position that this established fair market value. But the offer consisted of a mere three pages—very little due diligence was done, and there were limited negotiations between the parties. The Bowers company had a valuation in hand that came in at $39.7 million, and, when that was sent to the potential buyer, it dropped out of the negotiations.

The court ruled that this offer to buy was not relevant in establishing fair market value and made this interesting analogy: “An individual who makes an offer of $15,000 for a used luxury car with a Blue Book value of $40,000 does not, by virtue of making a ‘lowball’ offer that is never accepted, tend to establish that the car is worth only $15,000.”

Control. The DOL’s position on control has been that, if the ESOP does not gain “unfettered control” over the company immediately after the acquisition of all company stock, appraisers must apply a discount for lack of control. But Pia and Rusk point out that an investor need not acquire the entire bundle of control rights in order to reflect some degree of control value in the purchase price. This point was made in the ASA’s amicus briefs in prior cases, which was cited in the defendant’s expert’s report. The court accepted this concept.

The DOL expert used a “limited control” discount, but this was based on information not known or knowable (see prior discussion). Pia did not use a control premium because the cash flows in his analysis were already on a control basis. Rusk used a very small control premium (in the 3%-to-5% range) to reflect the impact of dual-class shares.

Does this ruling set a precedent supporting the use of control premiums in ESOP transactions? Rusk used a control premium, and one was used in the original valuation. While this case does not clearly set a precedent, if a control premium is used properly, the answer is, yes, a control premium may be appropriate. But Pia and Rusk point out that it is important to be cautious about the application of a control premium in ESOP transactions and to include a detailed narrative that supports the quantification, including a discussion about levels of value and cash-flow assumptions (i.e., to what extent forecasted cash flows are on a control basis).

Does this ruling finally dispose of the issue of “unfettered control” in ESOP transactions? That is the hope, but time will tell. The court did recognize that unfettered, absolute control is not necessary as long as the valuation attributes go along with the ownership. Elements of control such as corporate governance, oversight by the trustee, board of directors, operational control, and the like need to be considered.

In addition to these four primary matters, Pia and Rusk discussed several other valuation issues in the case during the BVR webinar.

Door opened? This case as well as prior cases clearly show a level of disconnect between the DOL and the valuation community. A question came in from the webinar audience: “Do you think this case will open the door for the DOL and the valuation profession to work together to develop guidance around ESOP valuations?” Pia and Rusk hope that it does. This idea has worked in other areas of valuation. For example, the Appraisal Issues Task Force is a voluntary group of valuation professionals who work with the FASB and the SEC to evaluate proposals and recommend methodology, assumptions, and approaches in the area of fair value for financial reporting. A similar mechanism could be set up between ESOP valuation professionals and the DOL. Pia and Rusk welcome that kind of collaborative effort.

A recording of the webinar is available, which is free to holders of BVR’s Training Passport.


Dan Rosio Partner, Valuation Services
Andy Manchir Partner, Business Valuation & ESOP Services

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