Methods and Hot Topics in Valuation

Transcription

1 Methods and Hot Topics in Valuation March 21, 2017 WORKSHOP E Presented by: Andreas Chrysostomou, Managing Director and Global Life Sciences and Integrated HealthCare Leader Katherine Klenda, Director Jonathan Goldblatt, Director Frank Deluccia, Director

2 Presenter Contact Information Andreas Chrysostomou Managing Director Global Life Sciences and Integrated HealthCare Leader New York, NY Jonathan Goldblatt Director Morristown, NJ Katherine Klenda Director Philadelphia, PA Frank Deluccia Director Morristown, NJ

3 Goodwill Impairment Test - FASB Elimination of Step 2 Updated Guidance for Contingent Consideration Discount Rates Brexit and Developing Trends CEIV Credentials and Requirements Certain graphics have been sourced from PresenterMedia.com 3

4 I. FASB Elimination of Step 2

5 Step 2 Elimination: In Brief In January 2017, FASB issued ASU which removes Step 2 of the GWI test The GWI test will now be a one-step test whereby goodwill impairment is calculated as the difference between the carrying amount of the reporting unit (RU) and its fair value, but not to exceed the carrying amount of goodwill allocated to that RU. The simplification eliminates the need to perform a hypothetical PPA in Step 2 to determine the amount of GWI Reporting units with zero or negative carrying amounts will apply the same one-step test, and will have the additional requirement to disclose the amount of goodwill they carry. The remaining aspects of the current goodwill impairment model are unchanged, including Step 0. The ASU continues to be silent on whether the impairment test should be carried out on an equity or enterprise level. 5

6 Current 2-Step Source: Erik Bradbury of FEI for the GWI study 6

7 New 1-Step GWI Testing Model Revised Test Source: Erik Bradbury of FEI for the GWI study 7

8 Elimination of Step 2 Scenario Resulting in More GWI Under New Standard Scenario A Prior Step 2 Application: Less Impairment NEW Standard Single Step Carrying Amount Fair Value Carrying Amount IPR&D CMP Goodwill Total Enterprise Value Goodwill Impairment Booked (10) (20) Assume that the Target remains a single RU. Taxable transaction with no DTL. The reduction in the EV is assumed to be due to unexpected outside events driving the value down. 8

9 Elimination of Step 2 Scenario Resulting in Less GWI Under New Standard Scenario B Prior Step 2 Application: More Impairment NEW Standard Single Step Carrying Amount Fair Value Carrying Amount IPR&D CMP Goodwill Total Enterprise Value 80 Goodwill Impairment Booked (40) (20) Now assume that the Target has legacy CMPs it did not acquire but developed internally, not reflected in the carrying CMP value. 9

10 Step 2 Elimination: The Impact Failing Step 1 will always result in a goodwill impairment under the new one-step test, which was not always the case under the previous impairment model. A higher impairment may result under the new one-step test when the fair value of longlived assets is below their carrying amount; or, A lower impairment may result under the new one-step test when there are significant unrecognized or appreciated intangible assets. 10

11 Step 2 Elimination: Effective Date For public business entities that are SEC filers, the guidance is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, For calendar year-end SEC filers, the ASU is effective in 2020 Apart from that, the guidance is effective for annual or any interim goodwill impairment tests: (i) in fiscal years beginning after December 15, 2020 for public business entities that are not SEC filers; and (ii) in fiscal years beginning after December 15, 2021 for all other entities. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1,

12 II. Updated Guidance for Contingent Consideration

13 Contingent consideration can help either the buyer or the seller or both to gain comfort with a transaction Contingent consideration is a part of many deals where there are substantial uncertainties about how the acquired business will perform post-transaction. Contingent consideration: Closes the gap in expectations for the business between the buyer and the seller Allows the buyer to share the risk associated with the future of the business with the seller, by making some of the consideration contingent on future performance Allows the seller to participate in the upside post-transaction Provides incentives for the seller to remain involved with, and help drive the future success of, the business 13

14 Under ASC 805, contingent consideration (CC) is to be recognized at acquisition-date Fair Value as part of the consideration transferred Contingent consideration is defined as: An obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met OR The right of the acquirer to the return of previously transferred consideration if specified conditions are met. 1? Contingent Consideration Initial measurement of contingent consideration under ASC Topic 805: Recognize at acquisition-date Fair Value as part of the consideration transferred 2 Fair Value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date 3 1. ASC Master Glossary 2. ASC ASC Master Glossary 14

15 Classification as contingent consideration vs. post-combination compensation expense Whether arrangements for contingent payments to employees/selling shareholders are contingent consideration in the business combination or separate transactions depends on the nature of the arrangements. Understanding the following may be helpful in assessing the nature of the arrangements: 1 The reasons why the acquisition agreement includes a provision for contingent payments Who initiated the arrangement, and When the parties entered into the arrangement If it is not clear whether an arrangement is part of the exchange for the acquiree or is a transaction separate from the business combination, the acquirer should consider... 2 a. The terms of continuing employment b. Duration of continuing employment c. Level of compensation d. Incremental payments to employees as compared with other selling shareholders e. Number of shares owned by the selling shareholders who remain as key employees f. Linkage to the valuation of the acquiree g. Whether the consideration appears to compensate employees for services rendered h. The terms of other agreements and issues such as income tax treatment 1. ASC ASC

16 Additional rules related to contingent consideration valuation Pre-existing Contingent Consideration: Unresolved CC liabilities and assets of an acquiree assumed by the acquirer in a business combination are also recognized at fair value and re-measured subsequently. Classification of Contingent Consideration: CC can be classified as either a liability, an asset (e.g., clawback), or (in rare cases) equity Re-Measurement of Contingent Consideration: 1 Equity: Not re-measured; subsequent settlement shall be accounted for within equity. Asset or Liability: Re-measured to fair value at each reporting date until the contingency is resolved. The changes in fair value are recognized in earnings Exception: A hedging instrument for which Topic 815 requires the changes to be initially recognized in other comprehensive income. 1. ASC

17 Update on The Appraisal Foundation s Valuation in Financial Reporting Working Group 4: Valuation of Contingent Consideration To address the complexity inherent in the valuation of contingent consideration, the Appraisal Foundation formed a Working Group on Valuation of Contingent Consideration. The purpose of this Valuation Advisory is to outline best practices in the valuation of contingent consideration. The Working Group includes Subject Matter Experts from Duff & Phelps, Empire, EY, KPMG, PwC and CliftonLarsonAllen. The Working Group released its First Exposure Draft on February 28, The comment deadline is April 28, The Exposure Draft may be accessed at the following address: 17

18 Estimating the expected cash flows from contingent consideration is relatively straightforward under certain circumstances Example CC Structures: A multiple of Revenue or EBITDA with no thresholds, tiers, caps or milestones Technique(s): Apply the multiple directly to the expected cash flow projections A milestone payment tied to an event not correlated with market returns (e.g. regulatory approval) Leverage industry/company experience to estimate the likelihood of the event, or have management assess it directly The underlying financial metric driving the CC is priced in the market (e.g., stock price) Apply standard option pricing models 18

19 A new challenge arises when CC is driven by non-linear structures, defined on non-traded metrics that are correlated with the market The Challenge Thresholds, caps, and/or tiers can result in payments that are a non-linear function of the underlying metric An underlying metric such as revenues or EBIT can be correlated with the market but assets defined in terms of these metrics are not typically traded in the market o The market pricing of this risk is not directly observable How should one value CC structured with these option-like characteristics, when the underlying metric(s) are correlated with the market but are not traded assets? The Solution In the context of earnouts with non-linear payment terms, when the underlying metric is not a traded asset (e.g., Revenue, EBIT) the risk-neutral Real Options framework (essentially, an implementation of the OPM framework for real assets) is an approach to be considered in estimating the fair value of the earnout 19

20 The real options pricing framework Implementation of the real options framework has four primary components: 1. Starting with management s expected case forecast of the underlying metric of interest (e.g., revenue). 2. Incorporating market-related (systematic risk) associated with the underlying metric of interest. There are two commonly used approaches: A. Discount management s underlying forecast to the valuation date at a risk-adjusted rate and use that present value as the starting point in the option pricing model B. Adjust management s forecast growth rate by the market price of risk of underlying metric forecast» If the risk-adjusted discount rate used in (A) and the market-price-of-risk adjustment in (B) are estimated using consistent assumptions, these two approaches are equivalent.» Note: these adjustments are made to the underlying metric itself before application of the thresholds, not to the resultant earnout payments. 3. Considering multiple scenarios around the expected case» Often accounted for by estimating uncertainty in the underlying metric (e.g., by simulating volatility in revenue growth) 4. Discounting to present value from the estimated payment date at a rate that captures time value of money and non-performance risk (e.g., the cost of debt) 20

21 How will management respond to future events? Simple discounted cash flow valuation: midpoint of range Value (mid-point of range) Probabilistic analysis: incorporate risk in the cash flows, rather than in the discount rate Expected Value Real option analysis: capture value via a contingent strategy Downside ROV Value Upside 21

22 This involves identifying roads we may take, and their impact on value Traditional Approach: Focus on single path, overlook uncertainty and management flexibility Real Options Approach: Confront uncertainty explicitly; identify a value-maximizing roadmap to address uncertainties as they unfold Monitor events Evaluate opportunities Choose and execute options 22

23 Decision analysis is well-suited to implement a real options approach when valuing early-stage ventures The challenges of valuing typical real options that they are mostly private risks with their own idiosyncratic distribution of outcomes have a simple solution Identify the key uncertainties Assess the likelihood of different outcomes and their implications on the cash flows Identify learning opportunities, and decisions you can delay until you are better informed Without the Option With the Option to Delay Product Launch Decision Launch R&D result Good (20%) $3,000M - $150M R&D result Good (20%) Product Launch Decision Launch $3,000M - $150M Bad (80%) - $150M Don t Launch $0 Don t Launch Value: $450M $0 Bad (80%) Value: $570M Don t Launch $0 23

24 Best practice is to capture how management can respond to uncertainty Enhanced methods address management options that maximize value by taking advantage of up-sides or mitigating down-sides, e.g.: Buy, sell, license, joint venture with a contingent development strategy or contingent deal terms Execute now or wait-and-see Expand into new indications or geographies, leverage a success into improved access to a physician segment, etc. Specifically, Real Option Valuation improves upon the Income Approach by capturing that the best choice depends on what you learn before the decision is made. 24

25 III. Discount Rates Brexit and Developing Trends

26 Brexit Background Summary In 2015, the Conservative party in the UK won a parliamentary majority in the general election with a commitment to renegotiating the UK s position within the European Union. Following the election, the UK Government entered into negotiations with the EU in order to secure more favourable arrangements and promised to hold a referendum on the UK s membership of the EU. The government s key objectives for negotiation were: Immigration: Tightening of immigration controls and implementation of tougher rules for EU citizens currently residing in the UK; Sovereignty: Conferring more powers to national parliaments giving those the right to collectively veto proposed EU laws; Competitiveness: Reformation of free trade agreements and reduction of bureaucracy for businesses; Economic Governance: Increasing autonomy for individual Member States and decentralize EU s powers. In early 2016, the negotiations ended with minimal reform to the UK-EU relationship. The referendum was held on 23 June 2016 and the UK voted to leave the European Union (51.9% for Leave, 48.1% for Remain). 26

27 Brexit Background Next Steps Source:

28 Brexit: Initial Market Impact Days immediately following vote, June 30 and early July

29 Foreign Exchange Markets Brexit Impact on the Pound Sterling June 2016 July GBP to EUR GBP to USD 1 EUR to USD 30 June 2016 Change from Brexit Vote to 7 July % -10.8% % Source: Bloomberg 29

30 GDP Forecasts for the United Kingdom and Eurozone Before and After BREXIT Vote United Kingdom Eurozone Real GDP Growth Forecasts (%) Real GDP Growth Forecasts (%) Pre-Brexit Vote Post-Brexit Vote - Nov2016 Pre-Brexit Vote Post-Brexit Vote - Nov2016 Source S&P n/a n/a IHS Consensus Economics n/a n/a EIU Oxford Economics n/a n/a n/a n/a n/a n/a IMF n/a Average Median % Decline in Forecasts Average 6% -52% -41% 0% -18% -9% Median 3% -53% -45% 0% -13% -6% Sources: S&P Global Ratings, Economic Research: European Economic Snapshots, dated October 2016; S&P Global Ratings, European Economic Snapshots dated May 2016; IHS, Preliminary Global Economic Forecasts Show Heavy Brexit Impact, dated 27 June 2016; IHS, Comparative World Overview, dated 16 November 2016; EIU, United Kingdom Country Reports dated 20 June 2016 and 7 November 2016; Consensus Forecasts, A Post-Brexit Outlook Update, dated 28 June 2016; Consensus Forecasts, Global Outlook, dated October 2016; IMF, 2016 Article IV Consultation Press Release; Staff Report; And Statement By The Executive Director For The Euro Area, dated 6 July 2016; IMF, World Economic Outlook, dated October 2016; Oxford Economics, Country Economic Forecast: United Kingdom, dated 31 May 2016 and 28 October

31 GDP Forecasts for the United States Before and After BREXIT Vote United States Real GDP Growth Forecasts (%) Pre-Brexit Vote Post-Brexit Vote - Nov2016 Source S&P n/a IHS Consensus Economics n/a EIU Oxford Economics IMF n/a Average Median % Decline in Forecasts Average -26% -8% -12% Median -23% -8% -9% Sources: S&P Global Ratings, Economic Research: Independence Day?, dated 1 July 2016; S&P Global Ratings, Economic Research: The U.S. Economy Shrugs Off its Sluggishness, Though It s Hardly Full Steam Ahead, dated 6 October 2016; IHS, Preliminary Global Economic Forecasts Show Heavy Brexit Impact, dated 27 June 2016; IHS, Comparative World Overview, dated 16 November 2016; EIU, United Kingdom Country Reports dated 20 June 2016 and 7 November 2016; Consensus Forecasts, A Post-Brexit Outlook Update, dated 28 June 2016; Consensus Forecasts, Global Outlook, dated October 2016; IMF, 2016 Article IV Consultation Press Release; Staff Report; And Statement By The Executive Director For The Euro Area, dated 6 July 2016; IMF, World Economic Outlook, dated October 2016; Oxford Economics, Country Economic Forecast: United States, dated 31 May 2016 and 15 November

32 Credit Ratings Summary Moody's Previously rated the UK at Aa1; Altered its credit rating outlook to "negative" on June 24, arguing that the negative effect from lower economic growth will outweigh the fiscal savings from the UK no longer having to contribute to the EU budget. It added that [Brexit] will weigh on the UK's economic and financial performance, with heightened uncertainty "likely to dent investment flows and confidence". Standard & Poors Previously rated the UK at AAA; Having declared that Britain's AAA rating depended on whether it stayed a member of the EU, Standard & Poors issued a statement stating that a AAA rating is untenable under the circumstances. Downgraded the credit rating two notches to AA. Fitch Previously rated the UK at AA+; Warned in May it would review the UK sovereign rate in the wake of a Brexit. Downgraded the UK to AA-; Fitch also announced in its May statement that a Brexit would enhance probabilities of downgrading other European countries ratings because of the potential losses in GDP that Brexit would have on other European countries, stating that the most exposed countries would be Ireland, Malta, Belgium, the Netherlands, Cyprus and Luxembourg, all of whose exports of goods and services to the UK are at least 8% of GDP. Sources:

33 Considerations in Developing U.S. Discount Rates

34 Has the risk-free rate lost its meaning? The risk-free rate in theory, when risk-free securities are freely traded, reflects three components: - Rental rate (real return) - Inflation - Maturity risk or investment rate risk All three of these economic factors are embedded in the yield to maturity for any given maturity length. Not possible to observe the market consensus about how much of the yield for any given maturity is attributable to these factors (with the exception of expected inflation). 34

35 What would one expect the risk-free rate to be absent Central Bank interventions and flights-to-quality? During periods in which risk-free rates appear to be abnormally low due to flights to quality or other issues (e.g. massive monetary interventions), Duff & Phelps recommends estimating a normalized risk-free rate. Normalization can be accomplished in several ways: Calculating trailing averages of yields-to-maturity on long-term government securities over various periods. Incorporate one of the various possible build-up methods. All build-up methods are based upon two fundamental relationships for nominal interest rates: 1) Relationship between nominal and real interest rates 2) Relationship between short and long-term horizons. To learn more about the equity risk premium, the risk free rate, and other cost of capital related issues, download a free copy of Developing the Cost of Equity Capital: Risk-Free Rate and ERP During Periods of Flight to Quality, August 2011, by Roger J. Grabowski at 35

36 Defining the Equity Risk Premium (ERP) The ERP (or notational RP m ) is defined as: RP m = R m R f RP m R m R f = Expected equity risk premium = Expected return on a fully diversified portfolios of equity securities = Expected rate of return on a risk-free security The ERP is expectational (i.e., forward-looking) over the expected duration of the net cash flows. 36

37 Unconditional ERP Unconditional ERP the long-term average ERP. Commonly use realized risk premium data (the ex post approach): While academics and practitioners agree that ERP is a forward-looking concept, some practitioners, including taxing authorities and regulatory bodies, use historical data to estimate the ERP under the assumption that historical data are a valid proxy for current investor expectations provides appearance of accuracy. Estimate of the ERP is the risk premium (realized return on stocks in excess of the risk-free rate) that investors have, on the average, realized over some historical holding period Underlying theory is that the past provides a reasonable indicator of how the market will behave in the future, and also that investors expectations are influenced by the historical performance of the market 37

38 Unconditional ERP (cont d) The long-term average of realized risk premiums is calculated from varying rates of returns on common stocks over shifting risk-free rates. They are generally reported annually. It is common practice to add the same long-term average realized risk premium (an ex post estimate of the ERP) to the market interest rate of the risk-free security throughout the following year regardless of the level of the rate on that security as of the valuation date. This common practice implicitly assumes either that: 1. during upcoming periods the difference between the expected return on common stocks and U.S. government bonds is constant; or 2. any decrease or increase in the ERP as of the valuation date is short-term and that the ERP is mean reverting to the long-term average of realized risk premiums rather quickly. 38

39 Problem with relying on unadjusted Historical ERP Risk- Free Rate (%) "Historical" ERP (%) Source: Morningstar Direct database. Used with permission. Risk-free rate data series used: Long-term Gov't Bonds. Capital IQ used for June 2016 (20-year constant maturity). (IA SBBI US LT Govt YLD USD). As seen in the 2016 Valuation Handbook Guide to Cost of Capital. 39

40 Bias in Realized Risk Premium Data Researchers estimating the long-term average ERP adjust average realized risk premiums for what they believe were non-recurring factors in prior periods or changing economic conditions. The years 1942 through 1951 reflected a period of artificial stability in U.S. government bond interest rates. During World War II, the U.S. Treasury decreed that interest rates had to be kept at artificially low levels in order to reduce government financing costs. This led to the Federal Reserve s April 1942 public commitment to maintain an interest rate ceiling on government debt, both long term and short term. After World War II, the Fed continued maintaining an interest rate ceiling, due to the Treasury s pressure and, to a lesser extent, a fear of returning to the high unemployment levels of the Great Depression. Postwar inflationary pressures caused the Treasury and the Fed to reach an accord announced March 4, 1951, freeing the Fed of its obligation of pegging interest rates. The artificially low rates of creates an upward bias in realized risk premium data from of approximately 1.1% 40

41 Default Spread Model December 2008 June % 7.5% 7.0% Duff & Phelps U.S. ERP Recommendation Conditional U.S. ERP (CERP) Based on Default Spread Model (Baa - Aaa) 6.5% 6.0% 5.5% 5.0% 5.3% 4.5% 4.0% Duff & Phelps U.S. ERP Recommendation as of Feb. 28, % Source: Morningstar Direct. Default Spread Model presented herein is based on Jagannathan, Ravi, and Wang, Zhenyu, The Conditional CAPM and the Cross-Section of Expected Returns, The Journal of Finance, Volume 51, Issue 1, March 1996: See also Elton, Edwin J. and Gruber, Martin J., Agrawal, Deepak, and Mann, Christopher Is There a Risk Premium in Corporate bonds?, Working Paper, 41

42 Conditional ERP Estimates U.S. Reported in the 2016 Valuation Handbook Guide to Cost of Capital: The Duff & Phelps Recommended ERP as of December 31, 2015 is 5.0% developed in relation to (and should be used in conjunction with a 4.0% normalized) risk-free rate, implying a 9.0% base cost of equity capital in the U.S. The Duff & Phelps Recommended ERP as of January 31, 2016 is 5.5%, developed in relation to (and should be used in conjunction with a 4.0% normalized) risk-free rate, implying a 9.5% base cost of equity capital in the U.S. The Duff & Phelps Recommended ERP as of November 30, 2016 is 5.5%, developed in relation to (and should be used in conjunction with a 3.5% normalized) risk-free rate, implying a 9.0% base cost of equity capital in the U.S. 42

43 Developing Forecasts and Risk- Adjustments

44 Drug Pricing Regulation There has been increased scrutiny on branded and generic prescription pricing of pharmaceutical products due to the changing political environment: A survey released in October 2016 showed that 64 percent of voters, including 52 percent of Republicans, believe that the federal government should place a limit on how much pharmaceutical companies can increase prescription drug prices. Both sides of the political spectrum have plans to push drugcost legislation and decrease drug prices Some have proposed a value-driven pricing similar to other health system approaches in the insurance industry How does one consider the significant regulatory and related risks in multi-year forecasting? 44

45 Millions Where do forecasts go wrong? Hidden assumptions Biased outlook Time wasted on non-material assumptions Perfunctory high and low scenarios High discount rate that obscures the risk Value that is masked by too many uncertainties Inadequate consideration of postdeal adjustments Typical Base Case, High and Low Scenarios $600 $500 $400 $300 $200 $100 $0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 45

46 Some best practices for improving forecasts 1. Bring hidden assumptions to light 2. Test and validate the assumptions 3. Identify key uncertainties 4. Risk-adjust the cash flows 5. Communicate the impact of uncertainty 6. Use an appropriate time horizon 7. Don t use the discount rate to adjust for private risks 8. Quantify synergies when they are relevant to the valuation 9. Ensure that probability assessments are accurate 10. Capture potential post-deal adjustments 46

47 When judgmental probabilities are needed, how do we ensure assessments are accurate? Keys are to: Be sure there is sufficient motivation» Demonstrate that the valuation is sensitive to the input Ease the burden on experts» Decompose the assessment Use techniques that overcome biases Duff & Phelps 47

48 You will get better assessments if you ease the burden on the expert, by decomposing the problem Decompose the problem to simplify the assessments Harder assessment: Easier assessments: Worldwide sales of Drug X in years 1 through 10 post-launch Decomposition Drug X profile at launch Drug X Peak Share given its profile Market Size Drug X Price Rest of World revenue as multiple of U.S. sales A good model can further ease the assessment burden (example: a market model that relates peak market share to attributes of the product profile.) Duff & Phelps 48

49 Internal Rate of Return (IRR) IRR is a diagnostic to test the relationship between operating cash flows and the operating entity value when the price is known. 49

50 IRR The Process in General Objective 1: Identify Market Participant operating cash flows and purchase price How? Remove non-operating assets and liabilities Projections align with the taxable form of the deal Identify synergies Align the projections with the synergies Objective 2: Calculate the IRR Based on information as of the valuation date 50

51 Why is the IRR Compared to WACC? Diagnostic to identify inconsistencies with Market Participant assumptions Price, PFI and WACC should all reflect Market Participant assumptions Provides a basis for the valuation of the assets and their risk Entity-specific synergies (in PFI and price) must be removed IRR is a critical reference for the Weighted Average Return on Assets ( WARA ) WACC and IRR should reasonably reflect the perceived risk of achieving the PFI 51

52 IRR WACC What do you do? Reassess the three main factors: 1. Purchase Price 2. PFI 3. WACC 52

53 IV. CEIV Credentials and Requirements

54 Trouble on the Horizon -- The SEC speaks out Scott Taub Comments are interpreted as being critical of the valuation profession. Paul Beswick Suggests that the valuation profession is fragmented and inconsistent, and would benefit from unified qualifications, standards and oversight. Paul Beswick Provides some hopeful remarks about increased dialogue in the valuation profession, although suggests that much remains to be done Steering Committee AITF Forum, valuations for financial reporting (VFR) Appraisal Foundation Begins sponsoring Valuation Advisories, adds to AICPA Guides Appraisal Practices Board Formed FV Quality Initiative Formed 1 st of 3 Bus. Valuation Roundtables 54

55 Fair Value Quality Initiative - Milestones Group Forms Address issues brought up by regulators. Big 4 valuation leaders and representatives of Valuation Professional Organizations ( VPOs ) comprise this group. Others invited include the CFA Institute, The Appraisal Foundation, the IVSC, and midsized accounting firm valuation leaders. SEC Meeting Group Leaders meet with Paul Beswick, Chief Accountant of the SEC, in the Spring to discuss the path forward Formal Meetings Begin Regularly meetings begin in the Spring/Summer; four work streams were identified and populated Progress Meetings were held with the SEC staff, PCAOB staff and the FASB Board and staff, as well as FASAC I in the Spring. 55

56 Fair Value Quality Initiative 2016 Milestones (continued) Interested Party Meetings Additional meetings with interested parties, the Governance and the Mandatory Performance Framework work stream occurred in early 2016; referred to as the friends & family meetings. Vetting of VPOs and Rollout of VPO Training and the CEIV Credential 3/2016 5/2016 8/2016 9/16-1/17 Mandatory Performance Framework The Mandatory Performance Framework work stream issued a draft for comment. Comment period ends 8/24. Assessment A subgroup of the Mandatory Performance Framework and be coordinated by the Qualifications work stream, comprised of a technical writer and an experienced exam writer from each VPO are developing the initial assessment 56

57 Recommendations for Professional Infrastructure Duff & Phelps, Big 4, and other valuation firms with VPOs have begun the process to increase uniformity and quality Develop a unified professional designation and infrastructure (perhaps in the form of an Alliance or Self-Regulatory Organization) that would focus on valuations for financial reporting purposes Three fundamental elements of a professional infrastructure to support public capital markets services would need to be part of such an effort: Accreditation/Certification and renewal criteria, including education, experience and continuing education requirements Professional standards that address not only professional behavior and ethics, but provide robust technical performance standards and accompanying guidance A quality review and oversight/disciplinary process that is recurring and is structured to give confidence that professional lapses are handled with appropriate rigor and consequence 57

58 Timing 2016/ Forward Expectation of widespread VPO enrollment Uniform accreditation test for valuation individuals who act as public preparers Only accredited VPO members to perform public reporting valuations or accounting firms to significantly expand scope of audit of valuation procedures of an UNACCREDITED appraiser Accepted industry wide performance standards Beyond 2017 Peer Reviews Ongoing continuing education 58

59 59 Mandatory Performance Framework (Executive Summary) Valuations for financial reporting purposes completed in a professional manner require adherence to a consistent set of professional, technical, and ethical standards as well as a set of guiding principles that help define how much work is necessary in order to provide supportable and auditable fair value measurements that serve as the basis for management s preparation of financial statements for financial reporting purposes. 59

60 60 Duff & Phelps Fair Value Quality Initiative - Workstreams Performance Standards Qualifications Quality Control Governance & Coordination 60

61 61 Duff & Phelps Certified in Entity and Intangible Valuations Baseline Requirements Initial Education & Assessment CEIV Minimum Experience Ongoing Requirements Experienced Entry 61

62 62 Duff & Phelps CEIV Baseline Requirements The individual must be a member of an approved VPO and meet the minimum experience, education and assessment requirements related to the approved VPO s business valuation credential 62

63 63 Duff & Phelps CEIV Minimum Experience The individual must have 3,000 hours of experience related to business and intangible asset fair value measurements over the five years prior to application for the fair value credential. Experience related to fair value measurement may include Auditor specialist valuation reviews of fair value measurements prepared by the firm s valuation team Signing valuation reports Performing, mentoring, supervising and managing fair value measurement engagements Consulting on, instructing, authoring, developing, though leadership and staff development on fair value measurement matters Documentation will be required to meet the experience requirements including attestation by partner/peer, resume submission, or a detailed submission of hours (realizing a submission of detailed work hours is not always feasible) 63

64 64 Duff & Phelps CEIV Initial Education & Assessment CEIV candidates who do not meet the Experienced Entry requirements will be required to undertake education related to the fair value measurement Body of Knowledge and the Mandatory Performance Framework This education will be delivered by each VPO The knowledge focuses on Auditing requirements as they relate to fair value measurements and the use of the valuation report in the audit process and An overview of financial reporting standards, valuation advisories, technical papers and other publications related to public interest valuations» The above two modules will be referred to as the Body of Knowledge Mandatory Performance Framework requirements Every CEIV candidate, including those who have met the Experienced Entry requirement, must successfully pass a uniform assessment relating to application of the Mandatory Performance Framework to the Body of Knowledge 64

65 65 Duff & Phelps CEIV Ongoing Requirements All CEIV holders must meet the following requirements to maintain and continue to hold the fair value credential: 48 hours of fair value measurement-related CPE over a rolling three year period with an 8 hour fair value measurement update required annually to commence on January 1 st of the calendar year following the credential holder s join date Compliance with the Mandatory Performance Framework 1,500 hours of fair value measurements-related experience over a rolling three-year period Submission to ongoing engagement level quality review 65

66 66 Duff & Phelps CEIV Experienced Entry Requirements Experienced Entry candidates are defined as qualifying individuals that have a minimum of 10 years of valuation experience (approximately 20,000 hours) with at least 50% of this experience being directly related to fair value measurements. Experienced Entry will be exempt from the requirement to undertake the education related to the Body of Knowledge but they are required to undertake the education on the Mandatory Performance Framework. 66

67 Valuation Advisory Services 67