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50: BerryDunn Roundtable

In this episode, visit BerryDunn in Portland, Maine. We share our roundtable discussion with BerryDunn's Seth Webber (Principal, CFA, ASA, CBA, CVA, CBEC) and Katy Whitehead (Manager, CVA, MBA).

Be sure to subscribe to our podcast to receive updates about our future episode with Seth Webber, as well as our 2019 webinar series where we will go into more depth on several of the key points covered in this roundtable.


About BerryDunn

"A member of the Top 100 accounting firms, and northern New England’s largest, we are a full-service accounting, assurance, and consulting firm, working with clients coast to coast in the US and around the world. Our range of expertise provides services to a wide array of clients from town, local, and state governments to healthcare, not-for-profit, higher education, commercial, financial services, high tech, and more.

While our company has evolved over the years to stay on the forefront of the many industries we serve, our mission has remained constant: to help each client create, grow and protect value―while delivering exceptional service, based on integrity, expertise, and a constant commitment to your success." [Source: BerryDunn, About Us]


Episode 50 Transcript

Announcer: 00:12 Welcome to The ESOP Podcast brought to you by Capital Trustees, keeping you up-to-date on all things ESOP.

Brian Keisling: 00:21 Hi, everybody. Welcome to The ESOP Podcast. This is Brian Keisling with Capital Trustees. Today's episode was recorded in Portland, Maine where Bret Keisling and Patrice Radogna visited BerryDunn [] and sat down with Katie Whitehead and Seth Webber. At the beginning of this episode, it's just between Bret and Katie, where we find out a little bit about her and what she does for BerryDunn, and then we go onto a roundtable discussion where they discuss what BerryDunn does and how that relates to Capital Trustees and internal and external trustees. In an upcoming episode of The ESOP Podcast, there's going to be a further conversation between Bret Keisling and Seth Webber, and for now we hope you enjoy this roundtable discussion.

Bret Keisling: 01:02 I'm sitting here with Katie Whitehead. We've just recorded a podcast roundtable with Katie and her colleague, Seth Webber of BerryDunn. Katie, thank you very much for doing the podcast and thank you for joining us for this little intro segment.

Katie Whitehead: 01:15 You're welcome. Thank you for having us.

Bret Keisling: 01:17 So, we are sitting in your office in Portland, Maine.

Katie Whitehead: 01:20 Yes.

Bret Keisling: 01:20 And I understand that you've been back here, but you're the prodigal daughter who came home to work on ESOPs!

Katie Whitehead: 01:29 That's correct.

Bret Keisling: 01:30 Is that what you expected when you left so many years ago?

Katie Whitehead: 01:33 I can't say that was, but here I am!

Bret Keisling: 01:36 We are glad that you're here. So take us a little bit, tell us what to do for BerryDunn and then just give us a little bit about your background.

Katie Whitehead: 01:42 Sure. I'm a business valuation analyst at BerryDunn. I joined the firm in February of 2017. Prior to that, I was in tax at another local CPA firm and I find that that's really been helpful with the valuation, bringing my tax knowledge to the business valuation process. Prior to that, I was living in San Francisco where I worked for UBS and private banking and I earned my MBA from the University of San Francisco with a concentration in finance. And, what made me get into business valuation was I took a great class in grad school for business valuation and I just fell in love with the subject, and it took me probably about 15 to 16 years to finally find my way into it, but now I'm happy and I don't plan on leaving it any time soon.

Bret Keisling: 02:36 Excellent. And you now, as I understand, have moved back to the town you grew up in.

Katie Whitehead: 02:40 Yes. Yes. I'm in Yarmouth.

Bret Keisling: 02:42 Yarmouth, Maine.

Katie Whitehead: 02:43 Yarmouth, Maine.

Bret Keisling: 02:43 And an interesting little tidbit, Seth Webber, who you work with now, you and he knew each other way, way back.

Katie Whitehead: 02:52 Yes, we did. We grew up together, pretty much, and now he actually lives across the street from my parents, which is pretty funny.

Bret Keisling: 02:59 It's a small world,

Katie Whitehead: 02:59 It's a small world. So... and our kids go to the same school. So, very small world.

Bret Keisling: 03:06 So you grew up in Yarmouth and then you left, you did your undergrad at the University of Rhode Island.

Katie Whitehead: 03:11 Yes.

Bret Keisling: 03:11 And then at some point made your way to San Francisco.

Katie Whitehead: 03:14 So after undergrad, I moved from Rhode Island to Boston and I worked as a mutual fund accountant at First Data Corp, and I was there for about two years, and then that's when I made my move to San Francisco.

Bret Keisling: 03:28 So, there's a lot of water here in Maine and out in San Francisco. Is that connected to your interest?

Katie Whitehead: 03:34 Yes, I love being on the ocean. I love visiting the mountains in Colorado and Utah, but I'm a Maine - I'm a Maine girl or I'm a California girl - I need the ocean. So a coast - east coast or west coast!

Bret Keisling: 03:48 Either way, you just want to be on the coast.

Katie Whitehead: 03:50 Right, exactly.

Bret Keisling: 03:51 I remarked to you just how gorgeous it is in downtown Portland where I spent some time if you were going to just sell Maine for just a moment: Why should someone come and visit or do business? What brought you home, I guess it's the...

Katie Whitehead: 04:04 What brought me home, was, it's a wonderful place to raise children and I have two boys, nine and eight. And I love the fact that they're able to ride their bikes to school safely. They have a yard to play in. I think the people are wonderful here in Maine. We really all work together to support the local economy. I think that's huge. I just think we have a really nice network of people, where it's very small community and I think everyone kind of helps each other.

Bret Keisling: 04:33 That is very cool. Katie, thank you for joining us on the primary podcast and thank you for the couple of minutes here.

Katie Whitehead: 04:39 Thank you so much for having me, Bret.

Bret Keisling: 04:43 Hi everyone. It's Bret Keisling of Capital Trustees with The ESOP podcast. We're here with a very special episode today. We're very happy to be recording in Portland, Maine with a couple of friends. First of all, Patrice Radogna, director of the Boston office of Capital Trustees is here. Hi, Patrice.

Patrice Radogna: 04:59 Hey, Bret. How you doing?

Bret Keisling: 05:00 I'm excellent, thanks. And we're also joined by Seth Webber of BerryDunn. Hi, Seth.

Seth Webber: 05:04 Hi Bret. Thanks for having us on today.

Bret Keisling: 05:06 We're delighted and Katie Whitehead of BerryDunn. How are you?

Katie Whitehead: 05:08 Hi Bret. I'm great, thanks.

Bret Keisling: 05:10 Excellent. So the four of us are here together and we wanted to have a discussion and we wanted to talk about some of the differences between internal and external trustees and, Patrice, last week, the week of October 15th, you were at the Great Lakes conference with all of us in Sandusky, Ohio, and you were at a presentation where they talked about some of the issues that trustees face, and that brought us to the topic of today. So why don't you tee up the topic for us.

Patrice Radogna: 05:33 Sure, sure. So I was in a presentation that was talking about trends, litigation trends actually, with ESOPs. So being a trustee, I was very interested in just kind of getting a recap of some of the major issues, and Tucker and Ellis did a great job of probing into these issues and looking at all recent cases in the last few years to see what the major issues are. And one what the claims are in DOL, DOL claims. And the number one issue by far, it turned out, is failure to probe and identify issues in valuation reports, So they have like 10 major issues that come up in the litigation, by far the number one was the failure to probe the valuation report. So I thought that was interesting.

Bret Keisling: 06:28 Patrice, you're actually working on a webinar series that we're going to launch in 2019 that's going to do an in-depth look at these issues, correct?

Patrice Radogna: 06:36 Absolutely. Absolutely. I'm looking at how, really understanding what a trustees duties are. A big part of that is, you know there's many duties, but a big part of that is setting the price for the valuation and what do you do, what are your processes and what are the steps that you take to get you there. And you know, this is what we do all the time. We see many valuation reports from different companies and we just talk about what that looks like and we make sure that we help. If they're internal trustees, it would be great, I think ,insight for an internal trustee to understand some of the issues facing them.

Bret Keisling: 07:15 And then before we bring our friends from BerryDunn, we'll just tee this up. As we've said on a number of podcasts, Patrice,, there is no difference between an internal and an external trustee from the Department of Labor's perspective, from the fiduciary liability. So if you're an internal trustee listening to this and you hear a process being explained and you say, I don't do that process, don't misunderstand what I'm saying. I'm not saying, Oh, Capital Trustees has it perfectly right. What I'm saying is external trustees who do this professionally have processes that are designed to satisfy the Department of Labor. So if you hear a process in this conversation, you want to take a look at your own processes. Our goal here is to help educate you so that you can do a better job and keep out of trouble because our view is if anyone's in trouble with the DOL, it doesn't help any of us. So we really wanted to do that. So, on the process. There are some big things that I'm going to tee up and then we'll see what you folks have seen. We hear kind of at conferences, there are sometimes where the internal trustee may not even review the draft report, it may go directly to someone else. So we want to kind of take through the process, and Seth when you're working with an internal trustee, do you notice a difference between the process of internals and externals?

Seth Webber: 08:32 We do. I think one of the things that we always try to do, whether it's an internal or external trustee, is make sure that there is more than enough time for them to review a draft report. So, you know, I would be shocked if somebody wasn't looking for the draft report ahead of a meeting. That to me would be a red flag. I just think, the valuation reports, Patrice, as you know, from having worked in valuation for so long, and Katie knows, and Bret, I don't know how many of these you have to review in the ordinary course of business, but there's a lot to them. And so I think the expectation that somebody could sit down at the beginning of an hour or two hour meeting and meaningfully understand all the material in there is a fallacy. And so our standard practices to give people at least a week, right? We try to give them two weeks, and we try to make sure there's at least one weekend in there so they can have some light bedtime reading.

Katie Whitehead: 09:33 ...and to feel free to come back with us with any questions they have during the review...

Seth Webber: 09:38 Right.

Patrice Radogna: 09:38 ... and probably even encourage that...

Katie Whitehead: 09:40 Absolutely.

Seth Webber: 09:42 Well, and that's one of the things we do. We love questions, and the more questions we get the better because that way we know people are actually digging into the report and looking at different things. It's always, I would say more concerning to us, and again, it doesn't matter if it's an internal or external, but when we send out the report and we know the report's been downloaded, but we don't get any questions. Because then we walk into the trustee meeting and we're not quite sure where people are coming from, what they've keyed in, and what they haven't keyed in on.

Bret Keisling: 10:14 Seth, let me explain our process a little bit because ours is a little bit different, but you hit the nail on the head I think in terms of why. Capital Trustees last year reviewed 60 valuation reports for ongoing and transaction purposes; almost definitionally if you're an internal trustee, you're only reviewing one a year. So right off the bat, we have the ability of of gauging the quality of the report compared to others. And Patrice, obviously you're coming with 20 years of valuation background, you have a feel from that side of it. We'll require three days turnaround from our valuation advisors for us to be able to do a phone call to review the report, but I think it ties in - we take three business days and it's because we have such familiarity. So the fact that you give them a week and that sort of thing is a very good idea.

Seth Webber: 11:05 Right.

Bret Keisling: 11:05 Let me ask what the experience is with the internal trustees. We probe everything. We probe the forecast, we probe the projections and one of the challenges with an internal trustee is oftentimes you're the one making the forecast, you're the one, maybe your boss makes the forecast. And to me as an outside person it's easier to probe because our paycheck isn't tied to that forecast. Have you run into any problems with not probing well or that sort of thing?

Katie Whitehead: 11:32 I don't think we've run into any problems with not probing well, I always feel this concern of can they change, can they switch over their roles? So let's say they're a CFO but they're also an internal trustee. Can they take off that hat and put on the internal trustee hat? I think that's kind of concerning because I think we find a lot of the internal trustees do in fact do prepare the forecast and a projection. Do you, do you agree?

Seth Webber: 11:58 And what I find, and this is more generically, is that left to their own devices most people don't want to do a forecast, and we've run into all kinds of examples of people who are actually have like almost the perfect data set to do forecasting and still refused to do it. So I think sometimes we, um, as the valuation analysts are pushing on people to do a forecast and trying to push them and probe some of their assumptions that go into the forecast. So, so from that perspective we're probably taking on a little bit of the role that the external trustees often take, which is, "Well, how do you know these are the numbers"? Or, "Geez, that doesn't seem like it lines up with your historic trends."

Patrice Radogna: 12:44 You're helping them along helping. It's really their numbers. But, oftentimes from what I experienced in my previous experience as an appraiser, is they needed -- there was assistance on the process in guiding and helping with the process. But very clear that the drivers, and the numbers, are their numbers.

Seth Webber: 13:07 Absolutely.

Patrice Radogna: 13:07 But, you know, let's help with the process

Seth Webber: 13:09 Well along that line with the process is, we heard a presentation not that long ago from some folks both on the trustee and the valuation side, and they were talking about process for their clients and this kind of like magic three- year window that happened when the light bulb would go off on forecasting. And to me it's not this magic light bulb. It's okay, we've been through a transaction, we're not sure exactly how the forecast influences the valuation report in total. So let's give it our best shot. Okay. Now that we understand that, so maybe they're a little high or a little low. The next year they tend to overcorrect either high or low and then by the third year they're like, okay, well, we've seen the high, we've seen the low, now we kind of strive to hit the middle. But that process takes three years unless you're doing quarterly forecasting or something, which we're not fortunate enough to have clients who are doing that.

Bret Keisling: 14:13 [Laugher. Multiple participants jump in.] I was about to say, which you would love!

Patrice Radogna: 14:13 That would be really nice!

Seth Webber: 14:16 Now we do have a guy in our group, Art Marshall who comes to us with a ton of experience. And Art used to run all the lodging operations for one of the ski mountains in the area.

Bret Keisling: 14:26 Very cool.

Seth Webber: 14:27 So they did a weekly rolling forecasts, because the ski season...

Bret Keisling: 14:33 Tied to precipitation?

Seth Webber: 14:34 Tied to precipitation and tied to ticket sales.

Bret Keisling: 14:37 Okay.

Seth Webber: 14:38 And tied to how things have gone. And so, like, if they had a couple of light weeks, then they knew that it was time to lay on the promotions and get some people up to the mountains and to fill up the beds. And so we are very fortunate and glad not to do weekly rolling forecasts, but there are businesses out there that, you know, every week they've got to go in and kind of figure out where are we had last week go and what does that mean.

Patrice Radogna: 15:03 And that's also your role as an analyst when you receive forecasts, so maybe year after year, you're receiving forecasts. One of the things I would assume is you're looking back to see how did they do?

Katie Whitehead: 15:16 Absolutely.

Patrice Radogna: 15:16 How did they do on a consistent basis? And if you are seeing that the company is not meeting their forecast or they're over on a regular basis, use that information, and that's an important tool to have a conversation about for going forward. So if you have any comment on that.

Seth Webber: 15:35 I agree 100 percent. The silliest comment I have ever received to-date was during a review of an annual ESOP valuation. And the comment was "The forecast changed from last year." And we said, "Yes." [Laughter.]

Patrice Radogna: 15:52 And it should!

Seth Webber: 15:56 And it should! But what the reviewer was expecting to see was...

Patrice Radogna: 15:59 ...static...

Seth Webber: 16:02 ...was that the out year, so now what would have been years two through five, we're just going to be copied and pasted over to now be years one through four with a different year five. But again, in that kind of coaching, mentoring, pushing, probing role...

Patrice Radogna: 16:24 What's the business today?

Seth Webber: 16:25 ...the client sits down and does a new forecast every year. And so we push eight years what you thought you were going to do last year. Here's what happened. How did that impact not only business operations from last year, but how does it impact your view of what the next several years are going to look like? So the forecast should change.

Bret Keisling: 16:47 And here I think is what we've all run into, is the response of, "But how can we know?" You know, how are they seeing the tea leaves? And that's a real problem. And we all know, and I've believed this since I was quite a bit younger, that business is business. So when we say forecasts are necessary, that's a generality that is true. The details are in the ski lodge that does weekly rolling forecasts versus you can do a five year plan on an annualized basis -- I mean how you do the forecast. But how do we get past the fact that it seems for a lot of people to be hocus pocus?

Seth Webber: 17:40 Well, I think the concern is always, and particularly now that there's more probing from everybody around the forecast, it's the, you know, is it a forecast or is it a commitment? And you know, so what we try to push people and assure people is we want your best thinking about your business for the next x years. So think about it like a weather forecast, right? So what we're forecasting for tomorrow...

Bret Keisling: 17:51 So that is the level accuracy we're shooting for is the weather forecast? [Laughter.] Well, I was kidding obviously...

Seth Webber: 17:55 Well, the weather forecast for tomorrow is fairly accurate. Your weather forecasts for days two through five starts to lose some accuracy and precision. And once we get beyond, like, year five or day five, then we're kind of entering into "Farmer's Almanac" territory, where we're trying to read the tea leaves, we have an idea of where things are going, you know, but that may or may not come to fruition. But if we're holding people to bring their best thinking to bear, then I think we're doing everybody a service. The concern is, it's the 20/20 hindsight. Recessions are hard to see going forward, but at the same time, if we're in a cyclical industry and you guys see this when you're reviewing, you know, information all the time. If you're in a cyclical industry and there's no evidence of that cyclicality in the forward looking forecast, what are, what are we doing.

Patrice Radogna: 19:00 Right.

Bret Keisling: 19:01 Katie, could you explain what's the practical effects of the forecast? You do the valuation and Seth had just talked in terms of the multi-year. You do a valuation. You have worked back and forth to be comfortable that it's accurate for your purposes. And then the next year they miss the forecast. Just explain what - so that the listeners understand - why it affects the valuation.

Katie Whitehead: 19:28 So if they missed the forecast and the next -- I want to make sure I understand your question correctly. So they missed the forecast and we recognize that in the next year's valuation?

Bret Keisling: 19:37 Yes, 2017, we've done the valuation and it's based on the five year forecast, and then we're doing 2018 and they were just off - high, low, whatever - way off.

Katie Whitehead: 19:44 Sure. Well, again, I think that opens up the conversation, "what happened?" You know, did you overestimate your revenue? Did, you know, did your costs jump for some reason? I think that's a really good conversation piece to kind of self-correct going forward for the future projection, projected years. I think with clients I've seen with projections when you ask them, "Well, what do you anticipate for the next five years?" It's almost like they freeze and they don't know what to say. It's like they need this, this magic ball or something, and so I think again, just opening up that area for conversation of what happened, really kind of understanding and self-correcting going forward.

Seth Webber: 20:27 So one of the things is kind of like the conversation we had yesterday with a client. So it's, "Hey, you missed - why?" And if they have discrete reasons as to why that are understandable, that weren't foreseeable, that has a different impact on how you perceive risk, than if they're like, "We did things and things didn't happen quite the right way." And building on what Katie was saying, one of the things that we see when we're talking with people about what happened last year versus forecast is if they have discrete concrete reasons as to why they missed forecast, that has a much different impact on our understanding of risk than if they really hadn't been monitoring performance or hadn't been thinking about the forecast since they delivered to the valuation analyst the year before.

Bret Keisling: 21:22 And so let's say that your company is a shipping company and there was a tsunami and suddenly you couldn't, you know, deliver; half your ships are messed up. When we review the forecast, that makes sense.

Seth Webber: 21:35 Absolutely.

Bret Keisling: 21:36 Conversely, they're shipping company, weather was fine, everybody seems to be doing well and you just missed it by 30 percent. You can't point to anything. That's where you're saying that's a different matter.

Seth Webber: 21:45 Correct.

Bret Keisling: 21:46 And you said that effects risk, How does that effect risk? What's your take on that...

Seth Webber: 21:51 If I could build on that even more... So, if it's a shipping company, and one of their primary costs is going to be fuel and all of their competitors hedged the price of fuel and they've decided that they don't want to hedge the price of fuel, and there wasn't a tsunami, but there was a spike in fuel prices last year and that tanked their profitability. To me, that's going to assess, that's going to impact risk directly because they're taking on operational risk that their peer group and their competitors have chosen to lay off on other people.

Bret Keisling: 22:22 Okay.

Seth Webber: 22:24 But if there's a tsunami, hopefully they had appropriate insurances in place, you know, so that there would be some, some money that comes back in. But the tsunami would hopefully be a nonrecurring one-time impact to their operations, given that they're in shipping, tsunamis do happen. Hopefully it doesn't hit all their fleet at the same time.

Bret Keisling: 22:44 And I am troubled -- I'm not surprised as I'm sitting here -- and folks, if you haven't been to Portland, Maine, this town is gorgeous -- there's a bay, it's beautiful. So I think that's kind of what got my mind about the shipping company example. Why I chose a tsunami, as the business... like, "All of your customers are devastated! Things are horrible!" And I was like, that was kind of a dark answer. So I'm going to think about that a little bit.

Seth Webber: 23:09 Well, but on the shipping. So, it's not just shipping that's impacting people, but it's related. So this year, let's say you're in shipping and suddenly, when we sat down on December 31st because we put ourselves in the shoes of the valuation date and the impact of, of different trade actions wasn't known and one could argue maybe they're still not known and knowable, but here on the coast of Maine, that has had a pretty immediate impact, you know, on certain industries. And so if we get to next year and somebody says, "Geez, I'm in the business of shipping lobsters and lobsters were hit by a 25 percent import tariff. And so our business dropped precipitously." Yeah, that's something that couldn't have been baked into their forecast last year. The question this year would be then what did you do to work your way out of that hole? And if they said, well, we're just going to sit and hope and pray, that's not as good an answer as, you know, we've been going out and we've been working on diversifying our export markets by looking at these countries or you know, we've got a new agreement with some guys up in Canada to take on the lobster that we can't sell to China.

Patrice Radogna: 24:24 Can I add something? Just because it's a topic that comes up in valuation all the time. In fact, it was one of those top reasons, or top items, that is litigated in the DOL, and it's the discount rate. And it's a fact of maybe appraisers or the valuation report didn't take into account the risk of forecasts and didn't, you know, adjust the discount rate. So I'm not making. I'm throwing a question out there right now. How do you look at discount rate and how do you look at that in conjunction? Because I have heard folks talk about what a discount rate should be just or if it's above three percent, I'm talking about the company specific component of a discount rate. So if it is above three percent or five percent, that's just too high. So I look at that, I'm like, Ooh, be careful, you know, as far as we look at that in a bubble or what are you looking context? In addition, the other factors that impact that discount rate

Bret Keisling: 25:27 Can we get a definition of discount rate first before Seth's answer for people listening and just what that is, and where, how that comes into play?

Seth Webber: 25:36 The discount rate that Patrice is talking about is also called a cost of equity, or it is the risk associated with the investment in equity in a business. And so that's probably a great area for the Department of Labor to probe into because there are several elements of a cost of equity or discount rate that are somewhat formulaic. They're driven by empirical data, and they're also driven by the larger market and what's going on in the economy. But then there's this big area that's driven, that's company specific risk.

Patrice Radogna: 26:17 So just to - and I'm going to fill in a little bit too - so, as Seth said, this is a rate of return that you apply in doing a valuation and there are several components that make up this discount rate, and there are factors that are known or are empirical data and there's one portion of this buildup on this rate that isn't based on empirical data and that's kind of what we're honing in on. It's called company-specific risk.

Seth Webber: 26:43 Right. And just for folks that don't look at a lot of valuations, a useful image in your mind is think of a seesaw. And on one end of the see-saw, we have value, and on the other end of the seesaw we have this cost of equity. So that as the risk in a business goes up, the value in that business goes down and vice versa. So the higher the company specific risk, conversely the lower the value would be. I don't have a hard and fast formulaic way of looking at forecast risk in building that in the company specific risk, but it is a factor. Because I think one of the things that, without getting too deep into the theory behind valuation, because that may bore your audience to tears and we try to generally avoid that...

Bret Keisling: 27:39 That's my job on this podcast! You be entertaining. I'll be boring! [Laughter.]

Seth Webber: 27:42 Okay. It's a deal. We're looking at really a theory of alternative investments. So if we, if we didn't invest in this business, what else would we invest in and what kind of return would we expect? Well, as we would be looking at these investments, one of the things we're looking at is forecast risk. So this actually shows up in both in ESOP specific valuations, but also in general business valuation that, you know, people may come and say, "Geez, I'm really worried about missing my forecast." And so we get know, common parlance we referred to as a sand bagged forecast, something that's going to be really easy for the company to meet. Well, there's not a whole lot of risk that they're going to miss that forecast, particularly if they've been a strong track record. So ironically, you know, they may be trying to give us a low conservative forecasts in order to, you know, manage valuation down, but because there's less risk in that forecast they may actually be having opposite impact, right?

Patrice Radogna: 28:50 And I guess that's my point. You have got to look at all the components of the valuation, the forecast being really a key component, in order to then say whether or not the company specific component of that discount rate was reasonable or not because they can vary, but it really, you know, there was other factors, but what your start, your discount rate is used to assess, to determine value, based on the forecast. You have a return - value is basically a combination of returns and risk. Your returns or your cash flows are your forecasts, and the risk is measured by the discount rate. So both of those are key in determining what the value is and what you - and a good appraiser like yourself, because all the issues that you're pointing out - will really not, you know, just understand what exactly are we talking about in risk in this company as a whole, and the number of specifically that we're trying to assess right now.

Seth Webber: 29:52 And it is one of the reasons why, to your point about, "Geez, never more than three percent" or "Should be in this range." We tend to shy away from those hard and fast rules...

Patrice Radogna: 30:05 ...Absolutes...

Seth Webber: 30:05 ...absolutes, because it's, appraisal done well is looking at the whole. It's looking at the totality of the information that's out there. So what's the forecast, what's the economy, what's the industry, how do they perform against the peer group? And then pulling all of that information together, are we coming up with a story that makes sense.

Bret Keisling: 30:28 Let me pause for just a moment because I want to back up and give a stern warning to any trustees. And then something, Seth, that you said in passing. Occasionally, and we'll see it as well with a management, although we're the external trustee. Occasionally internal trustees, in this case, or management, will try to manage the valuation result, the share price, because there might effect repurchase obligations ,there might be any number of things. And folks, if you're - and this is the listeners - if you are managing your valuation process towards a certain goal of a share price, you are risking a lot. That's not how it works. You understand it and you get to the fair result at the end of it. And the value is the value. It's the steps going into it. With that said, when you talked about maybe managing to get a certain value, I assume that only works for one time or the first year because you get a forecast or it might take to the third year, but you get a forecast and they did 20 percent over forecast and the second year they do 20 percent over forecast. The third year, do you guys work into some assumption that they keep going under forecast? You would make some adjustments, right? I

Katie Whitehead: 31:41 I think we point it out to them right away, within the first year or two that we noticed that, you know what again, what's going on?

Seth Webber: 31:50 And send it back and ask for a revision.

Patrice Radogna: 31:54 And I would imagine that sometimes the forecasting process becomes, you know, is this a futile exercise? And if we're really seeing that this is, they're not meeting those forecasts, and we're saying, it's kind of that garbage in garbage out that everybody talks about, and at some point saying, without getting too technical, there is another way to skin the cat. You can look at the forecast and then you can look at another way, it's just kind of backward looking, and say what have they done in the last three years and if you continuously - there's such a disconnect continuously with the forecast and versus what you actually have shown you're doing year after year, then maybe the year after year looking back is a better predictor of value.

Katie Whitehead: 32:37 And I think with reoccurring ESOP valuations it's very, I find it kind of unusual to inflate the forecasts for future years. Right. I feel like if anything, like we just touched upon, it's ultra conservative. So I don't, I don't find that we run into that too often for reoccurring valuation.

Bret Keisling: 32:57 And it's interesting because conservatism in the forecast, I wonder if they're just hoping to not be wrong, and therefore...

Katie Whitehead: 33:06 Sure!

Bret Keisling: 33:06 They'd rather exceed the forecast to be a little conservative, because that feels better.

Katie Whitehead: 33:10 Yes, yes.

Bret Keisling: 33:10 Whereas we're kind of looking at it as the accuracy, whether you're up or whether you're down, we can tell you that if you exceed the forecast, it's probably going to bump you up. If you miss it, it'll go down. But a 20 percent increase over the forecast functionally we think is the kind of the same as the 20 percent decrease in the forecast. Right? You're still off the forecast by 20 percent?

Katie Whitehead: 33:31 Right.

Seth Webber: 33:31 Right.

Bret Keisling: 33:31 Hey, one other thing, Katie, that you had pointed out, just in terms of the questions that you get back. And, again, this is to the listener. BerryDunn is very good at what they do. If you're an internal trustee and you're listening to this and you're saying to yourself, "Wow, I don't ask any questions of our valuation firm, and they don't ask any questions of me." If your process is you send a lot of [data] to the valuation firm and you just get a draft valuation back, I think we'd all agree that process is not good. You should seriously be looking at whether your valuation firm is bringing a robust enough effort to the valuation.

Katie Whitehead: 34:11 Right, and being available to answer any questions, too, and encouraging the client to ask a number of questions

Bret Keisling: 34:20 And then one of the things that I should point out with us as external trustees, our valuation firms have these conversations with management as well. They'll talk about the forecast. They'll talk about anything that isn't the story. And the example that I give is, regardless of any level of competence, I've been in business since I was 15 years old and if there's a story that I don't understand, I just - keep telling me until I understand it, because there's just a whole lot - and you guys are the same - we just, boy, if that doesn't make sense, you know, we want to understand why. But in our case, our valuation firms will go through that process with management and then they're going to go through it with us, you know, because we're going to do the same probing. Sometimes we just leave it at the valuation firm if we are comfortable that they've probed enough, other times we go back to the company as well. So the other difference between external and internals, is we almost have a two-step process. The valuation company gets firm with it and then we -- or I'm sorry, -- the valuation firm gets comfortable with it and then we get comfortable with it through them.

Patrice Radogna: 35:24 Right. And what you're talking about, Bret, is the exact number one issue for litigation and the DOL, is failure to probe the valuation report. So as trustee, what is, what has surfaced over and over again is that is not happening. And it might be because it's, there isn't an awareness that that should be happening. There might be an uncomfort level with an internal trustee, possibly that they maybe don't, aren't comfortable knowing the questions to ask. And, truly as an external trustee, when you do see a valuation reports from, you know, 40 different valuation firms, and there are a myriad of issues that can come up, you have perspective. You just have perspective to be able to know it isn't, "Do I have a list of questions?" It's "Do I have the right question right here with this valuation report?" Because something doesn't look right. There's something missing here. You can probe and ask that question and that's kind of, I think, the crux of why that is the number one issue.

Bret Keisling: 36:36 Patrice, I had to laugh -- and then, Katie we'll get to you in just a moment. But we had a potential client probably about six months ago and they were going through, it was an internal trustee, and they were going through their process and they said, you know, I think the valuation firm expects us to review that entire 40 page report. And they were like crazy about the 40 page report. And my response was, "It's only 40 pages?!" Like, you know, for us we look for a lot more, so they're saying, "Oh, there's so much data!" And I'm like, "You're missing half of it" or however much you are. Katie, you were about to make a point.

Katie Whitehead: 37:05 So, do you have any pet peeves as external trustees when you review valuations?

Bret Keisling: 37:11 Pet peeves, such as?

Katie Whitehead: 37:14 Or maybe, what are the biggest areas for concern when you review the valuations that you see? I mean, do you spend a lot of time looking at company specific risk, or do you spend more time looking at the discount rate? I mean, what are you....

Bret Keisling: 37:30 One of the things that we do, Katie, is we understand that there's a lot of discretion, between valuation firms among the discount rates, among any of the premiums that might be used or that sort of thing. We haven't, unless we feel very strongly as the trustee, we don't really impose our own rate on the valuation firm. And we should pause for the listeners here, and it's simply the way it is. Even though we rely very heavily on our valuation firms, it is the trustee that sets the share price, legally. So, at the end of the day, we know that the share price I'm setting is going to be the share price on your report, Katie, and they're going to match up, but they're going to match up because of the process. And fiduciarily when the Department of Labor is going to come, and we hear internal trustees say this all the time at conferences, "The valuation firm set the share price." And I'm just, my stomach sinks a little bit, because if you say that at a deposition, you know, your trustees admitting they're not doing their duty. So what we want to do is kind of understand what the valuation firm is thinking and make sure it's in the context. Like if you were to discount rate or whatever the, you know, I think we said three percent. If suddenly we're talking to someone and they're 12 percent, we're going to want to know why it's so far out of what we would expect. But if there's a difference between two and three quarters and three and a quarter, we're going to chat about it. But we also understand that's kind of the art that you folks bring to what you do, not the science.

Patrice Radogna: 39:10 So yeah, I can add a little bit to that. When I'm reviewing valuation reports, one of the things that I look for that I'm not always finding is I will, I'm looking for the report to in totality make sense, and in totality be tied together. So it isn't just, okay, let's do a valuation report, which if it's held to its standards, which is USPAP [Uniform Standards of Professional Appraisal Practice] standards, there's certain components that need to be in an valuation report. So I'm going to have an section on the economy, I'm going to have a section on the industry, I'm going to do a write-up on the company, and I'm going to include all these factors. But if it's really the report, absolutely should be tying in why all of these factors matter. If it doesn't matter, it doesn't need to be in the valuation report. If you've put it in the report, then there is a reason that it does matter if it's just put in without kind of tying it together and saying how this relates and doing a good analysis then I guess that would be something that I'm looking for. Don't just throw in an industry report and not tie it to how it impacts the company. What is it that you drew out a bit that it was that important? And maybe one other item is those guideline public companies, looking at that when we talked a lot about the income approach, the market approach is, is another widely used approach to value businesses and one of the methods within the market approach is guideline public company. Not saying that it can't be used, but really take a look at what you're doing there and look at those companies that are chosen. Look at your, you know, it isn't a given, you don't have to use a guideline public company method, and sometimes it just, um, the, there was not good cops out there and it was deemed to be not that relevant, not that helpful. So I would say that really analyze that and see if it's really helping the valuation. And you should be relying on that method in determining value. Do you have any thoughts on that?

Seth Webber: 41:21 One of the things, Patrice, that you were saying on everything that's in the report should be there. So both for external and internal trustees, I think a great question to ask at the of every section of a valuation report is, "So, what?" And "How does this apply to my business? How does this apply to my valuation? How does this apply to my share price?" Because if the report's not addressing that, then hopefully the valuation analyst can, and if they can't, maybe they need to go back and just add a couple paragraphs or a couple sentences as to, you know, so here's what's going on in the economy. Okay. "So what?" What does that mean to me again?

Bret Keisling: 42:05 And that's exactly right. We want to make sure the "So what?" is the, "What's the relevance? What does it mean to me?" And not "So what? You're not gonna make me read the whole report."

Seth Webber: 42:13 Correct.

Bret Keisling: 42:13 It's the show, the relevance to the company, is the "So what?"

Patrice Radogna: 42:17 "What do we draw from this?"

Seth Webber: 42:17 Tie it back to my business. Help me understand.

Bret Keisling: 42:20 Right.

Seth Webber: 42:20 Right. So draw that whole narrative thread. Guideline public companies: I think there's a lot of good data in there. I don't think that public companies look a lot like our privately held companies each and every day. The good data that's in there, you know, there's hundreds of thousands if not millions of transactions a day that are happening in these public companies. So there's a lot of data in there that we can mine that helps us think about how are investors thinking about risk, how are investors thinking about these industries? What, when investors in these industries are looking at companies, how are they pricing them? Yeah. What multiple, what benefit screen were they using? So there's a lot of good data that we can extract from, from them. But the reality is the risk profile with these companies looks very different. The growth expectations, you know, you've got the growth built into public company shares that's tied to a holding period.

Patrice Radogna: 43:24 Right. A very high multiples is usually indicative of extremely high growth. Like, for example, if you're looking at a restaurant and trying to value a privately held restaurant and you're looking at guideline comps, say for example Panera Bread or a Chipotle...

Seth Webber: 43:41 ...Or Shake Shack...

Patrice Radogna: 43:41 ...Shake Shack. The growth, if you've watched the growth of these quick service restaurants over the last 10 years, it's extraordinary. And how is that reflected? It's reflected in the multiples.

Seth Webber: 43:53 Right.

Patrice Radogna: 43:54 It's very different. And even their geography, their diversity of these huge conglomerate companies. Very different.

Seth Webber: 44:01 And there's a great case study out there, for if there are any listeners that are into reading case studies, on Jiffy Lube. Because their stock performance for years was driven as they were building out geographies. So like a Shake Shack, you know, would be in that instance now, but a Chipotle, that's already managed to expand from coast to coast, or a Panera that doesn't have new territories left to build out, their growth rates really start to flatten out and it has an impact on their stock performance. So one of the things is that growth rate. So you've got this supernormal growth rate during this short period, but in our privately held companies, a lot of times we're looking at these terminal values. So we're looking at growth rates in perpetuity. Well, in perpetuity, you know, is a very long time. [Laughter.]

Katie Whitehead: 44:53 It is! By the definition. [Laughter.]

Bret Keisling: 44:57 Why, yes it is. God, willing, unless there's a tsunami! [Laughter.]

Seth Webber: 45:01 Unless there is a tsunami that wipes out our poor little village.

Bret Keisling: 45:03 That's right.

Seth Webber: 45:04 So, but if the US economy is growing at, for sake of argument, three percent, it's hard for me to imagine how I can grow at five, six or seven percent in perpetuity. Just logically. It's hard for me to imagine growing faster than the US economy, unless my privately held businesses going to drive the US economy. So there's...

Patrice Radogna: 45:27 ...That's a LOT of burritos for Chick-fil-A! I mean for Chipotle... [Laughter.]

Seth Webber: 45:31 That's a lot of burritos for Chipotle! But you can look at that difference in growth rates in those public company multiples. You can also look at the size differential in those public company multiples and you can make adjustments. One of my pet peeves are people who use data from public companies to help set their costs of equity in the income approach and then say, but I couldn't find any guideline public companies.

Bret Keisling: 45:58 And Seth, that's what I was going to ask, and one of my pet peeves on this is, is we get a guideline public company, and let's say the employee owned company is a 30 million dollar enterprise value, and it's not unusual where like, "Here's the 2 billion dollar public company," and we're like, well, that doesn't seem the same. And then, oftentimes it's while we waited it, you know, as a double check. And that to me, I'm afraid it could be the appearance of kind of the voodoo, you know, the magic versus the art of we've got a company that doesn't really match up at all. So let's just give it a weighting. That kind of brings us...

Patrice Radogna: 46:39 That was less, a lower weighting....

Bret Keisling: 46:39 It gives it a lower weighting. In other words, I think it's tough for some people to see the relevance of comparing at all a 2 billion dollar company to a 30 million.

Seth Webber: 46:50 Well, so I would argue Bret, the relevance at all, is there are shares in that 2 billion dollar company that are being traded all the time. So, it may not be perfectly relevant, but we have a lot more data that we can look at.

Bret Keisling: 47:05 And I like your approach to the data of what are the investors looking at in terms of the industry, in terms of this, that, and the other thing. I think it makes a lot of sense.

Seth Webber: 47:12 But what we may have to do is scale that back, and this is one of the things that without seeing the totality of the report that you're looking at it'd be hard for me to, in a vacuum, comment on do I take that multiple and just apply it without any adjustment. Our practice would not to be, to apply, public company multiples directly to the subject company.

Patrice Radogna: 47:41 In other words, not to have it as a determinant of value.

Seth Webber: 47:45 Not only, not to have it as a determinant of value, but not to use the raw multiples. We scale the multiple for both sides and difference in growth expectations, and we've found oftentimes we get very consistent results by doing that with our income approach. But I think applying raw multiples from public companies to private companies is some people like to say it's apples and oranges. I like to say it's oranges and orangutans because it starts off sounding similar, but it's actually very different!

Bret Keisling: 48:19 Apples and orangutans. I will keep that in mind!

Seth Webber: 48:23 Oranges and orangutans.

Bret Keisling: 48:24 Oranges and orangutans!

Patrice Radogna: 48:27 I think this conversation right here, just highlights the judgment that appraisers need to use. And then a trustee that needs to evaluate ,because you're talking about a lot of factors, that are complex factors that you don't come across every day. And when it comes to, well, this appraiser used this judgment and well, how do I know that's right? It is difficult. There's no like, you know, when it comes to the judgment part of things, it's difficult. But at the end of the day somebody's going to make a decision and then that appraisal report has to be reviewed. And then that trustee needs to say, I think it's credible. And here's why.

Seth Webber: 49:07 Well, and it highlights, it's one of the huge advantages that you folks have as external trustees, is that when you review a report, you are bringing a lot more context and a lot more perspective to the reading of any one report because you have a broader view as to how other firms are doing it, how other analysts are applying different approaches, different multiples, different methods, whatever it may be. Where, the internal trustee is really relying on the analyst to bring their perspective and make sure that they're doing it well. And again, you know, as Katie mentioned earlier, that's where we love the questions because we want to make sure that we, we want to be challenged on our valuations, because we've done the work...

Patrice Radogna: 50:03 ...And it's a good process.

Seth Webber: 50:03 ...Where, we're willing to support our process and our product.

Bret Keisling: 50:07 Seth, let me do this. Let me give another helpful hint or stern warning to internal trustees, and then we'll just see if anybody has any closing thoughts as we wind this down. But I appreciate the conversation. I received one phone call from the Department of Labor regarding a client of ours that was under investigation and we knew when we were hired that the company was under investigation and, and there's a podcast where we've talked about that previously. So Capital Trustees wasn't implicated at all, but the Department of Labor wanted an interview with me as I was the trustee for our firm. It was a two hour phone interview. Our council was on another line, had phoned in. 45 minutes of the interview was specific to my client, an hour and 15 minutes I look at it as just a primmer on ESOPs. The Department of Labor was saying to me, can you explain the market approach? Now, this company connected to their DOL problems had been valuated for several years on a liquidation basis. So there was no market approach, these guys were barely holding on and have done a great job of turning themselves around -and we knew that, and got a lot of respect - but there were all kinds of things that just weren't applicable. The Department of Labor wanted to see if I had the knowledge as trustee to be able to address it, so my warning to the internal trustees is, if you see a market approach in your valuation report and you're not sure what the market approach is or why it's there, don't say, well, the valuation firm must know what they're doing. BerryDunn wants questions, but you also, as the trustee, your valuation advisor is not going to be in the room when you get some, you know, deposed if it really came to that. So you want to bring up your knowledge if it's in the report, you at least should have a conversational ability to discuss with your valuation expert. So, makes sense?

Seth Webber: 52:09 That makes sense to me.

Bret Keisling: 52:10 Every so often we like to give a stern warning to the trustees, because again, if you're going to be an internal trustee, we want to make sure that you do it right. Patrice, any closing thoughts as we wrap up?

Patrice Radogna: 52:22 No, I think this is excellent. I'm so happy to be here and share thoughts with both Seth and Katie from BerryDunn, it's really great.

Bret Keisling: 52:30 Katie, any closing thoughts for the conversation?

Katie Whitehead: 52:32 I do not. I've had a wonderful time speaking with you both.

Bret Keisling: 52:35 Thank you, and Seth?

Seth Webber: 52:37 Thank you.

Patrice Radogna: 52:38 Any forecasts from the Farmer's Almanac? [Laughter.]

Seth Webber: 52:42 Any forecasts from the Farmer's Almanac? It is supposed to be cold winter. We hope it's a snowy winter and we hope that young children never discover ice hockey so that everybody can go skiing instead. [Laughter.]

Katie Whitehead: 52:52 Well, my life is over.

Bret Keisling: 52:55 That's a mean perspective. Folks, we say thank you again to our guests Seth Webber and Katie Whitehead of BerryDunn and Patrice Radogna of Capital Trustees. This is Bret Keisling. Thank you for joining us today, and hope you'll come back and join us next time. Have a great day.

Brian Keisling: 53:10 Do you have feedback about this or any other episode of The ESOP Podcast? Do you have a topic you'd like for us to discuss on the show? Would you like to appear on the podcast as a featured guest or a panelist in a group presentation? Then we want to hear from you. Send us an email at Thanks for listening!

Announcer: 53:33 Thank you for listening to The ESOP Podcast. Brought to you by Capital Trustees and their managing directors Bret Kiesling and Rich Heeter. Production assistance provided by Brian Keisling and Third Circle, Inc. Logo designed by Bitsy Plus Design and music created by Max Keisling. Join us again next time for The ESOP Podcast.


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