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The challenge of a business valuation expert is to provide, what can often be complex and detailed, information in a cogent manner within a brief period of time. The characteristics of closely-held corporations, including the lack of a ready market for the stock, make the task of valuation a particular challenge to the lawyer”.
When an appraisal is needed
Most statutes are general; therefore, judicial precedent may be a determinative factor in what methods to value are used and are governed by the individual state. Most businesses possess Goodwill, which is beyond the value of other tangible assets owned. This is why a business appraisalexpert should be retained to value an intangible that is often difficult to measure. Black’s Law Dictionary (5th Ed.) defines intangible assets as: “Such values as .”
In California, which has some of the highest number of lawsuits and divorces in the country, the Golden v. Golden (CA 1969) case established the rule that, even if the enterprise is a sole practitioner practice, the value of goodwill should be considered. This is because the property is argued to go automatically to the licensed spouse and that (s)he is not actually selling or liquidating, but continuing business. The non-operating spouse of this community property is seen as effectually withdrawing and may be entitled to fair compensation for the interest owned. This implies that goodwill must be transferable to have value. Since the spouse is simply transferring the one-half community interest, it may have greater value as the other interest holder has an already established relationship with customers. This may be referred to as “compulsion value” or the unique circumstances surrounding the valuation and distribution of business interests in a dissolution.
It is vital to contact an expert before opposing counsel retains one that is in high demand; therefore, having an expert business appraiser file on hand is highly recommended. Be sure no conflict of interest exists. Also, inquire about the percentage the expert has represented the owner versus the non-operating spouse.
A cursory evaluation can be performed in typically five hours in many circumstances, with the fee applied to a more thorough engagement, if determined to be worthwhile. This usually involves providing the expert with copies of relevant documents, such as a sufficient number of years of financial statements and tax returns; lease, employment and partnership agreements; brief business history; articles of incorporation; interest to be valued and other operational materials.
Should opposing counsel have already received an appraisal report, a professional review can assure your clients an objective opinion was provided and offer alternatives, if the conclusion is suspect. Such reviews will examine whether the business appraiser appears to have the qualifications and expertise to render an opinion. The review will also determine if the report adheres to the Uniform Standards of Professional Appraisal Practice (USPAP) standards 9 and 10 and IRS Revenue Ruling 59-60; whether the assumptions and conclusions are technically correct as well as supported and documented; whether the appropriate standard of value is applied; and if, readily available data was omitted; particularly in the Market and Income approaches, to name a few areas that can be probed for efficacy.
A common area of neglect is an absence of supporting comparative information, which produces a report that is circular in logic. A report that makes a statement similar to “I have examined the Subject against itself and it is my opinion that the factors I have determined, such as risk and earnings, produces the following value”. A statement like this is based on nothing more than opinion, if details to each of the factors considered are not well represented by independent, empirical support, such as a market and economic analysis. Otherwise, how can one know that performance, of the enterprise in question, was influenced by internal or external factors? In other words, what is typical? This tends to be the valuation’s Achilles’ heel, regardless how thick or embossed the paper is in the appraisal report.
Request the entire working file of opposing counsel’s expert and determine whether the opinion is a preliminary or final report. This is in order to see what resources and processes were used to derive the conclusions presented and to limit the “wiggle room” during deposition and trial. Many legal practitioners ask that a written report is not prepared until after a value conclusion is reached and conveyed.
Under the amended (1993) Federal Rules of Court Procedure 26(a), experts must provide written reports prior to giving trial testimony allowing more time for effective cross-examination.
Selecting an “Expert” Business Appraiser
An appraiser with strong litigation support background can provide good interrogatories to produce documents and questions to raise during deposition. This can make opposing counsel’s expert “more honest” if the deposing counsel’s expert is present during testimony and provide follow up questions to responses that are unclear or seem suspect. This can make the use of client’s time considerably more productive.
If nothing else, working closely with an expert in business valuation prior, during and following deposition may be an excellent idea. Let’s be practical. The issues surrounding the value of an ownership interest in a closely-held business tend to be relatively infrequent and unless legal counsel has a strong finance/accounting background, (s)he is likely to be providing a disservice to the client, if an impartial opinion is not obtained. It is more relevant to determine whether there is sufficient evidence (substantive data) to support the opinion held. If retaining a CPA, insure competency provisions under AICPA Rule 201 are met.
It is amazing to find how many “experts” perform only three or four formal appraisal reports annually and often claim to provide dozens and sometimes hundreds of “informal” opinions. This is often because the practitioner may be performing many financial, tax or accounting services and not solely business valuations. If the “expert’s” position is fraught with inconsistencies and/or technical errors or conflicts of interest, a motion for summary judgment may be appropriate, when it becomes clear to at least one of the parties (and occasionally both) that the opinion fails to meet the Frye Standard; is not “expert” and would not assist the trier of fact in the disputed matter.
It’s important to remember that an appraiser is an “expert” in valuing businesses, not necessarily an expert in the industry appraised. Testimony is based on experience and expertise as an appraiser. Red flag an appraisal being performed by the business’ tax preparer as issues of bias and conflict of interest will surely arise as well as the degree of appraiser competency.
Perhaps, this is why the trial judge in his decision in the landmark case of Johnston v. U.S. (1984) expressed: “This Court is disappointed in the apparent fact that the so-called experts can take such license from the witness stand. These witnesses say and conclude things which, in the Court’s view, they would not dare report in a peer reviewed format.”
In many cases, the business appraiser’s written report fails to meet Rule 26 (a)(2)(B), because it often fails to contain a list of data considered; a summary of all exhibits that will support their opinions; the report writer’s signature (not firm’s) and their qualifications and compensation.
The Supreme Court Case of Daubert v. Merrell Dow Pharmaceutical and the more recent cases of Frymire v. KPMG Peat Marwick; G.E. v. Joiner; and Kumho Tire Company v. Carmichael, have strongly influenced the rules of civil procedure and evidence and provisions governing discovery (as applied in the Federal Rules of Evidence 701 – 706); particularly, the judge’s role as gatekeeper, as it pertains to admissibility of expert testimony.
The valuation expert must demonstrate the appraisal report meets applicable standards and uses appropriate methodologies; is not “advocating” a value and can be replicated. The report should also discuss why alternatives were not used or given less weight.
There’s considerable backroom discussion of selecting a “hired gun” when representing a value of a business interest. The rationale tends to be that, at best, the case may be won or, at worst, the trier of fact will take a “Solomon-like” approach. Here the difference will be split between the two disparate values.
In the landmark Buffalo Tool and Die as well as the Sirloin Stockade v. Commissioner (1980), cases the Court specifically stated that it would not compromise between two opposing values, but would instead reach a decision on the valuation reports presented.
Developing testimony around a pre-established value tends to be doomed since the opposing attorney will likely explore any biases or inconsistencies in the valuation report. This is because the factors that influence “opinion” all tend to drive the value in a single direction. Since the opposition’s expert is likely to be familiar with prescribed appraisal techniques, (s)he is in an excellent position to exploit weak areas. There are seldom instances where there aren’t both positive and negative influences in a business. It is easily challenged when they’re all pointing in one direction. The risk is that the report may become discounted leaving only one opinion to be considered.
It is unwise to believe that a retained appraiser is not expected to support the value advocated by the counsel retaining him or her. If the expert was uncomfortable with this position, they would be expected to refuse the engagement.
Selecting two business appraiser experts often only serves to cloud the most likely value, if only one appraiser is truly impartial. This is why many courts operate under Rule 706 and appoint or recommend the selection of one mutually agreed upon “neutral” expert, so no perception of alliance is present. This appears practical as fewer than 5% of cases ever go to trial. It should also apply to mediation and arbitration. It is strongly urged, for reasons more than maintaining a good working relationship, to insure that the expert’s billing accounts is current, so no allegation of influence may be made.
The criteria for selection of a qualified valuation expert, as is the case with many professionals, can often be over-simplified. The fact is there are a plethora of designations.
Some are rendered by simply completing a take home exam and stating that several business appraisals have been performed. During a recent blind study we conducted, following one completed through the Institute of Business Appraisers (IBA), a few years ago, over 60 firms offering business appraisal services were contacted concerning an estate matter of a fractional interest held in a $5 million manufacturer.
Fees, time frame and what to examine
The fees quoted to complete the work ranged from a low of $2,000 to over $12,000 with hourly rates ranging from $70 to $250! The average fee hovered between $5,000 to $7,000 with an hourly rate of $150, suggesting about 40 hours to gather information, conduct an analysis, determine and reconcile values and prepare the report. The fee for solid appraisal services is nominal compared to the dollars at risk. You’ll never know until the valuation issues are contested and litigated. While just a thought, would you want a client to have selected you based solely on fee? If the appraiser and his or her report is of he very highest quality, will there be valuations issues at all?
Sadly, hourly rates and final fees do not always beget better work products. Completion times quoted appeared to be represented as taking an average of 4 weeks. What is quoted and what is performed is not always the same, particularly during tax season.
Although requested, few appraisers provided their curriculum vitae, engagement letters or any material suggesting the degree of experience for the assignment. Additionally, only two firms suggested the need for a personal property appraiser. This is relevant as many manufacturing businesses’ value will likely lie as much in their operating assets (machinery and equipment) as they will in intangible assets, such as goodwill. Although requested, no firm provided a sample “sanitized” appraisal report, so the prospective client can get an idea of the work product being purchased. Perhaps this is why many legal practitioners are reticent to place their faith in such a questionable morass of competency.
It’s best to start gathering impressions from the moment you call. Does this office have a live person responding to your calls? How long does it take to receive a reply? What type of information do they provide? Do they offer recommendations as to the depth of the appraisal report based on the situation? Do they ask questions pertaining to the given situation? Are they being clear about the number of times designated as an expert, court appearances and performing similar assignments? Who will be performing the actual appraisal? What is their personality and would it persuasive and unflappable during deposition and trial? Can they provide references? Have they spoken or written articles concerning their industry and practices?
Unless your client has unlimited resources, not sifting through these issues can readily put you in a compromising position of hiring a business appraiser who may not assist you in successfully trying your case or working towards a settlement. This serves only to cost your client untold aggravation as well as loss of time and money. If you have found somebody with whom you’re comfortable, be sure to obtain an engagement letter, which clearly spells out the parameters of the assignment.
It is fairly typical to request a 50% retainer with the balance due prior to receipt of the final work product. In part, this is to protect the appraiser from delivering unacceptable news and not getting paid. The other is to remove any compromise of partiality due to not receiving payment.
The Appraisal Engagement
Due to the often-adversarial nature of the parties, clients should endeavor to restrict dialog with the business appraiser to issues relevant to the interest to be valued, as all discussions become discoverable during deposition and trial. An appraisal assignment begins by questions and responses between the interested party and the appraiser. The more accurate picture the appraiser has of the business, the better insight (s)he has to the issues that will need to be addressed in the actual engagement.
If these are addressed earlier on, the business appraiser can provide a reasonable quotation for performing the work and an estimate when it will be finished. Once agreed, the appraiser should provide a letter of engagement stating the scope of the appraisal (what work will be performed). It should also include the Objective of the appraisal; the date and “standard” of value as well as the interest to be appraised.
(Ex: We will determine the marital (investment) value of the 30% minority interest in the Subject “C” Corporation incident to a marital dissolution as of the date of separation, May 1, 1999.)
