Retaining a Business Valuation Expert

Reprinted from the New York Law JournalWritten by: Raymond Dragon, MBA, MS, CPVA, ASA

Retaining a Business Valuation Expert

For many attorneys, telling their clients to retain a business valuation (“BV”) expert is an everyday type of event. Estate and gift tax attorneys need credible valuations for gift tax filings, setting up trusts, and other estate planning strategies. For other attorneys, retaining a business valuation expert is only common in certain cases, such as the marital law attorney involved in the divorce of a business owner. For attorneys involved in business acquisitions, a BV expert might be required to establish a deal price, or more likely, to allocate the post-acquisition purchase price to the company’s tangible and intangible assets for financial reporting and income tax purposes.  Finally, for attorneys involved in shareholder disputes, intellectual property disputes, or business damages cases, finding a BV expert experienced in valuing minority equity interests, intellectual property valuation, or calculating lost profits is critical. But the question the client may ask is, “Why do I need to retain a BV expert, I retained (and paid) you to make my case?”

Client misgivings about retaining a BV expert may in part stem from a lack of knowledge about the role of these experts.  Business valuation experts value companies that are privately-held (not publicly-traded). The value of a publicly-traded stock can be found by looking at its price in the stock market. For a privately-held company, where this information is unavailable, the BV expert is acting in the role of the market.  

A BV expert will look at issues that might not be apparent to business owners or other financial advisors. Audited financial statements might not reflect the subject company’s true economic income. In many cases, the BV expert will work from tax returns and the company’s accounting books and records. The BV expert will use his forensic accounting skills to adjust the financial statements to reveal the true economic income of the business, which is a foundation of its value.  Basic issues that usually need to be considered are:

  • Separating the income a business owner receives for working in the business from the income received as an owner of the business.
  • Separating the value of the business from the value of the real estate if the business owns the building from which it operates.
  • Removing non-business expenses and separating out the value of nonbusiness assets.
  • Determining whether related-party transactions and expenses, such as rents and salaries, are at market rates.
  • Separating the income attributable to physical assets from the income attributable to intangibles, such as trade names or technology.
  • Determining discounts for lack of control and lack of marketability for partial interests.
  • Determining the appropriate standard and premise of value.

The last item, determining the appropriate standard and premise of value, is a key component of every valuation.  The standard of value is the set of rules under which the business is being valued, and reflects the governing law and circumstances of the case. Usually the standard of value is fair market value, but in shareholder disputes or divorce in certain states, the standard might be fair value. The premise of value reflects the operating condition of the business. It usually is going concern value, but in some cases could be liquidation value or another premise.

Depending on the applicable standard of value when valuing a partial interest in a business, the BV expert might apply a discount for lack of control (“DLOC”) and/or a discount for lack of marketability (“DLOM”).  A DLOC is a discount applied to the value of a partial interest in a business to reflect that the owner of the interest does not have 100 percent voting control regarding the decisions made by management. A DLOM is a discount applied to the value of a privately-held business to reflect that it usually cannot be sold as quickly or easily as stock in a publicly-traded company.  Many privately-held companies and partnerships have restrictions on the sale of interests to people outside the original investor group. In addition, an adjustment is often made for pass-through entities such as S-corporations and LLCs that don’t pay taxes at the corporate level.  Applying these discounts will make a partial interest worth less than its pro-rata share of the whole. This can generate significant tax savings in estate and gift planning.

Finally, an attorney must consider whether the expert is credible.  High caliber business valuation experts perform this work as their primary business, not as a sideline to tax or audit work. They have university degrees in finance, economics or accounting, sometimes at the master’s level.  They should possess one of the recognized business valuation credentials, such as the Accredited Senior Appraiser (ASA), the BV credential from the American Society of Appraisers, the Accredited in Business Valuation (ABV) credential from the AICPA, or the Certified Valuation Analyst (CVA) from the National Association of Valuators and Analysts. Their reports should state that the valuation was conducted in accordance with the professional standards of their credential. 

Lastly, if the matter is likely to go to litigation, it is important to ascertain whether the BV expert has court testimony training and experience.  Certain credentials are recognized by the courts, and experts possessing them will be viewed as more credible. Plus the big intangible is whether or not the BV expert has the personality to testify well.  Some view testimony as a terrifying experience to be avoided, while others view it like tackle football: you may get hit but you keep on going.  The expert with that “swagger” is the one for situations where testimony is probable.

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