Good news/bad news/good news on lost profits analysis
Ninety percent of the argument in ninety-five percent of the [lost profits and economic damages] cases is the ‘easy stuff,’ Brian Brinig of San Diego’s Brinig & Company, Inc., told a jam-packed session at the recent AICPA/ASA National BV Conference in Las Vegas. That’s the good news for valuation experts who take on what can often turn out to be time-consuming, intense litigation engagements. “The number of times I’m actually in an argument over the discount rate is few and far between,” Brinig told attendees. “In general, in the small business damages cases I do, I’m not spending my time arguing the discount rate but in defending the basis for my conclusion and projections: why the lost profits should be what they are.”
So what’s the bad news for BV experts in economic damages? Well—there are those tough cases concerning start-up businesses or businesses that never got off the ground “but for” the bad acts of the defendant. Think of the small business that claims it would have been the next Microsoft had the bank kept its line of credit instead of canceling it. “Good luck with those,” Brinig quips. “Get a bigger retainer.” Or get on the defendant’s side—which, he says, he does “much more happily. And they can usually afford to pay better.”
And then there is the issue of calculating the discount rate for lost profits and/or lost business value. When Brinig gave the audience five choices for the most appropriate rate to apply when present valuing future losses (the risk-free rate, the “business valuation” rate, investment value, another rate, or—“it depends”), the vast majority of attendees selected the latter. In some jurisdictions, is the rate governed by state law? Will your attorney school you on this? (“Good luck with that one,” Brinig says. “The cases are muddled.”) And what about the timing of the valuation—should you use an ex post or ex ante approach to the analysis?
The best news: The timing couldn’t be better for the impending release of BVR’s Comprehensive Guide to Lost Profits Damages, edited and authored by Nancy Fannon. Contributors also include Michael Crain, Dr. Bill Kennedy, Bob Gray, Tom Burrage, Michael Kaplan, Mark Dietrich, professor Robert Lloyd of the University of Tennessee College of Law, and many more. The 19 chapters will cover all critical aspects of lost profits calculations, from the basic methods and procedures to establishing evidence and defending Daubert challenges; from distinguishing lost profits from lost business value to discounting the damages measurement; from cases concerning intellectual property to those to regarding auto dealerships, construction firms, government contracts, and medical practices. The all-encompassing Guide will be available in early 2009 at BVResources.com; look for updates in the near future.
More discussion of fair value’s economic impact
There’s so much to consider in the latest news on “mark-to-market” accounting rules. A recent salvo came in the form of comments from William Isaac, former FDIC chairman under Ronald Reagan, which essentially blamed Fair Value for causing the current financial crisis.
Meanwhile, the Securities and Exchange Commission’s (SEC) congressionally mandated study of “mark-to-market” accounting, as authorized by Sec. 133 of the Emergency Economic Stabilization Act of 2008, expects the report to provide insights on: 1) the result of such accounting standards on a financial institution’s balance sheet; 2) the consequence of such accounting on bank failures in 2008; 3) the impact of such standards on the quality of financial information available to investors; 4) the process used by the Financial Accounting Standards Board in developing accounting standards; 5) the advisability and feasibility of modifications to such standards; and 6) alternative accounting standards to those provided in FAS 157. The last of two SEC roundtables on the topic (be held this week on Friday, November 21) is sure to generate additional controversy.
However, at the recent ASA/AICPA National Business Valuation Conference in Las Vegas, Bob Herz, chairman of the Financial Accounting Standards Board (FASB), sought to quell such debate among BV experts in his keynote address, including his acknowledgement that, “most people think the mixed attribute model [for accounting standards] is a problem, but how fast to change it—and to what extent—is critical. [It’s also] the source of the current controversy.”
Herz also paid tribute to the BV community for its contributions, both past and present, to the development of financial reporting standards, saying that the “active involvement by valuation analysts is much appreciated,” and that BV practitioners can continue to play a vital role in the future of fair value models through education, outreach, “and by making sure [the] profession is all that it can be.” How can you get involved? Herz suggests the members of the profession find out more about FASB’s Valuation Resource Group (VRG), offer comment letters and participate in roundtables.
For more on Fair Value: Check out BVR’s upcoming teleconference, Fair Value Measurement and Potential Liabilities, on this coming Thursday, November 20. The event—featuring Mike Mard, CPA/ABV, ASAof the Financial Valuation Group and also a member of the VRG, and Tony Yanez, Esq., with the law firm of Willkie Farr & Gallagher—is sure to provide a host of important information and insights on this hot topic. For more specific information about this and other teleconference programs and specific program registration requirements, click here.
Are global valuation standards closer than you think?
The London-based International Valuation Standards Council (IVSC) recently announced the appointment of two new boards—The International Valuation Standards Board and the International Valuation Professional Board—aimed at increasing the oversight and implementation of global valuation standards.
The IVSC contends that improving the quality and scope of international valuation standards may provide many benefits, including the better identification of investment or lending risk, improved confidence in financial reporting, and a more consistent approach to portfolio and asset valuation. According to the Chairman of the newly appointed Standards Board, Chris Thorne, “The financial crisis has brought into sharp focus the need for better consistency and transparency in the valuation of business assets of all types. Regardless of how the numbers are used in constructing financial statements, there is no doubt that investors and the public generally will benefit from the disclosure of objective and transparently derived values, especially in cross border transactions.”
The Standards Board has the task of defining standards for the undertaking and reporting of valuations in consultation with providers, users and regulators. The Professional Board was created to provide a focus for the currently disparate valuation profession around the globe; its goal will be to promote the profession generally and to benchmark educational and professional standards for valuation. Brad Wagar, Chairman of the new Professional Board, observes, “These are challenging times for people and capital markets the world over. What better time for the International Valuation Standards Council to advocate international valuation standards coupled with the enhanced education of, and implementation of best practices by, the world’s valuation professionals?”
Four easy ways to lessen your engagement risk
On the last day of the ASA/AICPA conference in Las Vegas last week, Ron Klein of Camico Mutual Insurance Company talked about engagement risk management for business appraisers. He separated all BV claims into two groups; the first group consists of all claims associated with a specific transaction (transaction-based claims), the second group consists of all other claims. And you may have guessed, the transaction-based claims “is where the money is” and are “4-50 times larger than all other claims.” Klein discussed a few things BV firms can do to help to mitigate engagement risk:
- Use a formal client acceptance procedure.
- Include someone other than the engagement partner in the acceptance process. The point: Take care to have an uninvolved third party with your firm sign off on the process.
- Do not become involved in the negotiations or financing of deals. Why? The more you are involved, the more advice you are seen to be giving and the more risk you incur.
- Don’t include words like “advised” or “assisted with” on company timesheets that describe the time charged to engagements. The reason: Opposing counsel will find this in discovery and infer greater involvement with the deal
And as an added bonus, Camico has published their 10 Ways to Manage Your Risk in This Economy here.
Loose lending practices may protect appraisers
In 2000, a steel plant in South Wales (U.K.) sought an asset-based loan from Bank of America (BOA). As part of its due diligence, BOA contacted a valuation firm (Dovebid), which entered into an agreement with the steel plant to appraise its assets. The appraisers valued an orderly liquidation of the plant’s assets at $8.5 million and a forced liquidation at just over $7.0 million. The appraisal contained the “customary proviso” that its conclusions were based on economic trends within 90 days of the valuation; it also disclaimed any guaranteed “sale results,” since its opinions did “not apply to any past or future dates.” Finally, the report noted that it was intended for use only by the purchaser (the steel plant) and any other users should understand that the purchaser did not receive any guaranteed values by paying for the report.
Based on this appraisal, BOA agreed to extend a $5.75 million to the steel company. The appraisal firm was neither a party to the loan nor a guarantor of the borrower’s obligations. Not long after, BOA sold the loan to Wells Fargo as part of a $374 million portfolio. Less than a year later, the steel plant was in default. Wells Fargo requested the same appraisal firm to conduct a second valuation, which it completed in July 2001—but Wells Fargo refused to pay for it, perhaps because it estimated the forced liquidation value at only $2.86 million. In March 2002, the steel plant went into receivership, its assets selling for $2.2 million.
Wells Fargo sued the appraisal firm for breach of contract, claiming that it (Wells Fargo) and BOA were third party beneficiaries of the contract between the appraisers and the steel plant. But on the appraisers’ motion for summary judgment, the U.S. District Court (Illinois) found no authority to support Wells Fargo’s position. “Appraisers, in these circumstances, serve the lender,” it said, “and a referral by a bank to a specific appraiser is simply a service to the lender by naming an appraiser that the lender deems to be competent.” BOA was not an intended beneficiary of the contract; the only beneficiary was the borrower. Wells Fargo came into the transaction “long after” the contract was complete.
Look for a complete abstract of Wells Fargo Business Credit, Inc. v. Dovebid Valuation Services, Inc., 2008 WL 4324231 (N.D. Ill.)(Sept. 18, 2008) in the December 2008 Business Valuation Update™. The full-text of the court case—in addition to over 2,700 BV-specific federal and state decisions—is available at BVLaw™.
Recommended reading for BV professionals
Need guidance to sort out the current financial morass and assess its impact on your business? We were taken by a short list of recommended reading outlined in a recent issue of The Arizona Republic. The list, which focuses on business and finance, includes more than a few “classic” BV-focused titles. For example, Valuation: Measuring and Managing the Value of Companies, by Tim Koller, Marc Goedhart and David Wessels is certainly worth a quick (or second) look.
See you in two weeks…
The upcoming U.S. Thanksgiving holiday means that you shouldn’t expect a new issue of the BVWire™ to hit your in-box next week. That said, rest assured that we’ll be back in December. Happy Turkey Day! We here at BVResources remain thankful for all our good friends, subscribers, and professional contributors in the greater business valuation community.