Business valuation for the practitioner: identifying the common areas of manipulation by the valuator.

• Author: Dellinger, Richard
• Position: Business Law

Cases are won or lost based on a business valuation. Business valuators are used in dissolution of marriage matters when a business is a part of equitable distribution, probate cases when the business is being transferred to heirs and a tax is to be paid on the transfer, and in partnership disputes when partners are interested in buying one or the other out of a business or selling a business to a third party. In those types of cases, each side retains a business valuation expert to assist with their case. Practitioners must be prepared to analyze their own expert's work and cross-examine the opposing party's expert. This article provides a user-friendly guide to assist practitioners in preparing their own business valuation expert for trial, and, more importantly, preparing to cross-examine the opposing party's expert.

Qualifications of the Expert

There are numerous types of people who think themselves experts with the qualifications to value businesses. Some people who are not formally trained in business valuation try to testify about business valuation issues. Despite the lack of formal training, the court may elect to deem the person an "expert" and consider the lack of training with regard to the weight placed on the expert's opinions. Even experts without formal training may testify about business valuation because the Rules of Evidence allow an expert to be qualified through "knowledge, skill, experience, training or education." (1) Hence, the court is not much of a gatekeeper, and many people who are not qualified to testify about business valuation nonetheless testify about business valuation. The practitioner must understand the education, training, and qualifications of the best qualified experts in order to argue that the evidence should not be given much weight because of the lack of education and training of the expert.

Business valuation is heavily dependent on accounting concepts, so at a bare minimum, a business valuator should have an accounting or finance degree. Preferably, the business valuator will also be a certified public accountant (CPA).

Business valuators are certified as accredited in business valuation (ABV) by the American Institute of Certified Public Accountants (AICPA) or certified as accredited valuation analysts (AVA) or certified valuation analysts (CVA) by the National Association of Certified Valuation Analysts (NACVA). To obtain ABV certification, the applicant must have a CPA license, relevant experience, and pass an eight-hour, comprehensive, multiple-choice exam. (2) To obtain the CVA and AVA certification from NACVA, the valuator must complete, at minimum, a five-day course, a four-hour exam, and provide a case study for their exam. (3) The AVA certification is for those who are not CPAs, while the CVA certification is for CPAs only. Out of these certifications, the CVA certification is considered the most prestigious certification.

The American Society of Appraisers (ASA) also provides business valuation certifications. Those certified by ASA are known as accredited members (AM), accredited senior appraisers (AS), or fellows of the American Society of Appraisers (FASA). Members must have a four-year degree, complete four three-day courses, pass exams at the end of each course, and complete two more exams. The members must also practice business valuation full-time for at least one year. (4) The FASA is considered the most prestigious in terms of business valuation.

The Institute of Business Appraisers (IBA) also provides business valuation certification. Those certified by the IBA are simply known as accredited by the IBA (AIBA). The IBA certification is not considered as prestigious as the ABV, AVA, CVA, or ASA certifications.

Valuation Method Used

The business valuation expert should follow the Uniform Standards of Professional Appraisal Practice (USPAP) in completing his or her valuation. Under USPAP standards, there are three approaches to valuation: the income approach, the market approach, and the asset approach.

The income approach valuation is the discounted value of the projected future income stream to the company. A market approach valuation is a valuation based comparison of the company to other comparable companies that have been sold on the open market. An asset approach is a valuation of the assets of the company only, which is essentially a liquidation valuation of the company. (5)

Generally speaking, the income approach is the most frequently used method for valuation because all of the information needed to conduct the income approach is usually available in the company's financial statements and third-party publications relating to the company's industry. (6)

Most valuators agree that the market approach is the best value of the company because it involves the comparison of the subject company to actual market sales. However, it is hard to find actual market sales, so the market approach is not as frequently used as the income approach.

The asset approach is not used very often because typically a company is worth a lot more than the value of its assets in liquidation. If a company were not worth more than its assets in liquidation, then the company would generally not be operational because the owners would find more value in liquidating the company than they would in running it on a daily basis.

The Income Approach Valuation

The first calculation with the income approach valuation is to build a...