Ways to Win/Settle Cases by
Leveraging Your Financial Expert’s Skills
Mediators and litigators take note. Value is seldom ever a single number. It is a range on a continuum as of a particular point in time.
Gold holds its same properties regardless of timeframe, so what causes the price of this precious metal to change from year-to-year, day-to-day and even hour-to-hour? The fact is that investors are not simply looking at gold, but the market overall and making judgments as to the stability of investments in everything from currency to debt (bonds) and equity (stocks).
Often it makes sense to examine a business in the context of an amalgamation of assets and liabilities as well as people, processes, place and period and how this impacts the two primary areas a BV expert is compensated to defend: level of risk and economic benefit.
Let’s briefly examine each in the context of a quantifying risk. How much time has the BV expert expended looking at who are the key personnel, what are their backgrounds and health? What are present staffing levels and tenure as compared to its industry and market(s)? What impact does the current market have on retention? How much have staffs’ efforts been key to the current growth and profitability of the business? What would occur if one or more of these individuals were to depart or had a rocky marriage or failing health? Since management and key personnel are often relevant to the success of most businesses and funding sources almost always begin examining these issues, it makes sense the BV expert has to do so as well.
This becomes germane when examining level of compensation and existence of buy-sell, employee agreements and by laws as well as the existence of a transition plan and insurance coverage. Each of these issues will ultimately be quantified by the BV expert in the form of a discount rate. If two owners had similar annual revenues, but one was 35 and had been in operation for five years and the other was 55 and in operation for 30 years, some relevant assumptions could be made as to continuity and future performance.
If it is understood, the real trick to a quality result is quantifying intangible assets’ values, then this begins by addressing what these assets are and how they’re leveraged to achieve results. What are these results? Simply put they are the benefits achieved measured by amount of business and value growth and the level of earnings that can be paid out that would not adversely impact future company performance.
An example may be two business advisory firms with similar revenues; however, the first has profitability that is almost twice as great as the second and the owner is primarily absentee. How can this be? Perhaps, the owner has been emphasizing grooming staff to take on more responsibility; s/he has procedures in place to handle most issues that flare up in a proactive versus a reactive manner. This pushes authority to a lower level and may free up management to conceive new innovations versus fighting the inevitable customer retention fire. Are such processes more transferable and, as such, have greater value to a third party? Are they protected, patented, trademarked, or copyrighted? Are non-compete agreements enforced and privacy a shared concern at all levels in the company?
What impact does the physical location have on attracting, attaining and retaining clients? Does it have strategic benefit due to its proximity to patrons or suppliers? What is the relationship between the company and the lessor? What are the terms of the lease or if the real property is owned is this advantageous to the business’ performance or has it tied up capital that could have been better deployed?
As was the example of gold, how has time impacted the performance of the business compared to its industry? What is the optimal period to hold such an investment? Does it, like most investments go through cycles or even seasonality, where an accurate picture must be reflected or will it skew the perceived investor risk? Are existing market conditions being fully considered as of the date(s) of value?
The BV expert should also be examining how each of these 4 “P’s” are leveraged and what the industry norms are when quantifying risk. As an example, if the company has opted to have a debt to equity ratio of 1 to 1, this may mean 50% is in the form of debt payable to a note holder instead of the shareholder. This may be compared more favorably if the industry has a typical debt to equity ratio of 2 to 1 where more proceeds go to repayment of principal and interest than to shareholders. This depends on the optimal amount of leverage and the loan terms as well as the level of growth the company is able to obtain using debt financing instead of waiting over a longer period to apply operating profits from the company. The interest payments are also tax deductible and acquiring newer equipment may allow the company to produce twice the widgets in half the time as well as enjoy the deduction of depreciation expenses.
The point is every company is an assemblage of components that does not operate in a vacuum, so how long it operates and when a snap-shot of performance is taken and how comparisons are made are all part of the detailed analysis necessary between simply providing a value estimate and a well reasoned and empirically supported result. While using gold as an example reflects what investors consider, the same principles apply to going concerns and asset holding companies. What is different is the depth and breadth of analysis that shows why there can be more than one value based upon what assumptions are made. What should become obvious is when more assumptions were developed to fill in the blanks, the wider the likely ranges between two value conclusions. The goal should be to zero in on the logic and support applied and quantified.
Ultimately, it is possible for closely-held companies to have supported values that could be determined to be +/-20% from a norm (or a 40% spread between high and low results). However, it’s often the case that one value opined was built on faulty or spurious assumptions that can fall well beyond a reasonable range. It’s insufficient to only know the value is contrived.
It becomes incumbent on the advisor(s) to collaborate and demonstrate through data collection, interrogatories, deposition and testimony that the three or four most significant egregious items assumed make the entire conclusion of the opponent worthy of a Daubert challenge. More preferable, a joint retention may reduce the likelihood of a poor outcome serving only one or no interests and placing counsel at risk.
Since so few disputes (2%) are resolved by the trier of fact, counsel and their trusted advisor have a duty of care to expeditiously identify flaws and obfuscation to bring fair remedies. Skilled expert retention is often the best net investment for the client.