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Ten Pitfalls Valuations Experts Should Avoid
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Feb 4, 2014
Experts testifying about valuation opinions can make or break a case. To avoid unpleasant surprises, be sure your valuations expert avoids this list of 10 common pitfalls:
1. Lack of preparation
This is basic, but it’s true. The more you know your analysis, the better things will go. That’s not the pitfall. The pitfall is to be unprepared because of fee constraints. Make sure the client and the attorney know how much your preparation will cost. You deserve to be paid for your preparation time and should bill and collect for it.
2. New opinions
Do not testify to opinions on which you were not asked to opine. In depositions and at trial, opposing attorneys may attempt to get you to offer opinions on areas outside your area of expertise and outside your scope.
Make sure that your growth rate and margins are supported by the necessary capital expenditures necessary to achieve that growth.
4. Discount rates
Most of us use either the modified capital asset pricing model or the build-up model. Remember that these models are only a means to an end. Basic financial theory says the discount rate must reflect the risk in achieving the projected earnings or cash flow.
5. Guideline public company method
Use public companies if you can find them. Don’t use them if you can’t. Don’t be afraid to discard this method if there are no good companies. Also, recognize that you are looking for “guideline” companies, not exact replicas of the subject company being valued.
6. Standard of value
Simply stated, know the standard of value that applies.
Furthermore, know the definition of the standard of value in the particular venue. For example, fair market value for marital dissolution may be defined differently than the standard definition in the tax arena.
7. Guideline company transaction method
Two words here – be careful.
Transactions are usually fairly complicated, and often there are unknown aspects of a transaction that can affect value. If either the buyer or the seller is a public company, there may be details of the transaction in public disclosures that can give the analyst more comfort. The bottom line is that the more details of a transaction you know, the greater the reliability of the information.
8. Discounts and specific company risk
Don’t double count. If you adjust for a risk factor in the specific company risk component of a discount rate, don’t also apply a discount to the value for the same factor.
For example, key person risk can be adjusted in the discount rate or as a discount, but not both.
If the individual value indications from the application of different methods are very far apart, averaging them will not help. Often, one of the value indications will be far apart from the others due to data limitations or other factors. If this is the case, don’t be afraid to reject the method.
10. Transaction perspective
Under fair market value, the perspective is from both a hypothetical buyer and a hypothetical seller. Some analysts focus only on the buyer and ignore the seller.
There are other pitfalls to look out for, but the 10 above should be avoided to enable valuation analysts to properly present and defend their work.
As always, the particular facts and circumstances will greatly affect the above factors.
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Hollings Center for International Dialogue