Forensic Accounting Perspectives : New York Business Valuation, Divorce, Business Disputes, Shareholder Disputes, Litigation Support & Accounting Forensics in Connecticut, New York & New Jersey

In 2010 we saw a number of high profile celebrity divorces and break ups occupying the tabloids and evening news. Tiger Woods and Elin Nordegren’s divorce was just the beginning. As the year closed we saw Sandra Bullock’s marriage crash and burn. Even Hollywood’s starlets like Elizabeth Hurley, Eva Longoria and Scarlett Johansson couldn’t avoid the hazards of matrimonial failure. In some instances these divorces may have ended inauspiciously due to a prenuptial agreement or the ability of the parties to cut ties financially without disrupting their lifestyle.

For attorneys representing clients in a divorce the breakdown of this economic partnership may require a forensic accountant and business valuation expert. But how does the matrimonial practitioner use this resource to better serve their client? Here are four things to consider, along with cases that illustrate the issues.

Always Use a Qualified Business Valuation Expert.

In Brooks v. Brooks, the husband owned minority interests in his family’s limited liability companies (LLCs), which held commercial property. At trial, the wife presented the companies’ financial statements and a real estate expert, who appraised the LLC’s underlying property at $61 million. Notably, the expert testified that his appraisal was only the first step in a fair market valuation (FMV), which required assessing the companies’ outstanding debt and closely held stock.

At the close of the wife’s case, the husband decided not to call his BV expert, saying there was “no valuation testimony” to rebut. Instead, he presented only the operative buy-sell agreements plus his tax returns, which essentially showed a book value of $400,000 for his LLC interests.

The court asked the wife if she wanted to call the husband’s expert to testify regarding the LLCs, including the effect of non-marketability and minority shares, but she declined. Thus the court was faced with the buy-sell and book values, on one side, and the broad real estate appraisals and financials on the other.

Finding the former “simply would not do justice,” the court took the appraised value of each property and multiplied it by the husband’s share in the LLC, less the mortgage debt on each property plus the value of cash-on-hand.

The husband appealed, claiming the trial court improperly equated the FMV of the properties with that of his LLC interests, thereby ignoring three “critical” features: lack of marketability, lack of control, and the effect of the restrictive buy-sells. The wife argued that since he’d neglected to present valuation evidence at trial, he couldn’t complain about its omission—but the appellate court disagreed.

The husband had “vigorously objected” to the wife’s real estate appraisals at trial, and her own expert conceded a lack of expertise to value the husband’s interests. The wife also rejected the chance to call the husband’s BV expert. At the same time, the trial court failed “to follow some reasonable path” in ascertaining FMV, which required assessing the marketability and minority aspects of the husband’s interests as well as any contractual restrictions, and the appellate court remanded the case for a new trial on valuation.

Use Your Expert to Facilitate Proper Discovery and Disclosure

In Hissa v. Hissa, the husband’s expert valued his orthopedic practice at approximately $320,000. By contrast, the wife’s expert valued it at $650,000, based in part on a comparison to industry averages. Both experts relied on the applicable FMV standard, and both agreed that accounts receivable (AR) were an important element. However, the husband failed to provide the wife’s expert with the same information concerning AR that he’d given his own expert, forcing the wife’s expert to estimate their value. The husband also provided flawed tax and financial information to both experts, and a result, the trial court found his evidence less convincing than the wife’s, and adopted her expert’s value.

The husband appealed, alleging the trial court erred by crediting the wife’s expert over his own. But, “the [trial] court determined that [the husband’s] failure to be forthcoming about his business expenses led it to discredit the information he provided his own expert,” the appellate court found, “particularly given his expert’s valuation of the medical practice at nearly one-half of what [the wife’s expert] determined the value to be,” and it affirmed the latter’s value.

Use the Expert to Educate the Court

In re Marriage of Armour, the vast majority of the parties’ wealth was tied up in the husband’s 50,000 shares of stock in his employer, which were subject to the company’s right of redemption at a below market price. Like many jurisdictions, California family courts prefer an in-kind division of marital assets unless economic circumstances warrant another method.

Here, the wife’s valuation expert analyzed the consequences of an in-kind division: Assuming the husband retained his stock for a reasonable time until retirement, his 50% share would produce a present value of $36 to $40 million, but the wife’s share would net only $18 million at the forced redemption price.

Despite this evidence, the trial court ordered a simple in-kind division and the wife appealed. Based on the wife’s valuation evidence, the appellate court found this “disregarded economic realities” and ordered a division that ensured an equal result for both parties.

Use Your Expert to Rebut the Other Side

In Gupta v. Gupta, the husband owned three medical practices and an imaging center in rural Texas. At trial, his expert valued the practices at $359,000 and the imaging center at zero, due to its significant debt service and operating losses. By contrast, the wife’s expert valued all the businesses at $780,000, excluding goodwill and a marketability discount.

In addition, the wife’s expert submitted a separate report to rebut the husband’s expert, highlighting his errors regarding valuation of revenue, AR, equipment, depreciation, and his misuse of historical financial statements. As a result, the trial court accepted the wife’s expert value, and the husband appealed, claiming the wife’s expert failed to visit the practices, interview his staff, or view the equipment. She also misclassified his practice, comparing it to “specialty medical practices” rather than a “general physician office,” and failed to factor the debts and losses of the imaging center. His rebuttal was too late, however, and the appellate court upheld the wife’s expert evidence in full.

Conclusion.

The valuation of a business is often a difficult issue; but it is crucial for attorneys to understand the role of the business valuation expert in marital dissolution so that they can effectively counsel their clients in achieving their goals in asset distribution and financial support. To learn more how our business valuation and forensic accounting team can assist you please call our offices at 516-829-4936 (New York), 203-357-1500 (Connecticut), 973-226-4500 (New Jersey) or visit our website at www.msgcpa.com.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Valuing the very small company can often be more challenging than valuing a large firm or corporation.  These types of valuations most commonly arise in the divorce cases, although they also are frequently present in shareholder litigation, partnership dissolutions, and similar litigation. Often, client budgetary restrictions are an overriding consideration. However, attorneys and valuation analysts can work together from the outset of an engagement to meet client budgets and provide credible valuation. Here are a few areas where communication and cooperation can be the most helpful.

Valuation Standards.  Just like attorneys, accredited valuation experts are bound by standards of professional conduct. However, none of those standards distinguish between a valuation for a small business (and perhaps small budget) and a larger business. Once engaged, valuation analysts often find themselves caught between performing a complete and credible valuation, complying with the applicable standard(s), and keeping the job within a client’s budget. In litigation settings, most valuation analysts expect to be cross-examined on whether they adhered to the proper standards. If not, a lack of client funds will be no defense, and the analyst’s credibility as well as the client’s case could suffer.

Managing Expectations. Proper client screening is just as important in the valuation as in the legal context. Valuation analysts can help retaining attorneys to inform the client why the appraisal is necessary, its potential costs and the benefits that will inure to the case. Clients—especially in the divorce setting—will often suffer from misplaced expectations or assumptions. These clients need to receive the proper information and guidance from their professionals as to the scope of the valuation engagement, its process and the problems it can solve—as well as those it can’t, including creating value in a business when in reality there may not be as much as the client anticipated or hoped. 

Discovery & Access to Records. Few things can drive up litigation costs and conflict faster than trying to compel another party to comply with applicable disclosure and discovery rules. At the same time, the other side may be genuinely frustrated by receiving an overly broad and generic discovery request. Valuation analysts can work with attorneys and the client from the outset of the case to narrow and tailor the scope of production, so that the experts will receive all of the documents they need—and none of what they don’t. Documenting clear, successive requests for production to the opposing party will also help in the event a motion to compel or an interim motion for fees becomes necessary.

Professional Protection. Communication and documentation are likewise critical to ensuring that both the attorneys and analysts meet the appropriate standards of care when valuing a very small business—with perhaps a small client budget to go with it. There are rarely any shortcuts in a valuation procedure that pay off in terms of case outcome or client satisfaction. By documenting every action and notifying each other whenever problems or roadblocks may arise, attorneys and the experts will help maintain their own credibility as well as their client and referral sources.

Case Study. Often, our initial due diligence reveal discrepancies concerning the integrity of the accounting records and tax returns presented. In these instances we often reconstruct one or more of the financial components to best determine the business’s financial capacity. Within our website we have presented two case studies that illustrate both common and the not so common approaches to these concerns.

To learn more about MSG’s business valuation, forensic accounting and litigation support services, please visit our web site www.msgcpa.com. 

• Email This
• Print
• Comments
• Trackbacks
• Share Link

When it comes to business bankruptcies, the numbers seem to loom larger with every year. From 2005 through 2008, annual business bankruptcies increased by over 200%. In the years 2009 and 2010, business bankruptcies were more than double for the years 2006 and 2007.

We have seen bankruptcy filings from businesses with long histories such as the 163-year-old Tribune Company, or, more recently, younger companies as Blockbuster, whose goal is to cut its debts from $900 million to $100 million, and Circuit City, which seems to be finding a second life online of late. No matter what the size of the company or its reputation, however, valuation plays a key role in the bankruptcy process; and, inevitably, valuation issues will arise.

These issues pervade throughout the entire bankruptcy process--and impact each of the stakeholders along the way. While it is the attorney’s job to reach legal conclusions as part of the valuation, fairness or solvency analyses, the valuation analyst may serve debtors, creditors and legal counsel as either a consulting expert or a testifying expert. Whether a valuation expert uses one or all three of the accepted methodologies—the income approach, the sales or company comparison approach, or the cost approach--they are influenced by data and assumptions used under the formulas.

A company typically elects to file for bankruptcy under Chapter 7 of the Code when continued business operations cannot be supported by the income the company is generating. If a company does elect to file a Chapter 7 bankruptcy petition, a trustee is appointed and the debtor then discontinues its operations and all assets are liquidated on an orderly basis. The proceeds are subsequently distributed to the claimholders and creditors in order of priority.

Valuation issues can range from asset/collateral matters, to disputes as to the true value of a business as a whole entity, to fairness issues related to the valuation of securities and cash flow streams being proposed to settle the claims of various stakeholders. What are some of the most common valuation issues in bankruptcy? A few that come to mind are:

• Distressed companies will often defer necessary expenditures that cause a reorganized company to catch up to retain a competitive position.
• If a recent downturn was caused by a low point in a “cyclical” industry, attorneys and valuation experts need to carefully consider the timing and magnitude of an uptick.
• Working capital deficits are common as accounts payable days lengthen;
• Restructuring professional fees can impact significantly on a company’s cash flows;
• When there is operational restructuring, severance and costs of closing a business’ locations need to be carefully considered.

Working in tandem, counsel and the valuation analyst should be aware of the nuances in market transaction method valuation. For instance, to the extent that financial distress in an industry has been caused by “inflated acquisition multiples,” then great caution should be employed in relying upon such market data.

In addition, it is very important for the analyst to adjust debt to market value in calculating numerator of multiples; to consider that the stock values of distressed companies may not be meaningful; and to utilize “debt-free” market multiples to mitigate the impact different capital structures can have on valuation.

It isthe expert’s responsibility to determine the current value of a business’s collateral, as well as determining the extent to which the collateral has recently declined in value or will likely decline in value in the future. In addressing the valuation issues in this regard, a going concern premise of value is typically assumed, unless the subject company is not expected to reorganize. Depending on the facts and circumstances of each situation, all traditional valuation methods should be considered.

In an economic downturn where even venerable, financially sound businesses can approach insolvency, it is important for valuation experts to capably assist attorneys—especially those with a broad range of legal expertise-- in resolving challenging valuation issues, and successfully meeting clients’ objectives in the bankruptcy process.

For more information about MSG’s business valuation, forensic accounting and litigation support services, please visit our web site www.msgcpa.com.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Until this past summer, the idea that YouTube might turn a substantial profit at long last may have been as improbable as Jon Stewart friending Glenn Beck on Facebook. But a federal judge’s recent ruling in YouTube’s favor in the 3-year-long copyright dispute with Viacom, the owner of such profitable brands as Paramount, Nickelodeon and Comedy Central, is a major victory in what some are calling a landmark copyright case.

The much-discussed suit revolved around Viacom’s allegations that YouTube only became the Internet’s most viewed video site by posting copyright-protected clips “stolen” from its shows. But in evoking a law that shields Internet services from claims of copyright infringement as long as the illegal content is removed,the Court noted that YouTube had removed about 100,000 videos the day after Viacom sent a mass takedown notice. If the Court in this case had agreed with Viacom, and ordered Google to pay the more than $ 1 billion in business damages the media conglomerate was seeking, the impact on YouTube’s future profitability could have been considerable.

For a media conglomerate such as Viacom, however, copyright infringement on a site that might attract well over a billion visitors a day, could translate into lost revenue from DVD sales and rentals, worldwide TV syndication, and paid online distribution of their content. When copyrighted content is readily available for free on YouTube, for example, the Court may take into account what profits, if any, would have been generated by Viacom if not for the alleged copyright infringement. But is this a case of lost profits or lost business for a media conglomerate--or perhaps both?

In considering whether a case merits a claim for either or both, one must examine the facts and circumstance early in the litigation process to analyze the appropriate theory of recovery. The final determination can directly affect the appropriate damage calculations as well as the identification of proper claimants to the litigation. In some instances, the courts have allowed both lost profits and the decrease of the market value of the subject business; however, on some occasions, the court has allowed one or the other.

Whether business damages are calculated by the financial expert as lost profits or lost business, the objective is to restore the plaintiff to the position it would have been --“but-for” the defendant’s actions that caused the damages. When calculating lost profits, damages are typically measured for a specific or limited period of time. In general, the loss is the difference between what the business would have produced during the loss period, minus what it actually did produce during this same time frame. All the business’s expenses are taken into consideration in both the “what would have happened” and “what did happen”scenarios.

Case law and statutes dictate what a plaintiff needs in order to demonstrate lost profits. It is the financial expert’s task to employ both a scientific and artistic interpretation of the facts and circumstances that will eventually tell a detailed, accurate story.

The approach to determine lost profits is multi-faceted and generally requires the following 6 steps:

1. Calculate lost earnings by comparing profit history before and after a damaging event,
2. Understand the subject company’s cost structure,
3. Examine the calculated expenses for reasonableness,
4. Determine causation (i.e. consider possible reasons for drop in sales),
5. Examine how things such as economic conditions, marketplace demands and government regulations have impacted a sales loss,
6. Present detailed information to support the assumed revenue, expense, and growth rates.

As an experienced practitioner, the steps of assessing lost profits can be simply stated; but more often than not, the process itself requires meticulous attention to detail and a sharp eye for any contradictory information. Often, one needs to step back to inquire about issues that arise during this endeavor.

Three that come to mind are as follows:

1. What influence does an immature line of business affect the overall operations of the entity?
2. How does a poor performing sector influence the results?
3. How influential should projections and forecasts that materially differ from historical results be, and how should they be utilized?

The financial expert knows that the credibility relevant to projected income—and anticipated expenses—is absolutely critical in supporting a lost profits claim. The analyst works methodically from business plans, market surveys, income projections, and other evidence of projected revenues to estimate future receipts. One may use data from industry sources, comparable companies, market data or any other source that may help in predicting accompany’s financial results. It is imperative that the expert acquires in-depth knowledge of the subject company early in the process: its products, markets and competition, and the market forces to which it is subject.

In a case when an entire business is destroyed, the analyst’s task is still to determine the lost future cash flow. But in contrast to a lost profits case, the loss is now permanent. Just as in the lost profit calculation, the expert considers all of the subject company’s expenses in the “what would have  happened” vs. “what did happen” scenarios. The fair market value of the subjectcompany is determined based on the assumption that an earningsstream will continue into perpetuity.

So when the attorney considers whether a plaintiff may recover both lost profits and lost value, I can tell you of an important exception: when a business operates for a certain amount of time and then closes as a direct result of the defendant’s behavior, thereby incurring a period of lost profits followed by lost business. In this case, the courts have found no “double-counting” of the plaintiff’s allowable recovery.

Simply summarized, how does a lost profits case differ from a lost business case? Lost profits are usually measured over a specific time period (e.g. the estimated time it will take the plaintiff to restore “normal” profits).With lost business value, profits are projected into perpetuity. A lost profits analysis views a business from the perspective of a plaintiff; a business valuation views the business from the “hypothetical buyer’s” perspective.

Drawing from the analyst’s skills in finance, accounting and economics, the financial expert—reasonable and objective-- can distill complex data into an  understandable, accessible communication that can prove invaluable to the litigation team.

This past August, Viacom filed an appeal in the U.S. Circuit Court of Appeals for the Second Circuit in New York; any decision, however, is likely several years away. Did YouTube build its business, in part, at Viacom’s expense, thus depriving the media conglomerate of significant revenue? Could YouTube have done more to keep illegal content off its site with the help of copyright detection tools it later developed after its sale to Google? Will Jon Stewart ever have Glenn Beck on his show? And could a clip still find its way on YouTube? Stay tuned. 

• Email This
• Print
• Comments (1)
• Trackbacks
• Share Link

As most forensic accountants and business valuators know, post-acquisition disputes between an acquirer and target company are on the rise. These conflicts can be disruptive, time-consuming and expensive. To help in successfully resolving a dispute, the post-acquisition advisor needs to be extremely well versed in accounting, business valuation, economics, finance and litigation. In times when bank failures and bankruptcies are not uncommon, resolving post-acquisition disputes can be a formidable challenge.

The most common disputes involve post-closing adjustments for working capital or net assets, indemnity or fraud claims, and earnout disputes. In a dispute involving both working capital and indemnity claims, for example, working capital claims are typically measured on a dollar-for-dollar basis while indemnity claims can be measured dollar for dollar, over a finite period or into perpetuity.

The measurement of damages into future periods is predicated on assessing whether the misstatement will affect future periods; the buyer’s expectations were based on future performance; the business was significantly devalued after the acquisition; and the misstatement would have been “material” to a “willing buyer.”

Potential disputes in mergers and acquisition transactions can often be just as complex as the deals themselves. It is the acquirer that instigates a dispute on the grounds that it’s unable to complete the deal because of financial shortfalls, although there are exceptions.

In a 2009 roundtable discussion published in Financier Worldwide, one participant commented:

“The economic downturn has significantly increased the number of commercial disputes, and it has changed the nature of dispute resolution. Where once parties could resolve their differences through negotiation because they sought to preserve an ongoing business relationship, they are now realizing that there is not a next transaction on the horizon, so that litigation and arbitration, as opposed to mediation or reconciliation, become more likely.”

Throughout history we have seen that challenging economic times inevitably lead to a significant rise in conflicts between organizations. In attempting to resolve post-acquisition disputes, even the financial expert comes to terms with the fact that there is a finite amount of ways to resolve it, and each approach has its benefits and downsides.

• Email This
• Print
• Comments
• Trackbacks
• Share Link