Business Valuation and Reporting in Matrimonial Disputes

Adherence to Development and Reporting Standards in Family Law Litigation

Family law practitioners deal with a host of complexities when resolving matrimonial disputes.  In high net worth cases, financial considerations soon become paramount.  Often the largest financial asset on the marital balance sheet is an interest in a closely held business controlled and operated by the family or single spouse.  In these cases, a significant portion of the marital estate and, accordingly, the key to a party’s financial future rests on the results of a proper valuation.  This article discusses the importance of development and reporting standards in litigation engagements.

[su_pullquote align=”right”]Resources:

Introduction to Matrimonial Litigation

30 Things You Need To Know To Be A Successful Matrimonial Forensic Analyst

Valuation Issues in Matrimonial Engagements

Matrimonial Litigation

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Family law practitioners deal with a host of complexities when resolving matrimonial disputes.  Prior to analyzing equitable division, counselors must often develop approaches for temporary support, child custody, visitation, temporary alimony, as well as the onslaught of emotional concerns brought by distraught clients.  In high net worth cases, financial considerations soon become paramount.  Often the largest financial asset on the marital balance sheet is an interest in a closely held business controlled and operated by the family or single spouse.  In these cases a significant portion of the marital estate and, accordingly, the key to a party’s financial future rests on the results of a proper valuation.

To resolve the value question, family law practitioners and courts seek the guidance and analysis of trained valuation consultants.  It is not unusual for each party to retain their own financial expert to provide the estimated value of the business.  In addition to using objective factors, valuators deploy experience and judgment when developing a conclusion of value.  Legal practitioners have an interest in putting forth a resulting value that will hold as the controlling fact; conversely, putting forth a value that is not well supported could have severe consequences to the counselor and client.  It is not unusual for values to be significantly divergent, sometimes caused by the poor development of the valuation analysis.

Standard-Setting Organizations

There are four main appraisal organizations in the U.S.:

• National Association of Certified Valuators and Analysts (NACVA)
• American Society of Appraisers (ASA)
• American Institute of Certified Public Accountants (AICPA)
• Institute of Business Appraisers (IBA)[1]

These organizations offer valuation credentials which establish minimum levels of education and experience requirements.  The credentials determine a minimum level of competence; while each credential attempts to confirm competency, requirements for each credential vary.  These organizations have worked to bring consistency, strengthen the profession, facilitate ethical practice, and enhance the quality of valuation services to users by establishing valuation standards.  While the standards can vary somewhat among the appraisal organizations, generally the professional standards of these organizations can be divided into two main categories:[2] 1) development standards (standards regarding how value is developed) and 2) reporting standards (standards regarding how value is reported).

The standard-setting appraisal organizations in the U.S. have generally established valuation standards that members are required to follow.  Certainly, it is important for valuators to know how valuation standards proffered by valuation organizations operate to provide appropriate guidance in the development and reporting of an appraisal.

Many valuation and legal practitioners seem to be aware that the standards allow for exemptions in certain circumstances.  However, certainly not all standards can be exempted, and standards applicable to the development of the valuation analysis should always be followed.  Valuations are increasingly subject to scrutiny over compliance with standards.  A failure to meet appropriate standards can and has had the effect of invalidating an opinion, with potential harsh consequence to the case.  In trying to ensure that a value presented on behalf of a client withstands scrutiny of opposing counsel, experts and court, valuators need to be aware of and consider whether the value presented was developed under the standards of the valuation community.

Valuation Development Standards

The developmental standards provide minimum criteria for the development of the valuation of a business or business interest.  The developmental standards apply whether expressing a conclusion of value or a calculation of value and mandate aspects of the valuation analysis, including the valuator’s consideration of the expression of value, scope of analysis, data sourcing, use of specialists, acceptable approaches, etc.[3]  The developmental standards also dictate how the valuator defines the engagement through the following:

• Subject to be valued;
• Interest to be valued;
• Valuation date;
• Purpose and use of the valuation;
• Standard of value;
• Premise of value;
• Intended users;
• Valuation approaches or methods;
• Assumptions, limiting conditions, and scope limitations;
• Ownership size, nature, restrictions, and agreements;
• Sources of information; and
• Other factors that may influence value when appropriate in the opinion of the (professional).

The developmental standards go on to mandate the types of information that should be obtained by the professional, including information related to economic conditions, book value of the enterprise, earning capacity, dividend capacity, intangible components, prior sales, control, liquidity, market comparables, and other available information deemed relevant.

It is critical to the valuation opinion that the developmental standards are followed by the valuation specialist.  Since the developmental standards provide the minimum criteria for developing the opinion, deviation from these minimum criteria puts the opinion at risk.

Recent cases have demonstrated courts reluctance to accept valuations based on a failure to comply with the development standards.  In the recent case of In re Marriage of Hagar[4] the court rejected the valuation because it was merely a computation based on industry “Rules of Thumb” and not based on “judgment” of the valuator.  This type of value is clearly prohibited by the developmental standards which state “Rules of Thumb” are acceptable as a reasonableness check, but should not be used as a stand-alone method[5].  In the case of In re Marriage of Cantarella[6], the court rejected a “preliminary valuation” because the valuator admitted he lacked documentation with which he would typically perform a more complete business valuation.  Valuators naturally rely on both written documentation as well as verbal information from representatives knowledgeable about the subject business.  Regardless of the form of the information, it is important for them to have relevant information that influences value.

Valuation Reporting Standards

The reporting standards provide minimum criteria for the reporting of the valuation of a business or business interest.  The reporting standards apply when the professional expresses any conclusion of value or calculated value.  The objective of the standard is to ensure consistency and quality of valuation reports.  Experienced valuation and legal practitioners might note a severe lack of consistency among valuation reports from case to case and for good reason.  The consistency element that might be obtained from following a set of reporting guidelines is not mandated.  The reporting standards are waived for the valuator in the context of a litigation engagement.  Specifically, the exemption from NACVA reads as follows:

A valuation performed for a matter before a court, an arbitrator, a mediator, or other facilitator, or a matter in a governmental or administrative proceeding, is exempt from the reporting provisions of these standards.  The reporting exemption applies whether the matter proceeds to trial or settles.  This litigation waiver does not, however, relieve the member from complying with the Developmental Standards and all other standards promulgated by NACVA.[7]

While the reason for this exemption is not discussed in the professional standards, many practitioners have justified the waiver because formal reports are not always practical in the context of a fast paced, limited-financial-resource litigation setting.  While some valuators choose to follow the reporting standards in the litigation setting despite lack of mandate to achieve the benefits of this best practice, many disregard the standard entirely.  What is most often overlooked is that the developmental standards are not waived in the context of litigation.  This is an important distinction that cannot be disregarded when placing reliance on a value used in litigation proceedings.  In order to understand the distinction, we look to the standards themselves.

The reporting standards discuss the presentation of the valuator’s analysis and support used to derive the conclusion or calculation of value.  They essentially require the valuator to document, whether in detail or summary format, the result of conducting a valuation under the required developmental standards.  In many instances, the process necessary for the valuation professional to comply with the developmental standards is vetted through the act of preparing a report that generally parallels the reporting standards.  This is the point in the process where the work that has been performed by the professional is laid out in a logical manner, support is documented, and methodologies, theories, facts, and approaches are explained and vetted.  In many cases, this serves a vital part of the professional’s quality control and review process.  This begs the question: Does foregoing the reporting standards in reliance on the litigation waiver increase the risks associated with expressing an opinion of value and also decrease the valuator’s, and vicariously the lawyer’s, ability to support the opinion of value?  One must ask whether foregoing the reporting process saves time because the professional has also foregone the developmental requirements?  If the practitioner has not issued a report, but has been diligent in adhering to the developmental standards, what have they done to document their work in support of this requirement?

The Slippery Slope

These questions highlight what might be a slippery slope for attorneys who do not require a valuation to adhere to the reporting standards.  In many instances, we have seen parties come to the settlement table with mere schedules purporting to identify value without strong support.  Schedules may not include any discussion of the reasoning used to apply broad approaches or key variables used to reach a value conclusion.  Schedules may not reveal any indication that the professional made efforts to study or understand the subject industry or entity or whether the professional even identified the proper interest to be valued.  The reader is left to guess what assumptions are imbedded in the value and what limiting conditions were present.  Without adhering to any sort of documentation or reporting standard, the reader cannot readily confirm the validity of the analysis.  Oral presentations by the valuator may be able to fill the gaps; however, these opportunities do not always present themselves in a fast-paced litigation setting.

These issues are highlighted in instances where each party has engaged their own valuation professional and each expresses an opinion of value materially different than the other.  This could be caused by a multitude of reasons.  Some differences are caused naturally by the differences in the valuator’s experience and judgment as applied to subjective variables such as the application of future growth rates or perceived business risk. Other differences might be caused by more troubling failure to identify and factor in available factual information, failure to apply appropriate valuation approaches, or failure to perform a proper calculation to derive a reasonable capitalization rate, for example.  Collapsing attributes into easily applied multiples of value without understanding differences between guideline companies or reconciling with other approaches for greater confidence in the conclusion is another example of what could be material differences.

Conclusion

Determining the value of a closely held business inside the marital estate may be the most important task in defining the financial future for a party to a divorce.  Reliance on an opinion of value or calculation of value that was not developed through adherence to the applicable professional standards, including both the developmental standards and the reporting standards, creates increased risks that such values will be rejected when resolving cases to a potentially significant detriment of a client.  Practitioners should be cognizant of this issue and determine whether or not adherence to developmental standards to determine value should also be documented well, consistent with circumstances to support a valuation in a litigation proceeding.

This article was previously published in The Cobb County Family Law Quarterly, June 2, 2014.

[1] NACVA acquired the IBA and its credentials in 2008.  In 2016, the IBA was absorbed into NACVA.  Effective 2017, the CBA and MCBA will no longer be awarded as the administration of the two has been indefinitely suspended.  CBA and MCBA designees will still be recognized and listed in NACVA’s membership directory.  They must pay dues and comply with NACVA’s recertification requirements to remain active and hold oneself out as a CBA or MCBA.

[2] NACVA, Professional Standards 2013.

[3] NACVA Fundamentals, Techniques, and Theory, Ch. 8. Professional Standards, pp. 7–8, dated 1995–2013.

[4] In re Hagar, 2010 WL 4807559 (Iowa App.) (Nov. 24, 2010).

[5] NACVA, Professional Standards 2013, section IV-F.

[6] In re Marriage of Cantarella, 2011 WL 86284 (Ca. App. 4 Dist.) (Jan. 11, 2011) (unpublished).

[7] NACVA Fundamentals, Techniques, and Theory, Ch. 8. Professional Standards, Page 11, dated 1995–2013.

Kevin Couillard, Fair Value Advisors, ASA, CFA, MBA. Mr. Couillard is Executive Director, Business Valuation & Litigation Support at FairValue Advisors, LLC. He has been qualified as a testifying expert on valuation matters and commercial damages in various U.S. Federal and State courts and alternative resolution panels. Mr. Couillard has provided expert opinions on damages, diminution of value, lost profits, and lost goodwill. He has been a guest speaker and lecturer on business valuation topics for many professional and trade organizations.

Mr. Couillard can be reached at (678) 291-9512 or by e-mail to Kevin@fairvalueadvisors.com.

Marc L. Effron, CPA, CFF, JD, CVA, is founder and managing partner of White Elm Group LLC forensic accounting and consulting firm. He is a Georgia CPA, AICPA certified in Financial Forensics and NACVA certified in valuation. Mr. Effron has over 20 years of experience in forensic matters from valuation to partnership disputes to large-scale international investigations for Big Four accounting firms. A significant part of his practice focuses on forensic and valuation issues in matrimonial litigation.

Mr. Effron can be reached at (404) 680-9181 or by e-mail to meffron@whiteelmgroup.com.