My Unimpeachably Abductive Inference

Conclusory Conclusions and Opinionated Opinions Tests of Time

The current valuation environment tends to be more about supporting the conclusion of value based upon the chosen approach and methodology with consideration of all three approach to business valuation far too often involving little more than the analyst placing a wet finger in the air and saying “ah yes, a discounted cash flow.” This eleventh article of the Unimpeachable Neutrality series discusses the need for abductive inferences when valuing a business and delineates conclusory conclusions, opinionated opinions, and concluded opinions of value.

I have a business that I would like to sell you. The only caveat is that I will allow you to look at either the balance sheet or the income statement but not both. Are you interested? Most wise investors, venture capitalists, and business owners would balk at a proposal to buy a business where the purchaser may only look at either the income statement or the balance sheet but not both. This is because an income statement or balance sheet may (individually or in tandem) render such a deal a non-starter. An income statement may be sufficient as a means of applying just the income or market approaches, but absent applying an asset approach to the balance sheet, how is one supposed to conclude that the business is not worth more dead than alive as would be indicated by an asset approach that renders a value higher than either the income or market approaches? While this thought exercise seems simple enough, the same abductive thinking often is not applied by a valuation analyst or appraiser when arriving or reporting on a conclusion of value. This eleventh article of the Unimpeachable Neutrality series discusses the need for abductive inferences when valuing a business and delineates conclusory conclusions, opinionated opinions, and concluded opinions of value.

Considerably Numb

The current valuation environment tends to be more about supporting the conclusion of value based upon the chosen approach and methodology with consideration of all three approaches to business valuation far too often involving little more than the analyst placing a wet finger in the air and saying “ah yes, a discounted cash flow.” Gone are the days where “consideration of all three valuation approaches” is often accomplished through the development of values under each of the three approaches and accompanied by a synthesis or reconciliation of each value conclusion under all three approaches, making it extremely difficult to delineate a full scope engagement, where no client or self-imposed restrictions have been applied from a calculation or other narrower scope engagement. While an analyst is free to arrive at their overall conclusion of value based on a single valuation approach or a reconciliation of multiple approaches or methodologies, it is my experience that fewer valuation professionals feel the need to truly “consider” all three business valuation approaches, as no real mechanism of compliance exists to assess whether an adequate level of consideration has been sufficiently performed. While case files can be subpoenaed to prove or disprove what was considered if not disclosed in the detailed report, there is no hard-set rule requiring the development of a value conclusion under each approach, as an appraiser or analyst may simply state, summarize, or disclose what and why they did or did not perform, develop, or select as most appropriate.

Revenue Ruling 59-60 beseeches consideration of all three approaches plainly known as the asset, income, and market approaches, which must all be considered to reach a valuation conclusion. That said, it is very hard to prove whether the appraiser or analyst considered all three business valuation approaches during their thought or scientific process absent the valuation professional actually developing a value under each approach whereby the analysis is tangible, visible, and understandable. The consideration of all three approaches to valuation is better served when all three approaches are developed, regardless of whether they are factored into the final conclusion of value or ignored (with reason) subsequent to being developed.

Less Likely Than Not

Developing a value under just one out of three approaches, where all three approaches to business valuation can be feasibly performed, only provides an estimate of value for 33% of the customary business valuation approaches. Regardless of whether one views this as selecting the most appropriate procedure under a valuation or a scope limitation agreed upon under a calculation, I would point out that the evidentiary standard in civil/divorce matters is “more likely than not,” and often is characterized as requiring a 51% degree of reasonable certainty. While there are reasons, excuses, and rational for not developing a value conclusion under all three approaches in route to reaching a final conclusion, a read of Revenue Ruling 59-60 makes clear the shortcomings of having a “go-to” approach when valuing a or any business or type of business. Revenue Ruling 59-60 states that “A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases. Often, an appraiser will find wide differences of opinion as to the fair market value of a particular stock. In resolving such differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science. A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance.”

Scientific Method Man

While business valuation “is not an exact science,” such does not diminish the value which can be derived from applying the scientific method to a business valuation. The scientific method is a process used to establish, prove, or arrive at an objective truth that is both logical and supported by evidence. The scientific method can be applied as a means of solving a problem or answering a question. The scientific method can be applied to valuation among other things and is not limited to science. Similar to a valuation, the definition of science is the process of gathering, comparing, and evaluating proposed models against observables. While I do not necessarily agree with the anecdotal view that valuation is both an art and a science, the definition of “science” is not all that different from the procedures a valuation entails. Financial experts should obtain and use sufficient, relevant, and reliable data in the formation of their expert opinions of damages or value. Identifying, requesting, and/or relying upon the most sufficient relevant data will always be a prerequisite to determining the right number, value, or amount. This step is critical in applying the scientific method, which entails that data is gathered, reviewed, and analyzed to arrive at a valid conclusion. An empirical exercise is that it can yield conflicting evidence in instances where the method of experimentation is not sufficiently performed, vetted, or applied. From a scientific method standpoint, such would be akin to a valuation analyst only developing a concluded value under one approach based on their professional judgement as to what they feel is the best and most appropriate valuation methodology or approach. Under the scientific method, it would be inappropriate to develop a value under just one of three approaches simply based on professional judgement regardless of whether that approach is being reliably applied to a sufficient level of general acceptance within a particular set or subset of industries. This is since when testing a model under the scientific method it is not acceptable to reach a conclusion if the results and data do not support a hypothesis.

Abductive Reasons

The most persuasive way to prove, find, or conclude that an expert’s findings and/or conclusions as reliable is through a process referred to as “abductive reasoning” which, in both theory and application, will result in an abductive inference. An abductive inference is also called an inference to the best explanation generally refers to the kind of inference drawn when selecting a hypothesis from a range of hypotheses (approaches) based on observations. In the world of business valuation, this is reflected in a valuation analyst considering all three of the most generally accepted approaches to valuation and reconciling the methodology under each approach that best explains and supports a valuation conclusion. Abduction refers to an inference to the best explanation and should not be confused with induction where a generalized conclusion is inferred from a range of known particulars. Unlike a logical inference made by deduction where one proposition can be logically inferred from other known propositions, “abductive inferences” are drawn about a particular proposition or event by a process of eliminating all other possible conclusions to arrive at the most likely one, as a means of identifying the conclusion that best explains the available data. This is like the last step of the scientific method as one must infer from observations to the available hypothesis (asset, income, or market approach) the hypothesis (or methodology under an approach) which best explains those observations.

Conclusory Conclusions and Opinionated Opinions

Professional judgement is and will always be an essential element of estimating value. Like all judgments made by human beings, one can effectuate a rush to professional judgement which may include “considering” but not developing a value conclusion under all three business valuation approaches. Expert testimony must demonstrate that the expert’s findings and conclusions are based on the scientific method, and, therefore, are reliable. The scientific method is used to find answers that are logical and supported by evidence. The scientific method is a process of trying to get as close as possible to the objective truth. You can use the scientific method to find answers for almost any question, though the scientific method can yield conflicting evidence based on the method of experimentation.

Conclusory statements or opinions proffered by experts that do not provide the underlying facts to support the conclusion. An expert opinion is conclusory when the opinion has no basis or when the basis provides no support. This would or at least could occur if one were to render a conclusion of value that ignores or omits any value developed under either the asset or income approach. In addition to these financial statements containing totally different financial accounts, whereas the income statement depicts both types of financial statements depict different financial aspects, one being a snapshot of the businesses financial position at a particular point in time (the balance sheet) and the other being a measure of businesses financial performance over a period of time (the income statement). For facts or data to be relied upon they must first be considered. However, not all facts and data considered must or will be relied upon. This is perhaps why Federal Rule of Civil Procedure 26(a)(2) notes that an expert’s written report must contain “the facts or data considered by the witness in forming the bases for the conclusions expressed” and not “the facts and data relied upon by the witness in forming the basis for the conclusions expressed”, as it is possible for one to rely upon insufficient facts and data (as in only developing a value under one approach) as a means to form an opinion. A reliable expert opinion that fails to provide factual support, rationale, or underlying facts to support or explain the conclusions reached may ultimately have no probative or evidentiary value.

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Zachary Meyers, CPA, CVA, has been retained in over 2,600 cases as a testifying, consulting, or joint/court appointed expert. He has testified and been qualified as an expert specific to civil, marital, and criminal litigation. Mr. Meyers was elected to the NACVA Standards Board in 2016, appointed Vice-Chair in 2017, elected Chair in 2018, and in 2019, was re-elected as Chair, which promulgates professional standards for financial professionals, analysts, and experts. Mr. Meyers was appointed as NACVA Standards Board liaison representative for the Global Association of Certified Valuators and Analysts (GACVA) Advisory Council in 2020, which liaises with NACVA’s international chapters in Africa, Canada, Europe, India, Taiwan, and Southeast Asia. In 2021, Mr. Meyers was elected to the Business Valuation Resource Panel of The Appraisal Foundation (TAF), whose purpose is preserving and improving the public trust in valuation.

Mr. Meyers can be contacted at (304) 690-2619 or by e-mail to czmcpacva@CZMeyers.com.