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Diminution of Business Value, Business Interruptions and Lost Profits: Reviewing an Expert Report

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Diminution of Business Value, Business Interruptions and Lost Profits: Reviewing an Expert Report Diminution of Business Value, Business Interruptions and Lost Profits: Reviewing an Expert Report Riley Busenlener, CPA/ABV, ASA, AEP®, JD December 18, 2019 Investment Banking Services offered through Chaffe Securities Inc., member FINRA/SIPC 1 Disclaimer . This presentation is only for educational purposes, as of the date of the presentation. This presentation should only be used for this limited, intended purpose. It should not be used in conjunction with any other matter. This presentation does not necessarily represent the professional opinions of the presenter or Chaffe & Associates, Inc. The proper methodologies and techniques to be employed in any engagement are fact specific and based on the totality of circumstances at hand. 2 I. DAMAGES AND AWARDS 3 Damages & Awards 1. Two most common approaches to quantify economic damages – Business Valuation & Lost Profits 2. Both share similar economic and financial principles 3. Reconciling dissimilarities between the two: . Each can lead to very different outcomes . Which one is/are both allowed in a specific case? . Will one approach make the injured party whole and the other not? 4 Damages & Awards Questions that need to be answered: 1. What would the business have earned “but for” the damaging event? 2. What other damages occurred? 3. What additional expenses have or will be incurred? 4. How long is the period of loss? 5. What is the growth rate of damages over the loss period? 6. At what rate should the damages be discounted to present value? 7. Should legal interest be applied to past losses? 5 Damages & Awards Questions that need to be answered: 8. Should income taxes be considered? 9. What are the key dates involved in the calculation? 10. What is the jurisdiction? 11. What is the applicable law surrounding the damages? 12. Other relevant information? . Background and History of the business . Historic Financial performance and Earnings Capacity . Management performance/depth . Benchmarking against industry . Expense analysis—fixed, variable, step-fixed 6 Damages & Awards: Business Valuation BV—Allocate value to a shareholder, decedent’s estate or marital estate. Applied almost exclusively in: – Entire business destruction – Shareholder oppression – Dissenting shareholder – Marital dissolution, and – Tax court Used when damages represent value into perpetuity, and not for a specified period of time— as defined by the nature of the action filed 7 Damages & Awards: Business Valuation BV—Permanent business value impairment / diminution in value cases often rely on business valuation as an appropriate measure: – M&A disputes, – Defamation and/or slander, and – Intentional business destruction Damages measure in these types of cases may be based on the difference between the value of the business in the but-for world and its actual value 8 Damages & Awards: Lost Profit . Lost Profits—make the plaintiff whole/put in the same position, ‘but-for’ the defendant’s actions that gave rise to the alleged damages . Applied almost exclusively to: – Breach of contract – Intellectual property infringement – Business interruption 9 Damages & Awards: Lost Profit . Lost Profits awarded only when injury can be related to an identifiable cash flow . Lost Profits commonly calculated based on – Difference between expected profits assuming no harmful event and – Actual profits achieved/estimated to be received 10 Damages & Awards: Lost Profit . Lost Profits – Typically measured for a specific, limited time period and not into perpetuity – Courts reluctant to award lost profits damages over extended periods of time due to the speculative nature of the underlying projections 11 Damages Timeline Present Value Time Value of $$ and Date of Future Damages Prejudgment Interest Trial to Date of Trial End of Date of (if applicable) Damage Claimed Period Act or Damage Damages Occurring from Date of Future Damages Claimed Act or Breach 12 Discount Rates . If not all uncertainty/risk resolved in expectation projections, then – Discount rate may contain a factor to account for unresolved risk not addressed in projection – Highly certain economic income discount rate that investor would have used to purchase the asset in free market exchange (- i.e. defendant’s borrowing rate) – At lower rate to recognize and quantify plaintiff’s loss by constructive forced sale of the asset’s ability to return an element of owner economic profit above plaintiff’s marginal cost of capital 13 Are Lost Profits and BV Identical Proxies for Damages in the Same Case? (i.e., Lost Profits cannot exceed BV, therefore damages should be limited to BV when lost profits estimate exceeds the value of the business) Debated issue—but consider this reasoning by Bob Dunn: “…if all other things are equal, using the same methodology should produce the same result for lost business value and lost profits. But all other things are rarely equal.” 14 Can Both Be Used To = Total Damages On Same Case? Yes, BUT… . Used only on slow demise of business . Cannot double dip . Measuring but-for profits from date of harm to date of decimation of business . Less actual profits . Loss of the business value on date of destruction is reduced by salvaging value 15 Can Both Be Used To = Total Damages On Same Case? Equation: (a – b) + (c – d) = damages to make plaintiff whole a = but-for expected profits b = actual profits received from date of harm to date of decimation c = value of the business on date operations ceased d = salvage value of the business 16 Lost Profits and Business Failure / Destruction $ Date of harm c = but-for business value (a – b) = lost profits Date of business b = actual profits failure Time 17 What Are The Differences, That Causes Unequal Results? . Measurement date . Premise of value – Ex ante (date of harm) – Free market exchange – Ex post (date of trial) – Forced sale/diversion of profits . Discount rate – Risk adjusted . Income taxes – Risk free rate . Damage period – Plaintiff’s use of funds – Finite or – Infinite? 18 What Are The Differences, That Causes Unequal Results? Business Valuation . Implicitly assumes damages into perpetuity . Using fair market value assumes willing seller and doesn’t consider – Risk factors assumed by seller – Marketability and control discounts can decrease damages making it impossible for the damaged party to be made whole 19 II. DIMINUTION OF VALUE AND REVIEW OF BUSINESS VALUATION REPORTS 20 Diminution of Business Value Methodology . What is the Diminution of Business Value? . The difference between – The value before the event in dispute where the value may be calculated as the present value of the future cash flow projections; and – The value after the event has occurred where the value may be calculated as the present value of the future cash flow projections after consideration of the value-impairing event 21 The Report . Cover of the report . Math . Signatories . Standards . Assumptions 22 The Cover of the Report . Subject Entity . Valuation Date . Standard of Value . Appraisers 23 Business Valuation Math . A business valuation goes beyond math. It's the assessment of a business's hard and intrinsic assets to determine its moneymaking power in the hands of the same owner or a new owner years from now. $125k + y + $328k + = ? 24 Premise of Value . Going Concern - value in continued use or as a going concern business enterprise . Value as an assemblage of assets - value in place, as part of a mass assemblage of assets, but not in current use in the production of income & not a going-concern business enterprise . Value as an orderly disposition - value in exchange, on a piecemeal basis; assumes assets will enjoy normal exposure to their appropriate secondary market . Value as a forced liquidation - value in exchange, on a piecemeal basis; assumes assets will experience less than normal exposure to their appropriate secondary market 25 Standards of Value . Fair Market Value – Amount at which property would change hands between willing buyer & willing seller, when the former is not under any compulsion to buy & the latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts (Revenue Ruling 59-60) . Fair Value – Usually, defined by various authorities & statutes . Investment Value – Specific value to a particular investor based on individual investment requirements . Intrinsic Value – Amount an investor considers to be "real" worth of an item based on evaluation of available facts. May be above or below fair market value 26 Main Certifications for Valuation Professionals . American Society of Appraisers [ASA] . American Institute of Certified Public Accountants [AICPA] . National Association of Certified Valuation Analyst [NACVA] 27 American Society of Appraisers [ASA] . AM – Accredited Member – College degree and two years of appraisal experience; must pass four courses and an exam and perform peer review of appraisal report . ASA – Accredited Senior Appraiser – Same requirements as those for the AM designation plus three years of experience . FASA – Fellow – Same requirements as those for the ASA designation, plus election to the college of fellows 28 American Institute of Certified Public Accountants [AICPA] . ABV – Accredited in Business Valuation – AICPA membership, Business Valuation license, completion of one-day exam, and involvement in ten business valuations. 29 National Association of Certified Valuation Analyst [NACVA] . AVA – Accredited Valuation Analyst – Business degree, completion of analyst exam, and two years of experience or completion
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