Why should an attorney understand the framework of business valuation standards? Your knowledge can yield dividends by supporting your valuation expert.
By Robert Schlegel, Kathy Hensley and Penny Lutocka, Business Valuators
Expert opinion from fact testimony is distinguished by the observance of professional standards. Performing a business valuation involves special knowledge, skill and experience. Different organizations have different standards. Not all standards are applicable to every appraiser, yet quite often two or more sets are applicable to an individual expert who is multi-credentialed or publicizes membership (even candidacy for a designation) in several organizations.
The Framework of Business Valuation Standards
It is up to each individual appraiser to be certain that the proper set of standards is followed. Adherence to standards implies an expert analysis that is conscientious, dependable, and verifiable with accepted professional procedures. The experts who follow recognized standards are far less likely to fall victim to Daubert challenges which results in the expert being disqualified. Conversely, experts who fail to perform work in accordance with recognized standards unless they differ from published governmental or judicial authority are subject to criticism and may have their credibility questioned by astute opposing counsel.
Beginning in 2012, there were five major appraisal organizations in the United States and Canada. They were as follows:
1) American Society of Appraisers (ASA)
2) Institute of Business Appraisers, Inc. (IBA)
3) National Association of Certified valuation Analysts (NACVA)
4) American Institute of Certified Public Accounts (AICPA)
5) Canadian Institute of Chartered Business Valuators (CICBV)
Effective July 1, 2012, IBA and NACVA merged into the Appraisal Database and Mentoring Services ™ (ADAM). All of these organizations have professional standards that address ethics, competency, objectivity, accepted procedures to develop the business valuation opinion, and how to report the opinion. These standards are dynamic; periodic updates, revisions and exposure drafts of new language are being regularly promulgated.
Beyond pronouncements of ethics and due professional care, each of the standards above fundamentally explains how an appraisal of equity assets is to be performed, and the various of types of reporting. “Development Standards” generally describe the type of engagement, identification of the subject, consideration of appropriate approaches and methods of analysis, application of premiums and discounts, support for the opinion, and requirements to maintain proper files and work papers substantiating the opinion. “Reporting Standards” generally outline the different varieties of written or oral communication acceptable. Several of the standards indicate that in litigation, arbitration, or mediation settings, reporting formats may be specified by legal counsel, thereby permitting a departure from noted standards. Any slackening of the reporting standards for litigation purposes, however, does not allow any departure from adhering to the developmental standards for doing the analysis or keeping records to support the analysis. All of the organizations seem to be moving toward common definition of certain terms. The current International Glossary of Business Valuation Terms can be found at www.bvappraisers.org/glossary/glossary.pdf.
In addition to the three organizations above, attorneys may also observe reference to four other sets of professional standards that address business valuation analysis directly or indirectly.
Uniform Standards of Professional Appraisal Practice (USPAP) – These are standards originally developed in 1987 by the Appraisal Foundation (and continually updated; see www.appraisalfoundation.org) as a response to real estate valuation needs from the Savings & Loan debacles in the 1980’s. USPAP Standards 9 addresses how to do business valuation work. Standard 10 addresses how to report business valuation work. There are also two trailing sections in USPAP – “Statements” have the same impact and requirements for practice; “Advisory Opinions” are simply illustrations of specific situations without the weight of Standards. Members of the ASA must conform to USPAP, however, members of ADAM and the AICPA are not required to conform to USPAP. As the first released standards for business appraisers, USPAP has set the tone that others generally follow.
ASA Business Valuation Standards (www.appraisers.org) These standards are to be used in conjunction with USPAP of The Appraisal Foundation and the Principles of Appraisal Practice and Code of Ethics of the American Society of Appraisers. These standards provide minimum criteria for developing and reporting on the valuation of businesses, business ownership interest, or securities.
Standards for Valuation Services (SSVS) No.1 (www.aicpa.org) was issued by the AICPA and is effective for all engagements entered into on or after January 1, 2008. These standards must be followed by all member of the AICPA. CPAs who practice in jurisdictions whose boards of accountancy adopts the AICPA standards must also follow this standard, even if they are not members of the AICPA. The AICPA promulgated the Statement on Standards for Consulting Services No. 1 which includes a wide range of consulting services and not just business valuations. It deals with a wide array of services such as due care and proper staffing for consulting engagements.
Chartered Financial Analyst Institute (see www.cfainstitute.org) has a code of ethics and standards of professional conduct. CFAs normally opine on investment strategies and are commonly employed by banks and financial management firms, but do serve as experts in business valuation.
The Internal Revenue Service (IRS; see www.bvresources.com/FreeDownloads/irs-guidelines.pdf for a copy) has recently published appraisal standards for internal use and work by their outside appraisers. Conceivably, reference to these standards would only surface in matrimonial issues with extreme tax consequences.
The Canadian Institute of Chartered Business Valuators (see https://cicbv.ca/) has Practice Standards, a code of Ethics and Practice bulletins that members must comply with. These standards include scope of work, reporting and disclosures. Failure to comply with the Practice Standards is a breach of a Member’s ethical obligations and the Institute can take action considered appropriate by the Board of Directors.
International Valuation Standards Committee (see www.ivsc.org/pubs) are the least likely to arise in matrimonial settings unless equity assets are being appraised with extensive international connotations with business valuation opinions from foreign appraisal professionals.
When presented with an equity asset issue, the response of most attorneys is to discuss with their client whether the needs of an expert is warranted. If they hire an expert it usually is an accountant or an otherwise credentialed analyst to form an opinion. Opposing parties typically react the same, with too often the result of a wide gap in opined value between two experts. Your understanding of the experts’ professional standards early in the process can help to avoid this problem, with more efficient use of the clients’ resources and a higher quality division of assets.
In hiring your own business valuation expert, first determine if the expert is a member of one or more of the professional organizations. Go the appropriate organization’s web site; check your expert’s claimed credentials, and download the current version of standards.
- Inquire as to the “level of service” to be provided.
- Based on preliminary information you have shared with the expert, ask if there are any anticipated qualifications to the opinion. Make sure your expert is independent.
- Clarify the reporting desired – oral advisory, some form (summary or detailed report) of written correspondence, and/or formal testimony.
- Understand if the expert has any hesitation of competence to undertake the assignment, and how he or she plans to overcome those issues.
If you are presented with an opposing expert who appears to have presented less than competent work:
- Establish the professional standards under which the work was performed. If the expert is a member of multiple organizations, multiple standards may apply. In this case, the expert may be bound by the highest, or most acute, level of work or reporting, not the lowest.
- Research both the level of analysis undertaken and the reporting of the opinion. Caveats such as calculation, consulting, preliminary findings, or limited opinion are tip-offs that you do not have a full appraisal or unambiguous opinion of value. Ask why!
- Clarify any difference between the standards and the opposing expert’s analysis with your own (or separately engaged) business valuation expert. Interpretations of minimum standards given materiality, financial comparison, and common valuation practice are necessary. Remember that the glass of water may be half full or half empty depending on perspective.
- Position the most egregious differences in deposition.
Business valuation professionals are continuing to be challenged with the development of ethical and work standards through a variety of organizations. These are dynamic, with periodic updates to wording. Whether a given expert analysis meets or fails to meet the threshold of professional and competent work is a finding of an additional expert opinion rather than a finding of fact. Work with your own expert to provide you with an education of the current progress of standards. In high dollar equity asset matters, your knowledge of what to expect in terms of good expert work and poor expert work should yield benefits of a compelling presentation.
Source: Understanding Business Valuation, 4th Edition, 2012 by Gary Trugman.
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Robert C. Schlegel, ASA, MCBA is a Principal with Houlihan Valuation Advisors® in Indianapolis, Indiana. Kathy Hensley, CPA/ABV and Penny C. Lutocka, CPA/ABV, CFP®, CFE are both Directors with Houlihan Valuation Advisors® in Indianapolis, Indiana.
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