Examples of Business Valuation Cases

The case:

The value of the husband's medical supply business had to be determined as part of the equalization of assets in a family case. The business was small, and the husband was the key person in the operations. In some years the business had been profitable, although there was only one year in which it had made a large profit; in several other years it had suffered losses. The Chartered Business Valuator estimated the value of the business at close to $200,000.00.

Analysis by Cusack Legal Services:

The business valuator made a number of errors, including:

  • The business was essentially a one-person operation, the husband was nearing retirement age, and it was questionable whether the business could be sold. However, the expert valued the business as if it would continue forever.
  • The business valuator used a standard method of weighting the net incomes and losses of the business over the years he examined. That method exaggerated the effect of the single year in which there had been a large profit, and minimized the impact of the losses the business had experienced.
  • No consideration was given to the anomalous factors that gave rise to the large profits that had been experienced in only one year.
  • The financial data used in the final year considered by the valuator was incomplete, resulting in an over-statement of income, and that year's income was given the greatest weight in his conclusions.
  • Two different methods were used for calculating the value of the business; however, they were applied in an inconsistent manner which resulted in an over-statement of value.
  • Unsupportable assumptions were made about applicable discount rates and comparable businesses.

When the valuator's report was analyzed by Cusack Legal Services, the business value was estimated at less than $100,000.00. The settlement reached at the pre-trial conference was based on the analysis completed by Cusack Legal Services, and saved the husband approximately $50,000.00.

The case:

Following the death of a retailer, his business passed to the surviving spouse and children, all of whom continued to operate the business for many years. Eventually a dispute arose that pitted one child and the mother against other children who had unilaterally taken control of the business. A lawsuit was started in which a remedy was sought for the oppressive conduct of the children who had taken control of the business. Although the allegations of oppression were disputed, the real issue concerned what it would cost for the controlling children to buy out the interests of the mother and the other child. A determination of that cost required the business to be valued. The business had substantial retained earnings and property holdings.

Analysis by Cusack Legal Services:

This business valuation contained a number of errors:

  • The shares owned by the mother were convertible to another class — the valuator failed to considered that feature, and therefore under-valued her shares.
  • The valuator's appraisal of competing businesses was weak.
  • The valuator made adjustments to the company's financial statements in order to prepare his estimate of value. These included assuming accrued bonuses of over $1/2 Million would be paid to the children who had taken control of the business, when payment of those bonuses was one of the issues in dispute.
  • An assumed rental factor was included, even though the business owned the buildings in which it operated.
  • In arriving at a capitalization rate used to calculate the value of the business the valuator relied upon risk factors that were generic to the broad industry in which the business engaged, rather than relying upon risk factors associated with closely comparable businesses.
  • The valuator relied upon information in a database to obtain values of "comparable: businesses". However, only 2 of 4 businesses considered were truly comparable, and the valuator's analysis did not lead to results that were actually consistent with any of the 4 comparable businesses found in the database.
  • The capitalization rate used by the valuator was increased on the assumption that a minority interest in the company would be difficult to sell. By increasing the capitalization rate the resulting value failed to account properly for a purchase by the children who had taken control of the business, made under court order, rather than a sale to the public at large.
  • The valuator relied upon estimated values of the buildings and land owned by the company. Those estimated values were not well-supported.
  • Although the business had been successfully operated for many years and had every expectation of continuing to operate successfully, the capitalized value of the business was estimated to be significantly lower than the estimated value of the underlying assets of the business.
  • Although the business had been successfully operated for many years and had every expectation of continuing to operate successfully, no amount was included in the estimates to reflect good will of the business.

The case settled shortly before the scheduled trial began. The child who had been excluded from the business was represented by another law firm and he settled for an amount that was approximately 15% higher than the value determined by the business valuator. The mother, who had been represented by Cusack Legal Services, settled for an amount that was more than 10 times the estimated value of her shares.