How can Business Valuations Diverge so Widely?

How Can Two Business Valuation Experts be so Far Apart on the Same Case?

Parties to business litigation and their legal counsel frequently express frustration and confusion when the expert witnesses on a case report wildly divergent opinions of value on the same business. Even judges voice their unhappiness with being presented with value opinions that appear to be polar opposites.

How can expert opinions diverge so widely?

The result of diverging opinions is prolonged litigation, higher costs for the litigants, weakened faith in the litigation process, and lowered opinion of the business valuation profession.

The cynical, albeit widely held view regarding why expert opinions diverge materially on a given matter is bias. Bluntly, there may be a perception that each expert’s opinion is simply produced according to the needs of the client who is paying that expert’s fees. However, while this may occur at times, we find this too simplistic and dismissive an explanation, for two reasons.

First, our experience has been that most expert witnesses hold themselves and behave according to a high standard of integrity. They have earned credentials that require them to observe a certain level of professional ethics. In short, most expert witnesses are not shills, and they don’t want to be viewed by their peers in this way.

Second, rules of evidence provide for gatekeeping criteria (the Daubert standard) that enable judges to exclude expert witnesses who are not fit to testify for that case, whether due to an impairment of their impartiality or for other reasons. Being excluded from a case under the Daubert framework can be immensely damaging to a professional’s capacity to be retained as an expert in future cases. It is highly unlikely that an expert will be willing to put their future testifying career at risk for one case.

Assuming that bias isn’t the dominant driver of divergent expert opinions, the explanations for the differences between value conclusions by different experts include the following:

Different Third-Party Information

This is, by far, the most frequent reason for diverging value opinions among experts. Experts have their own information sources, including economic data, industry forecasts, public company data, private transaction data, benchmarking data, cost of capital data, and others. Not every expert or expert’s firm has access to the same data sources and, accordingly, different data will lead experts to use different valuation development processes and reach different conclusions.

Different First-Party Information

Consciously or sub-consciously, clients and legal counsel can bias their experts. Clients and counsel aren’t being dishonest per se, but they understand and communicate the facts surrounding their cases through the lens of their perception of the dispute (and their desire to prevail in said dispute), and accordingly they may provide information that is filtered through that lens. The result of this client bias is that the expert is unwittingly fed information that inclines them toward a particular value result, quite probably without anyone’s knowledge.

And like it or not, it occurs from time to time in value and damage disputes that those who control the enterprise to have better information about the business than those who do not. The discovery process that leads to monetary conclusions can fail to capture all the information needed to reach an objective result. Depositions of the litigants and other experts may fill in blanks and clear up uncertainties, and updated appraisals and damage studies can be submitted in some cases. But the lack of a level playing field going in contributes to differences in conclusions, more cost, and confusion for the trier of fact.

Different Experience

Individual judgement is recognized as a valid and important contributor to the development of a valuation by every set of professional standards. Each expert brings a different professional experience with them to a matter. Experts have differing levels of knowledge of the company’s industry, different experiences with legal cases, different backgrounds, and different educational backgrounds. All of these personal variables can lead experts to approach valuation matters from different vectors. Human nature necessarily leads an expert to process a data set through the filter of their own experience, and that can lead to different value conclusions. Not only do experts’ backgrounds lead to interpreting answers to questions differently, but they also lead to asking different questions altogether.

Forewarned is Forearmed

Once you recognize that value conclusions between experts may honestly diverge, you can take action. When you encounter a significant difference between experts’ value conclusions, consider doing the following:

• Understand the experts’ backgrounds. An expert with a public accounting background may approach value differently than a former investment banker, or company controller. Different backgrounds often lead experts to approach a valuation differently.
• Examine each expert’s training. An expert with the CVA (Certified Valuation Analyst) credential may use different techniques than someone with the ABV (Accredited in Business Appraisal) or the ASA (Accredited Senior Appraiser) or the CFA (Chartered Financial Analyst). Neither is better than the other, but they may be different.
• Review the assumptions in each expert’s report, carefully. To the extent that the two experts used similar methodologies to value the business, place the model inputs side by side. With an income approach, this means comparing forecasted cash flows, long-term growth rates, cash flow adjustments and working capital adjustments. With a market approach, this means comparing search terms for guideline public companies and comparable transactions.
• Check the math. Mistakes happen. Even the best experts make them. Even ones with teams of analysts double checking and triple checking the math. Ask NASA if mistakes happen. Sometimes, a wild difference in value conclusions is the result of an undetected math or formula error.

Not all expert reports will reconcile using these techniques, but most will. It’s worth trying because you can glean insight into what testimony might ultimately be given at trial, and you may also uncover potential ground for settlement discussions. The benefit potentially is a better outcome for your client, as well as saving thousands of dollars in fees and months or even years of litigation.