An additional opinion can help resolve disputes
Suppose two competent experts are hired to value a privately held business. Even if both appraisers are unbiased and equally qualified, and apply sound appraisal practices, they are unlikely to arrive at the same number. In fact, valuation differences of 10% or
more are common — even under ideal circumstances.
And if they’re unqualified experts who misunderstand valuation practice or improperly advocate on behalf of their clients, the gap between their conclusions will likely be wider.
When neither valuator will concede and the disputing parties won’t split the difference, an objective third expert can help settle matters. He or she also can pinpoint the specific sources of the discrepancy, thereby minimizing the risk of arbitrary court rulings.
Selecting a tie breaker
When selecting a professional valuator to break a stalemate, parties need to resolve the following issues:
Who selects the third expert? Disputing parties typically propose and mutually select the tiebreaker. But they also may leave the decision to the deadlocked experts, who often know more about professional qualifications and reputations. Alternatively, courts frequently appoint experts.
What are the minimum professional qualifications? Before choosing a third expert, the parties need to agree on minimum training and experience qualifications — for example, preferred business valuation designations, requisite years of experience and industry specialization.
Who pays the expert? After the valuation dispute is settled, confusion over payment of professional fees can be frustrating. Most experts ask the parties to resolve this matter before they start work — beginning with an upfront retainer.
Setting the ground rules
Should the new expert start from scratch or begin by reviewing the other experts’ work? If opposing experts appear unqualified or unduly biased, starting from scratch may be the best option. In this case, the third expert will need access to the same source documents and the opportunity to conduct key valuation procedures, such as site visits and management interviews. As a point of reference, the third expert also may want to know the range of values prescribed by the two opposing experts.
But, in a best-case scenario, the parties can save time and expense if the third expert starts with the original divergent reports. The third expert can rate the quality of the original reports and pinpoint specific differences. He or she also can quantify the impact of each differing assumption on the valuation conclusion. Sometimes a third expert conducts a “partial appraisal,” cherry picking preferred methods and assumptions from the initial appraisals.
To illustrate, suppose a controlling shareholder’s expert values a 5% business interest at $1 million. The dissenting minority shareholder’s expert concludes the interest is worth $1.5 million. Neither expert will modify his conclusion, so a judge mandates the use of a third expert to help resolve the 50% difference equitably.
The third expert reviews the initial appraisals and prepares a memo, which identifies two valuation assumptions that have a material impact on the appraisers’ conclusions. First, the minority shareholder’s expert adjusted the company’s income stream for above-average officers’ compensation, thereby increasing his estimate of the company’s value.
Another key difference was in the application of valuation discounts.
The controlling shareholder’s expert applied discounts for lack of control and marketability to his preliminary value conclusion, thereby reducing his estimate of the company’s value.
By isolating these differences, the third expert changed the dispute from “What’s a 5% interest worth?” to “Should income be adjusted for officers’ compensation?” and “Do
valuation discounts apply in dissenting shareholder cases?” Finally, the expert provided business valuation resources to help the judge better understand these issues and make a more informed ruling.
Once the third expert submits his or her opinion, clients have several options for integrating third appraisals into their dispute resolutions. The three appraisals can be averaged together, or the third appraisal can be averaged with the nearest expert opinion.
Alternatively, the third expert’s conclusion, alone, may serve as the final value.
To minimize future conflict, the parties involved need to agree in advance about what’s expected of the third expert and how to use the third appraisal.
Deciding when enough is enough
When negotiations reach an impasse, a third expert can provide an effective alternative to the averaging of two divergent opinions. Whether used to avert court-imposed settlements or to help triers of fact make more informed decisions, third experts often infuse fresh ideas and curtail bias perceptions.
Sidebar: Settling without a third opinion
To encourage an acceptable outcome for everyone — without recourse to a third opinion — the parties must:
Respect expert independence. “Made as instructed” valuations not only violate every appraisal organization’s code of ethics, but also promote widely divergent expert opinions.
Disclose information in an amicable, timely manner. Accurate valuations hinge on access to all relevant financial data, site visits and management interviews. Controlling shareholders may impair the process by preventing opposing experts from accessing information or conducting valuation procedures.
Mutually define the valuation assignment. Some issues are legal, such as the appropriate standard or basis of value. Rather than leave these issues to appraiser interpretation, clients and attorneys should hash them out in advance.
Revisit appraisals. Allow each expert to review the other’s report and then correct his or her own report for errors or capitulations. Rebuttal memos also can help clients understand where the differences lie — thus eliminating the need to call in a third valuator.
This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. In addition, any discounts are used for illustrative purposes and do not purport to be specific recommendations.