Business Valuation in Commercial Litigation

Business valuation issues arise in many different litigation contexts, including:

• Shareholder and partner disputes involving the buyout of a departing or dissenting owner
• Breach of contract and post-acquisition disputes, including earnout and purchase price adjustment disputes
• Dissenting shareholder and statutory appraisal actions arising from mergers, consolidations, or other corporate transactions
• Breach of fiduciary duty claims, including diverted business opportunities and self-dealing
• Disputes arising under buy-sell agreements and other shareholder or operating agreements
• Fraud and misrepresentation claims arising from the purchase or sale of a business
• Minority shareholder oppression claims
• Partnership and limited liability company dissolution actions

While the underlying valuation principles are consistent across these contexts, the applicable standard of value, the treatment of valuation discounts, and the relevant valuation date can vary substantially depending on the nature of the claim and the jurisdiction in which it is brought.

The standard of value defines the specific value being estimated and the assumptions underlying that estimate, such as who the hypothetical buyer and seller are and what information they are assumed to have. The standard of value applicable to a dispute is generally established by the governing statute, the terms of a contract, or controlling case law, and it can differ significantly from the standard of value used in other types of engagements.

Fair Market Value

Fair market value is the price at which a business or business interest would change hands between a hypothetical willing buyer and a hypothetical willing seller, neither being under compulsion and both having reasonable knowledge of the relevant facts. This standard is most commonly associated with tax matters, but it is also applied in certain breach of contract and buy-sell agreement disputes where the parties or the governing document have adopted it.

Fair Value

Fair value is a statutory standard applied in most dissenting shareholder appraisal actions and, in many states, in shareholder oppression proceedings. Fair value is defined by the applicable corporate statute and by the case law interpreting it, and its treatment of matters such as marketability and minority discounts often departs significantly from the treatment of those same issues under fair market value.

Investment Value

Investment value reflects the value of a business or business interest to a particular owner or prospective owner, taking into account synergies, strategic considerations, or other benefits specific to that party. This standard can be relevant in disputes involving a diverted business opportunity, a specific prospective buyer, or a transaction where the terms and identity of the actual counterparty are known.

Because the standard of value can significantly affect the conclusion reached, identifying the correct standard, and supporting it with the applicable statutory and case law, is one of the first and most consequential steps in a litigation valuation engagement.

As in other valuation contexts, analysts in litigation matters generally consider three broad approaches to value, selecting and weighting them based on the nature of the subject company, the availability of reliable data, and the standard of value applicable to the dispute.

Income Approach

The income approach estimates value based on the present value of the economic benefits the business is expected to generate in the future, commonly using a discounted cash flow or capitalization of earnings method. In litigation, the projections and discount rate used under this approach are frequently contested, particularly where the subject company's historical results are volatile or where the projections were prepared in anticipation of the dispute.

Market Approach

The market approach estimates value by reference to prices paid for comparable public companies or in comparable private transactions. The selection of comparable companies or transactions, and the adjustments made to account for differences in size, growth, and risk, are common areas of disagreement between opposing experts in litigation matters.

Asset Approach

The asset approach estimates value based on the fair value of the company's underlying assets and liabilities, and is generally most relevant for holding companies, asset-intensive businesses, or companies with limited or negative earning capacity. In dissolution and dissenting shareholder matters involving such companies, the asset approach can carry particular weight.

Valuation conclusions are also affected by the level of value being estimated, and by whether discounts or premiums are applied to move between levels of value. These issues are frequently contested in litigation, both because they can have a substantial effect on the resulting value and because their appropriate treatment can depend heavily on the applicable standard of value and jurisdiction.

Control vs. Minority Interests

A controlling interest generally commands a higher per-unit value than a minority interest in the same company, reflecting the controlling owner's ability to direct the company's operations, distributions, and disposition. Whether the interest at issue in a dispute is a controlling or minority interest, and whether the valuation should reflect a control premium or a minority discount, is often a threshold issue in the analysis.

Discounts for Lack of Marketability and Control

A discount for lack of marketability reflects the reduced value of an interest that cannot be readily sold, while a discount for lack of control reflects the reduced value of a minority interest that cannot direct the company's affairs. The application and magnitude of these discounts in litigation depends heavily on the standard of value and the jurisdiction involved.

This treatment is not uniform across contexts. Many states, for example, disallow or limit the application of marketability and minority discounts against a dissenting or oppressed minority shareholder in a statutory appraisal or fair value proceeding, on the rationale that the majority should not benefit from discounts attributable to its own conduct in forcing the minority out. In other contexts, such as a fair market value analysis prepared for a buy-sell agreement dispute, these same discounts may be fully applicable. Identifying which body of law governs the discount analysis in a given matter is essential to a defensible conclusion.

The valuation date is the specific date as of which the value of the business or business interest is measured, and it is typically fixed by the governing statute, the terms of a contract, or an order of the court, rather than selected by the analyst. Common valuation dates include the date a triggering event occurred under a shareholder or buy-sell agreement, the date of a breach or wrongful act, the date a dissolution petition was filed, or the date immediately preceding a merger giving rise to appraisal rights.

The valuation date also determines what information may properly be considered. Facts and circumstances known or knowable as of the valuation date are generally reflected in the analysis, while subsequent events that could not have been anticipated as of that date are generally excluded, subject to variations in how individual jurisdictions treat post-valuation-date evidence. Because the choice of valuation date, and the treatment of events occurring before and after it, can materially affect the conclusion, this issue is frequently the subject of motion practice and expert disagreement in litigated matters.

The valuation issues described above tend to surface in recognizable patterns depending on the type of dispute involved. The following examples illustrate common valuation issues associated with particular categories of commercial litigation. These examples are illustrative only, are not based on any specific client or matter, and are not intended to describe the outcome of any particular case.

Shareholder Oppression and Buyout Disputes

A recurring valuation issue in oppression and statutory buyout matters is whether, and to what extent, marketability and minority discounts may be applied against the oppressed shareholder's interest. Because many oppression statutes and the case law interpreting them limit or prohibit such discounts, the analyst must determine at the outset which discount framework the governing statute and jurisdiction actually permit, rather than applying the discount methodology that might otherwise be used in a non-litigation engagement.

Dissenting Shareholder Appraisal Actions

In an appraisal action, a central valuation issue is often whether the fair value determination should include the synergies or other benefits expected to result from the underlying merger or transaction that gave rise to appraisal rights. Because most appraisal statutes exclude value attributable to the transaction itself, the analyst must separate the company's stand-alone going-concern value from any transaction-specific synergies, which frequently becomes a focal point of dispute between opposing experts.

Earnout and Post-Closing Purchase Price Disputes

Disputes over earnout payments and post-closing purchase price adjustments frequently turn on disagreements over the definitions of EBITDA, working capital, or other financial metrics set out in the purchase agreement, and over the normalization adjustments applied in calculating them. Because these definitions are contractual rather than governed by a single accounting standard, the analyst must interpret and apply the specific language of the agreement, often in the face of legitimate differences over the accounting treatment of particular items.

Breach of Fiduciary Duty and Diverted Business Opportunity Claims

Claims involving a diverted business opportunity or other breach of fiduciary duty often present a dispute over the appropriate valuation date, such as the date of the breach versus the date of trial, and over whether the analysis should reflect the performance the diverted opportunity actually achieved after the breach or only what could reasonably have been projected as of the breach date. The resolution of this issue can substantially affect whether, and how much, subsequent growth or decline is captured in the damages or value conclusion.

Buy-Sell Agreement Valuation Disputes

Buy-sell and shareholder agreements often contain valuation formulas or instructions that were drafted years earlier and did not anticipate the specific circumstances of the eventual triggering event, leading to disputes over the standard and premise of value the parties intended. Where the agreement's language is ambiguous or silent on issues such as discounts or the treatment of specific assets, the valuation analyst may be asked to reconcile the contractual language with generally accepted valuation practice, subject to the court's or arbitrator's interpretation of the parties' intent.

Partnership and LLC Dissolution Disputes

Dissolution disputes among partners or LLC members commonly raise issues concerning the treatment of undistributed profits, the accuracy of capital account balances, and whether a marketability discount is appropriate given transfer restrictions in the partnership or operating agreement. Because these agreements often address buyout or dissolution mechanics directly, the analyst must reconcile the valuation methodology with any governing contractual provisions before applying general valuation discount practice.

These examples are not exhaustive, and many disputes present more than one of these issues simultaneously. As with any litigation valuation engagement, the specific issues presented, and the methodology used to address them, depend on the facts and circumstances of the matter, the governing legal standard, and the jurisdiction involved.

In addition to preparing an affirmative valuation analysis, we are frequently retained to review and critique the analysis prepared by an opposing expert. A rebuttal review typically evaluates:

• Whether the standard and premise of value applied are consistent with the governing statute, contract, or case law
• The reasonableness and support for the discount rate, capitalization rate, or valuation multiples used
• The propriety of normalization adjustments made to historical or projected financial results
• The selection and comparability of any guideline public companies or transactions relied upon
• The application and support for any control premiums or marketability and minority discounts
• The internal consistency and mathematical integrity of the valuation model

A well-supported rebuttal analysis can be useful in cross-examination, in settlement negotiations, and in connection with any motion challenging the admissibility of the opposing expert's opinion.

We provide both consulting and testifying expert services in commercial litigation matters. As a consulting expert, our role is generally to assist counsel in evaluating the financial and valuation issues in the case, developing discovery requests, and preparing for the deposition or cross-examination of the opposing expert, without disclosing our own analysis or opinions to the opposing party.

As a testifying expert, we prepare a written report setting out our valuation analysis and conclusions, consistent with applicable disclosure requirements and professional standards, and we are available to support that opinion through deposition and trial testimony. Because expert opinions in litigation are subject to scrutiny under applicable evidentiary standards governing the admissibility of expert testimony, our analyses are built to withstand that scrutiny, with clearly documented data sources, methodology, and assumptions.

We work with counsel throughout the litigation process, from the initial evaluation of the financial and valuation issues in the case through report preparation, deposition, and trial, adjusting the scope of our analysis as the case develops and as additional information becomes available. Our broader litigation support and expert services describe that work across every practice area.

Early involvement of a valuation analyst can help counsel frame discovery requests, evaluate the strengths and weaknesses of the case, and assess the range of likely valuation outcomes before significant litigation costs are incurred. We regularly assist counsel with identifying the financial records and other information needed to support a valuation analysis, and with formulating deposition questions for the opposing party's principals and experts.

Throughout the engagement, we coordinate closely with counsel to ensure that our valuation methodology is consistent with the legal theory of the case and with the standard of value and other requirements imposed by the applicable statute, contract, or court order. We are also mindful of the confidentiality and, where applicable, privilege considerations that attach to a consulting expert's work, and we coordinate with counsel on document handling and communications accordingly.

If you are involved in a commercial litigation matter that raises business valuation issues, our team can help evaluate the financial and valuation issues in the case, whether you need an affirmative valuation analysis, a rebuttal review of an opposing expert's opinion, or ongoing litigation support. We are available to discuss potential engagements on a confidential basis and can typically provide a preliminary assessment of scope shortly after reviewing the key case documents. Contact us to discuss the facts of your matter and how we can assist.