Ethical Lapses in Business Valuations: Be Aware of These Key Areas
I have written numerous articles addressing ethics matters concerning either business valuation or litigation support. I continue writing about this issue because I keep seeing ethical lapses in various areas of decision making and valuation. By no means am I perfect. I spend a tremendous amount of time reading numerous journals and articles and attending various courses to keep current on valuation and litigation matters. We are all human, and that means that our work can include errors. The goal is to minimize errors by improving our judgment, especially regarding the developmental and reporting stages of an engagement (i.e., to comply with the standards).
COMPLIANCE WITH BUSINESS VALUATION STANDARDS
Business valuation (BV) practitioners have a significant number of professional standards to follow that most of the public are unaware of, such as (in no particular order):
1. Uniform Standards of Professional Appraisal Practice
2. National Association of Certified Valuators and Analyst (NACVA) Professional Standards (just updated and sent to their members for approval)
3. American Institute of Certified Public Accountants (AICPA) Statement on Standards for Valuation Services No. 1
4. American Society of Appraisers (ASA) Business Valuation Standards.
Many valuation analysts (analysts) must follow more than one of the above valuation standards. Business Valuation Resources (BVR) published in its Business Valuation Update, February 2015 edition, an article titled, “Different BV Standards Have More in Common Than You Think.” Mark Hanson and Mark Kucik spent a significant amount of time putting this material together. I highly recommend you take the time and read it. Not only is it informative, it illustrates that the underlying goal of all the various BV organizations for their members is to provide a meaningful, unbiased product to their clients.
COMMON TROUBLE AREAS
Some of the more common areas that I see lapses in BV analyses or reports are:
CONFLICT OF INTEREST
The AICPA’s Professional Ethics Executive Committee adopted and recently revised Interpretation 102-2, “Conflicts of Interest for Members in Public Practice.” I highly recommend all CPAs read this. The area of most concern is when a CPA has two clients and is asked to value the business relating to a divorce or partnership dispute. This commonly occurs when a CPA has clients such as a husband and wife or a partnership and they request a valuation by their CPA. The CPA has an obligation to both/all parties/partners. Therefore, the CPA has a conflict of interest. A conflict of interest can be waived, unlike independence standards. The CPA is required to obtain a waiver in writing from the parties (or party that is not be assisted) to assure they understand that the conflict of interest is being waived. I just had a matter in which the CPA recognized the conflict of interest, fired one party, and continued to work with the other party. Unfortunately, the CPA did not obtain the waiver from the party that was fired. The CPA was sued for an ethical violation— more commonly known as professional malpractice.
All of the above professional standards in one way or another indicate that the analyst must be competent when performing the assignment. We all may run into a new industry or type of business, but the professional standards require that the analyst obtain the knowledge and ability to perform the valuation prior to conducting it. I understand that work can be hard to come by sometimes, but analysts need to be careful and not take everything that comes their way. I turn away many engagements when I know I do not have the level of expertise and knowledge needed to con-duct a proper analysis. If I know it would take me a significant amount of time to obtain the necessary knowledge to perform an engagement in accordance with the standards, I need to consider whether the fee is worth the learning curve and liability exposure. In addition, I take into account that I most likely would not see that type of engagement again or not for a very long time. The cost benefit analysis for an analyst needs to be done in more ways than one. For example, how much will the fee be? How much time will it take to get the necessary knowledge to prepare a proper valuation analysis in accordance with the standards? Most importantly, will the exposure to the new unique industry be worth the liability exposure for potential incompetency?
CAP RATE AND EARNINGS/CASH FLOW
I continue to see valuation after valuation using the wrong capitalization rate with the earnings or cash flow. There is a significant amount of literature— in addition to good courses— on how to get this right. I not only see this in the earnings/cash flow approach, but in the market approach. I have recently reviewed two valuations using market value of invested capital (MVIC) and with an EBITDA multiplier, which is a good match except the analysts did not subtract long-term debt when giving an opinion/conclusion on the entity’s equity value. Their report and analysis supported a valuation conclusion on MVIC, not equity.
PROVIDING A VALUE WITHOUT THE DUE DILIGENCE
Many of us are asked what the business is worth based on reviewing just a few documents or just a financial statement. Many clients can be persuasive and insistent. It is hard to educate our long-time clients that we have professional standards that require us to conduct an analysis before we can provide a value. In litigation, attorneys also want to know information as soon as possible. By providing the client an answer— or even a range of value— before conducting sufficient due diligence in accordance with the standards, the analyst may violate the standards. If the client then uses that information in loan documents, legal filing, etc., it may come back to the analyst as an ethical violation and professional negligence.
BV STANDARD REFERENCE
All of the above valuation standards have in one way or another a requirement that the analyst state in his or her report that applicable BV standards were followed. If you are required to follow more than one of those sets of standards, you must disclose that you followed each of the standards and not just one organization’s standards. For example, I am a CPA, CVA, and ASA; therefore, I am required to disclose I followed SSVS No. 1, NACVA, ASA, and USPAP standards in all of my valuation reports.
By Scott R. Saltzman, CPA, CVA, ASA, MAFF Saltzman, LLC, Denver, CO
Building Value, Volume XIV, Issue II