I ask this question based on the calls I get from agency owners needing their agencies valued due to legal and/or tax issues. I recently received a call from a desperate agency owner in the middle of a horrible legal battle. This owner needed a solid valuation. The problem, and it is always a major problem, is the owner’s attorney just told him to go and get a valuation. That is lousy advice. It is lazy advice. If the attorney had taken the appropriate law classes, he/she would have advised what kind of valuation was required.
The attorney’s retort was, “That is why we hire an expert, so they can tell us what kind of valuation is required.” Again, that is so lazy. The type of valuation required is dictated by law. They are the attorney. They are supposed to know the law. At the very least, they should not leave the client hanging, trying to figure out if their attorney or the valuation expert is correct. The lawyer has a duty to identify the type and kind of valuation required (in fact, if they are a specialist attorney such as a divorce attorney, a business practices attorney, or a tax attorney, they should know the answer off the top of their heads). At the very least, they should have a conference call with the valuation expert, the client, and themselves to discuss the options.
I feel bad for the people needing a valuation who have hired these lazy, ignorant attorneys. Here are some facts to assist you if you need a valuation for legal and or tax purposes.
Types of Valuations: Most legal/tax valuations require a Fair Market Value appraisal or a Fair Market appraisal. The similarity of these terms is unfortunate because the definitions vary significantly. Because different definitions apply, different assumptions and even different data may apply. The result is the final value may differ by large amounts. Therefore, it is CRITICAL your attorney identify whether the valuation should be a Fair Market Value or a Fair Value appraisal.
Fortunately, they can look in their law books to discover the answer. I have had a majority of attorneys ask me for my legal opinion of which definition applies. I am not the attorney. If they do not know this basic point, or are not willing to look it up, they probably are not qualified to take the case.
Purposes:
In general, anything to do with taxes involves Fair Market Value. ESOPs generally require Fair Market Value too. Many buy/sell agreements require Fair Market Value (always read your buy/sell carefully because I’ve witnessed a number of agreements where the attorney used Fair Market Value and Fair Value interchangeably within the same document).
Many states and jurisdictions have determined that, unless elsewhere stipulated (such as a contract, and in particular a buy/sell agreement), Fair Value applies to partnerships where one or more partners is contesting some action involving the business value or is otherwise contesting the value, especially if the shareholder is a minority shareholder. The problem with Fair Value, among others, is that each jurisdiction has its own definition. Fair Market Value has a federal definition. This means the local attorney has to know the definition of Fair Value as it applies in that specific jurisdiction. It can be statutory or case law, but they have to look it up and provide it to the person completing the valuation.
The appraiser should have access to a database that spells it out by location, but the definition of Fair Value varies enough that a legal opinion, provided by the attorney, is required. Legal opinions happen to be the job of attorneys.
Fair Value is usually, but not always, the basis for valuations involving marital divorces. Here is where Fair Value gets more complicated and really requires quality legal advice. The definition of Fair Value may be different for a divorce that a partnership suit. The attorney has to identify the definition of Fair Value that is applicable to the specific situation.
Traps that Cost Clients a LOT of Money:
The attorney leaves the definition up to the client and expert to choose and then, lo and behold, it is the wrong definition causing everyone to start over.
The attorney fails to get agreement with the other party relative to what definition to use. This is a dispute so an agreement may not be possible but an attempt should be made. Otherwise, the case goes to court, one side argues Fair Market Value and the other side argues Fair Value. Apples and oranges.
If an attempt at one definition fails, then it is easier and less expensive to complete both valuations from the beginning or make a case regarding why one or the other is more applicable.
Other Mistakes:
Attorneys should know the applicable expert appraiser rules. For litigation purposes, different states have different expert witness qualification rules such as the Daubert rule. These rules stipulate what qualifications an expert should have to qualify as an “expert” in that state’s court. The attorney should make sure the appraiser qualifies as an expert under that state’s rules.
For taxes, the IRS has listed their required qualifications. In summary (please see their website for the details), the person should be a disinterested third-party that possesses specific recognized business appraiser credentials including, but not limited to, specific accreditations. Just being a CPA does not generally count.
Your attorney, if they are good, will guide you well through this process, probably in concert with a high quality accredited business appraiser. If your attorney does not do this, consider getting a different attorney.
NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.