How do valuation expert witnesses handle disputes over business value?
A logical step in resolving disputes over business value is getting the unbiased opinion of a valuation analyst. This holds true even when such disputes snowball into lawsuits. However, when this does happen, the role of a valuation analyst becomes a lot more nuanced and is referred to as a valuation expert witness.
The goal of valuation expert witnesses is to examine the financial health of a business on a particular date thoroughly under the lens of industry-recognized methodologies and communicate their findings impartially and clearly. The testimonies made by valuation expert witnesses have a huge bearing on which party’s claims are upheld. These testimonies can also impact the settlement amounts which can range in millions of dollars.
This critical role of valuation expert witnesses in resolving disputes over business value will be explored in depth in this article. Read on to know more!
What is expected from valuation expert witnesses?
In business-related legal conflicts, when a valuation expert is called to testify as an expert witness, the court would expect to gain an objective, credible, and research-backed opinion on a company’s valuation at a particular date and whether a valuation performed in the past was reasonable. As part of their testimony, the valuation expert witness must explain the methodology, list the assumptions, and speak to the accuracy of the information used as input.
The role of valuation expert witnesses must be taken on by someone with extensive experience in the industry and excellent communication skills that enable them to share their insights in a precise yet lucid manner.
The Role of Valuation Expert Witnesses: Key Information for Court Proceedings
In equity litigation where the value of a company is disputed, the court may expect to gain insights regarding the following things through valuation expert witnesses’ testimony:
Accuracy of company valuation and quality of methodology
The accuracy of a company’s valuation may become the point of contention in cases relating to share transfers or equity compensation.
For instance, if the Internal Revenue Service (IRS) finds that a company’s valuation did not comply with the requirements of Section 409A, then the employee or service provider who received equity compensation will face dire tax consequences such as penalties and higher-than-normal interest on unpaid taxes. Such individuals may sue their companies for negligence.
In such cases, the individuals may engage valuation experts to assess the business value and find any evidence of negligence in the valuation methodology. If evidence of negligence is found, these valuation expert witnesses would try to supplement the case being made by the plaintiffs through their testimonies.
Another scenario worth noting is when a majority shareholder exercises their drag-along rights to ensure that a company sale goes through. The minority shareholders may feel that the company valuation in such a company sale is too low.If such a group of minority shareholders wishes to contest the company sale in a court of law, the opinion of valuation expert witnesses can add significant leverage to their claims.
Calculation of damages in cases of financial fraud
A company’s financial reports, announcements, and statements made by its directors and officers influence the company’s share price. So, when a company misrepresents facts and figures in its communications, we say that it is committing fraud by creating a false perception about the value of its securities.
This kind of financial fraud can cause shareholders to sell their stake for less money than what it’s worth. Misrepresentation of facts and figures can also cause shareholders to hold shares that they would have otherwise sold or influenced investors to buy overpriced shares.
Once the evidence of fraud is found, the only question that remains is what should be the settlement amount. The testimony of the valuation expert witness can have a huge influence on this figure.
Here, the valuation expert witness must conduct a damage calculation which tells the amount of financial loss caused or financial profits foregone because of the fraud perpetrated. As part of such damage calculations, the valuation expert must prepare two sets of valuations. One of these valuations would be based on reality and the other would be based on the picture painted by the fraudsters. Then, the damages to the plaintiffs would be calculated based on the difference between these two valuations.
The damage calculations are even more important when complex securities are involved. After all, understanding the true impact of fraud on the value of convertible debt, derivatives, warrants, or assets like exchange-traded funds (ETFs) that are a mix of various other assets, can be excruciatingly difficult without expertise.
Equity value allocation
To secure funding, founders may issue various kinds of equity interests which they may want to buy back at a later stage. Because of the differences in rights and risks, the value allocation is not always in the ratio of investment amount.
For instance, a company may issue preference shares with no voting rights but fixed dividends, Simple Agreements for Future Equity (SAFE) notes, equity with anti-dilution rights, and have a multi-class equity system where one class has higher voting power than the other.
In such a situation, the complexities involved make it easier to have differences in opinion regarding the value allocation.
Hence, a court may expect valuation expert witnesses to provide an unbiased value allocation report. In preparation for their testimony, the valuation expert witness must review the ownership structure, establish the valuation date, appraise enterprise value using various financial models, and then, allocate value as per class hierarchy, liquidation preferences, and special rights afforded by each equity interest holder.
Accuracy of assumptions and discounts
To narrow down a company’s valuation to a figure or at least a narrow range, the person performing the valuation must make various assumptions regarding the growth rates, sensitivity to expected changes in the business environment, success of products to be launched, fruits of research and development (R&D), and industry and economic conditions.
These assumptions can have a huge impact on the company’s valuation. We can study the impact of economic performance on company valuations by looking at how stock market indices move in response to economic data releases. For instance, recession fears and weak economic indicators caused a 3.36% drop in Nasdaq in August 2024.
Another factor that has a considerable influence on company valuations is the discount applied. Generally, in the case of private equity, a valuation analyst will apply a discount for lack of marketability (DLOM) and a discount for lack of control (DLOC).
When the accuracy of the company valuation is disputed, valuation expert witnesses may be called to testify as to whether the assumptions and discounts were set as per industry standards.
Leverage Eqvista’s expertise to bolster your case!
Valuation expert witnesses are often relied upon for resolving disputes over business values. The court would expect the valuation expert witnesses to provide an objective and fact-based opinion.To effectively carry out this role, a valuation expert witness must have years of experience and a knack for simplifying complex financial scenarios without skipping out on essential details.
Through the testimonies of valuation expert witnesses, courts may expect to verify the accuracy of a company valuation, understand the extent of financial damage to investors due to fraud, verify value allocations to different equity interests, and understand whether the valuation assumptions and discounts were reasonable.
We believe that our experience of valuing more than 19,000 startups and corporations across numerous stages and industry segments in just six years since inception has equipped us with the expertise to carry out the duties of a valuation expert witness. Contact us to know more!
