A guy I work with on some transactions is a trained business appraiser, and he recently was shocked to discover at the last minute his valuation for a divorce case would be rejected because the judge only accepted Adjusted Book Value approach to valuation, and would reject any other approach. Like a fair one.
The Income Approach looks at a series of future cash flows and discounts the flows to a present value. Theoretically this should be the most correct, but it relies on an estimate of future cash flows – a guess. So I could see why a judge would not endorse that. One side would surely guess high while the other would guess low.
This is like a real estate appraisal, except the search for comparables is nationwide, and a statistical regression analysis is run to create a value. I find it very interesting because the model tells you which variables are the most significant in determining value. For example, you may use earnings, revenue, equipment, inventory, AR, etc. to run the model. You then enter data from numerous sold companies (from a number of sold-company databases) into the model. Not only will the model then predict the value of a new company you enter, it will tell you which parameters were the most helpful in determining value. As you may guess the number one parameter, consistently, are earnings. But if done correctly there are some statistics to wade through, so I guess some judges don’t want to get into that. Also, you have to enter good data into the model, or like many models – garbage in, garbage out. But that is why you hire someone like Fred to do it.
Adjusted Book Value is an asset approach to valuation, and it looks at the net equity of the business (assets less liabilities), making adjustments to try to estimate fair market value. For example, accelerated depreciation may have lowered the book value of some assets below fair market value. Or some assets may be carried on the books for a far higher value than they are actually worth (e.g. computer equipment). But what it doesn’t do is value earnings. To put it simply, you could value many businesses based on adjusted book value, then turn around and sell the business on the market for far more.
Fred doesn’t like the judge’s edict because as an appraiser Fred is suppose to choose or reject the various approaches, not the judge. Interestingly though, it actually helps Fred’s client, because when Fred went back and threw out the market approach and only used the adjusted book value approach, the company all of a sudden was worth almost exactly zero. The other side, of course, also hired a valuation expert, and that adjusted book value came in at $850,000. It hasn’t gone to court yet so I don’t know the outcome, besides that it will be in the middle somewhere.
So maybe that is the answer. This judge (and by the way, most judges in Fred’s experience do not prevent other approaches) is trying to force the most conservative, objective approach based on assets, and there is STILL $850,000 difference between the two parties.