Often, when a business valuation is required for divorce or shareholder types of disputes, the parties agree to use a neutral appraiser in hopes that it will help keep costs down and reduce acrimony. This approach often works, but sometimes, one party alleges that the financial statements are wrong due to alleged financial improprieties or for other reasons. In these instances, it is best to stop work on the appraisal and obtain a thorough understanding of the suspicions or allegations. If sufficient reason exists, an investigation should be performed to ensure that the party making the allegations buys into the valuation and doesn’t demand another valuation, thereby negating any cost savings hoped to have been achieved.
Business appraisers analyze financial statements for valuations purposes, they are not tasked with uncovering fraud or other irregularities in the financial statements. In fact, appraisers include, as part of their valuation, a listing of Assumptions and Limiting Conditions which usually include a statement that the company’s financial statements were accepted by the appraiser as complete and accurate without verification.
If the neutral appraiser does not have the skill set to investigate the allegations, a forensic accountant should be hired. Because of the nature of this type of work, it is common for the forensic accountant to be hired directly by the parties’ legal counsel so the work performed and any conclusions reached can be considered attorney work product and therefore privileged and confidential. It is usually difficult to estimate the amount of professional time required for a financial investigation as it can be difficult to predict the number of documents to be analyzed, what forensic accounting procedures will be required and the number of individuals to be interviewed. As a result, the financial investigation should be performed in phases, with the nature, amount of work, and findings of the preceding phase determining the worked to be performed during the succeeding phase. Working in phases keeps the clients informed and helps control costs. Otherwise, the investigation’s costs could outweigh its benefits.
The first phase usually includes interviewing the person making the allegations to obtain an understanding as to what they believe is wrong with the financial statements. Examples of financial statement misstatements include: not reporting all revenue (possibly decreasing value), treating personal expenses as business expenses (possibly decreasing value), incorrectly classifying certain transactions such as loan proceeds as revenue (possibly increasing value) or loan principal payments as expenses (possibly decreasing value). Depending on their magnitude, the value of the business could be off significantly.
We have been involved in situations where the neutral appraiser ignored the allegations raised by one party, and that party then refused to believe the value determined by the appraiser. This resulted in more money spent on additional valuations and more time needed to obtain a resolution. We’ve also seen the opposite where, upon learning of potential financial irregularities, the appraiser stopped work and required a forensic examination before proceeding. The appraiser then utilized the findings set forth in the forensic examination report to adjust the earnings. As a result, both parties bought into the valuation and settled the matter without the need for additional appraiser fees.
Thus, if you hope to help your client save fees and time by using a neutral appraiser, take the proper precautions if one side raises concerns about the veracity of the financial statements because if you don’t, it is more likely that more fees and time will be expended, not less.