8 More Mistakes to Avoid in Valuations
According to Tax Court Decisions
In this second part of a two-part series, we have collected eight examples of mistakes that valuation experts have made, as reported in federal courts tax decisions (see Value MattersTM, Issues No. 4, 2013 for “16 Mistakes to Avoid in Valuations: According to the Tax Court.”) It is important to note that there are two sides to every story, and courts do not always get it right. For this reason, we do not name any valuators in this collection of mistakes to avoid.
- Insufficient Due Diligence
In Freeman Estate v. Commissioner (T.C. Memo 1996-372), the taxpayer’s valuator failed to ask the subject company’s president whether he had plans for an IPO. In the Tax Court’s opinion:
The corporation had an initial public offering of stock in June 1990, at a price of $10 per share. The possibility of an initial public offering was discussed at a meeting of the board of directors of the corporation on August 24, 1989. In his report, [the valuator] states specifically that (1) during his interview with Bernard V. Vonderschmitt, president ... he did not inquire as to whether, on October 22, 1989, the corporation had any plans for a public offering of stock, and (2) he did not consider the potential for a public offering in carrying out his valuation assignment.
Petitioner has cited to us no authority prohibiting an inquiry into plans for a public offering. We assume that a potential purchaser would be interested in such plans and might pay a premium depending on her judgment of the likelihood of such an offering.
Likewise, in Bennett Estate v. Commissioner (T.C. Memo 1993-34), the Tax Court criticized a valuator for failing to investigate as would a hypothetical willing buyer:
Compounding this shortcoming is [the valuator’s] exclusive reliance upon the numbers listed on Fairlawn’s balance sheets with no further investigation or due diligence. [The valuator] himself acknowledged at trial that a hypothetical willing buyer would look behind the balance sheet numbers in evaluating their correctness and in applying valuation methods. Although [the appraiser] stated that he was not able to obtain requested documents from Fairlawn, we feel that [he] did not perform sufficient due diligence in this matter.
It is imperative that the valuator document all due diligence efforts in the valuation report, because the valuator may not get a chance to do so on the witness stand. Include unsuccessful efforts to obtain important information, with a legitimate explanation of why the effort failed (See, e.g., Winkler Estate v. Commissioner, T.C. Memo 1989231).
Another example of lack of due diligence, as well as incorrectly written descriptive report, is where the valuator failed to make relevant inquiries in Ansan Tool and Manufacturing Co. v. Commissioner (T.C. Memo 1992-121).
[The valuator] had not discussed Mario Anesi’s departure from petitioner with management to determine whether customers would leave or stay with petitioner. It is also unclear how [he] determined that only 10 percent of sales would be lost if Mario Anesi competed against petitioner, nor why the 10 percent loss would be limited solely to the first year after he left petitioner. - Unforeseeable Subsequent Events
A dilemma inherent in retrospective valuations is that life and business carry on after the valuation date. Consequently, the post-valuation-date events and cycles become known to valuators during the valuation process. The uncertainties, economic or otherwise, that exist on the valuation date can be lost when subsequent reality becomes visible and measurable. The problem that occurs when future expectations blend into history is that events subsequent to the valuation date are not supposed to be considered in a valuation, except to the extent that such events and conditions could have been knowable or reasonably foreseen.