In the iconic movie, Back to the Future released in 1985, Michael Fox, Christopher Lloyd, and a modified DeLorean, travel back in time using a time-machine automobile. They were able to affect events in the past using their knowledge of the present. Business valuation is not supposed to work this way. The business valuator is only to consider the facts and circumstances that are known or knowable at the date of valuation.
Many of you have clients who have difficulty in understanding this concept. The client believes that just because the date of valuation is a date in the past, i.e., five years ago, we now know how things turned out, and we should consider this present knowledge in valuing the business.
I recently gave expert testimony to a business valuation I had performed with a date of valuation that was over two years in the past. In my business valuation, I only considered the facts and circumstances that were known or knowable at the date of valuation. In brief, it was known or knowable that: 1) the company had reached an agreement to sell a subsidiary; 2) the deal was to close in several months; 3) the buyer would make monthly payments to the seller as part of the purchase price; 4) the seller assumed that his remaining two companies would continue to provide services to the buyer’s new acquisition; and 5) all assumed they would live happily ever after.
The opposing party hired Back to the Future’s Emmett Lathrop “Doc” Brown, Ph.D. (and business valuator) to review my report. Doc Brown arrived at the date of valuation in his DeLorean to report that I grossly overvalued the business because I had not considered future events. These events included that after a period of time; 1) the buyer defaulted on the payments to the seller, 2) the seller sued the buyer, 3) the buyer discontinued the services provided by the seller’s other businesses, and 4) nobody was living happily ever after.
Business valuator Doc Brown, became a CPA the year after production of the DeLorean ceased in 1984. Doc is also a certified business valuator with a lot of initials after his name. I pointed out to Doc that the AICPA professional standards for business valuations (AICPA STATEMENTS ON STANDARDS FOR VALUATION SERVICES No. 1 .43) clearly states:
The valuation date is the specific date at which the valuation analyst estimates the value of the subject interest and concludes on his or her estimation of value. Generally, the valuation analyst should consider only circumstances existing at the valuation date and events occurring up to the valuation date. An event that could affect the value may occur subsequent to the valuation date; such an occurrence is referred to as a subsequent event. Subsequent events are indicative of conditions that were not known or knowable at the valuation date, including conditions that arose subsequent to the valuation date. The valuation would not be updated to reflect those events or conditions.
Doc proceeded to explain that the professional standards are written by CPA’s who understand that the plain text of the rule is not what it means. The text actually means that subsequent events that come to the attention of the business valuator must be considered. So what do the nationally known business valuators have to say about this CPA secret code that permits Doc to go back to the future?
PPC’s Guide to Business Valuation is a highly respected guide to business valuations. It is authored by the some of the most highly respected experts in business valuations: Jay E. Fishman; Shannon P. Pratt; J. Clifford Griffith; and James R. Hitchner. In this guide, they reiterate the clear text language for subsequent events found in SSVS1.
Another nationally recognized business valuation expert and co-author of the CCH Business Valuation Guide and Business Valuation Guide states that:
The use of subsequent data occurring after a valuation date is unprofessional, lacks support, and runs completely contrary to the definition of fair market value. Fair market value is as of a given valuation date and can only reflect the information known on that date – not the circumstances, occurrences and information that have yet to occur and can only [be] obtained through time travel.
So Doc, I think it is time for you to stop your time travels and sign-up to drive the DeLorean for Uber.