Business valuation service is a growing specialty consulting service provided by CPA firms. Many CPA firms continue to view business valuation as a high-growth specialty service area as activity in bankruptcies, estate planning, ownership succession planning, and mergers or acquisitions has increased in recent years. Business valuation services are performed for various reasons, including:
· Transaction pricing and structuring, or potential transactions, such as mergers and acquisitions, private placements of securities, debt or equity, and employee stock ownership plan (ESOP) formation and transactions.
· Litigation and dispute resolution matters, such as marital dissolution and family law, bankruptcies, partner or shareholder disputes, and contract and commercial litigation matters.
· Taxation planning and compliance associated with corporate reorganizations, S corporation conversions, and the substantiation of income, estate, or gift tax-related property transfers.
· Inter-generational wealth transfer arrangements, such as estate planning, charitable contributions, and personal financial planning.
There are inherent risks associated with providing business valuation services, as one or more parties will rely on the results of the valuation when entering into a transaction, complying with a regulatory requirement, or implementing a financial plan for the future. The following discussion summarizes (1) some of the common situations where clients seek valuation services, and (2) some of the common procedures CPAs can implement to minimize their risk of malpractice claims.
As a result of the recent economic downturn, individuals and businesses of all sizes are pursuing bankruptcy protection. Increasingly, CPA firms are performing valuation services for these parties. These services may include valuation of:
· Creditor’s collateral property to ensure adequate protection,
· Debtor’s assets and liabilities as one part of the overall solvency analysis,
· Debtor business entity to determine the feasibility of proposed Chapter 11 plan of reorganization, or
· Property transferred by or received by the debtor to determine if a fraudulent transfer has occurred.
CPA firms also may be asked to perform a solvency analysis, which may require certain valuation analyses.
Marital Dissolution and Family Law
In this situation, the marital estate assets and liabilities need to be valued, regardless of whether the particular state follows equitable distribution or community property rules. If the marital estate owns a business or an ownership interest in a business, one spouse will typically retain the business interest and the other spouse will typically receive other assets in the marital estate distribution. Therefore, a family law matter may require valuation for both spouses to estimate the value of the family-owned business or business ownership interest.
Despite the current uncertain future of the Federal estate tax, estate planners need to consider the impact of the unified estate and gift tax credit on lifetime transfers of property. Some intergenerational property transfers may be subject to special IRC valuation rules.
Employee Stock Ownership Plan
As authorized by the Employee Retirement Income Security Act of 1986, the U.S. Department of Labor has promulgated “adequate consideration” rules related to the valuation of ESOP-owned employer corporation securities. To comply with DOL and IRS requirements, ESOP-sponsored company stock must be valued at least annually to determine the proper share price to support share transactions with plan participants, plan contributions, and plan participant allocations.
Business Ownership Succession Planning
Business succession planning includes consideration of alternative transactional structures available to business owners to meet their short and long-term objectives. These transactional structures include, for example, a management buy-out, an employee buy-out, (with or without an ESOP), a sale to an unrelated entity, or a corporate liquidation. For a closely held business, a management buy-out can be accomplished via a buy-sell agreement. The sale price established in the buy-sell agreement can be determined by a defined pricing formula based on the company equity value, the company performance over time, or some other agreed-upon pricing measures. The buy-sell agreement pricing formula is typically based on an independent estimation of the company value.
Risk Control Considerations
The primary allegation made in business valuation malpractice claims received by the AICPA Professional Liability Insurance Program is over or under valuation of assets (e.g., intangible assets) or liabilities (e.g., contingent liabilities). Other business valuation claims are caused by communication problems, conflicts of interest, or alleged fraud. Most claims arise when business valuations are performed as part of a tax planning, management advisory, or consulting engagement, typically in connection with a transaction. Because of timing constraints, clients often pressured their CPAs to perform the business valuation, regardless of whether the CPA had adequate valuation training and experience.
Client and Engagement Acceptance
Careful client and engagement acceptance practices can help a practitioner manage his or her professional liability risks. Often, business valuation services are provided to new clients. One-time engagements may significantly increase client and engagement risk due to a lack of prior experience in dealing with the client and with the client’s relevant accounting and other records. Absent a prior relationship, the opportunity to reevaluate previous conclusions made by other accountants based on reviews of subsequent events does not exist. CPAs should review the AICPA Practice Alert 2003-03 for recommended procedures on acceptance and continuance of clients and engagements.
The complexities of business valuation often require in-depth experience and understanding of a particular industry. A practitioner should be sufficiently competent to perform the valuation service in accordance with the applicable professional standards. Earning relevant professional credentials, for example, the Accredited in Business Valuations (ABV) credential awarded by the AICPA, will promote adherence to appropriate valuation principles and practices and demonstrate competence in this specialty practice.
A CPA should consider both the purpose and use of a business valuation and evaluate the risks of inaccurate valuation results. Defining both the purpose and use is important, since they influence the valuation approaches and methods to use, including the selection of the appropriate standards of value and premise of value. For example, if the valuation is for a decedent’s estate tax return, a CPA must conclude the fair market value standard of value of the subject property.
It is important to identify the users of a valuation report. If the purpose of the valuation is to assist the client to obtain financing, then the accountant may want to restrict the use of the valuation report to specified parties, such as company management and the intended lender, to limit potential liability to third parties. A CPA should avoid direct communications with a third-party and any other conduct that could be construed as evidence the CPA acknowledges the third-party reliance.
CPAs should document the scope, terms, and limitations of the engagement with a client in an engagement letter. Likewise, it is important to inform a client of significant matters impacting the valuation and to document all significant communications with the client. Even when the CPA is not providing a valuation service for litigation support purposes, there is always the potential of the CPA’s deposition or testimony in a contested valuation situation.
Professional Standards, Rules & Regulations
The Uniform Standards of Professional Appraisal Practice is promulgated by the Appraisal Standards Board of the Appraisal Foundation. Standards 9 and 10 provide professional guidance related to developing and reporting business appraisals. The IRS has also provided professional guidance related to business valuations performed for Federal, gift, and estate tax purposes in Revenue Ruling 59-60. A CPA should be familiar with the relevant Internal Revenue Code sections and regulations related to business valuation.
The AICPA consulting services executive committee issued SSVS No. 1 in June, 2007 to improve the consistency and quality of practice among AICPA members performing valuations. The Statement established standards of performance and reporting for all members performing valuation services within the scope of the Statement. Practitioners should read the Statement and become familiar with the standard. The Statement provides professional guidance on overall engagement, planning considerations, valuation analysis and development, and valuation reporting. The overall engagement considerations include professional competence, nature and risks of the valuation services and expectations of the client, objectivity and conflicts of interest, independence and valuation, establishing an understanding with the client, assumptions and limiting conditions, scope restrictions or limitations, and using the work of specialists. Other than in specifically identified exceptions, the statement applies to each engagement or any part of an engagement that estimates the value of a business, business ownership interest, security or intangible asset.
Practitioners who provide valuation services also need to comply with the AICPA Statement on Standards for Consulting Services (SSCS) and Statements on Standards for Tax Services (SSTS). The general standards of the profession (i.e., professional competence, due professional care, planning and supervision, and sufficient relevant data) also apply to valuation services. See the AICPA Code of Professional Conduct (ET §201.01). A CPA’s independence will be impaired by performing business valuation services for an attest client if the services produce results that are material to the client’s financial statements (ET §101.05).
Other professional standards (e.g., ASA and NACVA), rules, and regulations should be considered in planning a valuation engagement. In re: Med Diversified, Inc. v. Addus Healthcare, Inc. (Bankr. E.D.N.Y. Nov. 14, 2005), the Bankruptcy Court excluded the testimony and report of Scott Peltz, a defendant’s expert, leaving the defendant without critical expert testimony. Peltz did not have any business valuations certifications and admitted that his report was not a business valuations report. The court held that, even if Peltz’s experience had qualified him to testify as an expert, his testimony and report would still be rejected because he did not apply generally accepted methods of business valuation.
In addition, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 157, Fair Value Measurements in September 2006. SFAS No. 157 both establishes a framework for measuring fair value within the context of generally accepted accounting principles (GAAP) and expands required financial statement disclosures about fair value measurements. SFAS No. 157 broadly applies to financial and non-financial assets and liabilities to improve the consistency, comparability, and reliability of the fair value measurements.
SSVS No. 1 states that “The valuation analyst should establish an understanding with the client, preferably in writing, regarding the engagement to be performed…. The understanding should include, at a minimum, the nature and objective of the valuation engagement, professional standards under which the work will be performed, client’s responsibilities, valuation analyst responsibilities, assumptions and limiting conditions, type of report to be issued, and standard of value to be used.”
According to SSVS No. 1, a valuation analyst should include the following items in business valuation engagement letters:
· Identity of the client
· Purpose and intended use of the valuation
· Intended users of the valuation
· Specific description of each service and its work product, if applicable, to be provided in the valuation engagement, including identity of the subject entity and description of the subject interest
· Definition and description of the standard of value that will be used and its premise of value
· Valuation date
· Any assumptions and limiting conditions
· The type of report that will be submitted to the client and the date of delivery
· Any restrictions or limitations to the engagement (i.e., restrictions on the use of the report to specified parties, subsequent events, etc.)
· The responsibilities of the client (i.e., to provide the necessary information, a representation letter at the end of the engagement, etc.)
· The responsibilities of the accountant (e.g., regarding the use of specialists)
The demand for business valuation services is expected to increase in the coming years as the “baby boom” generation prepares for retirement. Careful management of engagement acceptance, training, quality control and client communications will assist practitioners in mitigating professional liability risks associated with these business valuation services.
Updated March 2009
CNA, Accountants Professional Liability, CNA,
· Resources on business valuations are available at AICPA Forensic and Valuation Services
· Journal of Accountancy, February 2001, A Nice Niche–If You Minimize Liability Risk by Joseph Wolfe and Sherry Anderson. A CPAs Guide to Valuing a Closely Held Business at https://www.cpa2biz.com/
· AICPA Practice Alert 2003-03, Acceptance and Continuance of Clients and Engagements at http://www.aicpa.org/download/secps/pralert_03_03.pdf
· USPAP 2005 Uniform Standards of Professional Appraisal Practice, Standard 9: Business Appraisal, Development, Standard 10: Business Appraisal, Reporting at http://commerce.appraisalfoundation.org/html/USPAP2005/toc.htm
· Reporting Standards Update: What all BV Analysts Must Know by David Anderson and Donald P. Wisehart, Business Valuation Update, December 2008
· Will the Real Business Valuation Standards Please Stand Up? by Martin J. Lieberman and David Anderson, The CPA Journal, January 2008
· AICPA Introduces Its New Valuation Standard by Edward J. Dupke, Journal of Accountancy, September 2007
· Professional Guidance in Business Valuation: Applying SSVS1 Robert F. Reilly, Journal of Accountancy, September 2007
· 50 Examples of When to Apply SSVS1 by John R. Gilbert, Journal of Accountancy, September 2007
· Suggested Guidelines for How to Implement SSVS1 in Your BV Practice by Randie Dial, Journal of Accountancy, September 2007
· Pension Protection Act Changes Valuations for Tax Purposes by Michael A. Crain, Journal of Accountancy, September 2007
· Valuation-Related Financial Advisory Services for Bankruptcy Purposes by Robert F. Reilly and Ashley L. Reilly, Insights, Autumn 2005
· Internal Revenue Code, Title 26, Subtitle B: Estate and Gift Tax, Chapter 14: Special Valuation Rules at http://uscode.house.gov/search/criteria.php
· IRS Revenue Ruling 59-60 at http://www.taxlinks.com/rulings/findinglist/revrulmaster.htm
· IRS Revenue Ruling 68-609 at http://www.taxlinks.com/rulings/findinglist/revrulmaster.htm
· There are inherent risks associated with providing business valuation services, a high-growth specialty consulting service. Malpractice claims can be caused by over or under valuation of assets or liabilities, communication problems, conflicts of interest, or alleged fraud.
· CPAs can manage their malpractice risks from business valuation services by:
o Committing to careful client and engagement acceptance practices
o Complying with professional standards, rules, and regulations
o Issuing a customized engagement letter
The purpose of this article is to provide information, rather than advice or opinion. It is accurate to the best of the authors’ knowledge as of the date of the article. Accordingly, this article should not be viewed as a substitute for the guidance and recommendations of a retained professional. In addition, CNA does not endorse any coverages, systems, processes or protocols addressed herein unless they are produced or created by CNA.
Any references to non-CNA Web sites are provided solely for convenience, and CNA disclaims any responsibility with respect to such Web sites.
To the extent this article contains any examples, please note that they are for illustrative purposes only and any similarity to actual individuals, entities, places or situations is unintentional and purely coincidental. In addition, any examples are not intended to establish any standards of care, to serve as legal advice appropriate for any particular factual situations, or to provide an acknowledgement that any given factual situation is covered under any CNA insurance policy. Please remember that only the relevant insurance policy can provide the actual terms, coverages, amounts, conditions and exclusions for an insured. All CNA products and services may not be available in all states and may be subject to change without notice.
IRS Circular 230 Notice: The discussion of U.S. federal tax law and references to any resources in this material are not intended to: (a) be used or relied upon by any taxpayer for the purpose of avoiding any federal tax penalties; (b) promote, market or recommend any products and/or services except to the extent expressly stated otherwise; or (c) be considered except in consultation with a qualified independent tax advisor who can address a taxpayer’s particular circumstances.
Continental Casualty Company, one of the CNA insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program.
CNA is a registered trade mark of CNA Financial Corporation. Copyright © 2009 CNA. All rights reserved.
Sponsored by: AICPA Professional Liability Insurance Program
 CPAs who have been asked to perform a solvency analysis or valuation analyses that will be used in a solvency analysis should refer to the guidance contained in a memorandum issued by the Valuation Standards Subcommittee of the AICPA, available within the AICPA Forensic and