The bestselling Business Valuation and Bankruptcy: Case Law Compendium is out now and is in its third edition. This must-have resource is replete with hard-won insights into the often challenging intersection of law and valuation. It summarizes case law and provides insightful analysis on a range of bankruptcy topics.
The following except comes from the third chapter, "Tips on Handling 10 Key Issues in Bankruptcy Valuations":
A number of issues have emerged that analysts will encounter when performing a valuation in a bankruptcy context. During a recent BVR webinar,1 Robert Reilly (Willamette Management Associates) cautioned that valuation analysts who become involved in bankruptcy-related assignments should expect their work to come under a great deal of scrutiny because most of these engagements are done within a litigation or some other adversarial context. Based on his extensive experience in this area, Reilly offers his advice on how to handle the challenges valuation experts will face.
- Limited guidance on definition of ‘value.’ The U.S. Bankruptcy Code doesn’t define any standard of value. The closest you’ll find is in Bankruptcy Code Section 506a, which states that “value shall be determined in light of the purpose of the valuation [emphasis added] and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.” Analysts and legal counsel will need to look to judicial precedent to see what value definitions the courts have accepted. The trouble is you’ll still find limited guidance as to which standard of value is appropriate in which bankruptcy circumstances.
Tip: Be familiar with the relevant sections of the Bankruptcy Code and the Bankruptcy Rules, but you should not be making legal decisions. Do not hesitate to ask for legal instructions from counsel with regard to any bankruptcy-related legal issues.
- Hindsight is discouraged. The use of hindsight is an issue with most all valuations, but it’s particularly controversial in a bankruptcy context. This is because everybody knows what actually happened to the debtor company (it filed for bankruptcy protection), so the tendency to use hindsight is quite common. Most bankruptcy valuations use a retrospective valuation date because there’s a specific historical event that triggered the distress, such as a dividend payment or a financing transaction. There is usually controversy over when the actual debtor company events would have been known or knowable.
Tip: The courts seem to adopt the known or knowable rule, Reilly says. You should consider only that information that was known or knowable as of the time of the valuation date.
- Choice of variables. You will get questions on your selection of individual valuation variables. A few examples: Do the individual variables really reflect the current state of the debtor company as of that valuation date, or do they reflect the reorganized state of the company? How do you consider the current financial condition of the company when coming up with a cost of debt, cost of equity, debt equity mix, and so forth? How do you consider the current condition of the debtor company when coming up with an expected long-term growth rate? One question in particular to think about is this: Should the selected discount rate relate to the business risk of the debtor company or to the performance risk of the specific set of financial projections? There is performance risk associated with the debtor company’s financial projections. If you do not adjust the discount rate for that performance risk, any projected increase in revenue or cash flow will increase the value conclusion. But that may not be reasonable. If greater risk is inherent in the enhanced cash-flow projections, then there should be a correspondingly risk-adjusted discount rate. With more aggressive financial projections, it is often appropriate to apply a larger (risk-adjusted) discount rate. And, with less aggressive financial projections, it is often appropriate to apply a lower discount rate.
Tip: Make sure you carefully document how you selected your valuation variables to show that the process was unbiased, transparent, and replicable. Be prepared to justify the quantity and quality of data elements considered in the selection of the valuation.
If you found those tips valuable, there are seven more of them along with data tables, case studies, and much more. This compendium will save you hours of research on your next case or valuation. You can order your copy of the compendium here in either print or digital format.