The Pros and Cons of Neutral Valuations

One recent trend in business valuations is a move toward neutral valuations. Hired jointly by both parties, a neutral valuator will investigate the relevant facts, perform a business valuation, and produce a neutral appraisal report with no bias toward either party.

The use of neutral valuators follows the recent trend away from litigation toward alternative dispute resolution where neutral parties are used to determine facts, damages, or other issues. There are potential benefits to this strategy, as well as a few potential drawbacks.

A neutral valuation may be required by law when a closely held business is involved in a buy-sell agreement or a marital dissolution.

Pros and Cons of Using Neutral Valuators

Neutral valuators are brought in when all parties agree that it will be more straightforward and less expensive than each using their own business appraisers. Using a credentialed, experienced neutral valuator can keep the business valuation process moving forward while building trust on all sides.

The biggest benefits of performing a neutral valuation include the following:

Cost savings: Instead of paying high fees to two or more business appraisers who may produce wildly different valuations, each party agrees to abide by the valuation of the neutral valuator.

For example, some buy-sell agreements require each party to hire their own business appraiser. If the valuation opinions are not within a certain percentage of each other, a third appraiser may have to generate yet another valuation. If the parties disagree about the prospects of the business or other matters, the time spent investigating these issues and managing the engagement could drive costs even higher.

Greater access to information: Both parties have an incentive to provide as much information as possible to the appraiser to support their valuation viewpoint. In most cases, each party will receive all the information provided to the appraiser, which increases transparency. Each party will also have access to communication with the appraiser, which will help prevent wildly different valuation assumptions by the parties.

A more objective and accurate appraisal: When one party hires a business valuator, the information they receive can be skewed in favor of that party. Despite their best efforts to remain objective, these valuators may end up producing an appraisal that favors this party.

There are also a few potential pitfalls to using a neutral valuator that you should be aware of, including the following:

Conflicting perspectives: The parties hiring the appraiser usually have opposing interests: One typically wants a higher valuation while the other wants a lower valuation. The appraiser must balance their conflicting input and arrive at an independent valuation despite pressure from the parties. Appraisers should look to independent sources of information to support input provided by the parties, when available.

No standard of value: The definition of a standard of value can heavily influence the business valuation. If no standard of value is set forth in the valuation assignment, the parties and their legal counsel must agree to a standard. In this scenario, the neutral valuator should help educate the parties about the relative implications of different standards on business valuation.

Distrust between the parties: Given the opposing interests of the parties, there is often a high degree of distrust between them. This makes it critical for the appraiser to remain neutral and objective while developing opinions about the reliability of the information provided by each party. This includes corroborating positions based on input from the parties with independent information whenever possible.

Are Neutral Valuations Right for You?

Given the escalating costs of business appraisals in contested matters, as well as court fatigue of “battles of the experts,” the use of neutral valuations is likely to increase. Examine the pros and cons to decide whether this is a smart strategy for your business valuation.

The Neutral Valuation Process

A neutral business valuation follows a four-step process:

1. Initial conference: The parties will discuss the scope and communication guidelines for the engagement while disclosing any potential conflicts of interest.

2. Discovery: The parties will provide relevant information that the business valuator will need to create a valuation opinion. Multiple rounds of discovery may be necessary.

3. Draft report: This report provides the parties with an opportunity to search for any missing information or errors and correct them before a final valuation opinion is issued.

4. Final report: The scope of work should describe the format of the final report, which can be a simple one-page document containing the valuation opinion or something more elaborate with detailed explanations of the procedures performed and their results.