Business Valuation and Forensic Accounting

The business valuation and forensic accounting disciplines often are required when valuing a  closely held business for divorce and shareholder disputes. Controlling shareholders may attempt to minimize income and cash flow  and understate assets in order to minimize the amount of cash required to pay minority shareholders or divorcing spouses. Valuation and Forensic experts  are able to uncover these type of financial misstatements and make adjustments to correct these intentional errors to avoid undervaluing the closely held business involved in the litigation.

While financial statements and tax returns are important sources of information when valuing a company, it is also important to look for public sources of information as well as to conduct on site visits and interviews with management and key employees. Patience and diligence are key elements to discovering understated assets and  unreported income. This is why it is so critical that a  financial expert be involved during the discovery phase of the case  even if it appears the case will settle amicably, the situation can turn hostile once the parties realize how much money is at stake. An expert can assist the attorney in compiling comprehensive  list of documents to request and if needed to request a court order to be allowed to tour company facilities and to interview management and key employees. If the expert is hired late in the case he or she may not have access to these resources.

Controlling shareholders may not be dishonest but experienced valuation and forensic experts know the warning signs that something may not add up. During a site visit and interviews with management and key employees expert consider a variety of factors as follows:

Do Company personnel seem cooperative or are they reluctant to answer Questions?

Does the interviewee seem agitated or nervous for example sweating or failing to make eye contact?

Do members of the management team provide conflicting answers to questions?

Was the Valuation or forensic expert denied access to certain parts of company facilities or documentation?

In addition to these qualitative factors the expert will bench mark performance of the company over time and against competitors which is part of the business valuation process. Experts also look for new items that appear on financial statements after the litigation action is filed. Examples include loans, management fees, rent or lease expenses paid to related parties, phantom employees on payroll, and excessive professional fees which may include the controlling shareholder’s legal fees.

While valuation and forensic experts maintain professional skepticism, they are not responsible for discovering fraud unless the client specifically hires them to conduct a forensic investigation. In cases where a controlling shareholder has an incentive to hide assets or misrepresent income,  you should consider  expanding  the valuation engagement to include additional forensic procedures.