A recent U.S. Tax Court case reminds us of a valuation ‘fact of life’: credentials are important and, in a dispute, often are the difference between winning and losing.

In Ringgold Telephone Company v. IRS Commissioner, a taxpayer and the IRS disagreed about the value of a limited partnership interest in a cellular license.  The taxpayer claimed the interest was worth $2,980,000 on the valuation date; the IRS argued the interest was worth almost twice as much: $5,220,423.  Judge Wells of the Tax Court decided the correct answer was $3,727,142 – signifying a win for the taxpayer; a defeat for the IRS.

Ringgold shows first-hand the importance of using a credible appraiser. 

“As is customary in valuation cases”, said the Court, “the parties offered expert opinion evidence to support their opposing valuation positions.  In such cases, we evaluate the opinions of experts in the light of the demonstrated qualifications of each expert…”  The taxpayer’s appraiser was a CPA with an ABV designation conferred by the AICPA and who had extensive experience valuing telecommunication entities.  The IRS’ appraiser, on the other hand, was a CPA who had no valuation credentials and had never valued a telecommunications entity.   

When you choose a valuator, always assume the appraisal may end up in court.  So choose someone who is competent, knowledgeable, experienced and can explain complex ideas in layman’s terms.  Those are the ingredients that Judge Wells of the Tax Court (or any judge hearing your case) is looking for.

Another aspect of this case is also interesting.  A short six months after the valuation date, this taxpayer sold his interest for $5,220,423 to BellSouth.  (That is where the IRS’ number came from.)  Nevertheless the Tax Court ruled the sale price was not the interest’s fair market value. 

How can this be?  Doesn’t the price at which an asset changes hands determine ‘fair market value’?  Not necessarily!  BellSouth was a ‘strategic buyer’, not a ‘financial buyer’.  In the valuation world, strategic buyers pay more for assets than ‘financial buyers’.  In a future blog post I’ll explain the difference between the two.  To get that post and other Valuation Matters updates delivered right to your email, enter your address in the Subscribe box on the right.

Business owners curious to know how investors would value their companies should pay attention to the British Petroleum PLC oil spill.  The incident illustrates how uncertainty can drive down value faster and more dramatically than any other single factor.  

As everyone knows by now, on April 20, 2010 a BP semi-submersible exploratory offshore drilling rig in the Gulf of Mexico exploded after a blowout and sank two days later, killing eleven people and causing a massive oil spill threatening the coast of Louisiana, Mississippi, Alabama, Texas, and Florida.  BP executives have refused to publically estimate the clean-up costs, but reports it has already spent over $1 billion and the ultimate cost may be many times that. 

BP is the fourth largest company in the world.  In 2009 it had revenues of $239 billion, $235 billion in assets and 80,000 employees.  Few companies are better positioned than BP to sustain the financial costs of a major disaster yet remain in business.  But since April 20, the stock market has knocked over $70 billion from BP’s market capitalization (that is, its fair market value).  Investors have sliced BP’s value by much more than the likely cost of the cleanup.

Why? 

In a word: uncertainty.  Many factors affect a company’s value – the economy, its industry, its management, the strength of its balance sheet and hundreds of others – but nothing affects an investor’s perception more than uncertainty.  The broken pipe on the floor of the Gulf of Mexico is belching out more than just oil – it is pumping out doubts about BP’s future.  Doubts about its ability to drill in the Gulf of Mexico.  Doubts about possible government fines.  Doubts about litigation costs.  So far the cost to BP of this uncertainty is $70 billion, and until the uncertainty gets resolved that number is likely to grow. 

The lesson owners should take from BP’s woes is that if you can show investors a steady historical trend and give them confidence about your company’s future (and its predictability), they will value your business more highly.

Longtime customers and affiliates of ours may have noticed a dramatically different SPARDATA website.  We launched “version 2.0” over the Memorial Day weekend, and hope you find the redesign to be a big improvement.  Not only is the website much less cluttered and easier to navigate, it also focuses on the two key questions business owners tend to ask about: ‘why  get a valuation?’ and ‘why choose SPARDATA?’

Another feature we are introducing is this Valuation Matters blog.  It will be a platform for us to discuss valuation matters of interest to Main Street business owners all over America, as well as their professional advisors. 

What kind of blog posts will you see appearing here?  We’ll provide information about how to increase the value of your business;  and stories about those who ran aground because they failed to understand what their companies were worth at a key decision-point.  We’ll discuss the four milestones all owners face at some time.  You’ll find recent developments in the valuation world that business owners (and their professional advisors) should know about.  If we find something that can help owners grow the value of their businesses, we intend to discuss it here. 

If you have any questions or would like to learn more, send us an email or call (800) 895-4100 x115.

Blogs are meant to be two-way conversations.  Tell us what valuation topic or question is on your mind by commenting below.  Valuation matters.  Let’s talk about it.