Financial valuation Applications and Models phần 9 potx

remainder or residual amount equates with goodwill. Keep in mind, goodwill
includes assembled workforce, but assembled workforce was valued separately to
obtain a contributory return for IPR&D and technology. As a result and pursuant
to SFAS No. 141, the indicated value of assembled workforce must be added to the
indicated value of goodwill to arrive at the fair value of goodwill for financial state-
ment reporting purposes.
96
For financial reporting purposes, included in the goodwill value is the fair value
of the assembled workforce of $1,790,000. Based on this analysis, the fair value of
Goodwill on December 31, 2001, was $62,050,000 (Exhibit 20.14).
ALLOCATION OF PURCHASE PRICE
The summary allocation of values is presented in Exhibit 20.15. In this exhibit, the
valuation conclusions are separated into three groups: total current and tangible
assets, total intangible assets, and goodwill. Individual asset valuations are pre-
sented within each group.
In addition to presenting the summary of values, this schedule provides a gen-
eral sanity check in the form of a weighted return calculation. The weighted return
calculation employs the rate of return for each asset weighted according to its fair
value relative to the whole. The weighted return can equal or approximate the over-
814 VALUATION OF INTANGIBLE ASSETS
96
FASB, Statement of Financial Accounting Standards No. 141, at B169.
Exhibit 20.14 Target Company: Valuation of Goodwill as of December 31, 2001 ($000s)
Cash and Acquisition Costs $150,000
Debt-Free Current Liabilities 25,000
Current Maturities of Long-Term Debt 4,000
Long-Term Debt 30,000
_______
Adjusted Purchase Price 209,000
Less: Fair Value of Current Assets (41,500)
Less: Fair Value of Tangible Assets (41,000)

Less: Fair Value of Intangible Assets
Software (7,070)
Customer Base (6,490)
Trade Name (23,760)
Noncompete Agreement (9,300)
Technology (13,500)
In-Process Research and Development (4,330)
_______
Residual Goodwill $ 62,050
_______
_______
Note: Some amounts may not foot due to rounding.
© Copyright 2002 by John Wiley & Sons, Inc. Used with permission.
all weighted average cost of capital for the business, although the rates may not
exactly be equal because the WACC equates to the business’s invested capital (here,
$184,000,000) while the weighted return calculation represents total asset value
($209,000,000).
The returns for each asset are those actually used in the forgoing valuation
methodology, that is, for tangible assets and contributory intangible assets. For con-
tributory intangible assets that were valued using a form of the income approach
(trade name and noncompete agreement), the return is equal to the discount rate
used to value that asset. Finally, the return for the assets valued under the multi-
period excess earnings approach is also their discount rate.
It should be clear that the one asset for which we do not have a return is good-
will and, admittedly, the return assigned is determined by trial and error. The good-
will return is imputed based on the overall weighted return needed to equal the
weighted average cost of capital.
Allocation of Purchase Price 815
Exhibit 20.15 Target Company: Valuation Summary as of December 31, 2001 ($000s)
Percent To

Fair Market Purchase Weighted
Asset Name Value Return Price Return
__________ __________ _______ ________ ________
Cash $ 1,500 5.00% 0.7% 0.04%
Investments in Marketable Securities 8,000 5.00% 3.8% 0.19%
Accounts Receivable 17,000 5.00% 8.1% 0.41%
Inventory 12,000 5.00% 5.7% 0.29%
Prepaid Expenses 3,000 5.00% 1.4% 0.07%
Land and Buildings 22,000 7.00% 10.5% 0.74%
Machinery and Equipment, net 19,000 8.00% 9.1% 0.73%
__________
Total Current and Tangible Assets $ 82,500
__________
__________
Software $7,070 18.00% 3.4% 0.61%
Technology 13,500 18.00% 6.5% 1.16%
In-Process Research and Development 4,330 25.00% 2.1% 0.52%
Trade Name 23,760 16.00% 11.4% 1.82%
Customer Base 6,490 18.00% 3.1% 0.56%
Assembled Workforce 1,790 16.00% 0.9% 0.14%
Noncompete Agreement 9,300 16.00% 4.4% 0.71%
__________
Total Intangible Assets $ 66,240
__________
__________
Goodwill (excluding assembled workforce) $ 60,260 28.00% 28.8% 8.07%
__________ ______
__________
Total Assets $209,000 16.05%
__________ ______

__________ ______
Note: For financial reporting purposes, the fair value of goodwill includes the fair value of assembled workforce
for a total fair value of residual goodwill of $62,050.000.
Note: Some amounts may not foot due to rounding.
© Copyright 2002 by John Wiley & Sons, Inc. Used with permission.
816 VALUATION OF INTANGIBLE ASSETS
If a goodwill return of, say, 10 percent is required to achieve a weighted return
of approximately 16 percent, this signals a problem and the analyst will have to go
back and review and revise his or her work—something is wrong! In this calcula-
tion, the goodwill return of 28 percent suggests that goodwill is substantially riskier
than all of the other assets but, at a return of 28 percent, still well within reason for
a proven going concern. Thus, the returns chosen for each asset are reasonable.
By its nature, goodwill is the riskiest asset of the group and there-
fore should require a higher return than the overall business return.
ValTip
Appendix 817
APPENDIX—INTELLECTUAL PROPERTY
One of the major difficulties in valuing intellectual property is determining value in the
context of licensor/licensee negotiations. All too often this context is assumed or sim-
plified, resulting in market royalty rates being applied out of context. Most valuation
analysts traditionally develop royalty rates from any of three traditional sources:
1. Negotiated licensing agreements
2. Surveys performed by various professionals, generally in cooperation with trade
associations
3. Judicial opinions which vary greatly depending on individual fact patterns
These traditional tools can now be augmented by databases of licensing agree-
ments extracted from publicly available sources. Such direct market data is some of
the most compelling evidence available to determine the appropriate royalty rate in
a valuation.
The market comparison-transaction method approach initially has four steps to

derive an overall value estimate:
1. research the appropriate market for comparable intellectual property transac-
tions;
2. verify the information by confirming that the market data obtained is factually
accurate and that the license exchange transactions reflect arm’s length market
considerations;
3. compare and apply the guideline license transactions’ financial and operational
aspects with the subject intellectual property; and
4. reconcile the various value indications into a single value indication or range of
values.
Empirical Research and Verification of Royalty Rates
Proprietary research of intangible assets and intellectual properties is important in
business valuation. The value the market perceives in intellectual property-intensive
companies is associated with their intangible assets and intellectual properties.
Valuation of such companies is often an exercise in intangible asset valuation meth-
ods rather than traditional business valuation methods. Emphasis should be placed
on proprietary studies (industry research, industry pricing metrics, and comparable
intellectual property transactions). Research and verification of comparable data
can be a time-consuming process. Recently, advances in information technology and
the availability of online public records have made research of intellectual property
transactions a realistic endeavor.
Databases that gather and organize comparative intellectual property transac-
tions are rapidly becoming the tool of the future to those analysts who specialize in
intellectual property valuation. At the time of publication, three Internet sites pro-
vide information for a fee:
1. RoyaltySource (www.royaltysource.com)
2. Consor
®
(www.consor.com)
3. The Financial Valuation Group (www.fvginternational.com)

818 VALUATION OF INTANGIBLE ASSETS
Comparing and Applying the Data
Intellectual property transactions should be compared to the subject company using
the following guidelines:
• The specific legal rights of intellectual property ownership conveyed in the guide-
line transaction
• The existence of any special financing terms or other arrangements
• Whether the elements of arm’s length existed for the sale or license conditions
• The economic conditions that existed in the appropriate secondary market at the
time of the sale or license transaction
• The industry in which the guideline intellectual property was or will be used
• The financial and operational characteristics of the guideline properties, com-
pared with the company’s intellectual property
Reconciliation
The last phase of the market approach valuation analysis is the reconciliation. The
strengths and weaknesses of each comparable transaction are considered; the relia-
bility and appropriateness of the market data are examined, including the analyti-
cal techniques applied. After considerable review, transactions selected should be
reasonably comparative to the company transaction and then synthesized into a rea-
sonable range.
Detailed Example of an Intellectual Property Database
The intellectual property transactions database of The Financial Valuation Group is
based on publicly available data. It includes approximately 40 fields comprised of the
names of the licensor and licensee, both the Standard Industrial Classification (SIC) and
North American Industry Classification System (NAICS) numbers for the licensor and
the licensee, the type of agreement (i.e., trademark, patent, copyright), the industry
name, the remuneration structure, royalty percentages (base rate, the low end and high
end of variable rates), royalty dollars (base flat fee, annual and variable fees), a descrip-
tion of the product or service, and so on. Custom searches of the database (using key-
words, SIC/NAICS numbers, or both) can be performed to obtain market comparables.

Searches of “all transactions” in The Financial Valuation Group database at the
publication date revealed:
Transactions by Industry
Industry groups as represented by the first two digits of the U.S. government SIC
codes are represented in transactions in the database as shown in Exhibit 20.16.
Intellectual Property Typically Licensed
While there are approximately 90 distinctly different intangible assets, the majority
of assets licensed are intellectual property assets which can be grouped within cate-
gories as shown in Exhibit 20.17.
Patents tend to be the most-licensed intellectual property, with trademarks,
products, and technology following respectively.
Appendix 819
Payment Structures of Intellectual Property Transactions
A comparison of the royalty payment structures disclosed in each transaction
reveals that approximately half of the licensing agreements are based on a set per-
centage or set dollar amount. There are many transactions that involve high/low
payments, which are usually based on performance, sales, or both. Annual Fee and
Monthly Fee agreements tend to be set at a fixed amount paid on a regular basis
throughout the life of the agreement. Exhibit 20.18 shows the various royalty rate
payment structures by the reported transactions analyzed.
Reasons to Use the Database
The database is used to support:
• Damages in an intellectual property litigation case
• Reasonable royalty percentage rates
• Accurate valuation conclusions
• Rebuttal of unreasonable value estimates put forth by others
• Transfer pricing opinions
Because royalty rates derived from transactions take so many economic struc-
tures, it is difficult to interpret them in a manner that is useful for a particular need.
Analysis of licensing transactions similar to a particular fact situation would be nec-

essary to determine a market royalty rate applicable to that situation. The analyst
with requisite skill, education, and experience will be able to draw upon the data to
form better-founded and defensible conclusions and opinions.
Exhibit 20.16 Intellectual Property Transaction Database—Transactions by Two-Digit SIC Industry
1%
4%
20%
25%
19%
4%
10%
4%
13%
10 - Mining, Construction (4%)
20 - Pharmaceutical, Apparel (20%)
30 - Electronics, Instruments (25%)
40 - Transportation, Utilities (4%)
50 - Wholesale, Retail (10%)
60 - Finance, Real Estate (4%)
70 - Services, Computer (19%)
80 - Health, Research (13%)
90 - Public Administration (1%)
© Copyright 2001. The Financial Valuation Group, LC. Used with permission.
820 VALUATION OF INTANGIBLE ASSETS
Exhibit 20.18 Payment Structures of Database Transactions
Fixed Dollars and Fixed Percent
Combined (12%)
Fixed Percent (25%)
Percent Variable (14%)
Percent and Dollar Combined,

Variable (7%)
Dollar Variable (4%)
Fixed Dollars (25%)
Royalty Free (8%)
Undisclosed/Unknown (5%)
© Copyright 2002. The Financial Valuation Group, LC. Used with permission.
Exhibit 20.17 Database Percentages for Intellectual Property Types
21.9
17.5
16
15.9
8.3
7.7
12.8
0510
15
20
25
Patent
Trademark
Product
Technology
Franchise
Software
Other
Percent
© Copyright 2002. The Financial Valuation Group, LC. Used with permission.
821
Marketing, Managing, and Making Money
in a Valuation Services Group

PURPOSE AND OVERVIEW
In addition to providing intellectually challenging work projects with almost endless
variety, the field of business valuation offers potential for outstanding compensation.
However, it is possible to win an engagement and provide quality client service but fail
to bill and collect a fair fee and/or incur sizable cost overruns due to poor practice
management. Optimizing the potential of a business valuation practice is not acciden-
tal, nor is it the natural result of merely “doing good work.” It involves developing a
strong skill set in nontechnical areas such as marketing and practice management.
For the purposes of this chapter, the term “good economics” will be used to
indicate a business valuation practice that has optimized its potential, given such
practice characteristics as the types of clients, the geographic market served, type of
services offered, staff size and quality, and age of the practice. This chapter explores
the key determinants of good economics for a given business valuation practice,
summarized as:
• The qualifications of the practice professionals to provide the particular services
offered by the firm
• The existence of niche valuation services that the firm can serve profitably
• The temperament suitability of the practitioners, especially the leadership, for the
type of engagements undertaken
• The practice’s acceptance criteria for engagements and its adherence to these
criteria
• The management/operating practices of the firm
When the three Ms—marketing, managing and money—are all properly syn-
chronized, business valuation in a professional services firm can be a rewarding career.
It is important to note that these very broad and informal engagement and
practice guidelines outline suggested goals that may not be achievable depending on
the nature and type of practice. They are also more applicable to a group practice.
WHAT GOOD ECONOMICS LOOKS LIKE
Record Maintenance and Analysis
To attain good economics, a practice should set realistic goals for operational results

and analyze unfavorable variances to determine the changes that should be made to
CHAPTER
21
achieve specified goals. Management should keep complete and timely records of
key practice results and analyze the results against previous periods and against
budgets and goals.
Higher Billing Rates
Until a practice’s reputation is established in the marketplace, it may not be able to
command top fees. However, practices should attempt to exit a market or type of
service that will not allow for higher rates over time, unless there are compelling rea-
sons to remain in that market or offer that service, such as a high volume of engage-
ments, to gain experience or because of the type of marketplace.
Realization and Productivity
If the practice’s rate structure (hourly or fixed fees) is appropriate for its skill sets
and marketplace, and engagements are managed for top efficiency, then the realiza-
tion percentage should be more than 90 percent.
Most practices count standard hours as 2,000 or 2,080 a year, or the number
of hours a part-time professional is available. Obviously, to attain a healthy aver-
age, the less experienced people should be 90 percent or more productive and the
professionals with leadership and sales responsibilities should be less productive.
Unless the practice fields a large team, say more than 8 people, then the practice
leader(s) should be productive for 40 to 50 percent of standard hours, since the
practice’s highest billing rates are charged by its leadership and leadership is
involved in marketing and other critical, nonbillable work.
822 MARKETING, MANAGING, AND MAKING MONEY IN A VALUATION SERVICES GROUP
Some practices whose revenues are based primarily on fixed fees make
the mistake of failing to maintain or to evaluate time records and other
information about efficiency and profitability that would indicate
problem areas that need corrective action.
ValTip

It is desirable that chargeable hours for engagements should, on aver-
age, result in billings equal to 90 percent or more of the recorded hours.
ValTip
Few Uncollectible Accounts
Bad debts and postengagement fee adjustments are unavoidable. Many practi-
tioners view them as a cost of doing business. With appropriate engagement
acceptance processes, including collecting significant retainers that are held as
deposits, and close engagement management, uncollectible receivables can be min-
imized. Since uncollectible accounts and billing adjustments occur on a client-by-
client basis, there does not seem to be a minimum or “acceptable” range for which
to strive.
Profit Margin Greater Than 40 percent
Before any compensation charges for the practice leaders, but after all other
expenses, the profit margin of the practice can be at least 40 percent. A well-man-
aged and efficient, highly productive practice can maintain a 50 percent or more
profit margin. Obviously this has a lot to do with the type of services offered and
the percentage of fixed fee competitive work.
Right Fit
Practices often start their life taking whatever type of valuation services they can get,
or whatever the leader is accustomed to performing or comfortable delivering. Over
time practices may evolve to other lines of services and may become entrenched in
one or more specific service niches. To attain good economics, the practice leader(s)
and key senior professionals must become highly qualified in a particular service line
and be temperamentally well suited for the requirements of the service. For exam-
ple, not everyone is comfortable with or interested in the requirements of dispute
resolution work.
What Good Economics Looks Like 823
On average, a group practice should be charging billable hours to
engagements for more than 70 percent of the standard hours available
for them to work.

ValTip
In spite of the higher profits offered by litigation services, some practi-
tioners find that being an expert witness is disruptive to the processes
needed to direct a practice that must deliver valuation reports on a reg-
ular basis.
ValTip
Each practice should frequently evaluate the services it offers and consider these
questions for possible action:
• Which services are more profitable than the others and should be encouraged,
and which ones are below the acceptable range of profitability?
• Which services are susceptible to the practice adjusting its pricing and opera-
tional approaches to attain more profitability?
• Which lines of valuation services really suit the skill sets, the temperaments, and
career goals of the practice team and its leader(s)?
OPERATIONAL KEYS FOR GOOD ECONOMICS
Certain key attitudes and habitual actions in operating a business valuation practice
are important to the attainment of good economics.
Bias toward Proactivity
Successful and profitable engagements do not result from sitting back and waiting
for information to come from clients, third parties, or the practice engagement team.
Practice leaders can establish a tight, clearly documented schedule for each engage-
ment and anticipate in advance changes in client needs or the ability of the practice
to deliver that schedule. Close monitoring and communication with the engagement
team and, for some matters, with the client must be a key component of each
engagement. This is particularly applicable to litigation services engagements
because of the many stops, starts, and long delays involved and because most of the
engagement direction and delivery dates are determined by third parties, such as the
client’s attorney.
Bias toward Continual Marketing Activities and Sales Results
Since the profitability of a professional practice is dependent on a high level of pro-

ductivity, there must be an order input rate that consistently is greater than the out-
put rate. In other words, the practice cannot run out of work for any significant
period of time. Some fortunate practices have a steady supply of work, but even
those fortunate ones recognize that maintaining ongoing activities is a critical factor
for future sales. When practice rainmakers are busy with client work, marketing
often takes a backseat. Good economics require marketing and sales results to be
fairly constant to maintain an order input rate greater than output rate. In some
824 MARKETING, MANAGING, AND MAKING MONEY IN A VALUATION SERVICES GROUP
Since a business valuation engagement is a consulting project, proactive
planning and control is key to maximization of the efficiency, quality,
and profitability of the work process and product.
ValTip
practices, that may require the leader to hire a seasoned or more experienced pro-
fessional. Doing this will free up time to market and sell.
Bias toward Planning and Communication
Certified Public Accountants are familiar with the General Standard of the
American Institute of Certified Public Accountants that work is to be planned and
adequately supervised. This standard not only promotes the delivery of quality pro-
fessional service, but is also key to superior profits. The profitable practitioner must
develop a bias for continuous and timely planning for engagements and other
aspects of the practice, and for communication of those plans to other profession-
als in the practice.
Bias toward Flexible Resources, Especially Staffing
In spite of the best marketing activities and planning for engagements, fluctuations
in the work flow will occur. These range from having too little work available to
keep the present staff busy to having more work than the staff can accomplish on
time. Therefore, the practice must strive for resource flexibility, especially its most
costly resource, the professional staff.
Any practice that operates in a competitive marketplace can form alliances with
other practices to share staff during slow times and can cultivate part-time profes-

sionals to pick up the slack during times of high activity.
Another smoothing methodology is to parcel out segments of an engagement
for various professionals to perform. For instance, one person performs the eco-
nomic and industry research while another performs the valuation approaches for
the same subject company. Some practices, particularly those that produce a signif-
icant volume of reports, believe this method promotes quality and efficiency. In
addition, some professional staff prefer to perform one part of an engagement rather
than another, and these preferences also can result in superior quality and efficiency.
Resource flexibility calls for a practice to look ahead to the nonhuman
resources that it may need and planning for economical ways to attain those
resources quickly. These resources include new databases, software, and other time-
saving and quality-enhancing resources.
Bias toward Quality Results and Client Value
If a practice unit does not have a culture of providing quality results and client value
in its engagements, then the work product may not meet client expectations, may
Operational Keys for Good Economics 825
Resource flexibility is a rich area for practice leaders to explore as they
seek to smooth the peaks and valleys of the work flow.
ValTip
result in unpaid rework or reduction in fees, and could damage the practice’s repu-
tation.
An often overlooked element of quality results and client value is the opportu-
nity to collaborate with other qualified business analysts on some aspects of a par-
ticular engagement. The input of other qualified professionals can enhance the
quality of the information utilized, the methods selected and implemented, and the
professional judgments used throughout the valuation.
Bias toward Training and Quality Improvement
All business valuation practitioners are “practicing” their craft and seek, like other
professions, to constantly improve their performance. A practice aspiring to good
economics must invest in regular training and improvement of its staff’s and lead-

ership’s abilities to provide quality services.
KEY ENGAGEMENT PRINCIPLES
An organized and disciplined approach is required for engagements with several
team members to coordinate the tasks required for the completion of the project.
Practices that aspire to good economics are advised to develop their own uni-
form but flexible processes for engagement organization and control. These
processes can take the form of checklists, reporting deadlines, schedules for client
communication, team meetings, and other means to promote disciplined engage-
ment activities.
Practices should consider developing written “guidelines” for appropriate
engagement processes and procedures that also allow flexibility for the particular
826 MARKETING, MANAGING, AND MAKING MONEY IN A VALUATION SERVICES GROUP
Unless the practice has a bias toward quality and client value, there is
less chance for good economics, at least for any sustained period of
time.
ValTip
Litigation services engagements in particular need an organized and
disciplined approach because so often the engagement criteria identi-
fied at the start are augmented and revised over the life of the project.
ValTip
needs of an engagement that are resolved by professional judgment. A “guideline
approach” to engagement organization and control would address suggested proce-
dures for these areas:
• Engagement acceptance process
• Terms and objectives of the engagement approach, resources, work plan, budget,
fees and collections
• Engagement control
• Achievement of quality and client value
• Litigation services engagements
ENGAGEMENT ACCEPTANCE PROCESS

Guidelines that assist professionals in the engagement acceptance process can pre-
vent the acceptance of an unprofitable engagement as well as properly establish the
requirements and environment for a profitable engagement.
Profile of Acceptable Engagements
An important element of the written guidelines for the acceptance process is a pro-
file of acceptable clients and engagement types for the practice or, in the alternative,
a profile of unacceptable engagements. For example, a practice may not be willing
to accept engagements for valuations for marital dissolution or for employee stock
ownership plans.
The profile should be well known and adhered to with discipline unless the
practice leader makes an exception. Discipline is particularly important when the
practice has a low backlog of work, for it is easy to rationalize that “any work is
better than no work.” The fallacy of this rationalization is that any given engage-
ment can result in the loss of time that could be used more profitably for marketing,
training or vacation, or performing an engagement later that is more profitable.
Questionable Opportunities
The acceptance process should include consideration of the ability of the practice to
obtain needed resources to perform the engagement and other matters that would
qualify the unit to accept a given opportunity. Sometimes the best engagement of the
year is the one that was declined and/or referred to another firm.
Engagement Acceptance Process 827
A practice may not want to accept engagements for individuals (as
opposed to companies) as clients without receiving substantial retainers.
ValTip
828 MARKETING, MANAGING, AND MAKING MONEY IN A VALUATION SERVICES GROUP
Guidelines for acceptance should include procedures to identify the characteris-
tics of a potential client that contribute to a profitable engagement. This includes the
willingness of the client to assist in the engagement and to agree on a reasonable deliv-
ery schedule. An important client characteristic to search for in the acceptance process
is whether the client is both willing and able to pay for the anticipated services.

Relationship Checking Process
The firm also may want to construct a database of prior relationships with poten-
tial clients and third parties. The database can be used to research the desirability of
the potential client prior to accepting an engagement. Such a database also can be
used to determine if relationships with opposing clients or attorneys exist. Such a
database should be kept current.
Client Expectations
The acceptance process should include communications with the client representa-
tive before work begins to explain how the engagement process works and what the
terms of the engagement will be for such matters as fees and payment, client assis-
tance, and deliverables. To maximize the opportunity for good economics, clients
should know at the outset the expectations for their role and all of the anticipated
economics and contractual terms of the engagement.
FEES, RETAINERS, BILLING, AND COLLECTION
Engagement guidelines will include procedures for setting fees, retainers, and client
billings and collections. These items should be discussed in detail during the accept-
ance process with the potential client. The decisions as to whether to accept the
engagement and how to structure the terms of the engagement must take note of any
balking by the potential client about the practice’s guidelines.
Determining the Fee Schedule
Hourly rates charged and fixed fee minimums should be fair for the market and the
qualifications of the practice and fit the risk and complexity of the engagement. This
can mean different rates and fees for different engagements. The practice should
monitor rates of its competitors frequently. Given its own portfolio of services and
clients, it should examine rate schedules periodically to adjust to market rates, costs
of the practice, and changing trends in the industry. On a given engagement, the rate
schedule should not be an issue with the client, although the overall fee may be an
issue regardless of the rates.
Retainers—By All Means
The firm should strive to obtain a retainer in advance of starting work on each

engagement, often held as a deposit until final bills are paid. Retainers are collected
to insure against future or unknown problems beyond the control of the analyst.
The amount received should cover a reasonable portion of the total engagement
and, depending on the size of the engagement and the type of client, may be 50 per-
cent or more of anticipated fees. It is not usually wise to start working on an engage-
ment until the retainer is received. There are obviously exceptions to this rule, such
as working with known clients or attorneys who have good reputations regarding
payment of fees.
Retainers also serve as a client qualification tool. Beware of the potential client,
particularly the new client who refuses to pay a retainer, or who wants to heavily
reduce the requested retainer or continues to decline to remit the agreed-upon
retainer. These are warning signals of a potential client who is not willing to pay fees
and are a precursor to future fee problems. These traits can be included in the pro-
file for unacceptable engagements.
Work Plans and Budgets
A sensible approach to engagement planning and control and to engagement eco-
nomics is to prepare a work plan and budget for some engagements. In some
instances, it is desirable to obtain approval from the client and client’s attorney for
the work plan and budget.
The budget may need to be revised during the course of the engagement. For
this reason, it is important to discuss with the client as soon as possible why addi-
tional work must be done and to arrange a fee increase. Clients are usually under-
standing about fair compensation for needed changes but do not want to be
surprised about an increase in fees.
Prompt and Frequent Billings
Guidelines should include procedures for prompt and frequent billings on engage-
ments. Analysts should explain to clients during the engagement acceptance process
how billings work, and what expectations are for prompt payment. Include specific
payment terms in the engagement letter, including the provision that valuation
Fees, Retainers, Billing, and Collection 829

In most situations, if you are good enough to be engaged, you are good
enough to be paid a portion of the fee in advance.
ValTip
Work plans and budgets, where appropriate, can be valuable tools that
aid in the supervision and control of the engagement team, and can be
critical in obtaining efficiency on the job.
ValTip
reports will not be issued, nor will expert witness reports be issued or testimony in
deposition or trial be provided, unless outstanding bills are paid. Develop a process
for fixed fee engagements that results in bills being accepted and paid at fixed inter-
vals of time or engagement performance.
Collecting Fees
Monitor compliance with payment schedules and follow up as necessary with calls
to the client decision maker. Slow payment of billings may indicate an unspoken
problem with the engagement, so troubleshoot all laggards. Send reminder notices
of unpaid accounts on a regular basis.
ENGAGEMENT CONTROL
Becoming more efficient and increasing the practice’s realization are functions of
exercising engagement control. Part of this control involves managing client expec-
tations and setting timetables, but most of it lies primarily with the ability of the
engagement leader(s) to be knowledgeable of the engagement details and to make
critical judgments and take prompt corrective action. Unless the leader knows what
is going on, corrective action will be delayed and the result will be an expensive
“redo.”
Many engagement leaders are reluctant to get into the details or tasks of the
engagement; after all, they worked hard and learned their craft in order to delegate
work to others. But the profits are in the details, and depending on the type of
engagements, the leader must plan and monitor the work and carefully manage time
devoted by the team to the engagement.
830 MARKETING, MANAGING, AND MAKING MONEY IN A VALUATION SERVICES GROUP

Sometimes the best approach to take with an engagement that is floun-
dering economically is to take the practice’s best people and put them
on the job to finish it up.
ValTip
The old adage “People do what you inspect, not what you expect”
applies to valuation engagements, for team members may not know or
admit on a timely basis that they are off track about the direction their
work is headed.
ValTip
Litigation Services Engagements 831
The key is to review the status of each team member on a timely basis to avoid
misdirection of his or her efforts. This principle can also apply to the engagement
leader. The reason for the universal application of this principle is that performing
business valuations and consulting engagements requires the exercising of a consid-
erable degree of sequential and overall judgment. Anyone can “get off track” some-
where within the planning, framework, and conclusions of an engagement.
Everyone can benefit from collaboration with another professional, if appropriate
and applicable.
LITIGATION SERVICES ENGAGEMENTS
Litigation services present significant differences from typical business valuation
engagements, even though the engagement may entail only performing a business
valuation or evaluating the work of another analyst. Some of the reasons for the dif-
ferences between typical valuation assignments and litigation services are:
• The uncertainty of the nature, scope, and timing of dispute resolution work
• The fact that dispute resolution engagements can and often do end abruptly, with
unbilled work in process and unpaid billings
• Third-party involvement and influence, especially the client’s attorney and an
adversary expert
• High stress on the analyst due to many reasons, including an emotional client
• Some of the work may have to be done alone or with less-experienced staff

• Written reports, required by U.S. District Courts, that are not typical valuation
reports
• Disruption to normal nondispute work flow, including time lost while waiting to
testify or obtain guidance
Practically everything that is required to produce good economics is magnified
with litigation services, including the opportunity to bill practically all hours at
higher profits. To avail oneself of this opportunity, the practitioner must be more
careful and diligent in observing many of the principles discussed in previous sec-
tions of this chapter.
A very general rule of thumb for frequency of inspection by a prac-
tice leader or engagement manager is that the work of juniors/novices
should be reviewed every two hours. The work of all other profes-
sionals should be inspected on a time interval of three hours for each
year of their experience. This is particularly affected by the type and
complexity of the engagement, the staff person, and the practice
leader.
ValTip
Planning and Communication
Because of the consulting nature of dispute work, an organized problem-solving
approach should be used in the planning stages and as the engagement progresses.
One such approach is commonly called the “look-back” approach due to its tech-
nique of visualizing all the elements needed at various stages of delivery and then
looking back to plan in reverse all the tasks that are needed to reach the delivery
point on time.
The analyst’s qualifications for the potential engagement are considered care-
fully because someone else may challenge the work product, especially if the engage-
ment is for expert witness testimony or court-appointed valuations. Depending on
the type of engagement, practitioners may be well advised to collaborate with
another experienced practitioner on dispute resolution engagements, especially less
experienced expert witnesses.

Timing of Work
Because disputes begin with a number of key unknowns about data to be used and
tasks that are needed, and because disputes are prone to end abruptly due to settle-
ment, the scope of work assigned to the analyst at the outset often changes signifi-
cantly. Due to this factor, anticipated revenue flow may terminate prematurely.
When work is assigned, it should be completed as soon as possible within the sched-
ule agreed on with the client or the attorney. This may help an attorney in the set-
tlement process. Also due to the shifting nature of the tasks within the scope of a
dispute engagement, when the completion date for a task is delayed but not can-
celed, a timely completion of this task according to the original schedule will mean
it will not have to be completed at a later date, possibly under more stressful
conditions.
Work Plans, Budgets, Billings, and Collections
Again, the nature of disputes—with their uncertain scope of work and propensity
for an abrupt ending—requires an even greater awareness and attention to the prin-
ciples needed to attain good economics.
Additional work plans and budgets may be used as the engagement progresses.
Prompt and frequent billings and payments are important, all of which should be
explained in the acceptance process and insisted on during the engagement. In a
high-fee engagement, billing should occur more frequently than monthly, perhaps
weekly or every two weeks. Determine at the outset the billing format desired by the
832 MARKETING, MANAGING, AND MAKING MONEY IN A VALUATION SERVICES GROUP
Preparing a work plan and budget for known tasks and obtaining
approval, aid the client and the attorney to understand the likely fee
levels required.
ValTip
client and the attorney. Plan the scope of written reports as soon as possible, and
budget liberally for time to prepare the reports and review them with the client and
attorney. The cost to prepare written reports, especially Rule 26 reports for U.S.
District Courts, can be a great surprise.

Supervision and Engagement Control
The engagement leader is often involved in certain details of litigation services tasks,
regardless of whether he or she is to be a consultant or expert witness. Three major
reasons for this are:
1. The consulting role calls for the analyst to provide a wide range of ideas and
problem-solving advice.
2. The testifying expert must know all the details of the work plan that provide the
foundation for opinions.
3. Other than the preparation of the business valuation aspects of dispute engage-
ments, some of the tasks to be performed may be unique, and staff may not be
as experienced with this type of work.
Working with the Client’s Attorney
In litigation engagements, the client’s attorney is likely to be directly involved with
the analyst’s work, and the client may have little or no involvement. For good eco-
nomics and other reasons, the analyst needs to communicate proactively, clearly,
and often with the attorney on many aspects of the engagement. The client’s attor-
ney is also very likely to be the go-between for all client communications, which
places a premium on clear understanding with the attorney about retainers, fees,
payment of invoices, and any action required by the client.
CONCLUSION
Professionals in service firms, particularly the leaders, need to practice the three Ms
(Marketing, Managing, and Making Money) to ensure a rewarding and fulfilling
career and successful practice. The disciplines of planning and supervision will
greatly assist in the achievement of the desired goals of the practice and its profes-
sionals.
Conclusion 833
Do not assume anything without frequent and clear communication
with the client and the client’s attorney.
ValTip
834

Business (Commercial) Damages
T
his chapter discusses the legal principles and quantitative issues and methods
related to determining business (commercial) damages in litigation matters. It
illustrates the differences between the estimation of value for a business valuation
and the calculation of lost profit damages. The theory and practice described
apply to both testifying experts (professionals who expect to testify as expert wit-
nesses) and consulting experts (professionals who do not expect to testify but who
will serve as consultants to attorneys). Only compensatory damages (lost profits
and diminution of value) are discussed in this chapter. Benefitof-the-bargain,
recovery of out-of-pocket expenses, punitive damages, and other types of recov-
ery allowable under the law are not discussed. Nor are areas of the law with spe-
cific criteria for determining recoverable damages such as patent infringement
cases addressed.
ROLE OF THE LAW AND FINANCIAL EXPERTS
The law drives all litigation matters including damage issues. Case law and statu-
tory law are the most important areas of the law that apply to financial experts.
As a practical matter, the financial expert may want to become familiar with
important cases and statutory law in the jurisdiction in which a particular matter
will be tried.
Financial professionals who serve as testifying experts will be retained by the
plaintiff or defendant or will work as a jointly retained or court-appointed expert.
In commercial damage cases, the plaintiff’s expert will present an opinion of the
amount of damages and the basis for the opinion. The defendant’s expert will either
CHAPTER
22
Although financial experts are usually not attorneys and are not
expected by their professional standards to know the law, attorneys fre-
quently choose experts who have some knowledge of the law that
applies to a particular litigation matter.

ValTip
Legal Principles Governing Damages 835
critique the plaintiff’s damage opinion and/or offer an alternative damage cal-
culation.
LEGAL PRINCIPLES GOVERNING DAMAGES
For the plaintiff to be awarded damages in commercial litigation, they must prove
two things:
1. The defendant was liable (e.g., it breached the contract or its product was defec-
tive).
2. The plaintiff suffered damages as a result of the defendant’s actions.
In most commercial litigation, the financial expert is not involved in the liabil-
ity portion of the case (with some exceptions, e.g., proving accounting malpractice).
Therefore, only legal principles most relevant to the financial expert are discussed in
the following sections.
Reasonable Certainty
The plaintiff must prove that the damages claimed are reasonably certain, that is, it
is reasonably certain that the plaintiff would have earned the amount of claimed lost
profits or the company would have been worth the specified business value.
Accountants who compile financial statements (as opposed to audited and
reviewed financial statements) and who prepare tax returns are accustomed to
accepting client representations without independent verification or testing.
However, in a litigation setting, similar blanket acceptance of key client representa-
tions should not be done unless they are considered reasonable by the expert.
Critical assumptions that have not been evaluated for reasonableness may not be
accepted by the trier of fact (e.g., jury, judge, arbitrator) and may render the expert’s
damage opinion invalid. Therefore, it becomes imperative for the financial expert to
evaluate the key assumptions to the damage opinion, including those provided by
the client, under the principle of reasonable certainty.
Business plans (or litigant’s financial projections) sometimes are used as a foun-
dation for damage calculations because business plans and projections created prior

to the wrongful actions are independent of the litigation motives of the parties.
However, since some courts have ruled that unproven business plans and financial
Establishing reasonable certainty involves rigorous analysis, of which
the identification and testing of key assumptions may be an important
part. Some of these key assumptions are based on client representa-
tions.
ValTip
projections are not adequate to provide the base assumptions for damages calcula-
tions, they still should be evaluated for reasonableness.
Proximate Cause
The plaintiff also must prove proximate cause, that is, that damages have been
proximately (directly) caused by the defendant’s wrongful conduct. Sometimes
proximate cause is simply referred to as causation. Under the principle of proximate
cause, only that portion of the decline in plaintiff profits attributable to defendant’s
wrongful actions is recoverable. For example, loss of profits due to a slowdown in
the economy are not recoverable.
Foreseeability
Another legal principle applicable to contract claims but not torts is foreseeability,
that is, “whether and to what extent . . . . damages, to be recoverable, must have
been foreseeable as a natural and probable result of a breach of contract at the time
the contract was made.”
1
In other words, the plaintiff must show that, at the time
the contract was made, the claimed lost profits were a foreseeable result of the
defendant’s wrongful actions. Damages that actually may have occurred but were
not foreseen as a probable result of a hypothetical breach during the making of the
contract by the parties, are not recoverable.
Example: A parts manufacturer was delinquent in delivering goods to an auto-
motive plant according to the schedule specified in the contract. This delay at one
plant had a compounding effect and caused three other plants to be shut down.

Based on the foreseeability principle, the plaintiff recovered its losses at all four
plants because both parties, during the making of the contract, had contemplated
and understood the compounding effect of a scheduling delinquency.
DAUBERT
AND ADMISSIBILITY OF EXPERT OPINIONS
In the 1990s, several court cases raised the standards for the admissibility of expert
testimony in federal jurisdictions. The most notable is Daubert v. Merrell Dow
Pharmaceuticals, Inc. (113 S. Ct. 2786, 125 C. Ed., 2d 469 [1993]). This case estab-
lished trial judges as “gatekeepers” over the admissibility of expert testimony at trial.
836 BUSINESS (COMMERCIAL) DAMAGES
Attorneys sometimes request that financial experts offer opinions on
causation. The expert should evaluate whether he or she has the qual-
ifications and foundation to render such an opinion.
ValTip
1
R. Dunn, Recovery of Damages for Lost Profits, 5th ed. (Westport, CT: Lawpress
Corporation, 1998), § 1.8.
Measure of Damages: Diminution of Value or Lost Profits 837
The Daubert factors are enumerated in Supreme Court of the United States
No. 92-102, William Daubert, et ux, etc., et al, Petitioners v. Merrell Dow
Pharmaceuticals, Inc.:
• “. . . whether a theory or technique . . . can be (and has been) tested.”
• “. . . whether the theory or technique has been subjected to peer review and pub-
lication.”
• “. . . the known or potential rate of error . . . and the existence and maintenance
of standards controlling the technique’s operation.”
• “. . . explicit identification of a relevant scientific community and an express
determination of a particular degree of acceptance within that community.”
Since the Court stated that these factors should be applied flexibly and that other
factors also may be considered, the Daubert factors are not necessarily applied literally.

Congruent with Daubert, Federal Rule of Evidence 702, “Testimony by
Experts,” states that an expert witness may testify “if (1) the testimony is based
upon sufficient facts or data, (2) the testimony is the product of reliable principles
and methods, and (3) the witness has applied the principles and methods reliably to
the facts of the case.”
Daubert and Rule 702 emphasize that expert witnesses must apply accepted
methods in the proper context and should expect to defend such methods not only
through ipse dixit (“because I said so”) but also through external proofs of various
kinds. Since the 1993 Daubert case, the federal courts have been moving resolutely
toward excluding “junk” testimony. In addition, some state courts have adopted
stricter criteria for the admissibility of expert testimony.
What does this mean for the financial expert providing testimony? The expert
should be prepared to prove that the methods and damage theory being used are
generally accepted in the professional community. The expert should know the rel-
evant professional standards and apply them properly. The expert should be knowl-
edgeable of and be prepared to reference the appropriate professional literature for
generally accepted methods. Furthermore, critical underlying data and assumptions
should be reasonable.
MEASURE OF DAMAGES: DIMINUTION OF VALUE
OR LOST PROFITS
Commercial damages typically are measured by one of two standards: lost profits
or diminution of value. When is each of these measures appropriate? The following
scenarios will provide guidance from which to answer this question.
Although Daubert involved a scientific expert, the court set forth four
criteria by which a trial judge could evaluate the reliability of all expert
testimony.
ValTip
838 BUSINESS (COMMERCIAL) DAMAGES
Scenario 1: Temporary Impairment
The defendant breached a five-year contract to purchase merchandise from the plain-

tiff. These lost revenues represented only a portion of the plaintiff’s entire business.
The company mitigated its damages by eventually replacing the lost sales, and the
business continued to operate. The results of the breach are illustrated in Exhibit
22.1. The measure of damages for a temporary impairment is considered lost profits.
Exhibit 22.1 Temporary Impairment
Scenario 2: Immediate Destruction of Business
The defendant breached a five-year contract to purchase merchandise from the
plaintiff. These lost revenues represented substantially all of the plaintiff’s revenues,
and the remaining customer revenues did not cover the business’s fixed costs. As a
result, the plaintiff went out of business soon after the breach. The results of the
breach for this example are illustrated in Exhibit 22.2.
Exhibit 22.2 Immediate Destruction of Business
$1,600,000
$1,200,000
$800,000
$400,000
$0
Lost Profits
1 2 3 4 5 6 7
Profits
Year
Actual Profits
Expected Profits
▲
▲
$2,000,000
$1,600,000
$1,200,000
$800,000
$400,000

$0
Lost Profits
1 2 3 4 5 6 7 8 9 10
Profits
Year
Actual Profits
Expected Profits
▲
▲