Tuesday, June 15, 2010
Evidentiary requirement and 409A valuation
Several clients ask us questions about what types of information is collected and why. You see, 409A valuations have got more to do with substantiation and evidence and less to do with valuation techniques and number crunching. One of the things we have noticed, especially, in valuation work from overseas is use of data sources, enumeration and explanation of data, and calculation methods that dont quite fit in with US Tax Court lingo or evidentiary standards. We collect information that is more appropriate to pass the evidentiary standards set out in usual IRS court cases and US GAAP standards. This also makes the audit work a breeze as most information they are looking for is set in in the manual. While working with one client, they mentioned that a company in India charges less for valuations and then when we inquired as to what they normally ask and process, the client mentioned that they use a single approach to arrive at results for all firms. Use of a single approach goes against the well established US evidentiary standard that all available approaches have to be weighed, before one or more approaches can be discarded. This "discarding" process has to be shown through calculations and comments. Cutting work short and then paying less for that defeats the evidentiary standards set out in the US. While the cost, income and market approaches are the usual methods to evaluate a firm or its assets' valuation, use of these methods have to be relevant and appropriate to how the "most advantageous transactions" market currently uses them. The valuations have to be created to reflect as if the buy or sale transaction occurred in the most advantageous market. Another thing to note that is the fact that, in the US we have something called "investment value", that widely differs from fair market value. Investment value cannot be used for 409A valuations. In reviewing valuations from overseas, we find that specific notations to which valuations are "investment" and which are "fair market", are totally missing. We are not sure how these valuations even pass US audit requirements as many of the valuations are shallow and will not stand scrutiny here, should the IRS were to scrutinize them in the future. While many of these foreign firms are presenting a quick, short valuation report, companies beware that they may not meet US evidentiary standards. We do understand the analytical strengths and cost advantages associated with doing overseas work. But cutting prices and sacrificing evidentiary standards is something we cannot advocate to any of our clients.