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Oct 17, 2019

Forensic Accounting and Business Valuation: Explaining Them to Judges and Juries

Communicating complex financial issues to nonfinancial professionals is essential for CPAs working in forensic accounting and business valuation. Chris Mercer, founder and CEO of Mercer Capital in Memphis, Tenn., specializes in how accounting professionals can better talk to judges and juries. Mercer will speak on this issue and what you need to know about buy/sell agreements when working with attorneys and referral sources at PICPA’s 2019 Valuation and Forensic Accounting Conference on Nov. 18 in King of Prussia, Pa. Mercer provides a preview of these critical topics in this episode.

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By: Jim DeLuccia, PICPA Communications Manager

Podcast Transcript

In today's episode, we will be exploring two topics critical to CPAs working in forensic accounting and business valuation. Why? Because we have our annual Valuation and Forensic Accounting Conference coming up on Nov. 18, 2019, at the Crowne Plaza Valley Forge in King of Prussia. Chris Mercer, founder and CEO of Mercer Capital in Memphis, Tenn., and incidentally, they also have offices in Dallas, Houston, and Nashville, will address explaining financial complexity to judges and juries and what you need to know about buy-sell agreements when working with attorneys and referral sources. Chris joins me on the phone today to provide a brief look of what he'll discuss at this conference in November.

Chris, thanks so much for taking time out of your busy schedule to speak with me today.

[Mercer] Well, thanks, Jim. It's a pleasure to be with you, and I'm looking forward to being with you guys in November.

That's great. We're certainly looking forward to hearing from you, and I know you've got a little bit of a full dance card at this conference. So, we appreciate your flexibility there.

[Mercer] Well, that's not a problem. Glad to do it.

For purposes of setting up this conversation, and since many of our listeners may not be experts in business valuation, what are the three elements of value?

[Mercer] Jim, let me answer that question indirectly and then directly. The value of a business today is the present value of all expected future benefits to be derived from the business, discounted to the present at a discount rate that is reflective of the risks associated with achieving those cash flows. The value of an interest in a business is the present value of all the expected benefits to be derived from the interest into the future over a finite holding period, expected holding period, discounted to the present at an appropriate discount rate. We talk about that discounted cash flow model and summarize it in a simple equation called the value is equal to expected cash flow capitalized by or divided by a discount rate less expected growth. So, those three elements are cash flow, their risk, and their growth, and those are the determinants of value for every business and every business interest. Appraisers sometimes make a mistake because they forget or overlook the important aspects of discounted cash flow when valuing businesses and business interests. But I talk about those in our new book coming out, The Integrated Theory, The Third Edition, but that's kind of an overview of the three elements of value.

Great, and as I mentioned in my into, you will address two topics at this year's Valuation and Forensic Accounting Conference, but let's start with presenting complex financial issues to juries and judges. What are a few key items you plan to cover there?

[Mercer] Well, I'm going to talk about a number of things and tell a number of stories. One of the key elements, one of the key ideas that I hope to convey is the importance of being able to tell a story when you're talking to a judge or a jury. We talk about some best practices for presenting complex financial information to judges and juries like breaking the information down into digestible chunks. I see so many appraisers, I've done it myself, who put so much stuff on an overhead slide or so many words on a page that it's simply impossible for the judge or a jury to understand or to figure out what it is you're trying to say. I'll talk about the use of visuals. I talk about PowerPoint, maps, flip charts, chalkboard, paper, whatever it takes. I have this theory. Many people of my age went to school, and we went to a classroom. We sat in the chairs, and up at the front of the room, there was a chalkboard, and also at the front of the room was a teacher, and the teacher had chalk, and she had control of the classroom.

I talk about this use of visuals from the standpoint of what I refer to as the chalkboard theory of control. If you've got the chalk, if you're standing there, if you're instructing people, then you have much more control over the outcome of that conversation. Having said that, you want to keep visuals simple, and then, help the viewer by highlighting information that the viewer should focus on. One more thing that I think I talk about is the importance of qualifications and the importance of putting those qualifications into the record. I recall a case many years ago where a guy who had worked for me was competing with me, and we were on opposite sides in a litigation. I testified first, and I got up, and they were reading my qualifications, or I was going through my qualifications with my attorney. And the opposing expert stood up and said, "We all know Mr. Mercer. He's qualified. Just let him testify." Well, I said, "Uh oh," but I testified, and then, the guy who had worked for me came up, and they went through his qualifications in excruciating detail.

As far as the judge was concerned, he was probably more qualified than I was. Focus on getting your qualifications into the record. I use the idea that a picture is worth 1,000 words, and a good visual, the idea is that, sometimes, a single visual, a single chart will make the matter ... make an entire difference in the result of a litigation, but those are a few of the ideas.

Right, and yeah, I can certainly ... myself not being a CPA or an accounting professional, I can appreciate how pictures can really help illustrate a point to someone. I understand you have a new book coming out on working with attorneys and referral sources on buy-sell agreements. Briefly, what are a few key points that you plan to address on this topic?

[Mercer] Buy-sell agreements are some of the most important documents in companies that have multiple shareholders. Much of corporate America is privately owned and buy-sell agreements are everywhere. They're in operating agreements for LLCs and partnerships. They're in shareholder agreements for corporations. Most of the time, most people don't think about their buy-sell agreements. One of the things that I talk to business appraisers about is the importance of understanding or learning enough about buy-sell agreements so that you can read your client's buy-sell agreements and become an adviser to them. And so, this book, while it may be geared toward attorneys, is also geared toward appraisers, similar to my book Buy-Sell Agreements for Closely Held and Family Business Owners, which lots of business appraisers around the country have used as a marketing tool.

The idea is to understand the buy-sell agreements and to cause people to reach agreement on how value will be determined. I don't draft buy-sell agreements. I'm not a lawyer, but I have been in the buy-sell agreement world long enough to know that most valuation mechanisms in buy-sell agreements won't work, and I'm talking about buy-sell agreements now that require a valuation. Quite often, the language in a buy-sell agreement will be 100 to 200 words. It will say that after a trigger event, one side will retain an appraiser. The other side will retain another appraiser, and the two appraisers will provide valuations. If they're within 10 percent of each other, then that will be the average, but they are never within 10 percent of each other. Then, the two select a third appraiser, and what we have here is a prescription for disaster because chances are the buy-sell agreement didn't properly define the standard of value, like fair market value. It didn't properly describe the kind of value that the owners were talking about.

You have disputes as to one side wanting an illiquid minority value and the other side wanting a strategic value. The purpose of the book is to help attorneys and to help appraisers understand the importance of this. One new feature of this book is that it provides template language for the valuation sections of buy-sell agreements. The users of the book, readers of the book, can take that language and incorporate it in buy-sell agreements, and I'll be encouraging business appraisers to talk to attorneys about including them as the appraiser for buy-sell agreements. It's a great business valuation opportunity because most successful closely held businesses need an annual or at least an every-other-year valuation in order to set price for the buy-sell agreement, in order for personal planning for the shareholders, in order for corporate planning and so forth. The whole idea of the book is to inform advisers about the importance of buy-sell agreements and then to help advisers structure buy-sell agreements from a valuation perspective so that they'll actually work. That's a simple concept.

I notice a theme between the two topics that you'll be presenting of working with professionals who may not be well-versed in financial matters, especially as it relates to business valuation. What inspired you to write your latest book and address this issue?

[Mercer] Jim, I have, I guess for at least the last 15 years or so, been fairly obsessed with trying to communicate with business owners and with other business appraisers to explain complex financial concepts in simple terms. For example, I wrote a book a few years ago called Unlocking Private Company Wealth. This book is geared primarily to business owners of successful closely held companies, and it talks about things like what is your rate of return, and why is that rate of return important? What is your dividend policy, and why is that dividend policy important? The idea of talking to appraisers about communicating with judges is very similar. What we're trying to do is communicate complex subject matter to people who don't have a background in it in a clear and convincing way. Then, the same theme is with this new book on buy-sell agreements because what I'm trying to do is to explain the complexities of valuation in such a way that attorneys and business owners and other business appraisers can understand so that we get buy-sell agreements in most companies out there that will actually work. It's just one of those things that I like to do. My wife says I delight in pointing out the obvious, and sometimes, I do.

I guess you probably touched on this in the previous response, but would you say there's a particular point that unifies both sessions that attendees will talk from the conference?

[Mercer] Well, I'll just say it again because I think it's so important. We, as professionals, have to be better, have to get better, at explaining complex financial concepts, not only to judges and juries but to clients and to other appraisers from time to time. If we do that, we will be much more successful in communicating our ideas and conclusions to the constituency that is relevant at the moment.

Great. Well, Chris, thanks again for sharing this insight with our listeners and really looking forward to your presentations this fall.

[Mercer] Jim, thank you so much. I think I'm pretty excited about coming up there because I like to talk about these things, and it'll be fun.

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Podcast transcripts are provided as a summary of the conversation and have been lightly edited for the written medium. The transcript is not a verbatim representation of the interview.
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