The Association of Insolvency and Restructuring Advisors (AIRA) released its new “Standards for Distressed Business Valuation,” which went into effect on March 1, 2014,[1] and will provide the best practices for valuation professionals. The standards apply directly to all AIRA members and Certificate in Distressed Business Valuation (CDBV) certificate holders whenever they offer an “opinion of value,” including valuation engagements or other engagements in which valuation approaches and methods are used to develop an opinion or conclusion of value.
AIRA’s members and CDBV certificate holders are required to follow these standards when developing an opinion of value regarding reorganization value, enterprise value, values of debt or equity in a reorganization plan, value of assets in a sale, liquidation values, financial reporting values (i.e., fresh-start accounting) and value of tax attributes for future use. Possible other topics, depending on the extent of the valuation opinion, include the value of capital structure, value of payouts under a reorganization plan, collateral values, best-interest test, a solvency opinion in a fraudulent-transfer matter and the value of an equity cushion in adequate-protection matters.
The central question to contemplate when deciding if the standards apply focuses on whether an “opinion of value” has been reached. If the engagement relies on valuation approaches and methods and requires professional judgment in their application, then the standards would apply since the engagement culminates in an opinion and/or conclusion of value.
AIRA’s valuation standards include assignment-specific exceptions that exclude services to perform calculations, reconciliations, cash-requirement computations, fairness opinions, damage computations, solvency opinions (i.e., U.S. Securities and Exchange Commission or other government-required opinion), internal-use assignments, situations requiring the use of a proscribed methodology (i.e., an employee stock ownership plan valuation), AICPA attest engagements and financial advisory services that do not rise to the level of providing an opinion of value.
AIRA’s valuation standards include several key elements that are common among the varying standards that have been issued by other professional organizations. These elements may consist of an independence requirement; a prohibition on contingent fees that are earned on reaching a conclusion or appraisal value; a requirement to explicitly state any limiting conditions; an expectation to clearly state all assumptions and their impact on the outcome and interpretation of the valuation; full disclosure of all people participating in the valuation; identification of the professional responsible for the valuation report; a signed certification of independence, which may include disclosure of the fee arrangements and other factors; identification of all information sources in order to allow replication of valuation computations and reports; and a requirement to follow generally accepted valuation approaches and methods. AIRA’s valuation standards also share certain key reporting requirements.
AIRA’s valuation standards differ from other more general valuation standards in that it formally recognizes that distress may not only be financial, but can also include operational, legal, regulatory and other factors. The AIRA standards state that the specific nature of that the distress and legal context and intended purposes giving rise to the valuation might require significant adjustments to traditional valuation methodologies. Typical valuation adjustments might not be relevant in the case of a distressed business interest, and they can potentially overstate the valuation.
Among the adjustments and specific issues that the AIRA addresses are hindsight and subsequent events, fair value, ownership and control, valuation approaches and methods; valuation adjustments, discounts and premiums, recognition of the importance of market conditions, reorganization values and enterprise values, relevant illustrations of assumptions and limiting conditions, volatility or truncation of cash flows, and risk-adjusted discount rates. The standards also discuss financing issues, including how perceived risks can affect the ability to secure financing, as well as the impact of higher interest rates, excessive leverage, the impact of significant changes to business strategy and liquidity constraints. The standards recognize the uncertain probabilities of an operational or financial turnaround, the impact of periods with shrinking revenues or declining margins, asset divestitures, significant payouts to constituencies, minimum floor values for collateral and the potential for limited relevant market data (typically from healthy companies).
Critically, the AIRA’s valuation standards do away with many of the distinctions among engagement types that are followed by other organizations. Instead of defining differences among valuation engagements (i.e., a calculation vs. valuation engagement), the AIRA states that it “considers the computation of value using valuation approaches and methods that require a member to apply professional judgment in the application of those approaches and methods to be a Valuation Engagement…. A Valuation Engagement under these Standards results in opinions regarding a conclusion of value.”
Similarly, AIRA has dispensed with the distinctions among various report types (i.e., nonappraisal calculation reports, detailed or comprehensive complete reports, limited or summary reports, or other engagement reports), opting instead to set minimum expectations for content and require its members and certificate holders to use appropriate “professional judgment” in order to provide “sufficient information” to fit the circumstances.
As a result of this approach, the AIRA’s standards are generally consistent and do not conflict with standards from other organizations, even though its standards offer considerable more guidance on matters pertaining to distressed situations and the legal environment that professionals may face. The existence of standards dealing specifically with distressed situations should help provide guidance on acceptable practices, as well as help promote best practices. These standards should also allow a practitioner to defend his/her work in court by providing a yardstick from which to evaluate and consider the practitioner’s work while further indicating that there is a solid foundation to support for his/her analysis and testimony.
The AIRA valuation standards were approved by AIRA’s board of directors after a thorough review by the individuals and firms whose members sit on AIRA’s board, and after consideration of input received during a public comment period. The range of firms involved and the scope of the review offer further indication of the importance and acceptability of these practice guidelines.
[1] Copies of the AIRA standards can be found at www.aira.org/aira/standards.