April 18, 2023

M&A Litigation: Valuation Issues in a Volatile Market

Yesterday, I blogged about how buyers and sellers in private equity deals are addressing valuation gaps.  Today, it’s time for the litigators’ perspective.  This Proskauer blog says that the turbulent market conditions that create valuation gaps also create litigation over valuation issues.  Here’s an excerpt:

Valuation disputes tend to be centered on disagreements about accounting practices, dates of assessed value, and valuation methodology. In times of financial uncertainty or distress, economic actors may gravitate toward less conservative accounting practices, which may be in tension with historical accounting practices.  Market volatility is also a breeding ground for valuation disputes based on the date on which the valuation was determined, as rapidly shifting market conditions can have significant impacts on value.

Valuation claims can also arise from differences of opinion regarding the valuation bases or methodology.  While the market value of most sponsor-owned portfolio companies would involve only an objective measure of an asset’s value without regard to identity of the buyer or seller, plaintiffs sometimes argue that the portfolio company or asset had synergistic value, or value that is enhanced by the presence of other assets.

Typical valuation methodologies include proposed and precedent transactions, discounted cash flow analyses, comparable companies and net asset value.  Increased volatility usually brings these valuation methodologies to the forefront of disputes.  Importantly, complex valuation claims often involve multiple valuation methodologies with a range of resulting valuations.

The blog goes on to note that “we are seeing one specific subcategory of valuation disputes – earnout disputes – growing in frequency.”  Wow, who’d a thunk it?  Anyway, the blog advises parties thinking about an earnout to focus on the areas that frequently give rise to post-closing disputes – methodology, obligations concerning the information required to calculate the earnout, the form of consideration, and jurisdiction & dispute resolution.

John Jenkins