Updated: Sep 8, 2022
“Valuation isn’t a problem until it’s a problem, and then it’s a problem.”
- Mercovus Valuations
New CEOs monitor several metrics in the hopes of keeping their jobs. They focus on hitting sales targets, retaining top talent, and many other things. Valuation reports, however, probably aren’t on the dashboard. Most executives file away the valuation they’ve received and think they’ll never see it again. Happy months or years can pass before that valuation is reviewed and a problem is uncovered. And then that valuation can get executives fired. In the rest of this brief, I will tell you a valuation horror story: Grab some popcorn.
A privately held company with some large government contracts asked me to help with warrant and common stock valuations. I authored many reports for this company over several years and had a great relationship with the CFO and Controller. And then, one day, they disappeared. Emails and calls went unreturned. I checked to make sure the company still existed and my contacts still worked there. It did and they did. But still, I was unable to get in contact with them. Until one day …
I received a scary email from a law firm engaged by this company. I was instructed to cease communications with their employees and answer solely to a committee of the company’s Board of Directors. “What could this be about?” I wondered.
Eventually, the mystery was revealed. Subsequent to the completion of our most recent valuation report, the company hired a new CEO. This executive was promised a lot of company equity; given the value of the company’s stock, this compensation would have resulted in steep personal taxes. The CEO wasn’t happy about this prospect and took action: He forced the company to hire a new appraiser, one that would opine that the value of the company’s stock was less than half of what I had opined.
The change was made, and everyone was happy, until the company’s Big 4 auditor took a look. The new value was ludicrous, said the auditor, and they wouldn’t sign off on it. With the client unwilling to accept a cheap stock charge, this became a sticking point.
Throughout this controversy, the company had a large amount of debt outstanding. The debt agreement had an auditor clause specifying that the company must obtain an audit from a Big 4 firm. Without the audit, the company was in violation of its debt covenants and in danger of going under! Internal struggles ultimately led to an internal investigation and the firing of the recently hired CEO. I was re-instated as the company’s appraiser, and we all lived happily ever after (except, I presume, the CEO and his handpicked appraiser).
You might think that because you don’t have debt with an auditor clause, this isn’t a relevant concern for you. While you may be right in this narrow sense, there are several other ways a bad valuation can come back to bite you. It goes without saying that this CEO never thought changing valuation firms would get him fired. It can be tempting to search for the lowest possible valuation some hired gun will sign their name to, and it won’t be a problem until it’s a problem: And then it will be a problem. Don’t make the same mistake this CEO did: Hire a quality appraiser to do quality work that will withstand scrutiny and won’t create more issues than it solves. Eric Sundheim, ASA Principal Mercovus Valuations