When the Valuation Becomes the Case

A distressed company is valued largely the same way any company is valued. There are multiple methodologies: the cost to create a comparable business from scratch, the cash flow the business is expected to generate in the future, the prices comparable companies have sold for. The methodologies are well established. What trips people up is not the mechanics, it is selecting the right methodology for the right circumstance and then being able to defend that choice when someone on the other side of the table has retained an expert whose entire job is to argue you chose wrong.

That is what valuation in litigation actually is. Not a calculation. A position. One that has to hold up under cross-examination by someone who has spent months looking for the places it does not.

What Valuation in Litigation Actually Means

Valuation in a business context means forming an opinion about what something is worth. In litigation, that opinion becomes evidence. That distinction changes everything about how the work has to be done.

A valuation prepared for strategic planning or internal reporting carries relatively few constraints. The analyst makes reasonable (one hopes, but it’s not always the case) assumptions, applies a methodology that suits the situation, and produces a number that informs a decision. If the assumptions turn out to be slightly off, the business adjusts.

A valuation prepared for litigation, or that ends up in litigation, faces a completely different set of demands. The methodology has to be appropriate for the specific standard of value the case requires. The assumptions have to be supportable, with references to actual data and accepted practice. The analyst has to be able to explain, in plain terms, why each significant choice was made, and why alternatives were rejected. And all of that has to hold together when opposing counsel tries to take it apart.

The gap between those two situations is where most valuation problems originate.

Standards of Value: Why the Question Has to Be Asked First

Before any valuation analysis begins, the most important question is what standard of value applies. This is not a technical formality. It determines what the analyst is measuring, and a conclusion under one standard can be meaningfully different from a conclusion under another, for the same asset, at the same point in time.

Fair market value is the standard most commonly applied in federal tax matters, certain bankruptcy contexts, and many commercial disputes. It represents the price a hypothetical willing buyer and willing seller would agree on, both fully informed and neither under compulsion to transact. Neither party is a specific person. The standard deliberately abstracts away from the actual parties in the case.

Fair value is a different standard, used primarily in statutory appraisal proceedings, situations where shareholders dissent from a merger and seek judicial determination of what their shares were worth. It is also the standard under certain state law claims. Fair value typically excludes discounts for lack of marketability or minority interest that would apply under fair market value, which often makes it a more plaintiff-friendly standard. The difference is not a technicality; it can move a conclusion by millions of dollars.

Investment value reflects what a specific buyer would pay given that buyer’s particular synergies, financing, and strategic position. It is buyer-specific by definition and rarely the operative standard in litigation, but it sometimes becomes relevant when the court is evaluating whether a transaction was financially reasonable for a particular party.

Liquidation value applies when the premise is that assets will be sold quickly and without the benefit of a going-concern marketing process. It is the relevant standard in liquidating Chapter 7 cases, in certain solvency analyses, and in situations where a business has already ceased operating. It is also usable in a Chapter 11 context as a comparison to the other options available.

Getting the standard wrong, or failing to apply it consistently or correctly throughout the analysis, is one of the most common and most damaging errors in litigation valuation work.

The Three Methodologies and When Each Applies

Valuation analysis typically draws on three recognized approaches. In litigation, the choice of methodology, and the weight given to each when multiple are used, is itself a point of potential attack.

The income approach values a business or asset based on its capacity to generate future economic benefit, typically discounted back to a present value. It is the methodology most sensitive to assumption selection: the projected cash flows, the discount rate, and the terminal value calculation. Each of those inputs involves judgment, and each can be challenged. The income approach is often the most appropriate methodology for ongoing businesses with predictable cash flows, but it is also the approach most susceptible to manipulation through optimistic projections or an artificially compressed discount rate.

The market approach values a business by reference to comparable transactions or publicly traded companies. The discipline here is in the selection of comparables. The companies or transactions used must be genuinely comparable in size, industry, business model, and market conditions, not merely superficially similar. In distressed situations, finding true comparables is often difficult, which limits the approach’s reliability – the mere fact of the distress makes healthy companies incomparable. In those cases, a market approach may still be used as a reasonableness check even if it cannot carry primary weight.

The asset approach values a business by reference to the fair market value of its underlying assets, net of liabilities. It is most appropriate when a company’s value is primarily in its assets rather than its earnings: real estate holding companies, asset-intensive businesses, or companies in liquidation. In a going-concern context, the asset approach generally understates value because it does not capture the value of the assembled workforce, customer relationships, or operational know-how. Using it inappropriately in a going-concern situation is an error that opposing experts will identify quickly. Also, in a distressed company, which is typically at or near balance sheet insolvency, liabilities outstrip assets, so may be no remaining residual net asset value.

In most litigation engagements, an analyst will consider all three approaches and explain the weighting applied. A conclusion that relies exclusively on one methodology without addressing the others invites the question of why the others were rejected.

Valuation in Bankruptcy: Specific Considerations

Bankruptcy creates valuation questions that do not arise in most other contexts, and the standards that apply are not always intuitive.

Solvency analysis is one of the most common valuation assignments in bankruptcy-related litigation. Fraudulent transfer claims, avoidance actions, and certain preference defenses all turn on whether the debtor was solvent at a particular point in time. That requires a retrospective valuation: an opinion about what the business was worth as of a historical date, using only the information available (what was “known or knowable”) at that time, not information that subsequently became known. Retrospective valuation is technically demanding and methodologically distinct from a forward-looking analysis.

Plan valuation arises in Chapter 11 reorganizations. The debtor must establish that the reorganized enterprise has sufficient value to support the proposed treatment of creditors. The equity that emerges from the plan is typically allocated based on the reorganization value of the business. Creditor constituencies often retain their own valuation experts, and confirmation hearings can become battles of competing valuation opinions.

Section 363 sale proceedings require a determination that the sale price represents reasonable value under the circumstances. The business judgment standard governs the debtor’s decision to proceed with a sale, but an aggressive secured creditor or objecting committee may challenge whether the process produced a result that genuinely tested market value. Valuation analysis supports or challenges that determination. 

In each of these contexts, the valuation opinion does not exist in isolation. It has to be coherent with the legal standard being applied, the procedural posture of the case, and the factual record that has been developed. For example, when a buyer or a plan proponent is an insider, or insider-adjacent, different legal standards can apply – when the “enhanced scrutiny” or “entire fairness” standards are implicated, valuation becomes more important.

What Makes a Valuation Expert Defensible

Two qualified experts can look at the same company, the same financial statements, the same set of facts, and arrive at genuinely different conclusions. That is not a failure of the process – that is the process. (One of my regular bankruptcy judges once joked from the bench that it was amazing how often many parties in a case showed up with experts, and all the experts happened to have opinions that supported their clients’ arguments, no matter how opposed those positions might be.) The reason opposing counsel hires an expert is precisely because different experts can approach the same facts through a different lens, use a different methodology, and reach a different result. The rebuttal report exists because that is expected.

What makes an expert defensible is not that their number is right in some absolute sense. It is that their process is right. The methodology has to be reasonable and appropriate for the circumstance. The assumptions have to be documented and traceable. The logic has to be clear enough that a judge or arbitrator or a jury without a finance background can follow it. And the expert has to be able to hold that position in deposition and cross-examination without retreating or becoming defensive in ways that signal they are not confident in their own work.

That last part is where the gap between analysts and expert witnesses shows up most clearly. An analyst can produce a technically sound report and still fail as a witness. If the process does not sit well with the opposing expert, that process is exactly what they will attack. An expert who cannot explain clearly why they chose their methodology, why they weighted the approaches the way they did, and why the alternatives were less appropriate for the specific circumstances is an expert whose opinion is vulnerable regardless of how rigorous the underlying work was. An expert that contrives a process to suit the result needed by the client will face a rough road defending that opinion. Do that often and other experts start to whisper; they get labelled with the worst of epithets – a “liar for hire.”

Credibility is earned through consistency: the same discipline applied across engagements, the same willingness to acknowledge the limits of the analysis, and the same ability to distinguish between what the data supports and what it does not.

Common Points of Attack

Opposing experts and opposing counsel will typically focus scrutiny on a predictable set of issues. Knowing where attacks are likely to come does not mean the work can avoid those areas. It means the work has to be done in ways that survive them.

Comparable selection in a market approach is almost always challenged. The criteria used to screen comparables should be established before the analysis is run, documented, and applied consistently. Post-hoc adjustment of the comparables set to produce a more favorable result is the kind of thing that surfaces in deposition.

Discount rate inputs in an income approach receive close attention because small changes in the discount rate produce large changes in the conclusion. The components of the rate, the risk-free rate, the equity risk premium, the size premium, the company-specific risk premium, each have to be defensible, and the company-specific adjustment in particular is an area where analysts sometimes exercise judgment that opposing experts will characterize as arbitrary.

Projection reliability is challenged in most income approach engagements. If the projections used were prepared by management during the period under analysis, the question is whether they were genuinely forward-looking or prepared with a litigation outcome in mind. If they were prepared by the analyst, the question is the basis for each significant assumption. Either way, the projections have to be grounded in something more than optimism. Projkections or a discounted-cash-flow model based on wholly unrealistic or unreasonable and unachievable business projections won’t hold up under scrutiny.

Hindsight bias is a particular risk in retrospective valuations. An analyst preparing a solvency opinion as of a historical date has access to information that was not available at that time. The discipline of limiting the analysis to contemporaneously available information and documenting that discipline is essential.

What Good Valuation Work Produces

A well-executed valuation in a litigation context produces more than a number. It produces a reasoned, documented opinion that answers a specific question under a specific standard of value, using a methodology appropriate to the asset and the context, with assumptions that can be traced to identifiable sources and defended on examination.

When two experts disagree on value, the disagreement is almost never about the facts. The facts are the same. The disagreement is about the process: which methodology was appropriate, how the comparables were selected, what discount rate the circumstances support, whose projections were grounded in reality. That is the actual dispute. Understanding it as a dispute about process, not about numbers, is what allows experienced counsel to engage the real issues rather than fight over outputs.

The opinion that holds up is not the highest number or the lowest number. It is the one built on the right methodology for the right circumstances, documented well enough to withstand a rebuttal report, and credible enough to withstand scrutiny of the expert who wrote it.

For information about Gavin/Solmonese’s valuation and litigation consulting services, visit our Valuation & Litigation Consulting page.