Without site visits and management interviews, it can be difficult for a valuation professional to gather all of the information needed to fully understand a business’s operations. This article provides insight on how these steps facilitate the valuation process. A sidebar identifies three cases that showcase the importance of these procedures.  

Zeefe v. Zeefe, Ohio App. Dist. 8, No. 69975, Jan. 22, 1998

Kohler v. Commissioner, T.C. Memo. 2006-152, July 25, 2006

Anzalone v. Anzalone, Pa. Sup. Ct., 835 A. 2d 773, Oct. 28, 2003

What are Experts Looking for?

When valuation experts tour facilities, they’re looking for conditions that may affect the company’s earnings or increase its risks. Questions they may ask include:

• Are the company’s property, plant and equipment in good condition?
• Do any fixed assets or inventory appear to be nonoperating, idle, obsolete or damaged?
• Do the company’s operations appear to be organized and efficient?
• How are working conditions? Is the facility clean and uncluttered? Do workers seem productive, or overworked and under unusual stress to perform?
• Are there any capacity constraints that might hamper the company’s ability to handle future growth?
• What’s the skill level of the company’s employees and managers?
• How is staff morale? Do any employees or managers appear to be disgruntled or adversarial?
• Are there any obvious environmental issues, such as pollution or questionable storage or disposal of toxic waste?
• Does the company have adequate physical controls over assets, such as inventory, cash and equipment?
• Are there any discrepancies between the interview with management and site visit observations?

If the business is a retailer or otherwise open to the public, management’s permission might not be needed to conduct a site visit. This may be helpful in adversarial situations in which the client doesn’t control the business.

The expert can simply show up like a mock customer to evaluate the typical customer experience and consider whether there’s adequate signage, parking and access. However, a formal tour must be scheduled if the expert needs a behind-the-scenes tour or wants to interview management.

What Questions are Asked?

Interviews with executives and other employees allow an expert to look beyond a company’s historical financial statements to factors that affect its future earning potential. Interviews allow the valuation professional to assess the quality of a company’s management team and other key employees, providing insights that formal titles and organizational charts don’t reveal.

For example, is management “thin”? That is, does the company rely heavily on the owner, the CEO or a small group of key employees, increasing its risk? If so, the expert will consider whether the company has taken steps to mitigate this risk, such as initiating employment contracts, noncompete agreements and well-designed succession plans.

Another key area of inquiry involves the strength of the company’s customer and supplier relationships. An expert will inquire about customer retention rates, formal long-term contracts and customer concentration risks. Relationships that depend on personal relationships with the owner or outside referrals may warrant an adjustment to the company’s value.

Experts will also inquire about the company’s competition, intellectual property rights, technology, brand-name strength, product development and strategies for reducing competitive risk.

Indispensable Tools

Site visits and management interviews can provide information — both positive and negative — that a company’s books and records will never reveal. Investing the necessary time and effort almost always pays dividends in the form of a more accurate valuation report that carries more weight with courts and other users.

Sidebar: A Courts-Eye View of Site Visits

In a litigation context, valuation experts who fail to conduct site visits and management interviews — or who don’t receive the access they need — may damage their credibility in court. Courts today are more knowledgeable about valuation concepts and want to see experts back up their assumptions.

Cases highlighting the importance of site visits and management interviews include:

Zeefe v. Zeefe. An Ohio appellate court relied on an expert’s valuation of a car parts business because, unlike the opposing expert, he personally viewed all three locations of the business. It was reasonable, the appellate court said, for the trial court to conclude that the chosen expert’s testimony was “more accurate and more reasonable.”

Kohler v. Commissioner. The U.S. Tax Court rejected the testimony of one of three experts engaged to value stock for estate and gift tax purposes. Among other things, the expert who was rejected met with the company’s management for less than three hours, insufficient time to understand the company’s business. The second expert was more familiar with the company because he had valued its stock in the past. And the third expert spent three and a half days at the company and interviewed 12 employees.

Anzalone v. Anzalone. In this divorce case, the court found that the wife’s valuation expert was more credible because he considered the company’s financial statements and recent performance. He also “interviewed management to learn what has happened behind the numbers and to obtain other key data and information that are not contained in the financial statements.”