When valuing a privately held company, several qualitative factors should be considered that will help assess risk and value drivers.  All things equal, the higher the risk factors the lower the company value.  This is especially true if a company is being valued using a market approach and applying multiples.  If the comparable companies are yielding a wide range of multiples then attention should be paid to the company’s individual characteristics that may move the needle to the lower or higher end of the multiple range. 

In Valuation for M&A: Building and Measuring Private Company Value, Chris Mellen and Frank Evens set forth the following (non-exhaustive) factors that would generally tend to increase or decrease a company’s value and multiple selected:

1.       Possess strong brand name or customer loyalty.

2.       Sales concentrated with a few key customers.

3.       Operate in a well-maintained physical plant.

4.       Operate in a small industry with a limited customer base.

5.       Generate a high sustainable net cash flow to shareholders.

6.       Have compiled or reviewed rather than audited financial statements.

7.       Possess competitive advantages, such as technology, location or an exclusive product line. 

8.       Operate with deficient working capital and generally limited financial capacity.

9.       Generally favorable future economic and industry conditions.

10.   Operate with limited management on whom the company is heavily dependent. 

11.   Sell a diverse mix of products to customers located in broad geographic markets.

12.   Sell commodity-type products that possess little differentiation from competitors.

13.   Operate in large, high growth industry.

14.   Substantial excess capacity exists in the industry.

15.   High barriers in industry impede entry by new competitors.

16.   Continual threat posed by substitute products and technological obsolescence. 

17.   Possess strong position in niche industry.

18.   Sell products through brokers, creating limited knowledge of or contact with product end users. 

19.   Are either the most efficient low-cost producer or high-quality producer or both.

20.   Possess history of litigation with customers, suppliers and employees. 

Do any of these factors sound familiar? How do you think these factors would impact a company’s value?

A series of recent Daubert cases illustrate how different courts may interpret the role of “gatekeeper,” which they perform under Rule 702 and Daubert, differently. In assessing the admissibility of expert testimony, some courts believe the law requires them to be inclusive while others believe close scrutiny of the expert’s qualifications and the reliability of his or her testimony is warranted.

Rule 702 of the Federal Rules of Evidence allows a qualified expert to testify if his or her specialized knowledge would assist the trier of fact and the testimony is based on sufficient facts and reliable methods properly applied to the facts. Under Daubert, the evidence must be relevant and reliable.

Ferraro v. Convercent, a contract and tort case revolving around a company that provided software-based services, falls into the first category. The defendants claimed the plaintiff’s expert was unqualified because he lacked the necessary experience valuing that type of company, but the court found the applicable law did not require this degree of specialized knowledge. However, Weinman v. Crowley, a bankruptcy case turning on insolvency, is definitely on the other end of the spectrum. The Bankruptcy Court, on its own accord, examined the insolvency expert’s qualifications and found them wanting, notwithstanding the expert’s experience in international finance. Also, in Ferraro, the court said some degree of speculation is common in expert testimony. In contrast, in Cargotec v. Logan Industries, a Texas appeals court found the damages testimony was inadmissible because the expert relied on management projections that were based on some unfounded assumptions, notwithstanding the expert’s independent work on the case.

The takeaway is that, while valuators and attorneys should study a lot of Daubert cases for a particular court’s take on Rule 702 and Daubert, courts have a lot of leeway in how they come out on admissibility.