As an appraiser, I am always making analogies to the frameworks and methodologies I’m exposed to in the profession. I suppose it’s one of the reasons I really like the valuation niche. There are so many areas of life where you can take different concepts from our work and apply them. You can also do that within the profession as well. One area I’ve been thinking about a lot is the explicit stratification of valuation methods in the accounting world. In that realm, the market approach reigns supreme. As a level I input, transactions in identical interests on an established exchange serve as the uncontested proxy for value. This makes sense I suppose. But unfortunately that leaves quite a few interests unaddressed. Generally, the closer to the market you can bring the valuation exercise, the better. However, it leaves me wondering – who is the best expert witness? A highly educated, credentialed academic, or a sales oriented market maker?
There are credible arguments to both profiles. The former has spent countless hours poring over data, research, and theoretical approaches to assessing value while the latter has actually been transacting. I suppose a good analogy would be who is in a better position to appraise a car – an engineer or a car salesman? If the make, model, and vintage are all aligned with the type of vehicle the car salesman transacts in on a daily basis (think, market maker) then I think the answer is the car salesman. He knows the market. He has extensive exposure to what the typical buyer values. Importantly each negotiating experience is a valuation engagement in its own right – calibrating the price with the market demand given the asset’s characteristics to facilitate a transaction. However, what if the vehicle was highly unique? A hybrid of car, truck, and airplane? One of a kind? Outside the market in which the salesman transacts? Is he still the best judge? Certainly some of his experience is still relevant. However, as the appraisal exercise delves deeper into the theoretical, the academic’s skill set and experience also become relevant. Perhaps the academic has developed a regression model that examines a thousand transactions in all three vehicle types, a statistically significant model that incorporates various characteristics. While it may not directly incorporate the behavior of specific buyers in identical interests, it extrapolates when there is no better alternative. Truth be told, the latter is more prevalent in the case of illiquid interests and intangible assets. Most of these interests have no level 1 proxies. Extrapolation is done out of necessity, not preference. With that said, is it more appropriate to value research ability and experience in the theoretical over practical experience.
However, I’m not so sure about that, either. As a former investment banker, I can tell you my experience in transacting in equity interests is actually deeper as an agent than an appraiser. The myriad of issues that come up in due diligence is extreme, because buyers are actually transacting. For example, when we appraise an interest in a privately held business, we usually talk with management, review industry research reports, study the companies and transactions thought to be comparable, examine the financial statements, and use all that information to synthesize our analysis. As an investment bank working with, say a private equity firm contemplating transacting in that same interest, they’re hiring accounting firms to do quality of earnings reports and verify financial controls, top consulting firms to vet market opportunities, performing background checks on management, working with lenders who are doing their own due diligence on the company, bringing in top executives in the industry to potentially take board seats and review the company’s strategy versus what might be best practice. And so, the agent’s experience is also quite profound – getting continuous exposure to how various buyers approach unique transactions and where they see value. Academics simply don’t get this kind of exposure – they are constrained to the data that is collected by those out in the field – the market makers. I always enjoy reading Daubert challenges for this reason. It also baffles me why prior testimony experience trumps both of these fundamental qualities. Someone with substandard finance academics and credentialing and no transaction experience but lots of expert witness experience is valued more highly than someone with the inverse.