Complete or Partial Destruction of a Business

Business Valuation Methodology

Lost profits can be determined through two main approaches:

• Lost profits methodology
• Business valuation methodology

The lost profits approach is often called ex-post, whereas the business valuation approach is known as ex-ante. We have a video that covers both ex-post and ex-ante methodologies created in 2023.

A key difference between these methodologies is:

The business valuation methodology (ex-ante) involves using all information available or knowable at the time of the wrongful act, emphasizing the lost or diminished business value.

The lost profits methodology (ex-post) leverages all data available up to the award date, focusing on the lost income stream.

Why use the business valuation methodology to calculate lost profits:

The business valuation methodology becomes crucial when a business sustains damage that permanently impacts its future earning potential. Business valuations are typically conducted to assess loss of value or reduced earnings capacity, integrating aspects of accounting, economics, and finance.

A business may suffer partial damage resulting in a total value loss or a temporary value loss where it eventually recovers. The business valuation methodology applies in both situations.

In cases where a business is impaired for the foreseeable future, conducting valuations before and after the wrongful event is necessary to measure the impairment and its operational effect.

For instance, if a business loses a key factory and cannot replace it, this indicates permanent impairment. However, if the factory can be rebuilt, it reflects temporary impairment. Depending on specific factors or assumptions related to the case, you may choose either the lost profits or business valuation methodology. Ideally, both methods should produce comparable results regarding lost profits and damages.

Complete Business Destruction

We encountered a situation where the government expanded a highway, moved the access point affecting the business, and removed a critical billboard, ultimately destroying the company.

Partial Business Destruction

In a scenario where the business experienced partial recovery but suffered lasting impairment due to government actions, such as removing an access point and a billboard, either the lost profit methodology or the business valuation methodology can be applied. Typically, the business valuation methodology is used for complete destruction, while the lost profits methodology is more suitable for partial destruction.

During the business valuation process, pinpointing the date of the wrongful act can be complicated. Therefore, close collaboration with the attorney to determine this date is crucial.

The business valuation methodology relies heavily on established business valuation standards, particularly those from IRS Rulings 59-60.

This video will not cover the requirements for business valuation. However, understanding different approaches, discount and capitalization rates, and other necessary elements is vital for preparing a business valuation, which is integral to the business valuation methodology.