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Valuing Lost Profits for Litigation Purposes (Series: Valuation 2020)

A competitor, contractor or other third party has taken actions that have damaged your client’s business in the form of lost profits. How do you measure the lost profits? Must you demonstrate lost profits with certainty? Over what period do you measure the lost profits? If your client has not recovered fully, can you include estimated future lost profits? These are all important questions in a lost profits case. This webinar addresses those questions and summarizes the different methods to measure lost profits, as well as some of the critical elements that must be considered in developing and presenting your damages theory in court.

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Valuing Lost Profits for Litigation Purposes (Series: Valuation 2020)

  1. 1. 1
  2. 2. 2 Practical and entertaining education for attorneys, accountants, business owners and executives, and investors.
  3. 3. 3 Thank You To Our Sponsors
  4. 4. Disclaimer The material in this webinar is for informational purposes only. It should not be considered legal, financial or other professional advice. You should consult with an attorney or other appropriate professional to determine what may be best for your individual needs. While Financial Poise™ takes reasonable steps to ensure that information it publishes is accurate, Financial Poise™ makes no guaranty in this regard. 5
  5. 5. Meet the Faculty MODERATOR: Beth Rubin - Ankura Consulting Group, LLC PANELISTS: Michael Pakter - Gould & Pakter Associates, LLC Richard Claywell - J. Richard Claywell CPA Don May - DMA Economics 6
  6. 6. About This Webinar Valuing Lost Profits for Litigation Purposes A competitor, contractor or other third party has taken actions that have damaged your client’s business in the form of lost profits. How do you measure the lost profits? Must you demonstrate lost profits with certainty? Over what period do you measure the lost profits? If your client has not recovered fully, can you include estimated future lost profits? These are all important questions in a lost profits case. This webinar addresses those questions and summarizes the different methods to measure lost profits, as well as some of the critical elements that must be considered in developing and presenting your damages theory in court. 7
  7. 7. About This Series Valuation 2020 This series of webinars teaches how commercial litigators use valuation experts in commercial disputes. Valuation is used by market participants to determine the price they are willing to pay or receive to transact a sale of a security, a business, or an any other asset. The same techniques are used to determine the price a party us willing to pay or receive to settle a claim or satisfy a liability. It should be no surprise then that when there is a dispute between two or more parties regarding value, the same valuation techniques and skills are necessary to resolve the dispute. Attorneys, accountants and business owners often rely on independent, third- party valuation experts to assist in the resolution of disputes or potential conflict situations. Some of the typical situations in which valuation experts are utilized include fair value financial reporting (GAAP accounting), bankruptcy, income tax reporting, property tax appeals, estate and gift tax planning and reporting, dissenting shareholder disputes, corporate transactions and disputes, divorce litigation, shareholder disputes or economic damages analysis as well as many other business and legal purposes. Each Financial Poise Webinar is delivered in Plain English, understandable to investors, business owners, and executives without much background in these areas, yet is of primary value to attorneys, accountants, and other seasoned professionals. Each episode brings you into engaging, sometimes humorous, conversations designed to entertain as it teaches. Each episode in the series is designed to be viewed independently of the other episodes so that participants will enhance their knowledge of this area whether they attend one, some, or all episodes. 8
  8. 8. Episodes in this Series #1: Experts: When Do You Need One & Where Do You Get One? Premiere date: 1/30/20 #2: The Basics- Working With an Expert Premiere date: 2/27/20 #3: Valuing Lost Profits for Litigation Purposes Premiere date: 3/26/20 9
  9. 9. Episode #3 Valuing Lost Profits for Litigation Purposes 10
  10. 10. What are the Different Types of Damages that can be Recovered in a Lawsuit? • Actual or compensatory damages – to compensate for proven injury or loss • Nominal damages – awarded if an injury has been suffered, but no loss has occurred • Punitive – in addition to other damages and available if defendant acted with malice, recklessness or deceit • Damages are intended to put the injured party in as good a position as he or she would have been absent the wrongful act 11
  11. 11. Lost Profits • An element of economic or compensatory damages  The harm suffered by the plaintiff as a result of the wrongful act of the defendant  Determined, with reasonable certainty, based on statutory rules and regulations or prior decided court cases • Consider if profits or the entire business has been lost  If profits lost, measure net (not gross) profits lost  If entire business lost, measure lost business value as an alternative to lost profits 12
  12. 12. To Prove Damages, Plaintiff Must Show… • Wrongful act of the defendant caused a loss • The amount of the loss can be estimated with reasonable certainty • For certain contract claims, an additional element to be proved must be that the loss incurred was foreseeable at the time the contract was entered into by the parties 13
  13. 13. Questions to Consider in Determining Lost Profit Damages • What caused the loss? • Who caused the loss? • Might other things have caused the loss? • What is the best measure of the loss? • What is the period of damages? • What kind of financial and operational information is available? • What is the capacity of the business? • What are the primary risk factors facing the business? 14
  14. 14. What Role Does an Expert Play in Litigation? Do I need One? • Expert witness: Provide an objective and independent perspective before a trier of fact – at a deposition, before a court, or in arbitration  An expert’s work is frequently discoverable including correspondence, notes, analyses, research, drafts, and workpapers  It is important to realize this at the outset of an engagement 15
  15. 15. What Role Does an Expert Play in Litigation? Do I need One? • Expert consultant: provides research, discovery, analysis, and may assist in fact finding, strategy, and identifying potential issues  Does not usually provide testimony  The work of a consultant is generally considered attorney work product and protected from discovery (when attorney engages the consultant)  If the consultant becomes a testifying witness, all prior work is discoverable including that performed while a consultant 16
  16. 16. Standards for Expert Testimony • Frye – demonstrate expertise and apply methods/theories that are generally accepted • Federal Rule of Evidence 702 – a qualified expert may testify if the testimony is relevant and rests on reliable foundation • Daubert – Federal Rule of Evidence 702 superseded Frye and concluded that methods do not have to be generally accepted as long as testimony is relevant and reliable 17
  17. 17. Daubert Challenge to Expert Witness • The judge is the gatekeeper and considers the Daubert factors to determine admissibility of an expert’s testimony  Theory or technique used can be or has been tested  Theory or technique has been subjected to peer review  Potential error rate is determinable, or standards exist for error rate that is acceptable, and  Theory or technique enjoys widespread acceptance in the profession 18
  18. 18. Expert Qualifications • An expert must demonstrate:  The requisite training, skill, knowledge, and/or experience in the field  The facts, data, assumptions and other documentation that were relied upon in forming conclusions and opinions  The basis for the conclusions and opinions, including the methodology used 19
  19. 19. Proving Lost Profits • Proximate causation – must be a link between the wrongful act and the damages • Plaintiff must have tried to mitigate damages and cannot claim loss to the extent that damages were mitigated • Lost profits must be proved to a reasonable degree, but not with entire certainty • Loss is mitigated to the extent that plaintiff’s actions/negligence contributed to loss 20
  20. 20. Proving Lost Profits • Proximate causation: there must be a causal link between the wrongful act and damages claimed  Transaction causation: “but for” the wrongful act, no loss would have occurred  Loss causation: the loss is related to the wrongful act  Both are required, but the wrongful act does not have to be the sole cause of the loss 21
  21. 21. Proving Lost Profits • Only lost net profits are allowed as damages • Lost profits can only be claimed over the “loss period”  Usually begins with the date of the wrongful act or later  The end of the loss period is usually the end of the term of a contract, a return to customary levels of profit or some “foreseeable period”  Sometimes the damage is permanent 22
  22. 22. Market Share Approach • Based on the difference between the plaintiff’s market share had there been no damage and its market share after the damaging act • When it’s appropriate:  When reliable market share data exist  When plaintiff company products/services fit within “market” 23
  23. 23. Market Share Approach • Strengths:  Can provide objective, reliable basis for estimating  Other companies in “market” are independent of the damaging act  Accounts for changes in the industry during relevant period • Limitations:  Difficult to determine market share (due to lack of data, comparability)  Difficult to assess due to dynamic markets 24
  24. 24. Before and After Approach • Based on a comparison of the plaintiff’s sales before the damaging event with plaintiff’s sales after the event, either actual sales or a projection of sales that would have been achieved in the absence of the wrongful act (“but for” sales) • When it’s appropriate:  When reliable historical data exists  When growth trends are predictable  In relatively static comparative environments 25
  25. 25. Before and After Approach • Strengths:  Relies on plaintiff’s actual, historical financial results as a basis for comparison to estimated future results  Courts often favor financial projections based on past results • Limitations:  Requires sufficient historical data  May not account for changes in the industry/economy  Periods before and after damaging act may not be comparable  Unavailable for newly established firms or start-ups 26
  26. 26. Yardstick Approach • Based on a benchmark or “yardstick,” a similar business unaffected by the damaging act – e.g., a comparable company, division or industry benchmark • When it’s appropriate:  When a reliable yardstick exists  With newly established firms 27
  27. 27. Yardstick Approach • Strengths:  Can provide objective, reliable benchmark for estimating  Yardstick is independent of effects from damaging act  Accounts for changes in industry or market  Accounts for differences in time periods • Limitations:  Lack of comparability between plaintiff and yardstick (e.g., size, sales channels)  Yardstick data may not be available 28
  28. 28. Sales Projection Approach • Based on a sales projection that was prepared prior to the damaging act or reflective of the terms of a contract • When it’s appropriate:  When a sales projection was prepared prior to the damaging act  When a stable trajectory of existing orders exists  When expected sales can be estimated from contract terms  May be appropriate for newly established firms if orders/contracts exist 29
  29. 29. Sales Projection Approach • Strengths:  Can provide specific objective, reliable estimate  Estimates of volumes and pricing agreed to by the parties to a contract  May reflect actual orders • Limitations:  More uncertainty with respect to sales beyond the period of existing orders/contract terms  Must demonstrate ability to fulfill the orders/projection 30
  30. 30. Choosing the Right Approach • Consider the availability of information – from the company, the industry, competitors, industry analysts, etc. • Consider the following factors prior to the damaging act:  Were plaintiff’s sales trends steady and predictable?  Did the plaintiff have orders in hand?  Were plaintiff’s sales trends comparable to another company or industry as a whole?  Which approach is most consistent with the facts in the case and market conditions during the damage period?  Is the company’s financial information reliable? 31
  31. 31. Avoided Costs • Lost profits as measured by:  Lost incremental sales/revenue  Less avoided incremental costs – those costs that would have been incurred with the generation of the lost revenues but were not  Plus costs that were incurred to mitigate damage that would not have otherwise been incurred if the revenue had not been lost • Fixed vs. variable costs:  Depends on loss period: fixed over loss period or semi-variable  Some costs may have been incurred prior to the damage 32
  32. 32. Estimating Future Profits • Must be based on reliable information and reasonable assumptions • Common sources for estimating lost sales/revenue:  The plaintiff’s actual prior and subsequent experience  The plaintiff’s capacity for growth  The plaintiff’s budgets, forecasts, or projections o Prepared prior the damaging event in the normal course of business o History of plaintiff’s ability to achieve budgets and forecasts o Who specifically prepared budget/forecast and for what purpose 33
  33. 33. Estimating Future Profits  Sales of identified lost customers  The experience of other comparable businesses, locations, business units or divisions  The defendant’s subsequent experience (i.e. sales, customers that were taken)  Industry averages/trends (i.e., yardsticks) • Recovery of lost profits are limited to the loss period 34
  34. 34. Measurement Date • Lost profits occur over time but are quantified at a date certain:  Dating back to the wrongful act (ex-ante)  Dating to trial date (ex-post) • If ex-ante, all lost profits are discounted to the date of the wrongful act  Often cannot use information unknown until after the wrongful act  Some jurisdictions will allow pre-judgment interest – bringing the value forward to judgment date  Some states require an ex-ante analysis 35
  35. 35. Measurement Date • If ex-post, past lost profits during the loss period up to the date of the trial are accumulated to the trial date and future lost profits during the loss period subsequent to the date of trial are discounted to present value  Usually information known after the date of the wrongful act but prior to trial can be used  Accumulation of lost profits to trial date may require interest 36
  36. 36. Interest • Pre-judgment interest: bringing lost profits to the date of judgment  May or may not apply depending on jurisdiction and relevant statutes • Post-judgment interest: bringing the lost profits to the date of payment subsequent to the judgment  Accounts for time-value of money until payments are made • Choosing the right interest rate:  Basis: the rate that would compensate the plaintiff appropriately  Risk vs. required rate of return: principle that investors require higher return for higher risk 37
  37. 37. Interest and Risk Profiles • Statutory: lowest risk profile • Yields on U.S. Treasury Securities: risk free • Prime lending rate: low risk • Company’s average cost of borrowing: lost risk • Company’s weighted average cost of capital: risk profile depends on risk of company • Company’s cost of equity (required rate of return of investors in company): high risk • Risk factor relative to the risk inherent in projection: highest risk 38
  38. 38. Other Issues • Risk adjusted lost profits vs. risk adjusted discount rates  Adjusting lost profits to a riskless stream or “certainty equivalents”, then discounting at the risk-free rate  Risk-free rate implicitly includes “real” rate of return and expected inflation  Adjusting discount rate for the perceived risk in the lost profits rather than the lost profits stream 39
  39. 39. Other Issues • Methods of estimating risk adjusted discount rates  Risk vs. required rate of return  Capital asset pricing model  Build-up model • Present value factors  Stub periods  End of period vs. mid-period discounting  Seasonality adjustment o 40
  40. 40. Taxation • Compensatory damages are generally taxed as ordinary income to the party receiving the damages  Damages calculations are usually prepared with pretax lost profits and discounted using after-tax discount rates o This methodology leaves the plaintiff whole after the payment of taxes on the damages award  Alternatively, the lost profits could be determined on an after-tax basis, discounted and then grossed up for the taxes that will be paid on the awarded damages  Both methods result in the same amount and leave the plaintiff in the position he/she would have been there had there been no wrongful act 41
  41. 41. Lost Profits Claim Defenses • Causation  Must be causal link between wrongful act and damages  Did plaintiff’s acts cause damage or contribute to the damage – negligence  If more than one act caused the damages, the lost profits should be quantified separately for each act to the extent possible 42
  42. 42. Lost Profits Claim Defenses • Lack of attempt/effort to mitigate  Plaintiff has an obligation to make an effort to mitigate damages  Cannot recover damages where the loss was foreseeable and could have been avoided without undue cost  Cannot recover lost profits beyond the period that would reasonably be required to recover (no windfalls)  Reasonable expenses incurred in attempts to mitigate are recoverable • Maximize avoided costs, maximize lost “net” profits • External factors responsible 43
  43. 43. About the Faculty 44
  44. 44. About The Faculty Beth Rubin - Beth Rubin, CPA is a Managing Director at Ankura based in New York. Beth is a certified public accountant and has more than 17 years of experience in assisting clients with complex damages, accounting, and financial matters. Beth provides litigation advisory services and specializes in calculating damages and performing financial analysis relating to breach of contract and intellectual property disputes. She has assisted both plaintiffs and defendants in determining lost profits, price erosion, reasonable royalty, and unjust enrichment. Beth has performed financial analyses relating to profitability, first-mover advantages, market value, manufacturing and marketing capacity, allocation of costs, licensing terms and royalties, and projections and forecasts within the insurance, food & beverage, oil & gas, consumer products, hospitality, fashion & apparel, pharmaceutical and medical technology, financial, and publishing industries. Beth also has significant experience relating to royalty compliance, purchase price disputes, valuations, and accounting and financial reporting. Prior to joining Ankura in 2015, Beth was a senior director at FTI Consulting from 2003-2015. 45
  45. 45. About The Faculty Michael D. Pakter - Mr. Michael D. Pakter has 40 years of experience in accounting and forensic accounting, business economics and investigations in numerous industries and diverse engagements, including more than 20 years of experience in economic damages and business valuations. He has participated in public hearings and alternative dispute resolutions, submitted expert reports in several jurisdictions and testified in arbitrations, regulatory proceedings and litigated disputes. State, Federal and Bankruptcy Courts, as well as arbitral bodies, have recognized him as an expert in accounting, financial analysis, forensic accounting, economic damages, business valuation and business economics. Mr. Pakter is a Certified Public Accountant (“CPA”), registered and licensed in the State of Illinois. The American Institute of Certified Public Accountants (“AICPA”) has recognized him as additionally Certified in Financial Forensics (“CFF”) and Management Accounting (“CGMA”). He can be reached at312.229.1720, or via 46
  46. 46. About The Faculty Richard Claywell - Richard is a practicing Certified Public Accountant, and holds the additional designations of Accredited in Business Valuation, Accredited Senior Appraiser, Certified Business Appraiser, International Certified Valuation Specialist, Certified Valuation Analyst, Certified in Merger & Acquisition Advisor, Master Analyst in Financial Forensics, Certified in Fraud Deterrence, Accredited in Business Appraisal Review. Richard has been valuing closely held companies since 1985. Richard’s practice is restricted to business valuation, economic damages, profit enhancement and exit planning. Richard received his Bachelor of Science in Accounting in 1979 from the University of Houston – Clear Lake. He then received certification as a Public Accountant in 1983. Over the years, Richard has earned additional accreditations that relate to business valuations, economic damages and fraud. Richard has been an instructor for the National Association of Certified Valuation Analysts for many years, has been an instructor for the Internal Revenue Service and the International Association of Consultants Valuators and Analysts (IACVA). Richard is currently the Director of Education for the IACVA and is responsible for the business valuations materials being taught in 55 countries. Richard has taught business valuation or economic damage courses in China, Korea, Taiwan. Richard has performed over 1,000 business valuations since 1985. Richard has testified in Texas County Court, Texas State Court, Bankruptcy Court and Texas State Courts. Richard has given testimony in economic damages (lost profits), shareholder disputes, personal injury, wrongful termination and divorce. 47
  47. 47. About The Faculty Don May - Don May is Managing Partner at DMA Economics LLC and possesses over 30 years’ experience in consulting, valuation and litigation support as well as researching, publishing and teaching at the university level. His experience includes implementing a broad range of damage analyses and valuations for businesses of various sizes and in numerous industries. Prior to founding DMA Economics LLC, Dr. May was Managing Director at Berkley Research Group and the Principal in charge of valuation and litigation support services for a regional accounting firm, a Managing Director for PricewaterhouseCoopers and a professor at the Massachusetts Institute of Technology - Sloan School of Management. Dr. May has prepared expert reports and testified in federal and New York state courts as well as AAA and FINRA arbitration hearings and has also effectively worked as an expert witness consultant in several multi-million dollar cases. 48
  48. 48. Questions or Comments? If you have any questions about this webinar that you did not get to ask during the live premiere, or if you are watching this webinar On Demand, please do not hesitate to email us at with any questions or comments you may have. Please include the name of the webinar in your email and we will do our best to provide a timely response. IMPORTANT NOTE: The material in this presentation is for general educational purposes only. It has been prepared primarily for attorneys and accountants for use in the pursuit of their continuing legal education and continuing professional education. 49
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  50. 50. About Financial Poise 53 Financial Poise™ has one mission: to provide reliable plain English business, financial, and legal education to individual investors, entrepreneurs, business owners and executives. Visit us at Our free weekly newsletter, Financial Poise Weekly, updates you on new articles published on our website and Upcoming Webinars you may be interested in. To join our email list, please visit: