A Nice Niche - If You Minimize Liability Risk

CPAs can protect against malpractice claims by being prepared ... and putting it in a letter. When opportunity knocks, a CPA may want to check what's out there before answering the door. The good news is that increased activity in estate planning, succession planning and mergers or acquisitions involving small to midsize businesses has fueled client demand for business valuation (BV) services in recent years. A small number of CPA firms specialize in performing BV engagements, and for the many firms considering the risks and rewards of tackling this niche as a new practice area others' missteps can provide valuable life lessons. Data on malpractice claims made against CPA firms arising from disputed valuations offer a roadmap for avoiding trouble spots. Culled from 1995-1999 claims for more than 22,000 firms insured with Continental Casualty Co. (CNA--underwriters of the AICPA's professional liability insurance program), the data highlight a scenario that's easy to avoid. Most of those claims arose from a tax planning, management advisory or other consulting engagement that had morphed into business valuation in mid-transaction at the client's request. In such cases, business owners ready to sell their companies--and comfortable with their CPAs--had pressed the firms for BV assistance, regardless of whether the CPA was experienced in valuation. Firms with insufficient training to perform the BV let themselves be coaxed into it by the client's assurances the CPA's knowledge of the business was the ideal qualification for the job. In instances involving the valuation of a closely held business, CPAs said they were caught unexpectedly, with no sense of a problem during the engagement. In other claims, the CPA accepted his or her first BV engagement because the client insisted the valuation was only a formality for a simple transaction already agreed on by buyer and seller. WHERE IS THE RISK? The data show malpractice claims arise from disputed valuations of service-based businesses more often than from manufacturing or retail businesses (see exhibit 1, page 50). Because service-related businesses have more intangible assets that contribute to goodwill, valuing them appropriately is critical to avoiding post-transaction disputes. [Exhibit 1 ILLUSTRATION OMITTED] Key employees, an established client base or a proven track record of providing high-quality service are the basis of goodwill for all business sectors. How to factor such intangibles into the overall valuation is a point of contention in a number of claims. In many businesses, goodwill is tied directly to the owner's involvement in managing the company as well as his or her relationships with the business's clients and vendors. When the owner leaves the business the relationships exit too, and the nature of the company changes. It's then that disputes between buyers and sellers can crop up. The predominant allegations in BV claims are over- or undervaluation of assets or liabilities directly affecting the dollars paid or received (see exhibit 2, page 51). Other disputes may be categorized as [Exhibit 2 ILLUSTRATION OMITTED] * Communication problems. These relate to engagement-scope disputes, primarily over the extent of the CPA's role in negotiations between buyer and seller. * Conflicts of interest. Problems typically arise when a CPA neglects to disclose up front that both parties to the prospective transaction are the CPA's clients. In such situations the claimant may allege that, based on previously rendered tax or accounting services, the CPA had enhanced knowledge of the business being valued and purposely omitted relevant information to benefit the other client. * Alleged fraud. These usually assert the CPA had an undisclosed financial interest in a business and benefited from a sale based on the CPA's valuation. THIRD-PARTY CLAIMS Surprisingly, third parties rather than clients filed 30% of the BV engagement claims in our data sample. …