Robert B. Dickie is the founder of The Dickie Group, which provides training in finance and accounting to most of the country’s leading law firms and to the in-house legal departments of numerous Fortune 100 companies. Peter R. Russo, retired from the Boston University Questrom School of Business in 2017, where he served for 15 years as Executive in Residence and Senior Lecturer. During that time, he served terms as the Faculty Director of both the Entrepreneurship Program and the Executive MBA Program. Bob and Pete have just published their third edition of Financial Statement Analysis and Business Valuation for the Practical Lawyer. Bob and Pete offer their insights and expertise on financial statements and business valuation.
Question: Since you wrote the first edition of your book, how has financial statements and valuation changed?
Answer: In the two decades since Bob wrote the first edition, there have been substantive changes in both how the financial statements are generated and how they are used. A series of accounting scandals, the most famous of which was the Enron case in 2001, led to an increased skepticism about reported earnings and a call for more accountability from management. The accounting profession and the Securities & Exchange Commission have responded and today management is held to a much higher level of accountability than was previously the case.
During this same period, the U.S. Generally Accepted Accounting Principles (“GAAP”) that drive the rules management must comply with in financial reporting, have been changing to be more consistent with the International Financial Reporting Standards (“IFRS”), as part of a long-term convergence project. While this process has taken longer than initially anticipated, GAAP is undeniably moving toward the time when a single set of rules will be applied globally. For example, in recent years, we have substantially revised the way that companies record revenue and account for lease obligations.
At the same time, users of financial statements have become more sophisticated. It is not uncommon to see companies measured by a more complex set of metrics than were once used.
Question: For the lawyer approaching financial statements and valuation, how much understanding does he or she need to understand of accounting issues?
Answer: The key to answering this question lies in how the lawyer provides value to his/her client. Sometimes the lawyer provides this value by answering the client’s questions, but often she can provide greater value by offering answers to the questions a client did not know to ask. Doing this does not necessarily require a deep knowledge of the accounting and reporting rules, nor does it require a great deal of finance expertise. What is needed is a basic understanding of how the numbers are generated, what information they do and don’t contain, and a sense of how the numbers are used. Of equal importance is an understanding of the motivations of management—what the client is trying to achieve with a transaction or strategic decision, and management’s biases in reporting. Armed with this level of expertise, the lawyer is able to work closely with the client to help achieve its goals.
Question: You both do an excellent job in describing valuation—when it comes to valuation and valuing a company, what are the most common mistakes made?
Answer: Perhaps the biggest misconception we see when discussing business valuation is that some people treat the question as one with a single correct answer. The value of any company is likely to vary based upon who the potential buyer is and what strategies they will be able to employ if they acquire the company. That is why we often see valuations expressed in ranges and calculations of value shown using multiple methodologies. In fact, in a business valuation, the methodologies employed often convey as much information as the numbers calculated. The process of valuing a company can help identify the drivers of value, call attention to key unknowns, and raise important questions which are worthy of attention.
Another common problem we see in business valuation is the lack of understanding of the limitations of some of the methodologies that are commonly used today. There is no “prefect formula” for calculating a business’ value and all of the methods used have their strengths and limitations. For example, if a business is being valued by comparing its performance to a group of comparable companies, it is critical to understand whether and in what ways the companies are truly comparable.
Finally, let’s keep in mind that valuing a start-up biotech company is much more difficult, and likely to yield a much wider range of possible valuations, than, for example, an apartment building in a prosperous neighborhood with a stable rent roll.
Question: This is a very daunting area of the law. How do you keep abreast of all the changes in both?
Answer: Certainly, reading about current events and trends is an essential part of staying current. But perhaps the most important skill is to stay intellectually curious. Conversations with others who find this space interesting can yield important new insights. And especially, when we see or hear of something that seems strange or unusual, seeking the story behind that phenomenon is a great way to continue to learn.
Question: Besides a business lawyer, what other types of lawyers would benefit from this book? Additionally, are there other professionals besides lawyers who would find this book useful?
Answer: Lawyers who work with estates certainly have a need to understand the concepts we discuss in this book, in that the assets that they are asked to advise their clients about are often investments in companies. This is particularly true if the assets include interests in privately owned companies, especially if they are minority interests. The knowledge might well also be useful for litigators handling securities cases, measurement of damages situations, or earn-out matters.
Other than lawyers, we think that this book can be extremely valuable to individuals who may not have business as their education emphasis, but who are making important decisions in companies. This is commonly the case in technology or life science companies, for example, where individuals with a background in science or medicine can rise to the ranks of upper management. We feel that this book can provide some very useful insights to someone like this, especially if an advanced degree in business is not a realistic option at this stage of the career.