Here are some examples of the sin of being overly precise:
1. A business owner wanted me to express the $5.2 dollar value of his firm as $5,205,156 (using my un-rounded weighted average value conclusion). There were 1 million shares outstanding; the difference in per share value was $5.200 versus $5.205 or less than 0.1%!
2. The highly regarded editor of a national business valuation publication as well as a court made a big deal out of a recent case in which experts clashed over the equity risk premium. One used a supply-side estimate of 6.0%, the other the historical average of 7.1%. There was no discussion of the experts’ other assumptions that built up the cost of equity capital (such as the highly uncertain company specific equity risk premium) or their (presumably very different) equity cash flow forecasts.
3. An attorney engaged in unbelievable word-smithing of a valuation report, quarreling over the placement of commas and demanding precision in the estimates of uncertain market data (such as the benchmark for lack of marketability discounts).
4. An accountant reviewing a valuation insisted on applying precise progressive corporate income tax rates to a business that earns over $4 million per year.
This demand for precision completely misses the point that financial forecasts as well as all of the market data we use (except for the risk-free rate on a given day) are inherently uncertain, some enormously so. To insist on precision to the penny per share or 1 basis point in a discount rate is impossible to obtain because of these uncertainties. Values are almost always a range of reasonable values or even a probability distribution, not a single, hyper-precise number (unless they are $0).
Worse, those who insist on over-precision often fail to fully comprehend the significance of major assumptions. For example, in a partnership value dispute where there is no buy-sell agreement, will discounts for lack of control and / or marketability apply? This will have a huge, uncertain impact on the value conclusion!
Even worse, when I work with someone who is obsessed with over-precision, I have yet to be fully successful in persuading them to focus on the big, sensitive issues that have huge value effects, rather than the picayune details. I often feel that I am talking to a brick wall when I bring up the macro versus micro focus.
Even worse, I have no effective response to someone who charges that lack of hyper-precision will risk the credibility of the valuation. I recently completed a draft valuation of a company that, according to my industry comparative financial analysis, performed better than average but not superbly. Using the Direct Market Data Method with a large sample, I therefore assigned the company a 75th percentile (25% of the sample was above and 75% was below the) valuation multiple. The advisors reviewing the draft demanded precise support for the 75% assumption, saying things like “the IRS will never accept that, they will jump on it as a guess” and so forth. They could not believe that there was no formulaic way to justify the percentile, which meant that they really could not accept the necessity of judgment as a supplement to sound qualitative and quantitative analysis.
If you have an effective response, please post it as a comment!