Reporting of Business and Property Appraisals for Bankruptcy Purposes
Many experienced analysts believe that reporting, and particularly report writing, is the most important part of the bankruptcy appraisal process. However, in practice, reporting the results of the valuation or economic analysis is often afforded precious little time and attention. Many analysts focus their time and attention on comprehensive research regarding industry and trans-actional data and on the rigor and sophistication of their applied micro-economics procedures. This statement does not imply that such time and attention are not important to the quality of the analysis. Rather, this implies that many analysts do not adequately consider the reporting of the results of their research and analysis until they already have exhausted their time or other resource budgets.
As a practical shibboleth, reporting the results of the appraisal is as important as performing the analysis. This assertion is true regardless of the form or format of the report. That is, this assertion applies equally to a verbal report (including expert witness testimony) and to a written report. It applies equally to a limited and a comprehensive report. If the report is confusing, misleading or incomplete, then the analysis has failed. This is true regardless of the rigor, sophistication or elegance of the analytical models used. And, this is true regardless of the relative or absolute correctness of the analysis. If the report audience (i.e., reader or listener) is confused, cannot follow the logic of the presentation or does not believe the presented results, then the analysis has failed. The results of the analysis may be 100 percent "right," but that "rightness" doesn’t matter if the report fails to effectively communicate the results of the analysis to the intended audience.
USPAP Reporting Standards
There is no specific statutory, judicial or regulatory requirement with regard to the format of a bankruptcy-related appraisal report. Even the Uniform Standards of Professional Appraisal Practice (USPAP) provide for a number of different report formats. Therefore, even under USPAP, the analyst may select the reporting format that is the most appropriate to the particular assignment. However, it is noteworthy that USPAP does require certain disclosure requirements even under the most abbreviated reporting format.
USPAP dictates minimum standards to be applied in all types of appraisal reports. These standards are somewhat specific to the type of property subject to appraisal. There are slightly different reporting requirements related to real property appraisals, to personal property appraisals and to business and intangible asset appraisals. In addition, there are certain standards that apply across the board to all types of appraisal reports. USPAP defines the term "report" broadly, as follows: "any communication, written or oral, of an appraisal, review or consulting service that is communicated to the client upon completion of an assignment."
USPAP does not specify the particular form of format of a bankruptcy-related appraisal report. For instance, USPAP does not specify a minimum number of pages or exhibits for a written report. Likewise, USPAP does not indicate that a written bankruptcy appraisal report must be in the form of a narrative report, as opposed to a memorandum or letter form. Of course, given the disclosure and representation requirements of USPAP, any memorandum or letter report would likely be several pages in length.
USPAP does provide for several alternative formats of written reports with regard to real property appraisals. These specific report format types are not mentioned at all in the sections of USPAP related to personal property, business or intangible asset appraisals. Therefore, they are not binding with regard to appraisal reports of these type of properties. Nonetheless, the three types or formats of real estate appraisal reports are informative to appraisers of any type of property. This is because such reports can be easily adapted to any bankruptcy-related appraisal reports.
USPAP defines the following three types or formats of real estate appraisal reports:1) self-contained appraisal report—a written report prepared under Standards Rule 2-2(a) of a complete or limited real estate appraisal; 2) summary appraisal report—a written report prepared under Standards Rule 2-2(b) of a complete or limited real estate appraisal; and 3) restricted appraisal report—a written report prepared under Standards Rule 2-2(c) of a complete or limited real estate appraisal.
USPAP Standards Rules 2-2(a), (b) and (c) each list 12 disclosure and representation requirements related to each of these three types of real estate appraisal reports. The principal difference between the self-contained appraisal report and the summary appraisal report relates to the level of detail in the presentation of the disclosure provisions. The principal difference between the restricted appraisal report and either the self-contained or the summary appraisal reports is the inclusion of a use restriction that limits the reliance of the appraisal report to the named client. The restricted appraisal report considers anyone else using the report (other than the named client) to be an unintended user.
Bankruptcy Appraisal Reporting Guidance
The following paragraphs present general guidelines to assist the analyst in the preparation of clear, cogent and convincing bankruptcy-related valuation or economic analysis reports. These guidelines do not correspond specifically to USPAP, to American Society of Appraisers promulgated standards or to any other authoritative professional requirements. Rather, they are common sense rules, based upon years of practical experience related to communicating (and, in some cases, miscommunicating) appraisals for bankruptcy purposes. The first general reporting guideline is arguably of biblical significance. While it may seem unambiguously obvious once it is articulated, all analysts should remember these two simple rules related to reporting the results of their analyses: 1) do what you said, and 2) say what you did.
Obviously, all statements made in a written or oral report should be true to the best of the analyst’s understanding. Each statement or assertion in the report should be associated with a documented research or analytical procedure. The report should not state (or even imply) that a document was reviewed, some research was con-ducted, a method was considered, a variable was estimated, a transaction was analyzed, a number was calculated, etc., if that statement (or implication) is not true. Analysts tend to bend (if not break) this rule most often when it comes to the support for the various input variables used in their analyses (e.g., growth rates, prospective price/volume/cost relationships, profit split allocations, etc.). Some analysts attempt to justify such variables with unidentified (and unperformed) research or with years of experience (unsupported by any empirical evidence). However, in truth, those variables may have been suggested by the client, projected in a company document or merely assumed. If that is the case, the analyst should simply state the actual source of the variable and not imply support that does not exist. Likewise, the analyst who faithfully describes each procedure that was performed will generally produce a complete and comprehensive report. It is disconcerting to the report audience when the analyst performed procedures that are not described. The typical reaction of the report reader is, "How did the analyst get here from there?" When procedures appear to be missing (even if they were actually performed), the credibility of the report—and the reported conclusion—may suffer.
The following 10 reporting guidelines are not inscribed in stone tablets. However, they are useful with regard to the preparation of the report of the bankruptcy-related valuation or economic analysis. These guidelines should be equally useful to experienced as well as neophyte analysts.
1) Analysts should avoid the use of "mystery" variables. These are variables that mysteriously appear in the report text or in the analytical exhibits. There is no empirical evidence or analytical procedure presented to support such variables. The report reader is left to wonder where a particular variable came from. The use of unsupported "mystery" variables often undermines the credibility of an otherwise sound analysis.
2) Analysts should avoid the use of mystery data. These are data for which the report presents no citation or other data source. Clearly, the source of significant data elements (e.g., inflation rates, risk-free rate of return, capital market performance indices, etc.) should be referenced. And, the references should be specific enough so that the reader can verify the subject data. For example, the phrase "economists’ consensus of the near term inflation rate is three percent" would not qualify as an adequately supported data source reference.
3) Analysts should avoid the use of vague or ambiguous statements. If the report reader has to ask "What does the analyst mean by this statement?," then the report has failed to adequately communicate the analysis. Often, a vague statement in a report can be more misleading than a factually incorrect statement. This is because the reader can check and correct an incorrect fact. However, the reader may never know if he or she has simply misinterpreted a vague or ambiguous statement.
4) Analysts should avoid the use of superfluous narrative. This sometimes occurs when the report includes generically prepared "boilerplate" descriptions of data sources or analytical procedures. This also occurs when the analyst has attempted to "cut and paste" narrative sections of previous reports for insertion in the subject report. All statements should have a purpose in the report. And, it should be fairly obvious where and how each statement or data element is used in the analysis. If the reader has to wonder "where (or how) does the analyst use this statement (or data element) in the analysis," then the report will not be clear, convincing and cogent.
5) Analysts should include an analysis of the historical results of financial performance related to the subject business or property. Such an analysis is clearly appropriate if the subject property is, itself, an income-producing asset. This would be the case with a property that generates lease, license, royalty or other income. Such an analysis is also appropriate if the subject property is directly associated with an income stream, such as historical revenues (e.g., for a trademark), historical production volume (e.g., for a product patent), or historical cost savings (e.g., for a proprietary process technology). It is informative for the report reader to understand the historical results of financial performance of the subject property, specifically if some version of an income approach methodology is used in the subject analysis.
6) Analysts should include an explanation for any adjustments that are made to the historical financial statements or to the historical operational data subject to analysis. It may be entirely appropriate for the analyst to make adjustments to historical financial and operational data. These adjustments may relate to the effects of discontinued operations, excess or non-operating tangible or intangible assets, extraordinary items (including non-recurring revenue, expense or investment items). Adjustments also may be appro-priate to allocate revenues, expenses and profits between or among tangible and intangible assets. However, it is appropriate for the analyst to list and explain any such adjustments in the report. When adjustments to historical detail are either aggregated or not adequately explained, then the report does not allow the reader to recreate all of the appraisal analysis. This use of "mystery" adjust-ments represents a report deficiency, even if all of the adjustments are appropriate and correctly made.
7) Analysts should ensure that there are no inconsistent valuation variables used in alternative analyses or presented in different pages of the report. For example, without a very convincing explanation, it would be inappropriate to use different present value discount rates or different expected growth rates in alternative analyses of the same property. It is also inappropriate to use related valuation variables that are internally inconsistent with each other. For example, without a very convincing explanation, it would be inappropriate to derive a yield capitalization (present value discount) rate of 18 percent and an expected long-term growth rate of five percent, and then use a direct capitalization rate of 10 percent. Assuming they all apply to the same measure of economic income, a yield capitalization rate of 18 percent less an expected growth rate of 5 percent math-ematically indicates a direct capitalization rate of 13 percent. Such inconsistencies (especially if unexplained) cause the report reader to doubt the credibility of the analysis.
8) Analysts should ensure that there are no inconsistent valuation variables presented between the analysis and the report. If a certain variable is derived in the report narrative, then it should be used in the quantitative analysis, and vice versa. For example, if a 30 percent profit split allocation is derived in the report narrative, then a 30 percent profit split (and not a 25 or 35 percent profit split) should be used in the analysis. It is particularly confusing to the report reader if one figure for a valuation variable is derived on page 18 of the report and a different figure of the same valuation variable is used in the analysis presented on Exhibit III, for instance, of the report.
9) Analysts should avoid using undefined terms and different terms with the same meaning or definition in the report. Analysts also should avoid defining the same term two different ways in different sections of the report. The jargon of property valuation and economic analysis is confusing enough for most report readers. The analyst should avoid making the report more confusing with the use of inconsistent or imprecise language. Lastly, analysts should avoid creating their own glossaries. There is a fairly well accepted lexicon with regard to appraisal terminology. It is usually unnecessary (and generally confusing to the report reader) for the analyst to create a new vocabulary of terminology.
10) The most common report writing error is to present the analytical conclusions without any supporting logic. Analysts should avoid the use of these "leap of faith" conclusions. These conclusions are usually followed by the word "therefore:" "therefore, the royalty rate is...;" "therefore, the remaining useful life is...;" "therefore, the amount of the damage estimate is..." Ideally, the analytical conclusion should be presented with the logical rigor and inescapable certainty of a mathematical proof. Of course, this is not always the case. There is a fair amount of professional judgment involved in most bankruptcy-related appraisal analyses. However, if the report reader cannot follow the analysis from points A to B to conclusion C, then the conclusion is not adequately supported.
These guidelines should help the analyst communicate the analyses related to and the conclusions of the business or property valuation or economic analysis efficiently and effectively.
These guidelines are intended to help make the report presentation clear, convincing and cogent. However, analysts should be aware that there is sometimes a fine line between being convincing and being an advocate. Analysts should consider that, if the analyses are rigorously prepared and thoroughly documented, then the conclusions will be convincing without the report having to be an advocacy document.