Defensible Business Valuation for Litigation in Egypt

The valuation opinion could be based on a financial analysis carried out to facilitate a transaction, establish an ownership value, evaluate damages, or settle commercial disputes; however, the nature of such valuation opinion undergoes considerable change when the valuation is scrutinized in court. Here, the issue is no longer about the reasonableness of the valuation figure generated; it is about whether the expert witness is able to prove how he arrived at that figure and why the underlying analysis is reliable. The methodology, financial data, market facts, assumptions, adjustments, professional judgements, and documentation could all be reviewed and attacked. In Egypt, extra care needs to be taken here because the professional qualifications and regulations needed for a regulated financial valuation may not be the same as the procedural process required for expert testimony in court. The Financial Regulatory Authority (FRA) has professional classifications of independent financial advisors and accredited financial valuers where professional licenses are obtained through professional examinations, professional codes, and ethics, and there are also standards of financial valuation of enterprises in Egypt.

Internationally recognized standards such as the International Valuation Standards (IVS) can provide an additional professional framework for the conduct, documentation and reporting of valuation work, but the applicable Egyptian legal and regulatory requirements remain fundamental to an Egypt-focused assignment.

The Egyptian Framework

The defense of a valuation in the Egyptian setting begins with an appreciation of the regulatory and legal setting within which the valuation is carried out. With regard to capital market activities, FRA assumes significant importance in licensing and regulating various professionals such as Independent Financial Advisors and Accredited Financial Valuers. FRA has also confirmed that those firms of financial advisers which have been duly registered to carry out financial valuations and fair value studies are expected to conform to the Egyptian Standards for Financial Valuation of Enterprises. However, the professional requirements to carry out a regulated valuation and the procedural capacity of a valuation professional in relation to his participation in judicial proceedings are two separate issues. Therefore, merely because a person holds a registration, license or accreditation from FRA does not mean that he or she can claim the status of a court expert. The defense of the valuation in the context of litigation is not only contingent upon the professional qualifications possessed by the individual but also the purposes of the assignment and the procedural requirements to participate in the process of adjudication.

Why Egyptian Valuations Require More Than a Standard Model

The economic environment of an Egyptian company is capable of creating valuation issues that need special professional judgement. The inflation rate, fluctuations in the foreign exchange rate, access to and the cost of foreign currency, interest rate fluctuations, country and sovereign risks, and differences between book and economic value are some of the factors which could have a material impact on the valuation of the business. Such factors can affect revenue projections, operating margins, working capital needs, capital expenditures, discount rates, terminal values and multiples. It is more difficult for private businesses, family-owned businesses or businesses with related party transactions in that the quality and comparability of the available information may be different from listed and highly-regulated companies.

Also, the lack of truly comparable listed companies and precedent transactions makes the application of the Market Approach more judgmental. In a contentious valuation situation, it is not enough to incorporate such issues in a model without any supporting evidence. The expert will need to prove why certain assumptions were chosen and what the basis for making these assumptions was. This is because of the trend in the IVS towards valuation risk and data quality issues.

Financial Statements and the Five Tests of Defensibility

The quality of a valuation opinion is highly dependent upon the quality and interpretation of the information underlying it. Past financial information may form the basis of a valuation, but it is not always an indication of sustainable economic performance of the business. A court-ready valuation, thus, would call for adjustments to account for non-recurring income and expenses, normalizing the earnings, evaluating any related party transactions, looking at any abnormal changes in working capital, spotting any liabilities that resemble debt and contingency items, among others. Such adjustments can directly influence the Discounted Cash Flow forecast, EBITDA multiples, net asset value, and cost of capital. A useful method of evaluating the quality of the resultant opinion would be the use of five interrelated tests. The test of Authority is about whether the expert is adequately qualified and working in accordance with the pertinent laws and regulations of Egypt; The test of Evidence involves checking whether material inputs can be sourced to their origin; Methodology checks if the chosen methodology is suitable in terms of the purpose and context of the valuation; Judgment checks if the assumptions made and the adjustments used are sensible, independent and sufficiently justified; and Communication checks if the valuation result can be adequately explained to the users, who may not necessarily be specialists in valuation. These tests help shift the emphasis from the valuation result to the valuation process.

Building the Evidence Behind the Opinion

Documentation is what bridges the opinion to its support. A sound opinion must clearly document the analytical process regarding the use of financial information, the source of the market data, the selection and adjustment of the comparable firms, the management forecast, the model, the assumptions for the discount rate, the terminal value, material adjustments, sensitivity and professional judgments. In case the management forecasts serve as input, it should be possible to validate them against the historical results and the supporting evidence from outside. When market multiples are used, the choice of comparable firms or transactions needs an explanation as well as any necessary adjustments for the relevant differences. The same applies to the cost of capital and the other market-based inputs, especially when interest rates, inflation and exchange rates are all in change. IVS gives a great importance to documentation and communication. Valuation work must be documented in such way that it is transparent about approaches, methods, inputs, models, professional judgments and valuation results. The goal is not to produce unnecessary documentation, but to make sure that the analysis can be independently reviewed and understood with all the limitations and uncertainty involved.

The Skills and Credentials of a Court-Ready Valuation Professional

A valuation specialist dealing with court business has a greater range of skills that extend far beyond constructing a financial model. Advanced valuation skills still form an essential part of those skills, such as DCF, Market Approach, multiples, asset and NAV approaches, cost of capital, control and scenarios. These should be supplemented with skills in financial statements analysis and forensic finance, which will help the expert to make adjustments, detect peculiarities of transactions and other aspects that can influence the sustainable value. Knowledge of Egyptian accounting, regulation and industry is required where the valuation subject is regulated by some specific system. Moreover, the knowledge of the macroeconomic environment of Egypt, including inflation, exchange rate changes, country risk, interest rates and market liquidity, is necessary for the valuation process. Apart from the technical knowledge, an expert prepared for the court should have skills in managing the evidence, maintaining independence, resolving conflicts and exercising professional skepticism, and writing a report that explains the results of complex financial analysis in understandable terms.

Oral presentation and examination techniques are just as crucial: the expert needs to have the capability to justify the approach and defend his or her professional opinions without turning into an advocate of the side that hired them. Licensing and accreditation under FRA can be considered in case the assignment involves one of the regulated activities, whereas internationally recognized credentials of CFA, ASA, ABV, CVA, RICS and accounting qualifications can provide additional support to professional standing depending on the nature of the assignment. At the same time, such credentials cannot be substituted for legal/procedural procedures involved in appointment of experts in Egypt, and their value lies in combination with practical experience, independence and sound judgment.

Conclusion

The reason why the valuation opinion is defensible in court is not due to the fact that the process yields one single number, but rather that the expert is able to explain why and how the estimate was made and how the reasoning behind the estimate makes economic sense. The defensibility of the opinion depends mainly on the congruence between the purpose and basis of value, quality of financial data, methodology used, the reliability of market data, materiality of assumptions made, and independence of professional judgment. In Egypt, there is another layer of complexity that needs to be considered in the valuation process. The valuation expert must be knowledgeable about both international valuation standards, including IVS when applicable, and the local regulations in Egypt for valuations. In case of valuation being a part of any of the regulated activities, the requirements stipulated by FRA as well as the standards of Financial Valuation of Enterprises in Egypt should be taken into consideration along with the requirements pertaining to the use of expert opinions in court cases in Egypt. Credibility and expertise, however, do not fully define the role of a valuation expert in the contentious situation. The real criterion is the ability of each assumption, adjustment and decision concerning methodology used to be supported by some kind of evidential basis and logical argumentation independently. In such a case, the whole valuation process becomes an expert opinion able to assist in decision making and, in case of necessity, the court, despite the disputed value.

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