For business appraisals in commercial litigation cases, it is important to understand the difference between lost profits and lost value. Though both are important aspects to consider when calculating damages, they have distinct differences.
What Makes These Two Calculations Similar?
In many ways, these two measures are more like brothers than cousins, sharing many of the same ideologies. The crux of calculating lost profits includes the projection of future income streams and then deriving the present value of that income stream utilizing a discount rate appropriate for the subject company. The focus of the damage calculation will be placed on the disparity between the profits that would have been realized (if not for the event that caused the damage) and the profits that were actually realized. This disparity can continue for an extended period after the date of the event or even indefinitely. One key factor to keep in mind is mitigating factors. The party who realized the damages has an obligation to attempt to mitigate, or lessen, their damages. This mitigation then reduces the calculated damages owed to the damaged party.
When a company experiences lost business value, which is typically utilized to measure damages when a business is destroyed, similar methodologies are utilized. Valuation specialists utilize multiple methods when appraising a business, one of which includes the income approach, which is based upon the expected future cash flows of the company. When this method is utilized, we find that calculating lost business value is like calculating lost profits. One distinct difference between the two, however, is that calculating lost business value is typically reserved for when a business loses all its profits, not just a portion.
An example of where a loss of business value might be appropriate without the loss of the entire company would be if there is permanent injury to the business’ operation such as if the business suffered a permanent loss of a product line or division within the company. In this instance, a business appraiser would determine the value of the company at the damage date based upon typical operations and then also calculate the value of the company at the damage date considering the permanent loss of that product line or division. The difference between the two values would be the damages amount. As with lost profits, mitigating factors would also need to be considered in the post damage valuation.
What Makes These Two Calculations Different?
Though the two measures might be brothers, they are not identical twins. There are specific aspects to these two calculations that make them distinctly different from one another. In many cases, lost profits are constrained by time, which means that the damages are limited. This could mean that the damages are related to a contract period. It could also mean that there is a foreseen point in the future where the damaged company will return to normal operations. However, lost business value considers the fact that the loss incurred will continue into perpetuity.
Another key aspect that can result in vastly different results is identifying parties. Under the definition of fair market value, a business appraiser will conduct a valuation considering a hypothetical buyer. When calculating lost profits, however, the analysis is typically performed from the plaintiff’s perspective. These two differences in perspective can result in significant differences regarding risk and, therefore, vastly affect damage estimates.
Another stark difference between the two calculations is what is known at the time of damage. In valuation, only facts known or knowable at the valuation date (typically the date of damage) can be considered. This ignores anything that transpired from the valuation date and the date of trial. When it comes to lost profits, consideration of these subsequent events would be utilized in determining damages.
Am I Entitled to Recover Both?
In short, the answer is yes. However, it is important to remember that if you utilize both calculations, there can be no overlap in time. An example of this might be a business suffering lost profits for a short period following the defendant’s wrongful conduct but prior to the court date, the damaged company suffers a permanent loss of that product line or department. In this instance, it may be appropriate to recover lost profits for the initial period and lost business value as of the date the damage becomes permanent.
Damage Control
Understanding the similarities and differences between these two approaches is key to success. Engaging a professional who is familiar and experienced in both business valuation and damages calculation can prove to be extremely beneficial in assisting the plaintiff in navigating the pitfall of the potential overlap in the damages calculations.
To learn more about these two methods or to talk to someone about your particular case, please contact Matt Stelzman.
