A Nice Niche—If You Minimize Liability Risk

CPAs can protect against malpractice claims by being prepared…and putting it in a letter.

  • INCREASED ACTIVITY IN ESTATE and succession planning and mergers or acquisitions involving small to midsize businesses has fueled demand for business valuation (BV) services. BV malpractice claims arise most often from a tax planning or consulting engagement that—at the client’s request—morphs into a BV in mid-transaction.
  • THE PREDOMINANT ALLEGATIONS IN BV CLAIMS are over- or undervaluation of assets or liabilities directly affecting the dollars paid or received. Service-related businesses have more intangible assets that contribute to goodwill than manufacturing or retail businesses do.
  • THE BEST SAFEGUARD AGAINST BV DISPUTES is an engagement letter specific to the project that defines its scope, briefly explains the different valuation approaches and methods that can be applied to a BV, and identifies those being used. Draft a customized letter for each engagement before any services are rendered.
  • BV PRECEDENT FOR STANDARD VALUATION methods was established through common usage and case law. Consult a lawyer when drafting a BV engagement letter.
  • DISCUSS THE PROVISIONS of the engagement letter in a face-to-face client meeting to address any client questions. Document this discussion in the client workpaper file. The absence of an engagement letter can compromise the defense of a claim if a dispute develops.
  • VET A NEW CLIENT THOROUGHLY, and get references for those from outside your geographical area. With existing clients use procedures as thorough as those for a new client. If a conflict exists, don’t take that job.
Joseph A. Wolfe is director of risk management, accountants’ professional liability, at CNA Pro., and Sherry Anderson, CPCU, is vice-president of claims.

hen opportunity knocks, a CPA may want to check what’s out there before answering the door. The good news is that increased activity in estate planning, succession planning and mergers or acquisitions involving small to midsize businesses has fueled client demand for business valuation (BV) services in recent years. A small number of CPA firms specialize in performing BV engagements, and for the many firms considering the risks and rewards of tackling this niche as a new practice area others’ missteps can provide valuable life lessons.

BV engagements generated less than 1% of total billings from 1995 through 1999 but were behind 3% of all malpractice claims—90% of those claims did not result from the services for which the CPA firm originally was hired.

Source: Continental Casualty Co. (CNA)
1995-1999 claims statistics.

Data on malpractice claims made against CPA firms arising from disputed valuations offer a roadmap for avoiding trouble spots. Culled from 1995–1999 claims for more than 22,000 firms insured with Continental Casualty Co. (CNA—underwriters of the AICPA’s professional liability insurance program), the data highlight a scenario that’s easy to avoid. Most of those claims arose from a tax planning, management advisory or other consulting engagement that had morphed into business valuation in mid-transaction at the client’s request.

In such cases, business owners ready to sell their companies—and comfortable with their CPAs—had pressed the firms for BV assistance, regardless of whether the CPA was experienced in valuation. Firms with insufficient training to perform the BV let themselves be coaxed into it by the client’s assurances the CPA’s knowledge of the business was the ideal qualification for the job. In instances involving the valuation of a closely held business, CPAs said they were caught unexpectedly, with no sense of a problem during the engagement. In other claims, the CPA accepted his or her first BV engagement because the client insisted the valuation was only a formality for a simple transaction already agreed on by buyer and seller.


The data show malpractice claims arise from disputed valuations of service-based businesses more often than from manufacturing or retail businesses (see exhibit 1, below). Because service-related businesses have more intangible assets that contribute to goodwill, valuing them appropriately is critical to avoiding post-transaction disputes.

Exhibit 1: Claims by Industry Type

Source: CNA Pro.

Key employees, an established client base or a proven track record of providing high-quality service are the basis of goodwill for all business sectors. How to factor such intangibles into the overall valuation is a point of contention in a number of claims. In many businesses, goodwill is tied directly to the owner’s involvement in managing the company as well as his or her relationships with the business’s clients and vendors. When the owner leaves the business the relationships exit too, and the nature of the company changes. It’s then that disputes between buyers and sellers can crop up.

Exhibit 2: Claims by Cause of Loss

Source: CNA Pro.

The predominant allegations in BV claims are over- or undervaluation of assets or liabilities directly affecting the dollars paid or received (see exhibit 2, above). Other disputes may be categorized as

Communication problems. These relate to engagement-scope disputes, primarily over the extent of the CPA’s role in negotiations between buyer and seller.

Conflicts of interest. Problems typically arise when a CPA neglects to disclose up front that both parties to the prospective transaction are the CPA’s clients. In such situations the claimant may allege that, based on previously rendered tax or accounting services, the CPA had enhanced knowledge of the business being valued and purposely omitted relevant information to benefit the other client.

Alleged fraud. These usually assert the CPA had an undisclosed financial interest in a business and benefited from a sale based on the CPA’s valuation.

A Cautionary Tale

A CPA firm performed bookkeeping, write-up, compilation and business and personal income tax services for many years for two clients. One client owned a small industrial equipment dealership, and the other had a parts-and-service company that specialized in such equipment. Different partners at the CPA firm served each client. In 1990 the owner of the industrial equipment dealership told his banker he wanted to sell his business and retire out of state. The banker knew the owner of the parts-and-service company wanted to expand and suggested that the two meet to discuss a possible sale.

The owners reached an understanding and requested a joint meeting with the two partners at the CPA firm to discuss their arrangement. Both partners told the clients they could not provide advice about the transaction because of the conflict of interest. Each client asked his CPA to disclose company financial records held by the firm to the other party. The CPAs agreed to do this only if both clients signed a letter acknowledging this conflict of interest, waiving any objection to it and stating the CPAs were not providing advice or recommendations on the sale or its terms. Unfortunately, neither the CPA firm nor the clients kept a copy of this letter.

Subsequently the CPA firm provided the requested information to both clients. The firm reviewed the sale contract and advised both parties on the tax consequences of the transaction. The final purchase price was $750,000, with 25% payable up front and a note providing payment of approximately $140,000 per year for four years. The transaction was a stock sale.

Six months later

The transaction soon began to unravel. The seller had failed to report outstanding accounts receivable on some service jobs. The new owners had to renegotiate financing at less favorable terms than those obtained by the prior owner. Cash receipts allegedly received in the two months before the sale were missing when the buyer took over operations, as were maintenance tools and other equipment. The buyer defaulted on the note in the first year, and the seller filed suit to recover. Both parties ultimately agreed to dismiss this lawsuit without payment.

However, the buyer then filed suit against the CPA firm, alleging improper advice regarding the value of the business, a conflict of interest in representing both parties to the transaction and fraudulent concealment. The lawsuit sought recovery of more than $2.7 million. The buyer alleged the CPA firm convinced him to agree to structure the sale as a stock sale rather than an asset sale to increase the company’s value for the seller’s benefit, and that this caused him to overpay for the business and incur excessive taxes. The buyer acknowledged the CPA firm had alerted him to the conflict of interest but said the firm had not been objective. He claimed that if the firm hadn’t told him it was a “good deal,” he wouldn’t have bought the business.

The CPAs said that both parties had agreed to the transaction’s amount and structure before consulting them, and that the firm had advised the buyer to take a physical inventory before closing the sale but the buyer ignored the advice. This case was tried before a jury, which awarded a six-figure judgment to the plaintiff.

Lessons learned from this case study are:

Use careful acceptance procedures with existing clients who request BV services. A client that’s an acceptable risk as a tax and compilation client presents a different level of risk in valuation.

Avoid conflicts of interests when providing advice to clients regarding a prospective transaction. If the CPA firm chooses to obtain the clients’ consent to perform services when a conflict exists, the firm should retain signed copies of the disclosure statement and not exceed agreed-on engagement-scope limitations.

Maintain complete records of all client communications throughout any engagement that involves a proposed business sale. Issue carefully worded engagement letters, and obtain client signatures before rendering services.

Don’t allow clients to push you into making management decisions for them, especially when a conflict of interest exists. Provide advice, not decisions.


Surprisingly, third parties rather than clients filed 30% of the BV engagement claims in our data sample. (Only audit engagements trigger an equally high proportion of claims from nonclients.) Such claims generally originated with one of two types of third parties:

A nonclient party to a business sale. For instance, prior to the sale of a family business the children of a client were paid for their minority stock holdings based on a BV report prepared for the client. When the new owner turned around and sold the company based on a significantly higher per share stock price, they sued, claiming the BV had undervalued the stock.

Lenders and investors. In many other claims nonclient parties alleged reliance on the CPA’s work when making an investment decision. In such cases, the nonclients performed no due diligence and had no professional advisers to assist them. In other claims, the nonclient alleged the CPA either had an undisclosed indirect conflict of interest (such as partial ownership of a business that subcontracted with the client) or had communicated opinions or conclusions to the third party inappropriately.

Third parties also claimed that businesses were overvalued or undervalued based on goodwill intangibles. Other claims focused on the practitioner’s failure to consider key employees in the BV, alleging that when key employees left after the sale there were operational problems, mismanagement and lost client relationships. Some buyers claimed the CPA had failed to properly investigate and comment on ownership of patents, copyrights or technology under development.


A review of claims shows that many CPAs failed to use engagement letters. Because disputes about scope or methodology used to value intangibles are common in such assignments, a CPA is wise to protect himself or herself—and the client—by issuing a letter defining the scope of the project, briefly explaining that different approaches and methods can be applied to a BV, and identifying and explaining those being used. The absence of engagement letters can compromise the defense of a claim if a dispute develops.

Accounting principles and tax codes set the standards for traditional accounting and tax services, but BV precedents for standard valuation methods have been established through common usage and case law. Case law pertinent to valuations prepared by actuaries, claims adjusters, real estate agents and real estate appraisers can affect the acceptance of valuation methodology by judges and juries when hearing a BV controversy.

The AICPA Statement on Standards for Consulting Services (SSCS) identifies valuation as a consulting service, and both SSCS and the AICPA Code of Professional Conduct apply to CPAs and firms rendering BV. However, these standards do not include technical standards and rules of practice. Although the IRS and the Appraisal Standards Board of the Appraisal Foundation provide regulations, revenue rulings and professional standards that CPAs must adhere to when they value businesses in circumstances such as estate and gift tax return preparation and reporting to federal regulatory agencies, there are no universally applicable standards for performing BV services.

Accordingly, engagement letters for this practice area are essential, and each business valuation should have an engagement letter specifically drafted for it with the assistance of legal counsel. It should:

Outline the roles and responsibilities of the CPA, the client and other professionals involved in a prospective business sale.

Detail the scope and objective of the engagement and any key terms used in the letter, such as fair value.

Include appropriate disclosures regarding the scope of services performed, the approach and methods used in performing the BV, and the information supplied by others that will be relied upon by the BV practitioner.

Establish that use of the CPA’s report is restricted to specified parties or an intended class of parties, such as prospective purchasers of the business.

Include disclosures regarding the risk that taxing authorities or third parties could challenge the valuation method.

Include provisions for withdrawal.


A CPA who wants to meet a high standard of care when performing a business valuation has to apply appropriate methodology (see “Tips for the Valuator,” JofA, March00, page 35) . Several basic practice management techniques can help CPAs avoid malpractice claims in this specialty.

Obtain solid training. Before accepting an engagement, CPAs need formal training in performing BV services—a client’s reassurance to the contrary notwithstanding. A number of organizations offer training and credentials in this specialty area (see “Where to Learn More,” below).

Perform client screening. A CPA should not accept a BV engagement unless he or she first has information on a number of issues, such as:

The reason for the engagement. Early in the client interview, find out why the client wants a business valuation, and when, how and by whom the valuation report will be used; consider the liability implications of those factors. For instance, if investors or lenders will use the valuation as a basis for determining the value of equity shares in a closely held business, recognize that in most states these parties will likely have the right to sue the firm that prepared the BV if a subsequent valuation dispute arises.

If the BV is intended solely for the use of a particular party, both the engagement letter and the BV report should include a paragraph restricting the use of the report. Consider adapting the example in AU 532.19 of the AICPA professional standards, which reads: “This report is intended solely for the information and use of [the specified parties] and is not intended to be and should not be used by anyone other than these specified parties.”

The client’s reputation and ethics. If the engagement is for a new client, a practitioner should inquire about the client’s prior experience in his or her industry and whether other professionals will be providing services relevant to the prospective transaction. Use your business contacts to verify the information provided and determine the client’s reputation for integrity and prompt payment. If the business or client is from outside your firm’s conventional geographic practice area, thorough scrutiny is called for. Request references such as lenders, attorneys, vendors or clients; verify the existence of the parties supplied as references; and contact them by telephone to obtain background information. In addition, consider investigating the prospective client’s credit rating and performing background checks on officers or owners of the business. Always disclose to the prospective client that you’ll be performing background or credit checks.

Conflicts of interest. Conflicts may arise from a request to perform a valuation of a family business in connection with a divorce when the CPA firm has provided tax advice to both spouses in the past and intends to continue rendering services to the business and the spouse controlling the business after the divorce. Avoid engagements where a conflict of interest exists; although disclosure and consent make the engagement acceptable under the AICPA’s Code of Professional Conduct, conflicts increase liability risk. It’s safer to decline in such instances.

The client’s level of sophistication. Is a potential client experienced in interpreting financial data? If the client enters into negotiations based on the requested valuation, can he or she compare the relative value of offers made, especially if buyers make offers based on their own due diligence? An unsophisticated client considering a merger or acquisition presents greater risk, as he or she places a high level of reliance on professional advisers and may have limited experience in managing a business similar to the one being evaluated. Mergers or acquisitions involving unsophisticated clients are more likely to be unsuccessful and result in malpractice claims against the BV practitioner. As in all areas of practice, clients with unrealistic expectations are more likely to sue when their expectations are not met.

Industry type and size of the business. Lack of related experience within an industry can lead to valuation errors. Consider hiring an expert to assist, if warranted.

Use engagement letters. The client should sign a customized letter for each BV engagement before any services are rendered. Preferably, the provisions of the engagement letter should be discussed in a face-to-face client meeting to address any client questions or concerns. Document this discussion in the client workpaper file.

Document thoroughly. Track all client communications in the workpaper file. In many cases, a client will make tax planning decisions based in part on a valuation report. Statements on Standards for Tax Services no. 8, Form and Content of Advice to Taxpayers, says that “written communications are recommended in important, unusual or complicated transactions.” Similarly, document discussions about valuation methodology in a letter to the client to avoid any possible misunderstandings.

BV services can be a rewarding and profitable practice niche if you adopt some basic risk management techniques to minimize exposure. BV methodology is constantly evolving, so stay current through training. Screen prospective clients thoroughly, issue engagement letters and document all client communications. If problems arise during an engagement, consult an attorney specializing in the defense of CPAs and ask your professional liability insurer for additional guidance. Be safe, not sorry.

Where to Learn More

American Institute of CPAs
1211 Avenue of the Americas
New York, New York 10036-8775

AICPA members who have performed at least 10 BV engagements can earn the Accredited in Business Valuation designation by passing an eight-hour examination. Many technical training programs and practice aids are available.

American Society of Appraisers (ASA)
555 Herndon Parkway, Suite 125
Herndon, Virginia 20170

Practitioners with two years of appraisal experience and 1 1/2 years of BV experience can earn the Accredited Member designation, and practitioners with five years of appraisal experience and three years of BV experience can earn the Accredited Senior Appraiser designation through a combination of training, testing and submission of past BV reports. ASA offers five training courses in BV services.

Institute of Business Appraisers (IBA)
P.O. Box 17410
Plantation, Florida 33318

The IBA is a membership organization providing training and assistance to practitioners specializing in the appraisal of closely held businesses. The IBA offers workshops, publications and practice aids.

National Association of Certified Valuation Analysts (NACVA)
1111 E. Brickyard Road, Suite 200
Salt Lake City, Utah 84105

CPAs without prior BV experience can earn the Certified Valuation Analyst designation by completing a five-day training course, passing a four-hour examination and preparing an extensive case study.

The Appraisal Foundation
1029 Vermont Avenue, N.W., Suite 900
Washington, D.C. 20005

The foundation promulgates a set of standards for appraisals known as the Uniform Standards of Professional Appraisal Practice (USPAP). Federal regulatory agencies require that BV reports provided to them comply with USPAP.

Business Valuation Resources

This is a Web site with a variety of products and resources pertaining to BV, including a useful list of “hot links” for the BV practitioner.


Year-end tax planning and what’s new for 2016

Practitioners need to consider several tax planning opportunities to review with their clients before the end of the year. This report offers strategies for individuals and businesses, as well as recent federal tax law changes affecting this year’s tax returns.


News quiz: Retirement planning, tax practice, and fraud risk

Recent reports focused on a survey that gauges the worries about retirement among CPA financial planners’ clients, a suit that affects tax practitioners, and a guide that offers advice on fraud risk. See how much you know with this short quiz.


Bolster your data defenses

As you weather the dog days of summer, it’s a good time to make sure your cybersecurity structure can stand up to the heat of external and internal threats. Here are six steps to help shore up your systems.