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Getting started in eminent domain valuations; CPAs are well qualified to perform services in this expanding field.

The battles between public interest and private enterprise are as old as this country. One of those battles involves eminent domain, also known as condemnation, or a government's right to seize private property for public purposes. With transportation and environmental concerns becoming more common legislative issues in most states, there is certain to be an increase in eminent domain cases in the coming years. This translates into more business for CPAs who perform valuation services.

This article examines the valuation process for businesses that are displaced as a result of expropriation proceedings. It also offers advice on how to get started in this growing practice area.


The concept of eminent domain is deeply rooted in statute and case law. Essentially it allows federal, state and local governments to seize property when such action is deemed in the public interest. Some of the more common applications are for inner city reconstruction, roads and highways, public utilities and land needed to meet a growing community's demand for educational and medical facilities. Today, cases increasingly involve creating landfills and protecting environmentally sensitive land.

Virtually all governments require that owners of seized property be compensated, but the amount given varies with each municipality. The issue of "just compensation" leads to an inevitable conflict between the government trying to obtain the property at the lowest possible cost and the business owner wishing to maximize property value. The final settlement typically is determined in a trial heard by a jury.

Eminent domain valuation cases are similar to estate valuations in some respects. In both, no party is at fault, per se. Further, the normal circumstance of willing buyer, willing seller does not apply. Unlike estates, though, in eminent domain cases the owners either suffer partial damage or are compelled to sell.

For businesses, determining the proper compensation is often difficult since many assets are intangible. Of these, the most difficult to measure are potential loss of goodwill and going-concern value.


What is the difference between goodwill and going-concern value? According to one court opinion, goodwill is speculative and stems from a business's reputation. Going concern, on the other hand, is measurable and based on an estimate of future profits from a well-operated, successful business. In this ruling, goodwill lacks value and generally is noncompensable, but going-concern value is measurable and can be compensated.

No doubt some CPAs would dispute that court's definitions. Whether referred to as goodwill or going-concern value, the fact is most states today recognize that businesses have intangible value.

The Uniform Eminent Domain Code, created in 1974, alleviates some of the differences between states. While it generally allows business owners compensation for the loss of goodwill or going-concern value, the burden of proof is on the owner. Currently, the code has bene adopted only in Alabama.

Nevertheless, the courts today appear more inclined to apply the same guidelines in condemnation proceedings as are used in tort actions for breach of contact suits, recognizing that businesses are entitled to damages and this may include goodwill or going-concern value.


Many factors must be considered when valuing an entire business or damages in eminent domain cases. The most important certainly is knowing and understanding local eminent domain statutes and case law. Some states offer not only guidance but also mandatory procedures for portions of valuations performed.

Next, the valuation date must be established. In some states it is the date the property was condemned, usually the date of the court filing. Other jurisdictions may use the date the title passes, the date of trial or whichever is earlier.

Knowledge of the industry the business is in is imperative. For example, a company that is depleting natural resources, such as one involved in oil or gas exploration, may have a limited future. The CPA must ask if the company has reached maturation in the economic cycle. On the other hand, is the company in a growth industry?

A CPA must determine early whether government seizure will force the condemnee out of business, take only part of the property, require relocation or merely prove inconvenient due to nearby construction. If demise is certain, lost tax credits and other carryforwards should be considered. Also, the business demise may create a monopoly due to lack of competition, which could violate antitrust laws.

If only a portion of the business property is claimed by the government, will enough property remain to continue the business? If not, generally the action is treated as a seizure of the entire property. In a recent case, a fast food chain restaurant lost almost half its parking spaces in a condemnation order. While the business could continue operations, the lack of parking was a severe disadvantage. The amount of damages is still pending in litigation.

Other important concerns can be found in the client's customer and vendor lists. Is the property of a major customer or supplier also being condemned, creating an uncertain future for the company?

If the business relocates, here are some of the factors CPAs must consider:

* How will downtime during relocation affect profits? Also, the company will need new stationery, invoice forms and other items that include its address and telephone number.

* Is the new location as desirable as the former? Some businesses are more sensitive to location than others. A retail store on a major urban street forced to relocate to a suburban side road could suffer financially. A paramount concern is whether customers will follow the business to its new location.

* Will the business have adequate public transportation, roads, sewer and water hookups, housing and parking? Have local statutes changed so that new environmental and regulatory factors will make the relocation more expensive or perhaps impossible? Can the business obtain a zoning variance if necessary?

* Will the value of the company's inventory decline if it's forced to move? Are the items perishable or do they have an unlimited shelf life? How much damage is expected when the business moves?

* If the company is a tenant, the lease should be reviewed to determine the time remaining or any options available, such as renewal at a preferential rate. Also, look for any clause that may have subrogated rights to the lessor.

* Does the business have a franchise or license? If so, does it have value? How will the value be affected? In some cases, the holder can't relocate without permission of the franchise organization or licensor. Even if relocation is possible, there may be territorial restrictions.

For businesses that are interrupted because of nearby construction, local laws will help determine if they are entitled to any damages. The courts generally rule against compensation for this type of damage, but the businesses may be entitled to severance damages resulting from loss of access to remaining or nearby property.


The initial steps in eminent domain valuation cases are similar to those performed for other business valuations: Obtain financial data, make adjustments to fair market value, compare applicable market data, compute replacement and reproduction costs, etc.

Intangible assets commonly are valued by applying one of the following methods:

1. Excess earnings method. Excess earnings are those not directly attributable to a business's net tangible assets. This excess is capitalized at an appropriate rate to determine intangible value. The formula is shown in exhibit 1 at left.

This method is sometimes referred to as the Internal Revenue Service or Treasury Department method because of its 1920 origin in Appeals and Review Memorandum 34. Its advantage is simplicity, but that is also its downfall.

Its application suggests historical profits either have been stable in prior years or were determined by weighted averages unsupported by empirical evidence. Most professional journals suggest using the prior five years' earnings and assigning a 5-4-3-2-1 weight.

The method assumes the same earnings will continue in the future. The likelihood of similar year-to-year earnings is doubtful and the assignment of simplified weighted averages is without statistical merit. This is most obvious when major changes have occurred during the past five years, such as a change in management, the development of new products or services or a change in company direction.

When the IRS issued revenue ruling 68-609, it generally denounced the excess earnings method, saying it should not be used to value intangibles unless there is no better method. Some people claim, however, that the real IRS objection is the conservative result it produces, which minimizes potential estate and gift taxes.

2. Discounted earnings method. The discounted earnings method is the better of the two for several reasons. Most investments in publicly traded companies are for potential growth, not prior earnings. Investors assume stock value will increase if earnings perform likewise, at least relative to the overall economy. Furthermore, the method recognizes that profits are not static. Here, the earnings for a certain prospective period are estimated and discounted to present value.

Some many argue that in eminent domain, the government's acquisition value should be based on prior data because there is no future for a business that is compelled to sell. The key word, however, is "compelled." To compensate a company fully (make it whole, in legal terms) requires at least some consideration of foregone future earnings.

This method also has intellectual appeal. If a business is performing well, its earnings will rise. While most economic performance typically is due to inventory or capital investment, some earnings might well be due to intangible.

Present value techniques do not necessarily require more subjective judgments than the excess earnings method. They certainly demand more time to compute. The method's defense is its economic soundness.

However, this method is particularly difficult to apply in eminent domain cases. Virtually no authoritative literature exists to suggest how many years into the future one should look, much less an appropriate discount rate. Most knowledgeable professionals favor a 5-year projection, while some prefer 10 years. Longer periods, mean greater chances of error due to uncertainty.

As for estimating projected earnings, it remains the informed judgment of the evaluator. It is impossible to use a cookbook approach to determine future business earnings because every situation is different. However, these are the factors most commonly considered in the computations:

* Historical financial data.

* Financial ratios.

* Previous stock sales or costs to admit a new partner.

* Benefits provided to stockholders or owners.

* Importance of business location.

* Years in business.

* Market share.

* Major changes in the company.

* Industry comparisons.

* Industry outlook.

* General economic projections.

The discount rate is based on, among other things, the current safe investment yield, cost of capital for small businesses, prior performance and expected return of the industry's publicly traded securities and the general economic outlook.

Intuitively, one knows the discount rate must be more than the guaranteed return rate on Treasury bills or bonds. Even publicly traded companies carry more risk than T-bills. It is reasonable to assume that small, nontraded companies have even greater risk. According to Shannon Pratt, president of Willamette Management Assoc., Inc., a business valuation firm in Portland, Oregon, "There is considerable evidence to suggest that the discount for lack of marketability alone for a closely held stock compared with its publicly traded counterpart should be at least 35%, and, in most cases, probably more."

Dr. Pratt cites numerous examples, including minority interest discounts and court cases, to support his conclusions. Since risk increases over time, the discount rate increases accordingly.

The formula for valuing intangible assets using the discounted earnings method is shown in exhibit 2 below. This formula resembles the previous one, but future earnings and appropriate discount rates have been estimated. It is assumed that after analyzing company data, 70% of the company's growth is attributed to tangible assets. The results are shown in exhibit 3 on page 69.
The results of applying the discounted earnings method
Year Estimated Discount Present value Present value
 earnings rate factor
 1 55,000 .40 .7143 39,287
 2 65,000 .42 .4959 32,234
 3 78,000 .45 .3280 25,584
 4 93,000 .48 .2084 19,381
 5 112,000 .52 .1232 13.798
 Intangible value 39,085

If a company's growth stems more from tangible than intangible assets, the valuation should be based on assets rather than income. For simplicity only, the approach in the example in exhibit 3 is based solely on earnings.

The examples in this article show valuation for goodwill or going-concern intangible value only. In condemnations, CPAs may need to value other intangible items as well, such as patents, mailing lists and preferential lease considerations.

Regardless of the methods used, substantial, informed judgment is required. It should be no surprise that two people could arrive at remarkably different values even if they use the same method.


If a business is damaged but not terminated, even more calculations are necessary. It is generally accepted that damages are valued based on discounted methods, but the discount used is not the same as that applied to goodwill or other items.

Since damages are generally easier to compute and support, the cost of capital or other reasonable basis is appropriate. Unless there is evidence this rate will change in the near future, the same discount is applied for all applicable years, especially if it is only a brief period.

In some cases, using a discounted cash flow or perhaps a combination of the two may be preferable. As Michael J. Wagner noted in "How Do You Measure Damages: Lost Income or Lost Cash Flow?" (JofA, Feb. 90, pages 28-33), discounting cash flow instead of earnings has more theoretical support in damage measurement.

Even though the methods selected are based on the facts and circumstances in each case, jurors tend to be more receptive to cash flow analysis, perhaps because they can more easily understand money coming in and going out than a concept such as profits. Some damages, of course, require no sophisticated techniques. Examples include moving expenses and other similar reimbursements.


Market sales data, industry sales multiples and other rules of thumb are always considered, but their value is questionable in eminent domain cases for several reasons. First, the business may be damaged but not terminated. Also, the owner may be compelled to sell, voiding the willing seller concept. And finally, the data for sales of small, closely held businesses are extremely limited and certain relevant information usually is not available.

A word of caution: Most eminent domain valuations are performed for very small, closely held businesses with annual sales of less than $1 million. Management decisions for small companies are more likely based on tax motivations so it is easy to undervalue earnings. For example, if the owners distribute all earnings to avoid potential double taxation, by definition there could be no excess earnings. Accordingly, the intangible value would be zero, an onerous conclusion.

As a result, I give little weight to price-earnings ratios for very small companies. Their ratios can't reasonably be compared with those of large public companies.

To limit distortion, I always begin the valuation process by segregating the benefits of stockholders--owners, such as compensation, value of fringe benefits, excess insurance coverage, dividends, etc. If the owners lease any property to the business, the lease terms should be reviewed for arm's-length dealing and adjustments made if appropriate.


Since there is no attest function in these valuations, independence is not an issue. However, it is probably in everyone's best interest to avoid performing eminent domain valuations for existing clients. Performing valuation services for existing clients may appear approriate, but in eminent domain cases, a jury usually decides the outcome. While all CPAs understand the necessity of maintaining independence, it is crucial we appear unbiased in these cases. Obviously the opposing attorney will make it appear the CPA's valuation is inflated because he or she is trying to obtain an excessive settlement to please the client. Right or wrong, the case is doomed if the jury believes this.

If the verdict doesn't favor the client, it may cost the CPA far more than the engagement was worth. The benefit of additional income should be weighed against the risks, which range from losing a client to defending a lawsuit for negligence.


Fees obviously vary from case to case, but my experience in Florida is that while they may be as low as $5,000, most cases for small businesses are in the $8,000 range. For larger companies, fees increase relative to the work involved.

Florida statutes provide for payment of the condemnee's "reasonable" fees, including expert witness costs, which generally eliminates the need to require a retainer. Nevertheless, work never begins without a signed engagement letter from the client, with the understanding the client will pay all charges not assumed by the state.

A representation letter from the client also is essential. Since the service involves projections, CPAs must remember to meet the requirements in the AICPA statements on standards for accountants' services on prospective financial information.


CPAs not already familiar with business valuation procedures should begin by taking some courses. The AICPA offers a one-day seminar, as do some state societies. Courses also are offered at universities and through independent organizations, such as the Institute of Business Appraisers in Boynton Beach, Florida, and the American Society of Appraisers in Washington, D.C.

Excellent references sources are the AICPA Management Advisory Services Technical Consulting Practice Aid no. 7, Litigation Services, and MAS Small Business Consulting Practice Aid no. 8, Valuation of a Closely Held Business.

Each state has its own legislation, rules and procedures for these valuations, which CPAs must know thoroughly. Every state maintains its own vendor list of those who prepare valuations for the state. CPAs can get on these lists by contacting their state highway or transportation departments for information or other assistance.

Most eminent domain cases are decided by jury. While jurors might be impressed by a CPA's credentials, they may not accept a CPA's opinion on business value. To add more weight to their opinions, CPAs might consider joining one of the business valuation organizations. The two already mentioned are national and offer periodic seminars and certification programs.

CPAs who have acquired the knowledge they need to perform these services may want to contact local attorneys who specialize in eminent domain cases. Since most of these cases are litigated, the CPA must be prepared to defend the valuation in court. Attorneys are always looking for competent appraisers who are also good expert witnesses in the courtroom.

Another good resource is the real estate appraiser community. While some perform their own business valuations, many lack either the knowledge or interest. Most seem to enjoy a team approach to a valuation case, knowing that either party can recommend the other to attorneys if their work is satisfactory.


The demand for business valuation services has grown enormously over the past decade. CPAs who develop expertise in eminent domain cases will find the effort well worth their while.

For those who already conduct business valuations or who want to enter this field, there is much work today and the promise of ever more in the future. Given their accounting backgrounds, CPAs already possess the most essential tools necessary to begin.
COPYRIGHT 1990 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Margolis, Bruce S.
Publication:Journal of Accountancy
Date:Dec 1, 1990
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