AES-2 or indicative valuations: The pros and consUnderstanding, as between AES-2 and indicative valuations, the differences, similarities, and impacts in contentious situations, is essential for making the right choice and ensuring clients’ (and their lawyers’) interests are best served. Independent valuations prepared in accordance with AES-2 should be expected to lead to comprehensive and higher-quality valuations, that comply with the High Court Code of Conduct for Expert Witnesses. This makes it the preferred choice in contentious situations, with AES-2 providing a robust framework to enhance the credibility and reliability of the valuation. Indicative valuations, on the other hand, offer flexibility and can be tailored to fit specific client needs and any cost constraints. But they can vary widely in scope and quality, ranging from basic assessments to near AES-2 standard compliant valuations. In contentious situations, while indicative valuations can be used, they require careful reconciliation with the Code of Conduct, ensuring the valuation basis is transparent, including the quality of information relied on. |
The terms AES-2 valuation and indicative valuation both stem from the requirements of Advisory Engagement Standard 2, Independent Business Valuation Engagements (AES-2), a mandatory standard for all New Zealand resident members of Chartered Accountants Australia and New Zealand (CAANZ). Their common usage is likely due to the high prevalence of CAANZ members undertaking business valuations in New Zealand.
An AES-2 valuation refers to a valuation prepared in accordance with AES-2 and other professional standards of ICANZ (the CAANZ standard setter). Other professional standards include the NZICA Rules and NZICA general ethical and professional standards, including the Code of Ethics.
AES-2 states it does not apply to an indicative valuation engagement, described as:
“where the valuation conclusion is based upon the consideration of limited information provided to the business valuer, with no requirement to assess the reasonableness of the information or to gather further information, provided that the basis on which the valuation conclusion is to be formed is clearly set out in the terms of engagement and any report produced by the business valuer as a result of the engagement” (Paragraph 3(b)).
In practice, indicative valuations are also commissioned by those who require an independent valuation but do not need it to comply with AES-2. In certain contexts, this appears a pragmatic and market led approach. However, it does mean AES-2 does not necessarily raise the low bar, being minimum standards applying to all valuations performed, but raises the high bar whereby the quality of an independent valuation should be enhanced via AES-2 compliance.
AES-2 also does not apply to arbitration awards, or valuation engagements where independence between the business valuer and the appointing party is not asserted or reasonably assumed by a user of the report (Paragraph 3(a) and 3(c)).
As such, three types of valuation engagement effectively flow from AES-2:
In practice, indicative valuations tend to refer to valuations in both categories (2) and (3) above, effectively any valuation other than an AES-2 valuation. They can vary widely in scope, from ‘back of the envelope’ calculations to valuations which are close to an AES-2 standard. Differences between competing indicative valuations can arise due to differences in the scope of information relied on, the extent the valuer has assessed the underlying information for reasonableness, and the extent of analysis and reporting.
AES-2 is a mandatory standard for all CAANZ members resident in New Zealand, even when the valuation subject is located overseas.
CAANZ membership includes both New Zealand and Australian members. AES-2 is not a mandatory standard for CAANZ members resident in Australia who instead follow professional and ethical standards issued by the Australian Professional and Ethical Standards Board (APESB). This includes APES-225 Valuation Services (APES-225), a similar standard to AES-2.
For business valuers in New Zealand who are not CAANZ members, there is no mandatory requirement to comply with AES-2. However, paragraph 4 of AES-2 states the guidance contained in the standard may be of relevance to them.
AES-2 relates solely to the preparation of independent valuations. Whether an engagement is independent is a matter for the business valuer’s judgement.
AES-2 also relates solely to the valuation of business interests, defined to include “shares, business assets, financial instruments, or any other interest in a business.” (AES-2, p8).
While unclear, the above definition suggests “interests” refers to ownership interests. Thus, the valuation of specific business assets or liabilities owned by a business (such as a brand-name), or an allocation of business value, appear to fall outside AES-2. For the same reason, AES-2 may also not apply to valuations prepared as part of a loss of profits assessment, since the ultimate assessment is one of lost profits and not of an ownership interest. However, even if there is no mandatory requirement, it may still be prudent to commission an AES-2 valuation.
There is also no requirement in AES-2 that it must be used for a particular valuation purpose. For example, to support a transaction price, or a valuation for court purposes. However, a requirement to comply with AES-2 may be set by contractual agreement or contained in other guidance. For example, Commissioner's Statement CS24/01 published on 31st July 2024 sets out accepted valuation methods when unlisted shares are issued to employees pursuant to a share purchase agreement. In circumstances where the employer commissions an independent valuation to support the price, CS24/01 requires the valuation to conform with commercially accepted practice, which is further defined as meaning a valuation prepared under AES-2.
The stated purpose of AES-2 is to: “establish standards and to provide guidance on the performance of an independent business valuation engagement and the preparation of an independent business valuation report.” (AES-2, p1). As this definition indicates, there are performance and reporting requirements to comply with, together with a requirement to maintain appropriate documentation.
Performance requirements relate to matters including planning, selection of valuation approach and techniques, valuation analysis and research to be undertaken. The areas addressed are what experienced valuers would likely consider standard and usual parts of a valuation engagement.
An important performance requirement of AES-2 is the valuer must establish reasonable grounds to believe that any profit forecasts, cash flow forecasts and historical unaudited financial results used in the valuation, have been prepared on a reasonable basis. The business valuer cannot simply accept that information at face value. AES-2 states the valuer should consider obtaining management representation letter(s), albeit this would not appear to limit their responsibility to consider reasonableness if undertaking an engagement that asserts to comply with AES-2.
As part of the engagement, the valuer must also prepare documentation to support the business valuation conclusion, justify decisions made in the conduct of the engagement, and demonstrate the engagement was carried out in accordance with the professional standards of ICANZ.
AES-2 then permits three different written reports, dependent on the purpose and intended valuation report distribution. If the valuation is not intended nor likely to be disclosed to third parties external to management / directors, a more abbreviated report may be produced. Otherwise, fuller disclosures as specified by the standard are required. The valuer must assume the report is likely to be disclosed to third parties unless otherwise restricted in the engagement terms.
A material AES-2 reporting requirement is that where the valuer has been limited in the scope of review or where information provided to them was incomplete, disclosure must be made of the limitation, the reasons given and, where possible, the potential impact on the valuation conclusion considered and disclosed.
This requirement highlights how AES-2 is fundamentally a standard that applies to independent valuation reports, even those that contain limitations in scope or in information provided. The existence of such limitations does not necessarily mean an AES-2 compliant report cannot be produced, but only that any limitations must be appropriately considered and disclosed.
As discussed earlier, the scope of an indicative valuation can vary considerably, from a high-level assessment to one which is close to the requirements of an AES-2 engagement.
This diversity in scope means it should not be automatically assumed that competing indicative valuations have been prepared on a ‘like for like’ basis. They may vary widely, including in terms of information relied on and the extent of work carried out by the business valuer.
Those commissioning an indicative valuation for dispute purposes should therefore agree a clear engagement scope with the business valuer. Readers should also carefully consider the basis on which the valuation conclusion has been formed as set out in the engagement terms (if available to them) and in the valuation report, and the potential impact on the valuation.
There are no mandatory valuation standards for CAANZ members preparing anything other than AES-2 valuations in New Zealand. However, when preparing an indicative valuation on the basis described in AES-2 or any other basis, a CAANZ member is still required to comply with the other professional standards of CAANZ, including the Code of Ethics. This suggests any conclusion on value must still be appropriate having regard to the intended purpose and circumstances of the valuation.
Business valuations prepared for contentious purposes, such as a shareholder dispute or relationship property proceedings, must be prepared pursuant to, or at least in contemplation of, the High Court Code of Conduct for Expert Witnesses (Code). The overriding duty of the expert witness under the Code is to assist the court impartially on relevant matters within their area of expertise, and not be an advocate for the party who engages them.
The Code also sets out rules relating to the expert’s evidence. This includes a requirement to state the issues being addressed, the facts and assumptions on which the opinion is based, the reasons for the opinions given, and any of the information relied on. Importantly, where the expert witness believes their evidence or any part of it may be incomplete or inaccurate without some qualification, that qualification must be stated in their evidence.
The above Code rules appear closely aligned to the requirements of AES-2. Both require independence. Both also require the valuer to set out in detail the work they have undertaken together with any restrictions or limitations on that work. An AES-2 compliant valuation should therefore likely result in a Code compliant report without adjustment.
This alignment indicates that preparation of an AES-2 valuation should be the preferred choice for a valuation engagement for legal dispute related purposes. Compliance with AES-2 also avoids “in-equality of arms” and likely client disadvantage when an indicative valuation must match up against the more rigorous framework and stronger “brand” of an AES-2 valuation. In practice, most valuations prepared for contentious situations are AES-2 compliant valuations.
Those instructing an AES-2 valuation can also take comfort in a recent Court of Appeal decision, Smalley v Williamson (SMALLEY v WILLIAMSON [2023] NZCA 174 [16 May 2023]), which found a mandate to apply AES-2 in an expert determination does not provide an opportunity for the determination to be overturned by way of a breach of mandate, by undertaking a detailed “line-by-line” review of AES-2 compliance. The Court found it is simply necessary to show that, where the valuer is required to comply with AES-2 under their mandate, they have applied it. In other words, compliance with AES-2 is not a prescriptive test or method, but it requires valuer judgment afforded to the valuer by their mandate.
Although an AES-2 valuation is preferred in a dispute related context, this does not mean an indicative valuation cannot be used. Indicative valuations can and are used, often because indicative valuations tend to be a more inexpensive option in terms of valuer fees.
However, to ensure compliance with the Code, a business valuer who is prepared to undertake an indicative valuation for dispute purposes may need to provide a ‘bridge’ between their valuation and the Code. The extent of any reconciliation will vary according to the scope of the indicative valuation but is likely to require more than labelling the valuation as indicative. In addition to their indicative valuation, evidence on differences between the indicative valuation and the requirements of AES-2 is likely to be the most efficient way to ensure the business valuer’s evidence is also Code compliant.
In that way, the basis of the valuation performed will be clear to the Court, including the extent to which the business valuer assessed the reasonableness of the information relied on, so that proper comparison between competing valuations can be made.
The views expressed in this article are my own.
