Loss of Profits vs. Business Value

If a business is damaged as a result of wrongdoing, there are two ways in which the plaintiff’s damages can be measured.

The First way is to calculate the plaintiff’s annual loss of profits; and the Second way is to calculate the value of the plaintiffs business at the time of loss; that being the amount that the plaintiff could have sold the business for at the time of loss.

Using the loss of profits route, the Accountant would forecast the annual profits for the damaged business based upon the industry and actual conditions applying at the time, and up until the date of the trial, and on into the future. This valuation should also take account of the fact that the projected profits were by no means “riskless”.

Using the business valuation route, one would calculate as if the defendant were “purchasing” the damaged business from the plaintiff at a “fair market value” at the time of loss. This valuation would be equivalent to the present value of the cash flows that would accrue to the owner of the business over its lifetime. A risk adjusted discount is then applied to convert the projected annual cash flows to a single lump sum.

Where the claim is for personal injury, it should be noted that significantly higher damage claims can be made under the lost profit method than under the business valuation method. This is because the business valuation method imagines that the plaintiff would have sold the damaged business immediately prior to the damage happening; thus attempting to estimate the proceeds the plaintiff could have received at that point in time. To the extent that no sale was actually contemplated; a loss calculation based on the value of the business can in those circumstances lead to an amount far different then would have been achieved by the plaintiff but for the loss had they continued to operate the business.

Indeed relying solely on the business valuation approach can be risky if there is any doubt as to the permanency of the loss. In these circumstances, the preparation of a detailed lost profits calculation on a year by year basis is essential. It should be noted that the business valuation and lost profits approaches often yield similar damages calculations. When they do not, it is usually due to the factors noted above. H.M. Courts may also subjectively prefer one approach to another. Experts should consider calculations under each of the above methods; and adopt the approach that best fits the facts of the case.