The following is a discussion of a business that incurred a loss of profits and sustained damages, which can result from any number of harmful fraudulent acts, such as the creation of a fictitious vendor, embezzlement, a ghost employee, or personal expenditures paid through the business.
If a business is subject to these wrongful acts by an inside or outside party that causes lower than expected profits, the injured shareholder or business may have a claim for loss profits damages. When the financial expert is retained he or she should meet with the attorney to discuss the facts and the appropriate measurement of damages. The date of the wrongful act is the starting date of the damage period. The ending date should be discussed with the attorney.
The damage calculation should result in restoring the plaintiff in a law suit to the financial position it would have been in, if not for the wrongful acts of the defendant. The primary calculation is the present value of projected cash flow. The lost profits calculation generally falls under one of these scenarios:
- Before and after method using company data;
- Yardstick method using guideline companies; or,
- Sales projection method using company projections.
The financial expert should have a complete analysis of the acts which caused the lost profits to meet the following standards:
- Proximate Cause: Proving the defendant's actions caused the claimant's damages to happen.
- Foreseeability: Could the plaintiff foresee the possibility of the wrongful actions and mitigate damages?
- Reasonably Certainty: Are damages readily certain to be the result of the alleged wrongful actions?
The profits from the income stream is the incremental revenue, net of avoided cost, or cost saved the past period, is calculated through the date of trial.
Within the damage period projections must not be speculative. They must be reasonably certain. The financial expert should determine the manner in which the plaintiff mitigated the lost profits.
Here's an example, a closely held company which had three 1/3 interest shareholders. Two of the shareholders forced out the third shareholder who filed a minority suit to be bought out. While preparing the valuation the expert determined the two shareholders had set up a mirror company, under a different name, dealing in the exact products, which cause the profits of the original company to substantially decrease in order to reduce the buyout price. To solve this situation, the new mirror company books, organizational data, product line, and customer base were all analyzed. With the help of the expert, it was shown with reasonable certainty the setup of the mirror company was a direct and proximate cause of profits diverted from the original company.
If your minority shareholder client faces this scenario then
Sage Investigations, LLC a leader in forensic accounting and financial investigations can help your client. With over 40 years of experience following money, Sage uses proprietary technology (DIO) to help develop the full picture of the financial aspects of the fraud. Sage strives to help clients structure a better future for their families. Learn more about assisting your clients by contacting retired Internal Revenue Service Special Agent Edmond J. Martin, Chief Investigator at Sage Investigations, LLC. Email
edmartin@sageinvestigations.com website: www.sageinvestigations.com or call 512-659-3179. Thanks to Kenneth Huff, CPA for his contribution to this article.
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