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Damage Calculations For New Businesses or "Still Born" Companies

2008-01-18 - New Businesses

Lately we have been asked if we have run across any instances where damage calculations have been made for entities that never really got started. Requests have come from clients who are involved in lender liability and contract disputes and litigation where the injured company or division was never able to get going. The key issues in the damage calculation often surround whether the injured company or entity was an actual functioning business or merely a good idea at the time of the wrongful action.

Damage calculations normally fall into three broad categories. Each of these categories requires a different approach to the estimation of the damages.

  • Lost profits require the skills of the economist to determine what the lost sales would have been and the accountant to determine what the lost profits on those estimated sales would have been.
  • Termination/Bankruptcy requires the skills of an accountant to determine what the value of the company would have been under "going concern" assumptions had the business not terminated.
  • New business failures or "still born" entities require both an economist and an accountant. The economist is required to determine the sales of the enterprise would have been. Since no historical accounting records exist, an economic or market approach could be used to estimate the size of the total market for the enterprise's goods or services would have been the share of that market it would have gained and the profits it would have earned.
In addition, an accountant is required to determine estimated cost structure, tax treatment and accounting presentation of the final damage estimate. Under these circumstance the accountant must rely on his knowledge of similar businesses or publicly available data.

Our criteria for determining whether damages can be appropriately calculated for a Still Born company are:

  • Product or Service Need - Was there a real economic need for the products or services provided by the company?
  • Observable Demand for the Product or Service - Can the market for the Product or Service be measured?
  • An Implementable Business Plan - The company has a well constructed and implementable business plan for the conduct of the business before the injury took place?
  • A Demonstrated Ability to Conduct the Business - Did the company have the requisite management, operational and financial capacity to carry out the plan?
  • A Basis for Comparable Cost Structure - Is there a similar company or industry that can serve as a proxy for the profits the company could have expected?
Two recent cases that we participated in illustrate some of the problems.

In a case involving libel, the plaintiff was the only other competitor in the field. The defendant, the other player in the market, libeled the plaintiff orally and in writing. Plaintiff had demonstrated his ability to manufacture and sell the product. His records contained bonfide orders and cancellations due to the actions of the defendant. Our approach was measure the size of the market, the ability of each of the client to purchase the product and measure the market penetration each competitor could have achieved based on their respective cost structures. The case was settled in favor the plaintiff.

In a case involving breach of contract, the plaintiff had planned a new line of business, an extension of his existing business, based on assurance from the defendant to provide raw materials for exclusive resale. Plaintiff had demonstrated his ability to provide the service in his own market and sell the concept in other markets as a license arrangement. His records contained bonfide licensee commitments and cancellations due to the actions of the defendant. Our approach was measure the size of the market for the service, the ability of each of the licensee to penetrate his relevant geographical market and the expected profits that the licensee and plaintiff could have achieved based on their respective cost structures.