Prospective Financial Damages

In addressing the issue of prospective or future damages, some element of uncertainty is necessarily present. This is especially true when the analysis involves a new business. However, lost profits for new businesses are not necessarily precluded simply because the business is a new one. The sharp line of distinction between old and new businesses has been replaced with the basic question of whether a prospective loss of future profits has been proven with reasonable certainty.¹ Proof of lost profits in a new business situation will be more difficult than with an established business.

Nevertheless, damages may be established with reasonable certainty with the aid of expert testimony, economic and financial data, market surveys and analyses, business records of similar enterprises, and the like. To remove such damages from the realm of speculation, objective analysis is essential.

In conducting such an objective analysis, the factors identified in the AICPA’s guide for prospective financial information² provides helpful guidance:

1. Economy – is the general economic climate favorable, uncertain or experiencing a general recession?
2. Industry – is the industry as a whole experiencing a growth period or a decline; is the industry emerging and unstable or mature and relatively stable; have other companies in the industry experienced a high failure rate?
3. Entity specific
1. Operating History – Is the business a start-up company with little or no operating history or a seasoned company with relatively stable operating history?
2. Customer Base – Is the potential customer base broad or limited to a few prospective clients; is the customer group diverse and changing or relatively stable?
3. Financial Condition – Is the new business adequately funded and in a strong financial position or a weak one?
4. Management experience
1. Industry – Is the management experienced in the industry or a related industry or relatively unfamiliar with the field?
2. Specific Business – Is the management team stable and broad based or is there a high turnover of key personnel with little management depth?
5. Products or services
1. Market – Are there other more experienced providers in the market; is the product proven or new and uncertain?
2. Technology – Is the technology rapidly changing technology or relatively stable; if the technology is new, can adequate demand be demonstrated objectively?
3. Experience – Does the experience of other providers in the market demonstrate the potential for success of the new product or service; is the entity’s proposed business a new product or an expansion of a successful product line?
6. Competing assumptions – Is there a wide range of possible outcomes or a narrow one?
7. Dependency of the assumption on the outcome of the forecasted results – Do the assumptions depend on the achievement of other forecasted results? To reach this conclusion, the following should be considered:
1. Is there a rational relationship between the assumptions and the underlying facts and circumstances?
2. Are the assumptions complete?
3. Were the assumptions developed without undue optimism or pessimism?
4. Are the assumptions consistent with the entity’s plans and expectations?
5. Are the assumptions consistent with each other?
6. Do the assumptions in the aggregate make sense in the context of the forecast taken as a whole?

Consideration of these factors alone does not result in a qualification that clears the hurdle of speculation. However, they assist in understanding the level of uncertainty inherently present and can help guide the analysis to factor in adjustments to minimize that uncertainty.

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¹ See, e.g., Robert L. Dunn, RECOVERY OF DAMAGES FOR LOST PROFITS § 4.2 at 220, 227-28 (3d ed. 1987); Restatement (Second) of Contracts § 352 cmt. b; Merritt Logan, Inc. v. Fleming Cos., 891 F.2d 349, 357 (4th Cir. 1979).

² AICPA’s AUDIT & ACCOUNTING GUIDE FOR PROSPECTIVE FINANCIAL INFORMATION, Ex. 7-1, Mar. 1, 2009.