What are the main reasons behind valuating a company during a dispute and what is the basis behind it?
There are various situations where a valuation may be necessary. First and foremost, you need to know the reason for the valuation. It may be a shareholder, partnership, estate, group, contract, tax or matrimonial dispute, an action causing loss, or a professional negligence claim. I once even did a valuation in a murder trial. There are many types of disputes where a valuation may be needed so you need to be clear on what is being valued, whether it is a whole company, a particular class of shares or a shareholding.
The date of the valuation is also important as this affects the information and accounts (etc) that are available and the factors that apply. This is particularly important in times of material uncertainty, as at present.
What do you look for when approaching a valuation?
Depending on the basis of the valuation, you will be looking at:
- The different classes of shares and their rights. In particular: voting, dividend, pre-emption and repayment of capital rights.
- You need to be aware of any provisions for conversion or change in rights and how these apply.
- The Articles and any Shareholders’ Agreements need to be studied for any provisions affecting valuation.
- In valuing a shareholding any provisions on minority discounts and how control is exercised are important.
- Any significant/material changes to the company’s market, customers, suppliers or key personnel, need to be ascertained and considered.
What are the main methods/basis for valuing a company?
Valuation is an art not a science and is, to quite an extent, a matter of opinion. There are no rigid guidelines, although there are plenty of norms and ranges to apply – some of which I expand on below. All methods of valuation include subjective factors such as rates of return, adjustments to profits, multiples, and asset values.
The Dividend Basis, where there is a history of dividend payments, to compare with market returns, is usually used in relation to small minority holdings. It is worth noting that a shareholding that receives a regular dividend, is going to be worth more than one which doesn’t.
The Net Asset Basis is normally used for valuing property or investment companies and trading companies where profits are low in relation to assets. In general, a company with greater net assets will be worth more than one with less. That must be tempered by the fact that it is not beneficial to have more capital tied up for the same return and much will depend upon the nature, use and realisability of the assets.
Assets are also a factor to consider in an Earnings Based valuation. The Earnings Basis, using post tax profits, is the normal method of valuing profitable trading operations.
How do you value a trading company?
The Earnings Basis is usually assessed, as well as the viability and trends of the business, the market, the strength of customers and suppliers and the degree of dependence on any of these and any significant shifts.
I will usually look at accounts that cover a three-to-five-year period and will probably weigh in on later years, depending on profit trends. If available, I would consider up-to-date management accounts, budgets and forecasts.
I look at how the company can arrive at maintainable profits by adjusting the accounts to a realistic position, analysing aspects such as rent, intercompany and management charges, unusual or abnormal items, directors’ remuneration in relation to their hours, and responsibilities and roles, in order to reflect a proper cost for managing and operating the company on a commercial basis. I will also need to adjust for any accounting periods that are greater or less than 12 months, bearing in mind any distorting seasonal factors, such as two Christmas periods in the same accounts.
Then having arrived at a maintainable profit figure, I will look at a relevant multiple to apply. I usually use a Price earnings ratio (PE) on post tax profits, although some valuers in some situations will use EBIT or EBITDA on pre-tax profits.
To arrive at a PE I will normally start with the PEs for quoted companies in the same business sector in the FT. I will then discount this for lack of marketability, size and other factors for a private company as against quoted, by between 60% and 75% depending on the relative size, strength or weaknesses of the company. This is then compared to the multiples achieved on actual deals by using sources such as Business Valuation Benchmarks (BVB) and the ICAEW Library.
Then, I refer to the Net Asset position and the extent to which this supported the value. Cash surplus to ongoing requirements, especially where there are distributable reserves, will usually give an increase in value.
How do you deal with material uncertainty such as COVID-19 and Brexit?
The precise date of the valuation is currently more important than ever. If it is pre- March 2020, then COVID-19 should be ignored as you should not use hindsight when valuing.
Dealing with a valuation in any time of significant uncertainty such as Brexit which has been ongoing for several years, is difficult, but the current situation with the pandemic is the most difficult and uncertain that I have ever encountered. There is considerable market unrest and volatility, frequent stock market changes, with past performance having less relevance, future prospects being uncertain and a real risk of total loss.
A minority of businesses are doing well and generally, following an initial severe drop, there is a rise of M&A activity in the market, but buyers, especially cash buyers, are cautious, in a strong position and looking for bargains, with emphasis on deferred consideration.
I, therefore, firstly prepare my valuation as normal based on past performance and current multiples and then look in detail at the current trading, financial position and future prospects of the business to produce alternative values in the light of that and demonstrate that my conclusion is reasonable.
What impact do such valuations have on disputes and does this give rise to challenges on the assumptions used?
In most cases, the known impact and uncertainty will give rise to a reduction in value. I, as with most valuers, would expect to incorporate a formal “Material Uncertainty Declaration” and would seek to be allowed to present a range of values, although the Court or the parties may not allow that. In that case, I would say so in my report.
On that basis, having carefully set out how I have used the different aspects to arrive at the value, I would not expect this to be challenged to any greater extent than usual.
David R Cook JP FCA MAE
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