When a valuation is too difficult?

11 Jun 2018

In the recent Versteegh[1] case, which was heard by the Court of Appeal in February 2018, it was noted that “The valuation of private companies is a matter of no little difficulty

The case involved the valuation of the Husband’s property development business, which focussed upon “slow burn” property development.  Despite significant costs being expended on experts to produce valuations the Judge at first instance concluded that he was unable to determine the value or future liquidity of the business.

It was not so much the range of values suggested by the experts, which were many millions apart, but the fragility of the values.  The Judge noted that a delay of 12 months in one specific project would reduce the resulting valuation from £45m to £33m; a reduction of £12m or 26%.  In slow burn property development a delay of 12 months would not be unusual.

In terms of liquidity, what was more difficult for the valuers, I imagine, is the forecasts produced by the business were historically optimistic.  Actual cashflow generated in 2014 and 2015 was 5.6% and 16.4% respectively of the forecasts produced in advance.

In any valuation of a private company the expert valuer must look to all available information to support and confirm the valuation.  As the value of a share lies in the ability to obtain a return on it at some future date, then historic profits are only a part of the evidence looked at by the valuer. 

A valuer will look at comparable transactions and comparable quoted companies (if either exists) as well as forecasts and budgets of the business to be valued. 

The use of forecasts and budgets must be undertaken with some caution.  The valuer must understand the forecasting process adopted, and then compare contemporaneous forecasts to actual results for historic periods.  If some correlation exists between these then the valuer may place some reliance upon the forecasts produced, although they are by their very nature guesswork, although some are more informed than others.

In the absence of the ability to sense check a forecast, caution should be taken. In a recent case I was presented with a forecast as part of the valuation of a family business for matrimonial purposes.  The business did not historically prepare forecasts but had produced its first budget and forecast a few months prior to my appointment as a single joint expert.  That rang the first alarm bell !  The second bell rang when I identified that, based on the forecast, the business would be insolvent six months or so into the next financial year, and the Husband provided no cogent plan to refinance when asked about the forecast insolvency. 

Valuations for matrimonial purposes are artificial, as it is unlikely that the Court would order the sale of the family business, therefore the valuer must assume a hypothetical sale between a willing buyer and a willing seller. 

A willing buyer would in a real transaction have the ability to undertake detailed financial and commercial due diligence and structure the purchase in such a way as to protect themselves from downside risk as part of the negotiations, and the seller may accept such a structure as it could reward them for upside risk. 

However, there is a reluctance to incur significant costs in valuing a private company for matrimonial purposes as it is unlikely to be sold.  Therefore the courts favour a more broad brush approach.  To quote Lord Nicholls in the Miller and McFarlane cases “A thorough investigation … can be extremely expensive and of doubtful utility”.

In the Versteegh appeal the court accepted the judge correctly approached the difficult valuation of the business interests, based as it was on extensive expert evidence.  The judgement includes some helpful discussion on the process of valuation, and the specific approach to development property valuations.

Interestingly the original judgement included a 13% Brexit discount, as the final hearing followed shortly after the EU Referendum.  I wonder what level of discount would have been applied if the case has been heard now?

For assistance with any valuation cases please contact Adrian Pym on 0121 711 2468.

[1] Versteegh and Versteegh [2018] EWCA Civ 1050

In any valuation of a private company the expert valuer must look to all available information to support and confirm the valuation. "