The concept of value is at the heart of almost all of our transactional work, says Luke Morris , Corporate Finance Partner. “Please could you just give us an idea of what it’s worth?” is a common request to us, and is usually because a businessperson has some kind of transaction in mind. It may be a sale, or an acquisition. It may be that funds need to be raised against collateral. Or perhaps there has been a shareholder dispute, divorce or death, and assets need to be divvied up.
G iving an idea of “what it’s worth” is not as easy as it sounds: we need to understand the purpose of the valuation, the framework and definition of value basis being applied (yes, there is more than one – and in the case of “fair value” at least three different understandings of what that means depending on where you look and the precise circumstances). The primacy of the market What we can say for those countries living and working in the Anglo-Saxon tradition is that the idea of “the market” has absolute primacy in our business practice and in our Courts. When we look at the “market value” of a private trading business we tend to assess what we think the business is capable of earning, on a consistent and maintainable basis, as well as what the market is paying, as of now, for every pound coin of those earnings. There is quite a bit of empirical data available to us professionals, as well as our experiences from real, often contemporaneous and very comparable, transactions. The current market So, what is the current market really saying? There are constant reports in the financial press about the rise in number / value of mergers and aquisition deals involving UK companies (inbound, outbound and domestic), much of it talked up by advisers or people in the industry who have a vested interest in doing so. The reality is, as a general trend, the “topping off” of corporate valuations in the last year or two. A factor in a hypothetical buyer’s thought process, as set out above, is inevitably that of “consistent and maintainable” earnings in the future. I don’t want to use the “B word”, but if such earnings appear to be becoming more doubtful, or if additional costs are anticipated, those earnings are naturally supressed in the valuation calculation and, ultimately, in what the buyer will pay. Accountants are nothing if not risk-averse. The B word has, since 2015 onwards, already been prudently priced in and this is now coming through in real deal data.
A closer look at domestic acquisitions suggests buyers (on average) paid lower “multiples” of earnings last year. Average prices paid were down across most industries, even though average earnings (and earnings margins) increased. This does not tell the whole story though – average data rarely does. The IT sector has remained resilient, even showing an increased multiple over prior year average. Investment in UK technology companies has grown substantially, with FinTech and AI being the key areas attracting investment. Healthcare is another hot sector. Consumer staples appear to be the hardest hit. The fundamentals of the market remain the same: key drivers of multiples are size, margins, and growth prospects. Test of the Court But back to our question: “give us an idea of what it’s worth?”. Even having determined a market value for a business, on an agreed upon basis, we often then come up against the situation of allocation of assets between two parties, perhaps a shareholder dispute or in the divorce courts. It is understandable that how the values of different assets are compared comes under question. This leads on to some deep conceptual issues. What do we mean by value? If a house is valued at £500,000 is that its value now, or is that its value during the expected time to sell of say 6 months? Answer: it is its value now assuming that it has been marketed for sale in the previous 6 months or so. With a company we know that the valuation is done on the cusp of a notional transaction taking place: the due diligence has been done, the contracts have been prepared and we are at the completion meeting. The cash is sitting there in the solicitor’s client account. The value is therefore the value now, assuming, once again, that it has been marketed for the previous 6 months. Take a thought experiment: if a company valued at £1m is “worth” a lesser amount than £1m in cash in the bank, does this mean that the company has been over-valued? Should the value be discounted further for its lack of liquidity?
The answer is that the discount for lack of marketability cannot relate to the current transaction – as we are assuming a transaction immediately about to occur. This discount refers to the extra costs and time associated with later transactions – and these have already been priced into the valuation by the buyer. In 2018 divorce lawyer Judge Mostyn used the colourful phrase used in the title of this article and argued that there was no difference: “once the hammer went down the shares were as good as cash”. The answer is that we do valuations assuming an imminent transaction, but the quality of the underlying asset has not changed- it remains illiquid. It also remains risk-laden, but that it should be as likely to deliver a gain as a loss. The only way that the Courts can achieve fairness in such situations is to divide liquid and illiquid assets between the parties whenever this is possible, and that is what tends to happen in practice. Because, despite the clear conceptual logic, most people still want the cash. Scrutton Bland’s Corporate Finance team have extensive insight and experience of the region’s business landscape, allowing them to provide in-depth, independent, professional advice for confidential transactions. For more information please contact luke.morris@scruttonbland. co.uk or tel 0330 058 6559 .
C O R P O R A T E F I N A N C E | S C R U T T O N B L A N D | 3 9
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