When we receive a request to value a business it is usually accompanied by financial statements and management accounts, and rightly so. These documents show the historical financial performance of the company – the story of how the company became to be in its current position. With smaller businesses, robust forecasts are not always available, and the best way of understanding the future prospects of a company is to understand its past.
What is often less understood is why we insist on speaking to the party or parties who run the business, despite the wealth of historical information in the financial documents. We sometimes find instructing solicitors or one of the parties can be very resistant to these conversations taking place.
Although the past financial performance of a company is key to understanding where it might be heading, it is, as the name suggests, ‘past’ and is only part of the story. Performing a valuation relying solely on historical accounts is like reading or watching The Fellowship of the Ring and trying to state the detailed events in The Return of the King.
We discuss below some recent examples where significant factors affecting value were not (nor should they have been) reflected in the historical financial information. In each of these situations any valuation prepared by reference solely to the financial statements would be materially incorrect.
We were instructed to prepare a single joint expert valuation of an events planner. The business was heavily impacted by the COVID-19 pandemic, as one might expect. One might assume the business would recover and be able to generate profits at a similar level to what it achieved pre-pandemic. However, when discussing the future prospects with the director, he advised that a major customer was no longer using the business’s services. Pre-pandemic, this client had accounted for c40% of total fees in previous years. As such, past levels of trade did not reflect future expectations.
We were valuing a group of five companies involved in the construction sector.
Discussions with the director raised key issues faced by the group. Two of the companies shared a sole customer. The customer had six months left on its site lease and the director considered it highly unlikely the lease would be renewed, meaning that the customer would likely cease to trade or move its trade to another location. The director was preparing for this and had identified a suitable course of action to get new clients, but this involved a move to a new location for the company we were valuing, meaning that company’s trade was going to face significant uncertainty for a period of time, impacting our valuation conclusions.
Disputes of leadership
A small software-as-a-service company was being valued as part of a divorce. While the company was small, it had been consistently profitable for many years, indicating that future stability was likely. However, it soon became clear that the parties were in dispute as to which of them should continue to run the business; both had separate skills they could offer – one in IT, one in marketing. In this case, we concluded the outcome would be the same whichever party took the business forward, as the market rate cost of the work carried out by each party (plus an external provider of the skill the business was losing) was the same. If the departing shareholder had a skillset that could not be so readily replaced, it is likely that the value may have differed depending on who remained.
As demonstrated by the above examples, the financial information can only get you so far in a valuation. It is therefore important for the parties to be aware of the need for, and the importance of, discussion about the business being valued.
We appreciate that, where valuing a business in the context of a dispute, the valuer discussing matters with an individual who is not trusted can be unnerving. Measures can be put in place for additional transparency if required. At the end of the day, both parties should rest assured that the valuer is focused on obtaining a comprehensive understanding of the business and experienced in separating the facts from the fiction.