Valuation approach – how to manage client expectations
When undertaking a company valuation, there are a number of key questions we consider at the outset to inform the approach taken.
Broadly, these include:
- What industry does the company operate in?
- Is the business trading? Profitable? Does it prepare forecasts?
- Have there been any changes or exceptional activity?
- How large is the business? Is it reliant in any way?
Asking the same questions of your client at the outset and understanding the impact of their answers on valuation approach can help you to manage your client’s expectations of value.
Trade
The nature of a company’s trade and the availability of financial information will inform the method of valuation. Investment companies or loss making trading companies may be best valued on an asset basis, whereas profitable trading companies should be valued by reference to their earnings where this outweighs an asset based approach.
Change
The purpose of considering past results of a company is to generate an expectation of future trade on which to base a valuation. Therefore, it is vital to understand whether the nature of a business has changed and identify any exceptional performance which would indicate past results are not representative of future performance. In this event, it may be necessary to make adjustments to prior performance to offset one off fluctuations or to set aside periods of trade entirely.
Whilst discussions with the client are key to understanding a business (see also The importance of context on this subject), we also review its detailed trading results and recent history to assess whether income and expenditure (both fixed and variable costs) are in accordance with the overall trajectory – be that stability, growth or decline. Any changes in income or expenditure which do not align with expected trends for the business may indicate exceptional performance or changes in the business.
COVID-19 is likely to have represented a period of exceptional trade for many businesses requiring valuation. A valuer’s approach to this period will depend on the trade of the business preceding and proceeding the exceptional trade. In the event that a business can demonstrate a subsequent return to normal trade, it may be appropriate to set aside this period entirely for valuation purposes.
Other changes we have seen in recent valuations include:
• the closure or acquisition of a subsidiary
• a fundamental pivot in business activities such as a change in the products or services being offered
• director illness impacting trade
• changes in regulations impacting the wider market.
The impact of each of the above on the valuation approach adopted depended on the degree to which the company’s trade was affected and the extent to which it was possible to accurately adjust past results to reflect the changes.
Size
The size of a company and the extent of any reliance on either staff or customers will have an impact on valuation approach. At the extreme, an owner-managed business with no additional staff which relies on the specific expertise of its owner may have no value over and above that of its assets. The reason being that sales are generated as a result of the particular expertise / reputation of a specific individual. Whilst the matter will ultimately turn on the specifics of the situation, a business such as this can be best thought of as an income generating vehicle for the individual in question.
Other examples of reliance may not be immediately obvious. We have seen companies with healthy income and profits but which are reliant on a large proportion of sales from a small number of blue chip clients. Any evidence of a declining relationship or the potential for a loss of business from just one customer could have a major impact upon the ability of the company to turn a profit. In this case, a client can expect to see the associated risk reflected in a reduction in value.
Having an expectation of how a business may be valued can be key to managing client expectations from the outset. We are more than happy to provide training sessions to solicitors on how to understand company accounts and what to look out for from the context of valuation.
This article addresses approach to valuing a company. For information regarding the impact of share rights and restrictions on the value of an individual’s interest, see Share valuation: when all is not as it seems.
