Robert Parry, a managing director in our Forensic Accounting and Investigations team, takes a closer look at this pandemic-related conundrum.
In normal times, using details derived from market transactions in shares in listed companies has regularly been referred to as one of a range of potential inputs to help estimate multiples for private companies. But, in times of crisis, the market value of listed companies has been pretty volatile. Certain market sectors have fared better than others, but even within sectors there is variation. In addition, referencing a valuation to listed company dividend yields is tricky at a time when some listed companies have stopped paying dividends altogether in an effort to preserve cash. In determining the discount rate to apply in a discounted cash flow model, where now for the risk-free rate and various risk premiums?
The Sword of Damocles
This current crisis has left the Sword of Damocles hanging over what were previously regarded as sound businesses. If more investors are facing the real possibility of losing their entire investment, the return required for investing in those companies will increase – and that will drive down the price that an investor is willing to pay.
Guidance for those in disputes
In any economic environment, valuations generally represent a subjective opinion: it’s still possible to give that opinion right now - even if it’s couched in cautious terms. In certain situations, such as litigation and other disputes, not giving a valuation at all is normally not an option.
From our perspective as expert witnesses, the courts still need the best guidance available. The challenge for the courts is that they can’t award a range of damages or loss – only a single figure. Experts will continue to provide ranges, but they can support the court by giving an indication of where they consider valuation falls within that range, and how they arrived at that conclusion.
Parties in dispute that have agreed to an expert determination process still need the expert to reach a final determination.
What does the future hold?
This ongoing uncertainty could see the courts change their approach altogether. When it comes to unfair prejudice actions for example, the courts have very wide powers under s996 to “make such order as it thinks fit”. In the future, we might well see judgments including new innovative solutions to ensure fairness; they could involve the more frequent retention of equity or the issuing of share classes with protected rights for “exiting” ordinary shareholders.
The conventional approach taken by the courts dictates that events that occur after the valuation date can’t be taken into account: the ‘no-hindsight’ rule. But Coronavirus (COVID-19) is a such an extreme, once-in-a-generation event (we hope) that no-one considering an acquisition around the end of 2019 could reasonably have predicted its impact. We do most of our valuation work some years after the index event, so an event in the second half of 2019 might not trigger the need to produce a valuation until, say, 2022 or later.
Two or three years from now, we’ll be looking back and putting ourselves in the position of an investor trying to value a company last year. By the time the valuation is being prepared, we should have a much better idea of how much – and for how long – COVID-19 has affected the economy and businesses. However, the potentially dramatic impact on valuation will really test the no-hindsight rule. For example, an entertainment venue valuation in late 2019 should not factor in any Covid-19 impact if the no-hindsight rule is applied, but many such businesses will have closed for a large part of 2020 if not permanently.
Additionally, a systematic risk of this seriousness is something that may well need to be factored consciously into valuations as we move through the pandemic and out the other side.
Get in touch with me today to find out more and in case you missed it, please see a link to a webinar we held earlier this year on how to approach business valuations during uncertain times:
View the webinar
In case you missed it, please see an article from our colleagues in our Corporate Finance team that discusses the various valuation methods that can be applied during this time.
Valuing businesses in challenging times