One aspect of business valuations that are often difficult for parties to grasp is the sensitivity to the valuation date.
Put extremely, the valuation on one day may not be the same as on the next. This may be a result of significant factors or events that arise between the two valuation dates.
We have recently been involved in a number of business valuations that were significantly and negatively impacted by the current circumstances of the business and actions of management.
One such example was the valuation of a business in the construction industry. We became very familiar with the business over a longer period of time than usual as the parties struggled to agree a settlement. Due to the timing of certain factors that we will discuss below we were instructed to prepare a second valuation of the business some seven months after our initial report.
Historically the business had been displaying growth and generating substantial profits.
However, the future profitability of the company was in jeopardy due to changes in industry regulations, something that the husband was keen to emphasise. This led to the management team adapting the business strategy to diversify into a new market.
“The husband is sitting on a springboard for the generation of significant future products.”
In order to be able to operate in this new market, the business purchased a property at considerable expense, and had even paid a premium as suitable space was in limited supply. The property, however, was not suitable in its original state and, at the point of our valuation, a number of buildings on the site had been demolished. This significantly diminished the market value of the site and consequently the value of the company.
To add to it all, the company was also the subject of a legal claim, the outcome of which was uncertain but, if successful, would negatively impact the value of the company and diminish the value of any goodwill.
When valuing the company there were a number of risks that needed to be considered, risks that were relatively new and that the business could potentially navigate its way past, although its ability to do so was uncertain.
“The company today, as it stands, is worth something on the market to a willing purchaser.”
The wife (who would be transferring her shares to the husband) was concerned that the valuation of the business would be too low as a result of the focus on these factors. She questioned whether more emphasis should be given to the future position of the company, particularly with regard to the potential increase in the value of the property any investment may bring about.
“On the other hand …where there is risk, there is also reward.”
It is possible, and even probable, that in the future, once all uncertainties are resolved and the necessary investment undertaken, the business will be more valuable. The Judge in the matter appreciated this fact but recognised that we had been instructed to determine the current market value of the business.
“He is receiving an asset which is clearly valuable and may become very much more valuable. That carries uncertainty…”
Emphasis must be placed on the word current and therefore the valuation should reflect the risk to the company as a result of current industry changes and legal claims.
Whilst a valuation on an income basis will consider the potential future performance of the business, assets and liabilities must be valued at their current value rather than potential and unknown future value.
To assess the future value of the property, once developed, it would be necessary to consider the expenditure required as well as the potential future value. A reasonable assumption is that one would equal the other given the uncertainties involved.
Had we valued the business before these risks were known or after they were resolved, we would likely have concluded on a higher valuation (assuming all other factors were the same).
“I found Miss Hart to be a sound and sensible, professional witness who had carefully and thoroughly considered the evidence and come to sensible conclusions.”
In fact, between the first and second valuations, the legal claim had come to nothing and the valuation of the company increased as it had addressed some of the market uncertainties.
In short, we had been instructed to value the company at the worst possible time.
It is not often that we get to see the judgments in the matters in which we are engaged. It was comforting to be able to read how the Judge appreciated the sensitivity of the current valuation in the settlement he proposed.
Quotes in this article were taken from the judgment