Commercial disputes focused on the valuation of a business can be drawn-out leading to the need to
update valuations prepared earlier in the process.
Often when we undertake a valuation in a commercial dispute, we provide our valuation (either in the form of calculations, a letter or a report), maybe answer a few questions and then silence (we may not even hear how or if the matter settles).
Occasionally, out of the blue, we receive correspondence informing us that the matter has not settled and, as undoubtedly some time has passed, our valuation is now out-dated. A business valuation can only ever provide the value at one point in time (although, for a stable business in a stable market, it may be reasonable to rely on the business valuation several months after it is prepared). In short, we are asked to start all over again.
In this article we consider typical reasons why parties may struggle to reach an agreement on the value of a business and the typical issues that arise on revisiting a business valuation.
Why might a valuation not be agreed?
Business valuations are usually calculated using historic (proven) information. Where a company’s performance is stable and is expected to remain so, it is comparatively straightforward to prepare a robust valuation. However, where the future performance of a business is not expected to mirror past trends or there is uncertainty, the resulting valuation may appear fragile or be out of kilter with expectations, leading to difficulties in agreeing a settlement.
Fragility in a valuation is typically a result of the timing of the valuation – for example if we have been instructed to value a business as the worst possible time. Recently we were asked to value a business which had spent nearly 20 years developing some patented multi-million pound technology which was not yet ready for launch or testing in the marketplace. With no knowledge of whether the product would perform in its last round of trials or the potential demand for the product if it was successful at the trial stage it was difficult to prepare a meaningful valuation.
The timing of a valuation can have a major impact on the conclusion
In our experience, situations where parties may struggle to agree a valuation include:
- growing businesses (either new or expanding);
- declining businesses (businesses reaching the end of their life);
- businesses operating in a changing market (facing significant uncertainty); and
- businesses for which there is limited or very poor quality financial information.
In the first three situations, the valuation calculated will be time sensitive. Thus, if a year on the parties have not reached a settlement, the value of the business may have changed and it may be necessary to update the previous valuation (by update, we mean re-do). Unfortunately if the financial information available is poor the first time around it doesn’t tend to change second time around. If the business’ circumstances have not changed there may be little point in rehashing old ground.
What may stay the same?
A year (or maybe slightly more) is not a
long time when considering a business and we would not expect there to be significant changes when revisiting a valuation – the structure and history of the business will likely be the same (except, perhaps, for some more recent trading results). Thus, unless a business is facing or in the midst of a period of significant change, the maintainable earnings are likely to remain similar.
We would not expect there to be a significant change in the multiple to be applied to these maintainable earnings especially if there are few deals in the industry (note also that the most helpful public index of deal multiples is only published on an annual basis).
A business may be facing change, but if there are robust forecasts available at the point of valuing the first time around, the valuer will be able to incorporate the impact of these changes into their valuation such that the value will not significantly change upon revisiting (assuming these forecasts prove to be accurate).
A longer period between valuations will increase the likelihood of a change in value
If, at the time of revisiting, significant uncertainty remains, the valuer will be faced with the same problems as when first valuing a business and second time around the valuation may not be any more robust.
What may have changed?
We would expect a valuation to change as a result of unexpected changes in the business or industry or as a result of changes in financial performance that could not be anticipated.
Upon revisiting, the financial performance of a company that was unstable when first valuing may have “levelled out”. Equally any uncertainties may have crystallised and the impact may be known. This will impact conclusions in respect of both the maintainable earnings of the business and the multiple (a more stable business or one with a strong track record may command a higher multiple).
The value of a stable business will, in theory, stay reasonably constant
In commercial disputes, the valuation is frequently required at a set date. In such circumstances, without the provision of additional information presenting a different picture of the business (which can be substantiated), we would not expect the valuation to change second time around.
Ultimately, whether a value will have changed depends on the timeframe for revisiting (a longer period will likely result in a larger difference) and whether the business was facing any uncertainty at the time of the initial valuation.
Despite the valuer having a previous knowledge of the business, substantial work is required in undertaking a second valuation in understanding changes in the business and industry and in researching appropriate multiples and relevant deals.
Questions about changes in financial performance will need to be asked, and the expert will have to revisit old ground to get back up to speed. The work required is not significantly less than that required first time around. Any second valuation will therefore not be a cheap (or quick) undertaking and this should be considered carefully before going ahead.
Read the full Forensis newsletter
Article taken from our Winter edition. You can download our latest Forensis Commercial newsletter from our latest publications page