Valuation Snapshot - Spring 2019

Valuation Snapshot Spring 2019

Welcome to the latest edition of Valuation Snapshot. In this regular publication we look at the trends and issues behind business valuations, and provide bite-sized advice that can help you and your clients when valuing a company.

PE investors are driving demand Our latest snapshot shows a slight sag in average multiples. With Argos and PERDa indices holding level the downturn is driven by the PCPI. Digging further, the Private Equity Price Index or PEPI – a related index also produced by BDO of deals where Private Equity is the buyer – is holding steady.

Key valuation indices Q1 2009 to Q1 2019

This reflects our experience as deal doers where we are seeing really strong demand from the Private Equity community for SMEs. Strong ongoing liquidity in that sector is creating pressure to invest. So our overall view is that in reality prices are holding steady.

Don’t drop the anchor!

Avoiding bias in business valuations It’s a cliché that business valuation is both an art and a science. Or as its been more aptly put, it’s a craft. Either way it needs to be done thoughtfully.

Google a valuation You don’t need to look hard online to find websites that invite you to input your data and it will value your company for a low fixed fee. The trouble is that an “under the bonnet” valuation is just some maths – this is a problem because you have no idea if the website is asking the right questions, and more importantly, it’s only as good as the data input. As they say garbage in, garbage out.

Bias in your approach But if you do treat valuation as a craft, to be conducted thoughtfully, making insightful and supportable judgements about the business at each step, you need to guard against bias – and this can arise accidentally.

An experiment Anchoring is a well-documented phenomenon.

There have been psychology experiments that have demonstrated this. Business students were asked if they’d pay the last two digits of their national insurance number for each of several items. Then they’re asked the maximum they’d be prepared to pay item by item. Despite it being random, students with higher NI numbers consistently indicated higher maximum bids.

When not to anchor The anchoring phenomenon can work to one’s advantage and a good reason why it’s often helpful to go first in a negotiation – to try to anchor the debate at your end of the value range. But it has no place in valuation as the valuer should form an independent judgement.

Acting responsibly As a corporate finance adviser, I’m keen to understand what my clients objectives are as input to negotiations. Conversely as a business valuer I need to be deaf to the client’s desired valuation. This might be a business valuation for divorce purposes, or to do with shareholder exit, or tax.

But I need to avoid anchoring bias to make sure I arrive independently at my best judgement of valuation which is supported by the evidence and by my understanding of the business.

Lake Falconer lake@pemcf.com

Pressing the reset button

Matthew Eady meady@pem.co.uk

It’s always recommended that prior to the grant of options under an Enterprise Management Incentives (EMI) scheme, the market value of a share is agreed with HMRC. So what’s changed?

Historically, HMRC have tended to agree valuations based upon underlying financial performance even if there have been transactions in the company’s shares at or around the same time. In many cases, HMRC have agreed nominal valuations for tax purposes where funding round prices over the same class of share have been significantly higher.

However, earlier this year HMRC reset their approach following an internal EMI Risk Assessment – making their methodology more vigorous and applying the doctrine that there is no better indicator of market value than actual transactions involving the same or similar asset. This ostensibly uses the due diligence undertaken by investors in helping HMRC form their opinion.

If there have been transactions in the same class of share over which the EMI valuation is sought, the price paid on the transaction is now HMRC’s starting point. There is little regard to underlying company performance.

What does this mean?

The change in policy will mean that tax valuations agreed with HMRC will invariably be higher going forward – potentially using up the individual employee EMI limit (£250k) and overall company EMI limit (£3m) sooner than may previously been the case. Further, as many companies gravitate towards the tax value when determining the exercise price, future optionholders will find that they need

to pay more to exercise their options. This may well be at odds with colleagues who were granted qualifying EMI options prior to the change in HMRC policy.

A let down for start-ups Perhaps the most notable area where this change will be felt is within start-up companies – reliant on the one hand on sharebased funding to survive and on the other, to using share incentives as a means of recruiting and retaining key employees where cash is king. Such company’s will find it’s no longer possible to grant qualifying EMI Options at nominal value without income tax (and potentially national insurance) implications arising on exercise. This is disappointing given the Government’s view of the role that employee share incentives play in economic growth.

PEM Valuations From time to time, your clients may ask you how to value their business.

Such requests could be triggered by: ▪▪ ▪▪ ▪▪ ▪▪ ▪▪ ▪▪ ▪▪

Divorce Shareholder exit Disputes Restructuring Business planning Tax and Accounting Regulatory reasons

Yet for many advisers, valuations are not their day job.

This is where the PEM Valuations team can help.

Why refer your clients to us?

Focused Our valuations are produced by a specialist, multidisciplinary team with a valuations focus.

Personal We have a flat structure so clients always receive cost effective senior level attention.

Commercial Our real world experience in company sale and purchase negotiation means we don’t just claim to be commercial, we have the transaction record to prove it.

Tailored We do not use a software driven or “form-filling” approach. Our reports are based on a thorough understanding of the business to be valued, and tailored to the specific needs of the owner.

Get in touch: 01223 728 222 Take a look at the new pemcf.com PEM Corporate Finance LLP is authorised and regulated by the Financial Conduct Authority, registered number 212875.

Registered in England & Wales, company number OC302288 at Salisbury House, Station Road, Cambridge, CB1 2LA. If you no longer wish to receive this publication, or if you have had a change of address, please email info@pemcf.com.