BVR Logo 3 December 2019 | Issue 9-1

BVWire—UK is a free service from BVR focusing on the business valuation profession in the United Kingdom. We offer news and perspectives from valuation thought leaders, the High Courts, HMRC, the standard-setters, ICAEW, RICS, and more.

Please be in touch with your perspectives, news, and ideas—and pass this issue along to colleagues (complimentary sign-up instructions are here).

Submit agenda items for 25 February 2020 HMRC Shares and Assets Valuation Fiscal Forum by 14 January 2020

Business valuers who wish to attend the forum this year should notify Helen Malone by close of business on 14 January 2020. The same applies for any BVWire—UK reader who wishes to propose an agenda item or topic of conversation.

The year’s meeting (the first since October 2018) will be hosted at RICS (Parliament Square, London) commencing 25 February at 1.00 p.m.

One topic already included for discussion in February is the recent First Tier Tribunal of the Tax Chamber’s Vantis Tax Limited decision (TC07404). The sole issue before the Tribunal was the market value of shares gifted to charities. HMRC contended that the shares in question were placed on the Channel Islands Stock Exchange (CISX) at inflated prices resulting in overstated tax relief claims in respect of the gifted shares. James Rivett QC appeared for HMRC, and John Friend of Kukar & Co represented two of the five appellants from Vantis.


Intangibles often require their own discount rates to derive WACC, Shaw and Higgs report

Since there are very few comparable statistics, analysts often need to assemble their own matrix of required asset return rates for enterprises with intangibles, Steve Shaw (Financial Seminars) told attendees at last month’s ICAEW Valuation Community Annual Conference in London. ‘The important thing is that you’re consistent between one [valuation] and the next,’ he said, even though the tax benefits of FRS102 separable assets have been reduced.

Shaw presented with Ashley Higgs (Smith & Williamson). The two well-known analysts reviewed WACC conclusions for two comparable firms: one capital-intensive and one a knowledge firm. In the first case, a combination of a 4% discount rate for intangibles (83% of total assets) and a 25% rate on intangibles (17% of assets) results in a 10% WACC. By comparison, a 4% discount rate on the knowledge firm’s tangible assets (23% of assets) and 18% on intangibles (77% of assets) results in a WACC ‘fulcrum’ of 15%.

This model is simplified, since, as most analysts realise, not every intangible has the same required rate of return. Typically, Shaw sees descending discount rates similar to the following example:

  • Goodwill—25%;
  • In process R&D—20%;
  • Unpatented technology—16%;
  • Copyright—11%;
  • Patents and external use technology—11%;
  • Workforce in place—10%;
  • Customer relations—10%; and
  • License agreements—10%.

Shaw discussed the valuation methods best matched to complicated scenarios such as purchase price allocations, negative goodwill, and insolvency. In particular, he relies on contributory asset charge. It is ‘used to reflect the use of all assets in the production of a margin,’ Shaw says. Each benefitting asset (a customer relationship, for example) ‘pays a hypothetical rent to use other contributing assets.’

This question comes up frequently in BV, particularly in purchase price allocations where discount rates tend to increase for assets further down on the balance sheet. So it’s relatively normal to use different discount rates, and it’s logical to see how other evaluations—for instance, regarding the new right to use lease standards—might also require multiple discount rates.

Shaw and Higgs recommend that business valuers also conduct a test of the weighted discount rate across all asset classes to ‘guarantee the average discount is in line with the discount rate for the entity as a whole.’

New IVS, including extensive guidance on deriving discount rates, becomes effective 1 January 2020

The latest revisions to the IVSC’s International Valuation Standards, having completed the lengthy public comment and review process, become effective 1 January 2020. BVWire—UK has covered important components of the extensive update, which replaces IVS 2017, in previous issues (for example, here’s our analysis of the new complex financial structure section).

New Sections 50.34-40 are worthy of review by anyone preparing business valuations: Most of the new guidance will be familiar to BVWire—UK subscribers, but the detail expands the standard to (hopefully) increase uniform practices globally. Common sources of discount rates include Duff & Phelps and BVR’s Cost of Capital Professional.

For the first time, in section 50.34, the IVS will require documentation of both the method used and the inputs selected to derive discount rates:

50.34. In developing a discount rate, the valuer must:

  • document the method used for developing the discount rate and support its use,
  • provide evidence for the derivation of the discount rate, including the identification of the significant inputs and support for their derivation or source.

The IVS update also requires careful balancing of the quality of the forecasted cash flow with the selection of the appropriate discount rate. This new guidance confirms what’s obvious in practice but not always documented by analysts.

50.36. Valuers must consider the risk of achieving the forecast cash flow of the asset when developing the discount rate. Specifically, the valuer must evaluate whether the risk underlying the forecast cash flow assumptions are captured in the discount rate.

This section is combined with the new section 50.37, which lists the methods a valuer might employ to identify key components of risk in the cash flow analysis (historical performance, economic growth rates for the country and industry, etc.). If these elements indicate that the enterprise’s forecast does not capture risk appropriately, the new section 50.38 now requires an adjustment in either forecast or the discount rate:

50.38. If the valuer determines that certain risks included in the forecast cash flow for the asset have not been captured in the discount rate, the valuer must 1) adjust the forecast, or 2) adjust the discount rate to account for those risks not already captured.

  • When adjusting the cash flow forecast, the valuer should provide the rationale for why the adjustments were necessary, undertake quantitative procedures to support the adjustments, and document the nature and amount of the adjustments,

  • When adjusting the discount rate, the valuer should document why it was not appropriate or possible to adjust the cash flow forecast, provide the rationale for why such risks are not otherwise captured in the discount rate, undertake quantitative and qualitative procedures to support the adjustments, and document the nature and amount of the adjustment. The use of quantitative procedures does not necessarily entail quantitative derivation of the adjustment to the discount rate. A valuer need not conduct an exhaustive quantitative process but should take into account all the information that is reasonably available.
Should business valuation be more sensitive to market pricing?

BVWire—UK has been privy to a number of conversations recently with leaders from valuation professional associations around the globe. One concern raised regularly anticipates the economic downturn predicted by the business press and most financial pundits.

A common theme: Fair value analyses often lag cyclical changes in investment or market values during periods of rapid change. As an example, the director of the Nigerian valuation professional organisation (VPO) explained to BVWire—UK that, in his country, the single biggest consumer of valuations is the governmental bank that assumed distressed assets after the last financial crisis. Because of the lag, fair market reports overvalue these distressed assets, and the government ‘have not been able to dispose of their assets at prices comparable to the valuations.’ He reports that his appraiser members face a great deal of pressure to ‘price’ assets rather than provide market value as required by IVS.

Other UK agencies, and valuers, have also complained that valuations don’t follow market variations rapidly enough. One RICS board member cited the UK retail sector, which is struggling, but discount rates and market comparables have not dropped with commensurate haste.

‘If there’s a crash, as every one is predicting, values are likely to stay “too high” for some time, when prepared using BV standards for some time,’ she warns. There isn’t a simple answer to the following questions:

  1. Do BV standards, and the valuation profession generally, have increasing responsibility to provide fair market values as well as market pricing?
  2. What are the risks?
Dates for your business valuation diary

HMRC Shares and Assets Valuation Fiscal Forum, 25 February 2020, London

ICAEW Practical Business Valuation, 16-17 March 2020, London; 14 and 26 May 2020, London; 9 and 29 July 2020, London; 9 and 19 November 2020, London

ICAEW Business Acquisition & Due Diligence, 22 April 2020, London

73rd CFA Institute Annual Conference, 17-20 May 2020, Atlanta

Our thanks to Marianne Tissier, Andrew Strickland, and Nick Talbot for their valuable contributions to BVWire—UK.

Interested in working with BVR in the UK as a partner or ambassador?
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Please contact David Foster (Executive Editor) at: or +011-917-741-3853

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