BVR Logo 19 July 2022 | Issue 40-1

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, IVSC, 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).

FCA propose revamp of premium stock rules to define control better

The Financial Conduct Authority released new proposals regarding listed companies that employ dual-class share structures (DCSS) for purposes such as employee share schemes. While these proposals don’t impact SMEs (or any company with less than £30 million in turnover), they set the legal and regulatory stage for perceptions of control. Among the new proposals for companies with DCSS premium listing requirements:

  • Raising the ownership threshold for significant transactions that require shareholder approval to 33%, from its current 25%;
  • Limiting the use of dual-class share structures based on weighted voting ratios of no more than 20 to 1;
  • Setting restrictions on who may hold premium shares, both regarding when such shares are available, and to whom, other than founding directors, the shares may be issued;
  • A reduction in the required level of free float for companies adding premium stock schemes to 10% of turnover; and
  • An increase in the minimum market capitalisation required for listing on the main market to £50 million—ostensibly to increase investor trust and reduce perceived smaller-company risks.

FCA released the proposals last month, but Clare Cole, director of market oversight, presented an outline of their intent.

SSBV continue their business valuation programming with EY’s Mossios offering current minority interest discounts for UK valuers

The latest Society of Shares and Business Valuers (SSBV) session focused on current minority interest discounts for UK valuers and was led by Sandra Mossios, now a partner at EY. This session was not recorded in order to ensure an open discussion, but Mossios offered an overall view of discounts in the UK as the featured speaker.

Inflation, IFRS 16 (Leasing), FOREX, geopolitical exposures for your subject companies, staff shortages, and “so many other complex factors have contributed to market data and forecast variations,” she says. These also influence minority interest discounts.

She said these changes require all valuers to improve their analyses, making them “robust and supportable, scrutinising models and sources of data.” The UK continues to allow discounts depending on the facts of the case, and there are longstanding legal precedents, including the general rules that “personal relationship involving mutual confidence” of quasi-partnerships might not be eligible.

Mossios referred SSBV members to other sources available to support DLOC and DLOM conclusions in the UK (besides restricted stock and other US or international resources), including:

  • ACCA’s Technical Fact Sheet, which argues that “even for small uninfluential minority interest a discount of no more than, say 33% may be appropriate”; and
  • HMRC SAV Manual (now available in the Practical Share Valuation book by Eastaway et al.), which offers guidelines for discounts up to 70% for less than 10% positions, depending on the facts in the case.

High leverage, low revenues, volatility, and low asset base tend to lead to higher discounts—but Mossios noted that the benchmarking is difficult. She noted that even US expert Chris Mercer has been questioning the traditional “Mandelbaum factors” in his business valuation blog recently.

Larger blocks (above 20%) of bigger companies may be very difficult to sell due to both marketability and illiquidity, so those often generate high discounts as well. Still, “relying on blanket averages is no longer supportable,” Mossios commented.

SSBV’s next session is 19 October with David Bowes. A registration link is included in the listing below.

One researcher concludes the DCF is ‘untestable’

The paper, “The DCF Valuation Methodology Is Untestable,” equates price and value, which most BVWire—UK readers would question. Nonetheless, the paper’s author, J.B. Heaton (One Hat Research LLC), suggests that the discounted cash flow method works fine for bonds but not for businesses, projects, or stocks because it is untestable.

“While bonds can be viewed as examples of DCF pricing, this depends on their prices often being observable and their ‘expected’ cash flows typically being bounded above by their promised cash flows,” Heaton writes. “For capital projects, businesses, and common stocks, there is simply no way to determine whether a DCF valuation is a good representation of the causal mechanisms behind market values.”

Recordings available of free webinar series from the IVSC

Kroll has been sponsoring a series of webinars presented by the International Valuation Standards Council (IVSC) in June. Recordings are available for the past programs if you click here. Past webinars in the series covered topics including the global economic outlook, the impact of inflation on valuation and the cost of capital, and the growing influence of digital assets in the investment world. Speakers include IVSC chair and former UK Chancellor of the Exchequer, Alistair Darling; Kroll chief economist and Financial Times columnist, Megan Greene; IMF Global Markets chief and former IOSCO deputy chair, Ranjit Singh; Corporate Reporting Users’ Forum (CRUF) chair, Jeremy Stuber; PwC global asset and wealth management leader, Olwyn Alexander; UCLA emeritus professor of finance, Bradford Cornell; and many others.

Damodaran tosses some dynamite during BVR webinar

Historical equity risk premium? “I don’t like a backward-looking and stagnant premium.” A “normalized” risk-free rate? “Don’t use it.” The size premium? “Fiction!” Company-specific risk premium? “[expletive deleted]!!” Never one to mince words, Aswath Damodaran (New York University Stern School of Business) aired his strong views in response to questions from the audience during a recent BVR webinar. His opinions are always thought-provoking, and he gave some solid advice on valuing companies amid inflation.

A full recap of the webinar appears in the August issue of Business Valuation Update.

Inflation and valuation: The webinar title was “In Search of a Steady State: Inflation, Interest Rates, and Value; The (Inflation) Genie Escapes the Bottle!” He’s done a number of lectures on this, but we asked him to focus on the practical aspects of how valuation experts should assess the impacts of inflation when valuing a private company. Damodaran pointed out that there are disparate effects of inflation, and the value of some companies will be unaffected, others will be negatively affected (to varying degrees), and a few may actually benefit from inflation.

He advised experts to go “back to fundamentals” and examine six basic variables when determining how sensitive your subject company is to inflation. One variable is “pricing power,” which is the ability of companies to pass inflation on to customers. Of course, the more power a company has that enables it to pass price increases on to customers, the more protected it would be from inflation. The other variables are cost structure (margins), investment efficiency, cost of equity, cost of debt, and what he terms “failure risk,” which is a separate variable not reflected in cash flows nor the discount rate.

Can social value be a standard of value?

The Social Value Working Group at the International Valuation Standards Council has released its second paper, “Defining & Estimating Social Value.” This series dives into the very popular environmental, social, and governance (ESG) waters. While ESG has become the darling of the investment data world, the applicability of these essentially subjective and “black box” data to valuation analyses is extremely problematic. They expose valuers to double counting, scrutiny from auditors and regulators, and further problems.

This paper examines whether “social value” can be a basis of value, the difference between social value and the social component of ESG, and whether the existing valuation principle of highest and best use can apply to social assets and social value.

The IVSC committee is also seeking feedback from valuers on a number of related survey questions:

  • Do you think that the definition for highest and best use within a social value context needs to be expanded or reframed, and, if so, how would you revise the existing definition?
  • Should governments and charities be maintaining a social value balance sheet in addition to their traditional balance sheets?
  • Do you consider that the current discussions on ESG adequately addresses social value concepts in both a for-profit and not-for-profit world? If not, what would give this discussion more prominence and stimulus?
  • With the information that is presently available, is it possible in most situations to quantify and measure social value accurately? If yes, how, and, if not, what is missing?
Dates for your diary

13-15 September: IVSC Annual General Meeting, Fort Lauderdale, Fla.

3-5 October: 12th Annual International Valuation Conference, Riyadh, Saudi Arabia

19 October: Society of Shares & Business Valuers How to Lose at the Tax Tribunal With David Bowes, London and virtual, 17:30 BST-19:00 BST

7 December: Society of Shares & Business Valuers’ Causation and Financial Losses: Factors to Consider With Prem Lobo, London and virtual, 17:30 BST-19:00 BST

Want to share a news item? Have feedback or comments? Please contact David Foster at ukeditor@bvresources.com.

Want to share a news item? Have feedback or comments? Please contact
David Foster at ukeditor@bvresources.com.


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