HMRC’s Shares and Assets Valuation (SAV), whose remit is the valuation of all shares and nonland assets for tax purposes, hosted popular Fiscal Forum meetings until 2018, but, for reasons of internal change and then COVID-19, business valuers have not had the opportunity to hear directly from the agency since then. That long delay ended last week when Steve Thomas (MRICS), the assistant director of HMRC’s Assets, Residence and Valuation section, held a Q&A at ICAEW’s 2021 Business Valuation Conference.

Thomas is familiar to many BVWire—UK readers. He’s a clear spokesperson for SAV and currently leads their litigation team of 70 based in Nottingham (50 to 60 of those are trained valuers who work across all the disciplines). Like all of SAV, Thomas has been working remotely since March 2020, including the ongoing work in front of virtual tribunals for hearings. SAV had hired a team of new valuers just before COVID-19, and training and CPD proceeded remotely, so those are now fully integrated.

SAV received 10,355 valuations during the 2020-21 tax cycle, slightly down from the 11,857 received in the year leading up to COVID-19. Thomas described SAV’s service levels as “commendable” during this period, since their internal reporting showed that they dealt with 97% of all correspondence regarding valuations within 40 days (and most—84%—within 15).

Half of the valuations SAV receive continues to be those for enterprise management incentives. This service allows companies to obtain assurance of market values prior to the granting of these tax-advantaged options. “EMI referrals haven’t lessened during lockdown,” Thomas told the ICAEW group. “They are very much 24/7/365. We receive them on Christmas Day, Easter Sunday, and at 2 or 3 o’clock in the morning.” They’re given priority. Still SAV extended the option period from 90 to 120 days to give more time to initiate the grants. As of now, they plan to continue this extension.

Let’s not repeat fiscal valuation mistakes: SAV are concerned about the possibility of “bad valuations driving out the good,” and he assured all the attendees that the professionals and managers at SAV are aware of the problem and wish to curtail it. “We have made mistakes, but please don’t push our valuers to repeat them,” Thomas stated firmly.

“Please, let’s have a sense check before you send a valuation into us. If you’ve got actual transactions in similar-sized holdings of the same class of share at around the same time at £100 a share … all other things being equal, don’t let your clients expect SAV to agree at a 10th or less of the actual transaction figure for EMI purposes.”

Agents have submitted valuations on this basis, Thomas recounts, and, “in a couple of cases, have got quite upset with us for not accepting their proposals.” To try to give better guidance, SAV have added illustrative samples to SVM110050 of their “Shares and Assets Valuation Manual.” Actual valuations lead the hierarchy of determining share price, so “please don’t try to hide them on page 41 in a footnote…. Please give us full details from the start.” While SAV don’t negotiate, call first to see whether what’s relevant can reduce uncertainty, Thomas stated, considering:

• Funding events;

• Forecasts;

• Discounts; and

• Effects of COVID-19 on value (including both winners and losers—and the surprise that “COVID-19 trumped Brexit,” as moderator James Palmer of Kroll/Duff & Phelps said).

One ICAEW attendee asked about valuing growth businesses where the EMI shares are currently underwater. Are those shares now worthless? Thomas said, whilst each situation is judged on its own merit, valuers must consider the risk and potential reward to the owner. A share valued at a very low price has little risk, he said, so that implies there is no potential for reward. Why would an enterprise float those shares, and why would an investor buy them, if there were no potential reward?

BVWire—UK notes an increasing effort by leaders of the UK BV profession to educate the business public on the value of independent business valuations. An example from last week comes from Kroll/Duff & Phelps and Ogier.

Colin Everson, associate managing director at D&P, and David Welford, partner, BVI Dispute Resolution, Ogier, released their thoughtful summary of the UK business valuation profession in Global Banking and Finance Review, directed at the commercial litigators who continue to generate so many valuation engagements. BV analyses combine “scientific methods of financial analysis with deep market knowledge and professional judgement to provide robust measures of value,” Everson and Welford write. “Commercial litigators are likely familiar with the broad concepts involved—but perhaps not with how valuation principles can be deployed in contentious cases.”

They go on to describe the power of business valuation to “assist in the resolution of disputes … so the legal team can get on with the substance of the claim” in actions related to fraud or recovery of debt, disputes following a merger or acquisition, insolvency proceedings, and unfair prejudice petitions pitting minority against majority shareholders.

Independence is mission critical: They also explain how independence (and especially conflicts of interest) are essential. Lawyers frequently neglect or hedge the fact that, as this article explains point blank, “the obligations of a valuation expert are to the court, not to fight the client’s case. At the same time, the expert must be prepared to robustly defend their methods and conclusions against challenge from the other side, in particular when giving live evidence. The credibility of any analysis depends on the expert’s ability to stand behind it without lurching into advocacy of the client’s position.”

Apparently a good pandemic cannot slow the aspirations of investment bankers with liquidity to spare, and the Q1 2021 Argos Index, released last Friday, offers new record-setting evidence.

The Argos Index, created by Epsilon Research (Paris), measures the level of private midmarket company valuations in the eurozone each quarter, has been released. Acquisition prices of unlisted European SMEs reached a new high of 11.3x EBITDA, surpassing the record-setting average of 11, for the last quarter of 2020. Investment funds led the inflation. “They reached a new record high of 12.7x EBITDA, following the record set in the previous quarter and widening the spread with multiples paid by strategic buyers, which stood at 10.8x EBITDA,” Epsilon reports.

Investment value and willing buyer/willing seller values have little in common, except, of course, for the fact that owners of small and medium enterprises see multiples such as 11.3 times EBITDA and assume their valuations should achieve similar lofty results. Every business valuer has faced the difficult task of explaining a 4.0x result to an owner who expected 10x. It’s unpleasant expectation management.

Carried out since 2006 by Epsilon Research for Argos Soditic, the index is calculated based on the information contained in the “Epsilon Multiple Analysis Tool” (EMAT), the database of European acquisition multiples and deal analysis reports with deal values between €1 million and €500 million.

BVWire—UK readers may click here to download the complete study.

Highlights of the Mergerstat Review, 2021, released yesterday,include:

• Top 20 deals of 2020 in the UK, as well as the EU, the US, Canada, Latin America, and Asia;

• Full analysis of current premiums paid over the targets’ equity and enterprise values;

• Transaction Roster based on Mergerstat industries;

• Top 100 global deals summary; and

• The popular industry analysis section.

Mergerstat Review, 2021, published by BVR, is available in PDF or print form for £211 plus shipping for print. All summary tables are derived from the FactSet database, using the most current updates and corrections.

CAPM received a Nobel Prize, is used in nearly every business valuation textbook from McKinsey to Pratt and Grabowski’s Valuing a Business, appears in all business valuation certifications and the CFA exam, and is used in corporate finance. There isn’t a better alternative. Nonetheless, Pablo Fernandez (IESE Business School, Universidad de Navarra) told ICAEW 2021 Business Valuation Conference attendees on 20 May that “CAPM can be an absurd model, lacking any relationship to human understanding.”

It’s easy to attack the use of CAPM, betas, WACC, and market premia as follows:

• Discount rates are not observable, for one thing.

• Every source, from Bloomberg on down, derives different betas for the same company, Fernandez said, looking, for instance, at the published beta for Coca-Cola on a specific date in 2014.

• Some sources use betas with false precision (Fernandez cited a UK utilities study that derived an average beta to nine decimals to the right of the decimal point).

• CAPM “also assumes all investors have homogeneous expectations, and only care about the expected return and the volatility of their investments.” Without disagreement on expected or required returns, Fernandez points out that “trading volume would be very small.”

• Ian Cooper did a separate session on the adjustments many analysts apply (for small size, distressed assets, country risk, or other factors). These adjustments can compound business valuation “anomalies.” In 2021, we’re now in an economy with a negative risk-free rate, for instance, a lower equity risk premium of perhaps 5% and a resulting real cost of capital as low as 2%. At such historically low rates, premiums have a disproportionate impact and, in fact, can “drive your entire valuation. Your adjustments matter a lot, at the moment,” Cooper concluded—a 12% micro-cap size premium reduces value by about 76% for small firms, he showed. “Certainly, the evidence for this kind of adjustment is less clear now than it was in the past,” making the application of size premia more complicated.

“This is the schizophrenic approach: to be a democrat for the expected cash flows but a dictator for the discount rate,” Fernandez said, since investors have different expected cash flows but equal expectations of the required return.

“There is a great dispersion and some odd betas (for instance, negative, or higher than one). We kept all the betas and averaged.

And they used the last two years of STOXX averages. Why two years? “The historical period (five years, three years) and the returns period (monthly, yearly) change considerably from one day to the next.”

Then, they unlever the betas, calculate the average of the unlevered betas, and relever it using the average debt-to-equity ratio of the comparable companies. The result was a levered beta with nine figures after the decimal point.

Business valuers, of course, have to assume a representative or common buyer—as defined by standards having to do with “willing buyer, willing seller” and “market participants.” Furthermore, Fernandez agrees that the use of industry betas reduces the strange variances between individual company beta calculations and actual market risk. This puts business valuation on a stronger methodological basis than much of the investment analysis community.

Another advantage that business valuers have over the investment market is that there’s more agreement about whether CAPM is driven by historical, expected, required, or implied equity premia. Fernandez argues confusion arises because many analysts don’t distinguish, so some are “creating a discount rate based on something that happened to my father when he was very young.”

As George Bower said in discussion at the end of the session, the question is still “how should valuators ensure that their judgment is robust and free from bias/noise? How can we make our valuations defensible?” And, of course, as David Greene commented, “Most people still get lost in the maths of the DCF basis.”

More analysts question the use of size premia. Still, the smallest companies sold at a 45% discount to overall market prices in 2020, says a set of new general indices produced by MarktoMarket. These breathtaking haircuts on value were presented at last week’s ICAEW Business Valuation roundtable.

Rather than disappearing, as many analysts claim, or being immaterial, as others argue, the discount in this study increased from 31% in 2019.

“Nano” transactions, with values less than £2.5 million, took most of the brunt of the COVID-19 downturn. “Micro” deals (at prices in the £2.5 million-to-£10 million range) had much smaller EV/EBITDA multiple discounts for the same period, as shown below. They were also discounted, but not nearly as much.

Deals about £10 million continue to see premium pricing compared to the overall market average, MarktoMarket concludes. It’s at this range where deal competition drives higher prices from private capital, and this clearly protected those sellers from loss in value during 2020.

Two recent articles from Business Valuation Update, published by BVR, may help UK valuers support the forecasts they select and the quality of the data they present in their business valuation reports. “Defining Terms: Forecasts v. Projections—Why Does It Matter?” argues that some valuers (and many users of business valuation analyses) confuse the difference between the terms “forecast” and “projection.” “Some people use them interchangeably, but these are formal terms found in the literature, so they should be used appropriately,” the article argues.

A second article from this month’s BVU is “Eliminating Outliers in Financial Data Without Cherry-Picking.” J. Richard Claywell discusses one method (developed by Mark Filler) for determining outliers that is defensible from the allegation of cherry-picking—that is, bias in selecting data to either suit the client’s wishes or to generate a specific result for the client.

Love may not survive, but the financial obligations of marriage carry on, even when COVID-19 changes the valuation of marital assets. Business valuers who do family law work know that a divorce legally ends a marriage, but it does not end financial commitments to each other even after the decree absolute has been granted. There is no time limit for making a claim.

Still, the UK courts attempt to minimise set-aside agreements under which financial settlements are rewritten. A new case, HHJ Kloss in HW v AW 2021 EWFC B 20, directly addressed an application to set aside a marital consent order because of the impact of the pandemic on the value of the husband’s business. The husband owed a series of lump sums totalling £1 million based on a financial dispute order that was entered 13 March 2020. The UK entered lockdown 10 days later.

Fast forward to 2021, and now a stay application, an enforcement application, and then a set-aside application were filed. The husband’s business distributed commercial photocopiers, an industry sector that everyone would agree was dramatically hurt by the pandemic.

The judge accepted this principle, stating: “[T]he COVID-19 pandemic is an extraordinary event, different in nature and scale, to any similar world event in the lifetime of the parties…. It is akin to a war, with tentacles spreading across the world.” Therefore, again in principle, the pandemic could allow a successful set-aside claim (a “Barder” event).

But … not in this case: The judge ruled against the husband on the premise that the risk to his company was reasonably foreseeable and that the husband had assumed the risk by keeping the company, which would lead to the greatest potential of personal reward.

An additional note on valuing marital assets in 2021: BVWire—UK is hearing more reports of contention because one spouse accumulated, but did not disclose, crypto assets during COVID-19, while court proceedings were delayed. A typical conversation one lawyer reported involves an anxious spouse who says, “Over the last year or so, I have overheard my husband telling friends about the success of his bitcoin investments. We are now getting divorced and I have no idea how much his cryptocurrency holdings are worth or how to even find that out.”

Despite the powers of the family courts in England and Wales, they can rarely overcome anonymous and undeclared crypto. Business valuers know, of course, that the key is to audit funds flowing into—or out of—traditional “fiat” accounts. This will often lead to either a currency address, or a digital wallet, since the blockchain records all transactions.

If the analyst cannot discover links in this manner, there’s still hope. Courts are accepting documentary evidence (witnessed conversations, emails, etc.) that allow them draw inferences regarding such assets. And, of course, as with the new COVID-19 case discussed here, nondisclosure is always a strong reason (and an excuse for court-defined penalties) to demand a set-aside of previous marital settlements at any time in the future, if new evidence emerges.

14-15 June: ICAEW Advanced Valuation Techniques, virtual classroom taught live by Steve Shaw

21-25 June: NACVA Business Valuation and Financial Litigation Hybrid and Virtual Super Conference

28 June: ICAEW Valuing a Pharmaceutical Company Webinar, 14:00-15:00 BST

13-16 September: IMAA's Damodaran on Valuation, live—online (repeated 8-11 November)

24-26 October: ASA International Conference, Las Vegas

27-29 October: IVSC Annual General Meeting (programme and format information to come)

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David Foster at ukeditor@bvresources.com.