It’s a big step for dignity and a step away from “unnecessary mud-slinging.” After 6 April 2022, married couples in the UK will be able to divorce without assigning blame or fault, thanks to ministerial approval of the Divorce, Dissolution and Separate Act of 2020, announced late last week. Financial experts who assist in the division of finances can expect better focus and perhaps just a little less anger and frustration from their matrimonial clients.

The courts don’t enjoy hearing about who did what to whom any more than business valuers do—it only extended or exacerbated the tension and often overt hostility. Trying to find a fair financial settlement often had to be delayed for “cooling off” periods. The current procedure is specifically unfair to the experts the family courts rely on, since business valuers, for the most part, were unable to recover fees for the extra hours and stress.

“For decades airing the ‘facts’ of a deteriorating relationship in legal documents was the only way to end matters,” comments Sarah Anticoni of Charles Russell Speechlys. “By removing the blame game of a couple having to prove whose ‘fault’ it was that the relationship had irretrievably broken down, it is hoped that all energies can be more constructively channeled into making future plans for any children of the family and for dividing finances fairly.”

Others note that this step is a long time coming, often referring to New Zealand, which allowed for no-fault divorces in 1969.

No-fault divorce basics for business valuers:
After April 2022:

• Couples will no longer have to agree to be separated for two years (or five, if the other spouse does not consent) or have proof of their partner being at fault in order to file for divorce;

• Only one person needs to desire the divorce, and their spouse will not be able to refuse the application; and

• HMCTS’ online divorce systems will have been updated so that the new process is simplified and works as intended.

It’s noteworthy that the G7 came to a landmark international tax agreement earlier this month. It’s the first since the turn of the century—the previous century, that is. These proposals will next go to the G20 finance ministers meetings in July and then on to the entire OECD.

The most prominent policy in the agreement is the 15% floor on corporate profits. The policy attempts to reduce tax haven competition that hurts all parties by creating an international “race to the bottom” in corporate tax rates.

Business valuers won’t simply be able to plug in a new effective tax rate standard when valuing small- and medium-sized enterprises. Among the valuation variables still in play are:

• The UK’s digital tax regime is now in conflict with this new set of international rules, creating potential double taxation for the large tech multinationals;

• Most of the EU believe that the 15% rate is too low;

• China and India are not currently involved in these proposals;

• Ireland still operates under their current corporate tax rate of 12.5%;

• Private capital can still move more or less freely to tax havens, so most businesses that require business valuation services won’t change their policies, even if Google and Apple need to make adjustments; and

• As with many international agreements, there’s a reasonable chance the US will not accept nor enact the provisions—particularly since there’s a US perception that a minimum corporate tax unfairly targets a handful of US multinationals.

How helpful are discounted cash flow and cost of capital analyses when you’re analysing a small, unlisted enterprise?

Luke Morris, corporate finance partner at ScruttonBland, says that the income approach has the potential to simplify valuation theory for SME clients. Speaking at the recent ICAEW 2021 Business Valuation Conference, Morris stated that, “from a practical point of view, we help clients to make sure that return on investment is higher than cost of capital. If we get that right, we are winning.”

“The income approach differs from market approaches, wherein the analyst compares the business to similar assets where trading information is available,” Morris continued. Market data—from listed companies, for instance—may seem remotely connected to a small-business owner’s interests. In some cases, they may better understand how their discounted cash flows generate value.

First, the income approach basics as they apply to business valuation: The income approach converts future cash flow into a single current number by means of some sort of model. If that income stream is level, then we know that the time value of money can be calculated with a fixed annuity analysis.

Using annuity theory to create a capitalisation rate, valuers can extend current value into perpetuity. (DCF theory becomes more complicated when necessary growth and taxation factors are included, of course.)

Furthermore, as all analysts understand, “businesses are rarely stable … so we give our thanks for Excel spreadsheets,” says Morris. He argues that the concept behind the income approach is still relatively simple, despite these complicating factors. “The purpose of the analysis is to identify the value of all future cash flows discounted back to today. In the models, logically, lower growth creates lower value, as does volatility and lack of profits,” Morris explained. Again, nearly every small-business owner understands these concepts.

How do capitalisation and discount rates appear in practice for smaller businesses? Andrew Stickland (ScruttonBland and also a board member of International Institute of Business Valuers) looked at the practical application of these basic valuation principals, particularly in contentious situations where the tribunals look to financial experts for guidance. He noted two interesting cases where the income approach helped the tribunals reach a decision. One case depended on support the valuer provided for the reasonableness of a 2% growth rate assumption (N Green v HMRC (Chartersea) (2015)).

A second shareholder dispute case (Pinfold v Ansell (2017)) required the application of a DCF that settled with discount rates in the 19%-to-20% range. This case also assumed background economic growth only.

P/E ratios (from market approaches) do not “account for differences in capital structure,” which can be particularly problematic when valuers consider small enterprises. “A company should not be valued differently just by reference to the way that it is funded,” Strickland reminded ICAEW attendees.

Yet, if two companies have the same operating margins but one has high interest expenses, given the same P/E ratio, different values will be derived. “The highly geared company be penalised by P/E ratios valuations,” Strickland says.

Small enterprises create unique challenges for business valuation: BVWire—UK notes that RICS, IVSC, and other international valuation standards tend to assume debt, liquidity, and tax standards that are more typical of larger listed entities, so Morris and Strickland offered a few valuation essentials for small enterprises:

• EBIT multiple analyses will yield much fairer “enterprise value” results when small companies are financed primarily by debt;

• Post-tax analyses are essential to weight small-company cost of capital decisions that capture the impact of risk created by significant debt funding; and

• Increased diversification reduces risk. Since less diversified buyers tend to acquire small companies, the cost of capital of the presumed pool of potential buyers should support a lower value.

Investors love it. Regulators desire it. Progressive startups (and listed companies facing reputational damage) promote it.

More importantly, as reported by Saba Palizi at Macfarlanes LLP, 45 of the FTSE 100 firms have added ESG measures to their long-term incentive or executive bonus compensation schemes. One of the latest firms to link 15% of their bonus plan to an “Agenda for Change” is the retailer Boohoo, primarily to help counter the £1 billion reduction in share value they suffered in 2020 when allegations of supply chain abuses surfaced.

But do the expensive new environment, social, and governance ratings Refinitiv and CapIQ heavily promote offer any tangible benefits for business valuation? BVWire—UK is not aware of a single business valuation report that uses an ESG rating to change a concluded value.

So the IVSC perspectives paper released last week, “A Famework to Assess ESG Value Creation,” written by Kevin Prall, starts the debate. Prall envisions ESG-generated adjustments to value along six (generally) intangible pathways:

• Brand strength;

• Intangible asset “intensity”;

• Lack of proprietary technology;

• Reliance on human capital;

• Premium to “book” value; and

• Customer relationships.

Enterprise management incentive (EMI) schemes have become popular since the government introduced them as a simplified way for small businesses to offer stock options to key staff. The UK’s EMI scheme is currently only available to companies and groups with less than £30 million of assets and fewer than 250 employees. Share values under option are capped at £250,000 per person.

These restrictions limit the use of EMI schemes, particularly for startups lacking the liquidity to pay for top talent. At last year’s budget, the government announced a review to determine whether access to EMI schemes should be broadened to help more high-growth companies attract and retain talent. Last month, the government requested guidance on how to expand the scheme while avoiding abuses or unsupported valuations.

More importantly, COVID-19 created the risk that EMI option holders would no longer meet the working requirements if their hours were reduced. Under the original provisions, such employees would not be eligible for new EMI options and they could be disqualified from holding existing ones.

Fortunately, provisions from the draft Finance Bill 2021 to protect the interests of eligible employees and EMI option holders have just been extended to 5 April 2022. The extension should make business and tax valuations for these stock options much easier until the EMI structure is expanded.

It’s likely that the government may minimise some EMI restrictions based on input they receive, to make the plans even more attractive to both employees and smaller businesses. Restrictions on vesting periods and conditions, total option values, and other factors may evolve.

A revised finance theory study, “Age, Gender, and Risk-Taking: Evidence From the S&P 1500 Executives and Market-Based Measures of Firm Risk,” reappeared in the new issue of the Journal of Business Finance and Accounting last month. The revised version (updating a 2020 original) jumps into the risky debate about whether younger men, apparently influenced by their daily habit of slaying beasts for dinner, are more prone to corporate risk-taking than older men and/or women. (Nonbinary leaders are not considered here—leaving one to assume that there aren’t any within the S&P in large-company senior leadership.)

Undeterred by cancel culture, Jarkko Peltomäki, Jukka Sihvonen, Steve Swidler, and Sami Vähämaa document that chief executive officer (CEO) and chief financial officer (CFO) age and gender have a direct effect on market-based firm risk measures “in addition to the indirect influence they may have through corporate policy choices.” How did the authors prove this? They examined stock returns and company-specific risk indicators. Firms run by older men in this elite and small sample have slightly less volatile stock returns and lower specific company risk. Hiring a woman, they conclude, doesn’t really reduce your stock volatility (corporate boards, take note!), but it may reduce firm-specific risk tendencies—a little.

Perhaps the most important conclusion to be drawn is that most business valuation experts cannot depend on finance theory to reach defensible conclusions. Imagine presenting this evidence before a contentious tribunal or as part of a fiscal business valuation.

Anecdotal evidence supported by a slew of scholars: Beginning with the “upper echelons theory” advanced by Hambrick and Mason, fittingly in 1984, the authors cite “abundant empirical evidence” that the characteristics, personalities, and experiences of individual CEOs and CFOs are reflected in firms’ business strategies, performance, financial and investment policies, and other corporate outcomes.

Some might have stopped there or tipped off a few investor friends that they might outperform the FTSE by investing only in large-cap stocks managed by a pair of older (white?) men. Having then profited by investments in enterprises with big cash reserves and no volatility, those same now-wealthy investors should put all their cash in woman-owned banks.

Business valuers may be seeing less insolvency work as government measures to minimise insolvencies reduced registrations 38% in the first quarter of the year, as reported in the UK’s latest quarterly company insolvency statistics, published on 30 April. The previous Q4 2020 also saw fewer insolvency registrations than the same period in 2019.

These data reflect registrations, rather than procedure start dates, so the decrease compares to data before the impact of COVID-19 or the implementation of government efforts. The trend remains, but the report acknowledges the range of government support put in place currently. No one is certain whether a surge in insolvencies will be triggered when these protective measures are lifted.

For now, all types of insolvencies have been reduced, the report shows:

• Creditors’ voluntary liquidations made up the clear majority of insolvencies in Q1 2021, but these are still down 24% on 2020;

• Administrations have been stable across the quarter but are still 52% lower than the same period in 2020;

• Compulsory liquidations have declined the most and are 26% lower than the previous quarter and 85% lower than Q1 2020 (not surprising as restrictions on the use of statutory demands and winding-up petitions remain in place);

• In Q1 2021, no companies obtained a CIGA moratorium and only two companies had a restructuring plan sanctioned by the court; and

• CVAs are also down 54% and 46% on Q4 2020 and Q1 2020, respectively. The report notes that Q1 is traditionally the most popular period for CVAs but that companies hesitated this year while the Virgin Active, New Look, and Regis cases were resolved. These protections end on 30 June.

There may be a rush of insolvencies currently suppressed by the government measures after the introduction in June 2020 of the Corporate Insolvency and Governance Act 2020 (CIGA), which was rushed through the UK Parliament in a five-week period. As the biggest change to the UK’s insolvency and restructuring legalisation in over 20 years, one of the cornerstones of this new legislation is the introduction of the Restructuring Plan. COVID-19 aside, a wide range of restructuring options has already been implemented within a Restructuring Plan—for example, a solvent recapitalisation (Virgin Atlantic), a combination of debt-for-debt and debt-for-equity swaps (PizzaExpress), and, most recently, a solvent wind-down (DeepOcean).

23 June: Risks of Non-Financial Disclosure Requirements, virtual, 12:00 BST

23-24 August: Excel Modelling—Investment Appraisal, Valuation, and Business Cases, ICAEW live online, 09:30-12:30 BST

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)

21-29 September: Practical Business Valuation, ICAEW live online four days 09:30-12:30 BST

24-26 October: ASA International Conference, Las Vegas and online

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

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David Foster at ukeditor@bvresources.com.