‘Common law is shifting under our feet, so this is an interesting time to do valuations in contentious situations, whether it’s a family or a non-family situation,’ Andrew Strickland (Scrutton Bland) told BVWire—UK last month. He particularly noted the evolution from the ‘three tests’ 1973 House of Lords decision in Ebrahimi v Westbourne Galleries Limited, which established some standards for quasi-partnership holdings. This decision originally offered special protections to family businesses in certain prejudicial behaviours such as not paying dividends to shareholders. A business holding was deemed a quasi-partnership if:

• The association formed or continued based on a personal relationship involving mutual confidence;
  
  
• An agreement existed indicating that some or all of the shareholders would participate in the conduct of the business; and
  
  
• The agreement places restrictions upon the transfer of the members’ interest in the company.

These standards were refined by Section 994 of the Companies Act of 2006, which sought to clarify business actions ‘conducted in a manner that is unfairly prejudicial.’

Strickland notes that business valuators—and the High Court—have struggled to refine the definition of ‘mutual confidence.’ ‘It matters whether it’s a family business or not, for instance. Are relationships between siblings always based on mutual confidence? That’s not always true when families are dysfunctional, but the courts seem to conclude based on personal relationships that there is mutual confidence,’ he says.

Not always, however. There are cases such as Booth and Booth [2017] EWHC 457, where minority discounts of 30% made sense since extended family ownership was so distant that the quasi-partnership test didn’t hold.

Nonfamily relations are different. In these situations, discounts may be ended when quasi-partnership status ceased for reasons such as new shareholders. However, excess remuneration is often added back, both in family and nonfamily cases, Strickland comments.

One current example of section 994 actions Strickland cites is McCallum-Toppin and McCallum-Toppin [2019] EWHC 46. Here, the High Court specifically saw prejudicial conduct in lack of dividends, excessive directors’ compensation, and unfair use of directors’ loan accounts. The court disallowed discounts, saying, ‘A sale at a discounted value would present an undeserved windfall to the purchasing respondents.’

Strickland summarizes the fairness trend as a desire by the courts to evolve, slowly, toward basic principles. ‘Fairness is the lodestone and guiding principle of the courts. Did people pay full price to enter? What was the behaviour—good and bad? These questions challenge the quasi-partnership standard, and whether or not minority shares should be discounted.’

Two sources of industry betas were introduced this week in BVR’s Cost of Capital Professional (CCPro) to help in estimating the industry risk premium (IRP) component of the buildup method for developing the cost of capital for a private company. CCPro users can choose either source to derive the IRP the platform calculates, or they can input an IRP they develop on their own.

Two sources: A CCPro user has the choice of using betas published by Professor Aswath Damodaran (New York University Stern School of Business) or Salvidio & Partners. Dr. Damodaran is known as the ‘dean of valuation’ and is widely respected by the business valuation community. Salvidio & Partners, a Rome, Italy-based business valuation firm headed by Ascanio Salvidio, produces a quarterly report on levered and unlevered industry betas for 134 industries in North America, the EU, and Western Europe.

Meanwhile, the 2019 edition of the Duff & Phelps Valuation Handbook - International Guide to Cost of Capital was released last week and is available for $675 USD. The handbook provides inputs and methodology to enable analysts to ‘assess risk and develop cost of capital estimates.’ Exhibits provide country-level risk premia, relative volatility analyses, and equity risk premia (ERPs).

Business valuers in the UK often rely primarily on public-company multiples, given the lack of other comparables. BVWire—UK recently surveyed business valuation professionals and confirmed that our readers need better UK-based small and medium enterprise (SME) metrics. The survey found BDO’s PCPI to be the most common tracker for midmarket deals—but not particularly helpful for SMEs and lacking in industry segmentation. The other top sources are the Price Earnings Ratio Database (PERDa), BVR’s DealStats (though there is limited UK data), and BVB Insights. Other sources mentioned by respondents included FactSet, FT Market Data, and Plimsoll. ‘A UK or EU-specific DealStats would be a very useful tool for BV practitioners,’ one respondent commented.

Another said, “I’ve seen valuation reports for local cell phone repair businesses where the only data point is the price earnings ratio for BT.”

In the second edition of his latest book The Dark Side of Valuation, Aswath Damodaran discusses ‘the perils when we extend the pricing lessons we learn from looking at more mature, publicly traded firms to a young, private business.’ This problem is magnified by the frequent lack of multiples or other metrics from comparable smaller private companies.

Damodaran warns: ‘[A]lthough private and public companies can share characteristics, they also differ significantly. Consequently, these differences affect the underlying value of a public company and create an imperfect comparison for valuing a private company.’

Public companies typically:

• Are much bigger than private companies;

• Have had time to sort through growing pains, mature in the market, and stabilize;

• Have diversified streams of revenue and established customers;

• Often have lower growth prospects—which influences their fundamentals and the multiples paid for by investors; and

• Should have a greater chance of surviving than younger companies, and therefore trade at higher market enterprise values.

Particularly within a competitive landscape (in private equity, for example), ‘proper due diligence founded in private market data can protect against overpaying for a deal,’ Damodaran concludes.

IVSC-WAVO Global Valuation Conference 2019,
13-14 June, Frankfurt, Germany

BVR Finding Comps in DealStats: Examples and Best Practices (A Free Webinar), 18 June, 18:00 GMT

ICAEW Practical Business Valuation, 11 September and 25 September, and 11 November and 25 November, London

IVSC Annual General Meeting and IVAS/IVSC Business Valuation Conference, 7-9 October, Singapore

ICAEW Excel Modelling—Investment Appraisal, Valuation and Business Cases, 18 October or 15 November, London

ICAEW Annual Business Valuation Conference,
23 October, London

ICAS New Corporate Insolvency Rules for Scotland Course, 31 October, Glasgow; 1 November, Aberdeen; 7 November, Edinburgh; 15 November, Perth

UK200 Group (the network of independent law and accounting firms) Annual Conference,
13-15 November, Liverpool