The Society of Shares and Business Valuers launched their 2022 webinar series last week with a challenge from Mike Blake, the managing partner of Brady Ware in the US, to add rationality to early-stage company valuation by relying more heavily on market inputs. The income approach is not always effective in prerevenue situations, so Blake turns to guideline public company and transaction method alternatives.

“Our job as appraisers is not to be merchants of hope, so our job is to cut through the fog, and that puts us out on an island intellectually,” Blake told the SSBV members. “We don’t have the benefit of an easily visible touchstone … and the markets are often irrational.”

SSBV have made the recording of Putting the Science Back Into Startup Valuations available for paid subscribers. Blake, an ex-investment banker and venture capitalist, admits “there’s remarkably little rigor around placing rational values on these interesting companies.” Valuers must question financial motivations, and market rationality must be called into question when it turns out “someone did a deal because they wanted to sit on the same board.” There’s an element of luck. The market (Blake says the median UK premoney seed capital valuation is now approximately £4 million) is largely unobservable.

Blake compares the “binary” status of startups to Schrodinger’s famous cat. “They’re both dead and alive at any given moment.… Most startups do not succeed at the level that justifies the risk, or even return the startup capital.”

All startup financial projections are conservative: “Every founder presents their company with the descriptor that their projections are conservative,” Blake laughed. “I have yet to see an entrepreneur lay a set of projections in front of me and say that they represent the deepest and most profound fantasies they’ve ever had.” BV experts are then supposed to force some rationality into those projections.

Projections may not be as reliable—and neither are the elements of the discount rate. While the risk-free rates and market risk premia are generally determinable, Blake recognises the potential “lack of science from CRS, industry specific risk premia, and size premia.” “Most of the discount rate is the result of our professional judgement,” he concludes.

“We’re often presented with forecasts that create the uncomfortable situation where I need to go back to the client and say I can’t accept them,” Blake says. “This is not my favourite part of the job. But if I can go back to them with market data,” then valuers don’t have to argue that they know the business better than the entrepreneurs do.

Plus these market data sources offer a secondary validation tool, and “I thank god for their assistance” when defending a valuation conclusion, Blake says.

These factors lead Blake to switch emphasis to the market approach. His session offered an excellent list of places to turn to find proxy market data for a set of companies for which EBITDA and revenue multiples are less certain. Among his nonstandard approaches:

• Turn to the angel investor community. “There are groups of UK angel investors who you can talk to every day,” Blake said. Valuers can use these professionals “to establish that there is a market for your target company.”

In addition to traditional valuation multiples, “calibrate value to invested capital,” Blake advises. Like any market approach, start with:

1. The relative size of the startup;
2. The stage of investment; and
3. How long the company has been around. The market prices a “sweet spot in investment year vintage between staleness and freshness.… If a company has been around long enough and has no inflection point, it’s worse than having no track record."

• Turn to Crunchbase Pro for small listed company comparables. Market cap data from the thousands of companies on the leading exchanges that have less than a £1 million in revenue show that the “markets price on a basis beyond historical revenues and EBITDA.” Blake acknowledges that “these noncontrolling shares may be trading sparsely, but at least the discounts are built in and there’s a lot of data.” Big firms with large research budgets can turn to CapIQ and PitchBook to find these comparable companies, but now that Blake’s left that world, he relies on Crunchbase Pro. (He notes that his clients love these data because they include so much information they can use about their company, their competitors, and future potential funding sources.)

• Consider risk factor summary methods. Blake offered the SSBV attendees a great scoring table based on standard risks (management, stage, competitive, litigation, etc.) with the assumption that a median UK premoney valuation would be £2.5 million. While valuation experts might not like risk rating methods, Blake confirms that “the angel marketplace uses them.”

• Add real options modeling to startup analyses. While many “clients often struggle to understand the mechanics and implications of these widely used methods,” they demonstrate the idea of value “gates,” Blake says, which calculate the negative value of events that may be terminal for the success of the company. Lattice models and their probability ratings can be particularly helpful.

Are these radical sources reliable? Blake’s experience says they support his conclusions well even though it’s hard to argue that market pressures don’t unduly influence the underlying market data. “Some of the noise can be reduced, and we have to assume some level of market efficiency and rationality in the transactions generated by these data.”

Details on SSBV events throughout the remainder of 2022 are listed in “Dates for Your Diary” and on ssbv.org. Membership in the organization is not required for the events but is available free at the student and corporate levels—and for a small fee at the Fellow, Full, and Associate levels.

The RICS Standards and Regulation Board (the SRB) has “unequivocally accepted” all 13 recommendations in the “Independent Review of Real Estate Investment Valuations” it commissioned in September 2020. The independent review was led by Peter J. Pereira Gray and supported by an Expert Advisory Group.

In part, RICS was anticipating the Financial Reporting Council’s (FRC) request for the separation of audit from advisory services by 2024. And, at the time, RICS was also attracting its own media scrutiny for concerns about independence.

In their 13 January 2022 response to the recommendations, RICS’ restates its initial aim in requisitioning the review, which was to ensure that these valuation services “remain relevant and trusted in this important and sensitive professional field” following growing concerns then over the performance and the independence of valuers—and RICS oversight.

Highlights of the recommendations include:

1. The need for standardised governance arrangements for commissioning and receiving valuation reports for high-risk and “regulated” valuations;

2. The requirement that real property valuers should ensure that the consistent separation of valuation from advisory activities within firms;

3. A requirement for a new valuation compliance officer role specifically to cover valuation process and conduct;

4. The creation of a new independently led valuation regulatory quality assurance panel, under the jurisdiction of the SRB;

5. Additions to the RICS Red Book to include further standards around the conduct and recording of valuation instructions and meetings between client and valuer; and

6. Recognition that the tangible property valuers should incorporate the use of discounted cash flow as the principal model applied in preparing property investment valuations.

SRB notes that the review did not find any “systemic issues that lead to questions regarding the overall credibility or accuracy of valuations.”

Netflix and Facebook stock faltered since the last issue of BVWire—UK, reminding the rest of the investment world that you can’t use large-tech stock prices as a measure for value in any other sector of the economy.

Once again, Aswath Damodaran offers some clear perspective for business valuers (and everyone else—his “Musing on Markets” editorial on this subject has over 21 million views—our business valuation rock star!):

Over the course of the decade (2010-2019), the FANGAM stocks increased in collective market capitalisation from $719 billion from $5.07 trillion, and their share of the overall equity value of all US stocks also surged from 6.5% to 14.9%. It is not hyperbole that without these stocks, the last decade would not have been a great one for US equities.

The HM Treasury has outlined possible new provisions of the United Kingdom’s research and development (R&D) tax relief system, with emphasis on increasing tax incentives for investments and innovation undertaken in the United Kingdom. Currently, there is no requirement that R&D activity must be conducted within the UK to be eligible for tax reliefs, so valuers don’t need to account for different rates in their cash-flow projects.

Because of labour, regulation, and skill shortages, certain research activities in the life sciences, and software and data licencing sectors, will still receive full credit.

All R&D tax reliefs claims must be endorsed: The December report also attempts to curtail abuse by requiring greater detail for all claims, as well as digital endorsement by a named senior executive of each company. This requirement could add costs (and reduce value) for startups and SMEs.

Draft legislation is expected by the end of the summer, as the chancellor of the exchequer moves beyond the implementation of the OECD’s October 2021 global minimum tax rate proposals.

Everyone from the FT on down has reported on the exuberant UK M&A market for 2021. So, while not wishing to rain on the proverbial control premium parade, it’s worth noting that FactSet has reported a significant downturn in activity for January.

The February issue of the FactSet Mergerstat Monthly Review is now available to download. Highlights of the report include:

• M&A activity fell 19% in January;

• The sectors with the biggest increase in M&A activity over the past three months were technology services, commercial services, and distribution services;

• The sectors with the largest declines in M&A activity over the past three months were finance, utilities, and electronic technology; and

• The biggest global deals announced in January are:

• Microsoft Corp. agreeing to acquire Activision Blizzard Inc. for $US 74 billion;

• A private group led by Vista Equity Partners Management LLC and Evergreen Coast Capital Corp. entering into an agreement to acquire the remaining 88% stake in Citrix Systems Inc. for $US 11.4 billion; and

• Take-Two Interactive Software Inc.’s deal to acquire Zynga Inc. for $US 11.1 billion; Acacia Research Corp. and Starboard Value LP’s proposal to acquire Kohl’s Corp. for $US 8.9 billion.

Year-end 2021 data, including equity risk premia, CRSP decile size premia, and industry betas/IRPs, are now available in BVR’s Cost of Capital Professional platform. The platform is a simple, transparent, and cost-effective service for estimating the cost of capital and is designed to bring more professional judgment and common sense back into the process, which has become too much of a complex “black box” of applied mathematics. It supports the buildup method and CAPM calculations for any valuation date. It also gives you the flexibility to choose the start year for historical return data based on what segment of history you believe best offers a reasonable basis to make estimates of expected future returns. For a personalised demo of the platform, click here for the most current industry risk premia, equity risk premia, size premia, and risk-free rate figures all in one platform. Access data from credible sources including the US Federal Reserve, CRSP, Dr. Aswath Damodaran, and Salvidio & Partners.

TODAY 1 March: Growth Shares Valuation, virtual ICAEW event, 13:00-14:00

29-30 March: IPBC Europe IP Value Creation Conference, London

29 March: Society of Shares and Business Valuers’ Protective Put Option Theory—The Use of Mathematical Models in Valuation Cases to Calculate a DLOM With Andrew Strickland, London, 5:30 p.m.-7 p.m.

12-20 April: ICAEW Practical Business Valuation, virtual classroom. Repeated 21-29 June.

15 June: Society of Shares and Business Valuers’ Minority Interest Discounts With Sandra Mossios, London, 5:30 p.m.-7 p.m.

9 July: Society of Shares and Business Valuers’ The Absence of Size Effect With Clifford Ang, London and virtual, 5:30 p.m.-7 p.m.

14-16 September: IVSC Annual General Meeting, Fort Lauderdale, Fla.

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

19 October: Society of Shares and Business Valuers’ How to Lose at the Tax Tribunal With David Bowes, London and virtual, 5:30 p.m.-7 p.m.

7 December: Society of Shares and Business Valuers’ Causation and Financial Losses: Factors to Consider With Prem Lobo, London and virtual, 5:30 p.m.-7 p.m.

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