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, 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).
||It’s easy. Retain 90% of your customers, grow 50%, and your business valuation client will be worth 10X
Here’s a quote on the current 4Q state of the UK private equity marketplace that explains the disparity in valuation expectations held by investors, owners, financial analysts, and those concerned about closely held businesses. Answering the question for last week’s Enterprise Times, Cavendish Corporate Finance LLP partner Anthony Platt explains why PE firms are still paying multiples of 10X or more on turnover to buy assets from other PE firms:
Private Equity have been the biggest buyer of PE assets for some time in the UK mid-market. They love it. If you can find a 90%, recurring revenue business, which has got £10 to £30 million in revenue, is profitable, and seeing 20% to 50% growth, you could sell it ten times over.
We don’t dispute this statement, and Platt points to the sale of CaseLines to Thomson Reuters, or another sale of the wealth management ‘platform,’ Intelliflo to Invesco.
Still, these FT-reported big deals cause the following problems for business valuers:
- The reason these deals get such high multiples is there aren’t any available companies that actually match the description above.
- Every small-business owner who reads about these deals driven by the need to put money into play rather than by financial fundamentals ignores the 50% growth, 90% retention metrics and becomes convinced that their mobile phone repair enterprise is worth 10X.
- When disputes arise (whether matrimonial, tax, or commercial), one side is likely to quote these well-publicized deals as evidence that they’ve been victimized, again ignoring true sector economics.
- Business valuers accept the fact that any terminal growth rate above perhaps 5% is suspicious. The projections required to earn a payout at a 10X multiple often have terminal growth rate assumptions well above 15%. It’s never happened yet.
- When PE buys, their liquidity (particularly debt liquidity) is practically infinite. Try to get your client’s neighbourhood bank to loan their family business 10X revenues.
||BVR enhances implied minority discount offers with FactSet Mergerstat control premium upgrade
The value of control has been trending lower in the UK. Current overall data from the FactSet Mergerstat/BVR Control Premium Study of over 1,300 UK companies show a median increased value of controlling interest shares of only 20.7% (this converts to a median implied minority shareholder discount of about 17%). The control premia averages have dropped from the 27%-to-29% range, typical of the period from 2011 until last year.
These premia and discounts vary widely by industry sector and other factors. To help UK business valuers, BVR has just released major enhancements to the data and functionality of the Control Premium Study. Starting today, subscribers will see platform upgrades. Please join us for our free webinar on Thursday, 5 November, where we will discuss the changes.
Most importantly, users will find:
- Invested capital premiums/discounts: A Mergerstat invested capital premium and the corresponding implied minority discount will now be included along with the equity premiums/discounts.
- New platform: The study is moving into a new platform that features enhanced search/filter capabilities, customized display and Excel downloads, the ability to save searches, and more. Our subscribers have expressed a great deal of interest in invested capital premiums, and we are excited about this addition.
- More timely data: The study will now be updated weekly, rather than quarterly. This means you will have access to all the new controlling interest purchases each week—no more waiting until the quarter ends.
- Additional fields: We have added fields for the target company’s cash and equivalents, interest-bearing debt, and book value of preferred stock. Whether you are trying to verify the calculation for the invested capital premium or looking to subtract cash from the target’s invested capital value to calculate enterprise value, you will have the fields available to do so.
- Expanded quarterly report: Have you seen the enhanced and expanded Control Premium Study quarterly PDF report? You can view a sample issue here.
- Day pass: The new platform will feature a day pass purchase option instead of the previous single-search purchase option. Now, instead of just purchasing the data for an individual industry, you can access the full data set for an entire 24-hour period.
Contact BVR at firstname.lastname@example.org with any questions.
||How flawed is the risk-free rate for
When valuers are expected to supply a DCF analysis (an increasingly frequent need), most start with the risk assumption of a market premium compared to government bonds. As Pablo Fernandez reminds us in his latest publication:
[T]he market risk premium (MRP or ERP) is the answer to the following question: Knowing that your money invested in long-term Government bonds will provide you a return of RF% almost for sure, which additional return you require to another investment (in a portfolio with shares of most of the companies with shares traded in the financial markets) for feeling compensated for the extra risk that you assume?
In 'Normalized' Risk-Free Rate: Fiction or Science Fiction? however, Fernandez questions whether the valuation profession is causing itself some problems when valuers ‘fix’ the risk-free rate (which is near zero or even negative) when the current rate doesn’t create an accurate valuation.
He provides evidence with a model DCF analysis of a hypothetical large consulting and financial services firm (some UK business valuers may think they recognize Duff & Phelps as the model).
Fernandez identifies four cases where the ‘invented’ RfR creates an obvious fiction:
'1) it does not exist: we cannot invest in any financial instrument and get the “Normalized Risk-Free rate” without (or with little) risk;
'2) in several cases it is higher than the cost of debt;
'3) in several cases it is higher than the required return to debt;
'4) most valuations do not adjust the value of Debt accordingly to the “Normalized Risk-Free rate” they use.’
||English High Court holds that a legal professional’s sharp acts can’t be shielded from damages under the ‘iniquity exception’
A family dispute regarding the value of control has occupied the courts for eight years, but one portion of it has achieved resolution in Barrowfen Properties v Girish Dahyanhai Patel & Ors.
In this case, the question came down to whether there was a ‘strong prima facie case’ that a director had breached at least one of their statutory duties. The director in question claimed legal professional privilege, so the claimants had to prove to the English High Court that the ‘iniquity exception’ to privilege was triggered. The court observed that this exception engages if either: (a) those allegations involve fraud, dishonesty, bad faith, or sharp practice; or (b) the director consciously or deliberately preferred their own interests over the interests of the company and did so ‘under a cloak of secrecy.’
Sadly, the business valuation issues in this contentious saga took backseat (and key documents regarding the valuation of the assets in question as well as other facts were not disclosed) despite the fact that the alleged sharp acts included:
- Making improper amendments to the register of members—and then fraudulently voting for falsely excluded members;
- Forging resignation letters for fellow directors;
- Creating schemes to force the claimant into administration so that other defendants could buy real property at a discount; and
- Other ‘alleged breaches of fiduciary duties and common law duty of care.’
Mr. Leech QC (sitting as a judge of the Chancery Division) granted the claimant’s application after thankfully determining that the allegations met the relatively low legal test of ‘fraud, dishonesty, bad faith or sharp practice’ as defined by previous cases.
||The value of internally generated intangibles depends on where they were created
‘Against a backdrop of the growing importance of intangibles, for regulators and legislators there is clearly scope for improving comparability between European company accounts by increasing the harmonization of the treatment of intangibles by SMEs,’ a new survey issued by the European Federation of Accountants and Auditors for SMEs reveals.
Business valuers in the UK will hear a great deal on this issue, particularly since, as reported in BVWire—UK, the European Financial Reporting Advisory Group (EFRAG) is conducting a research project on improved intangibles reporting.
‘The Financial Reporting of Intangibles by SMEs in Europe’ compares SME practices in the UK with those in Germany, Portugal, and elsewhere. Despite IFRS for SMEs, some countries required capitalization of development costs, depending on the entity size and type of intangible. The UK retains an added option for small and medium businesses for development costs, as do some of the other European countries.
Our thanks to Marianne Tissier of Valuology for alerting us to this report.
|| Dates for your diary
1 December: ICAEW Practical Business Valuation, virtual, four-day course
4 December: ICAEW Excel Modelling—Investment Appraisal, Valuation and Business Cases, virtual, 9:15-12:30 BST
9-10 December: EACVA 14th Annual Business Valuation Conference, virtual
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