April 2017

Business valuations are often needed in connection with various types of litigation, such as disputes between shareholders or partners, divorce cases and cases involving the loss of a business opportunity. In addition, valuations may occasionally be required in personal injury or loss of profits cases in which a business has ceased trading or has been sold.

We list below various aspects to be considered in valuing a business, which may or may not be relevant according to the type of litigation involved.

To determine the approach to be taken it may be necessary to consider whether…

  1. the primary focus of the valuation will be on the capitalised maintainable earnings of the business, on the value of discounted future cash flows, on its net asset base or on the capitalised value of dividends paid by the business
  2. previous valuations were prepared for other purposes (e.g. previous transfers of shares)
  3. there are provisions relating to transfers of interests in the business in its Articles of Association or its partnership deed
  4. there are agreements between shareholders or partners which may impose conditions on the transfer of interests in the business or the way in which shares or goodwill are to be valued
  5. the valuation is to be prepared on the basis that the business is a going concern or on a break-up basis

Information or issues relating to financial performance may include…

  1. the need to consider the business’s profitability for a number of years prior to the valuation date if the valuation is to be based primarily on maintainable earnings and whether the profit figures need to be weighted to give more importance to the most recent results
  2. management accounts as an indicator of the business’s most recent performance
  3. the order book and any budgets, forecasts or business plans prepared by the business as indicators of future performance
  4. whether the historical profit stream needs to be adjusted to take account of directors’ remuneration which is high or low compared with that paid by companies of a similar size, transactions with partners, shareholders or directors which are not at arm’s length, abnormal tax charges or “one-off” profits or losses which may arise, for example, from the sale of an asset
  5. the extent to which the financial statements of the business can be relied upon (e.g. whether they were audited or reviewed and whether the tax authorities raised any queries on its tax computations)
  6. trends in the turnover of the business and changes in its customer base
  7. the cash flow generated by the business before interest, depreciation and tax

Issues relating to the assets and liabilities of the business may include the extent to which…

  1. its net asset value is significant
  2. any assets such as land and buildings need to be revalued to provide a more accurate indication of the net asset value of the business
  3. goodwill is recognised in the balance sheet of the business or needs to be taken into account
  4. the business has surplus assets which could be realised
  5. there are contingent liabilities resulting, for example, from claims against the business
  6. there are any significant forward commitments such as leases or contractual arrangements

Issues relating to the sector in which the business operates may include…

  1. general trends and the level of competition in the sector
  2. whether the sector is subject to regulation which may affect business performance
  3. Price/earnings ratios for listed companies in the sector
  4. the extent to which indicators of financial performance are comparable with sector norms
  5. the existence of valuation conventions for specific business sectors, for example, the convention of valuing some professional practices by reference to a multiple of turnover

General issues may include the extent to which…

  1. the business depends on the skills and experience of its principal partners or directors
  2. the business relies upon certain key customers, suppliers or employees
  3. there is a possibility that a buyer would be prepared to pay a “hope value” for a business which is not particularly profitable in the expectation of being able to improve its profitability

Conclusions

As all businesses differ, it is important to avoid an over-simplistic or mechanistic approach to valuations and to ensure that they are independent, based on the best available information and prepared on the basis of the most appropriate methodology.

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The information contained in our Newsletters is provided as general information only. It does not constitute professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. In addition, since the Newsletters were published in recent years, the information contained in them may not be applicable at the current time.