Valuation of interests in unquoted companies

Transcript of seminars delivered by Andrew Marsden and Roger Isaacs on Valuation of interests in unquoted companies and other businesses 

Note: It is recommended that you watch the videos of the seminars delivered by Andrew Marsden and Roger Isaacs rather than relying on this transcript relating to the valuation of interests in unquoted companies and other businesses.

The videos of this seminar series can be seen at: https://commercialchambers.org/videos/

Good morning, everybody, and welcome to, this, the second of these seminars in which Roger Isaacs and myself are examining the valuation of shareholdings in unquoted companies and the valuation of other business interests.

As I said last week, Roger and I have prepared a note to accompany these talks, and we will circulate a copy of that at the end of this talk. That note itself contains details of the legal authorities for each of the principles and propositions that I’m going to refer to and for those who want to take research further in this area it’s a pretty good starting point I’d suggest.

Roger and I are, of course, happy to take questions and I’m delighted to see we already have one. I hope Roger is doing his homework already but I think we propose to consider those questions at the end of the seminars. So if you do have a question, then please use the question and answer function or chat function on the Zoom platform and we’ll do our best to answer those questions at the end of the seminars.

So last week we looked at the role of experts in valuation and the court’s approach to the determination of valuation issues. We then considered the different bases of valuation and finally we wound up with an examination of the principles lying behind the assessment of market value, including consideration of the asset based valuation and the earnings based valuation methodologies.

This week we’re going on to consider (1) the use of comparisons; (2) the treatment of surplus assets; (3) issues that arise in connection with valuations where the business concerned is considered to be particularly dependent upon a particular individual and the services he provides in connection with that business; (4) adjustments to market value that may be required when seeking to identify a fair or equitable value; (5) consideration of the question of the appropriate dates for valuation purposes; and (6) finally, we’ll look at the significance of any pre-existing agreement between the protagonists as regards relevant methods of valuation applicable for stated purposes.

First, I’m going to consider, as I say, the use of available comparators. As I sought to emphasise last week, once a preliminary assessment of market value has been made, whether that’s an assessment that’s conducted on an assets basis or an earnings basis, the courts have repeatedly emphasised the need to check the status of that preliminary assessment by reference to data from comparable real world transactions.

Most usually, of course, those real world transactions comprise sales of companies or businesses but, in particular circumstances, comparators might also be derived from, for example, prices obtained on new issues or new investments within the enterprise concerned.

Usually the appropriate comparisons in any particular case are derived from sales of unquoted companies and businesses. However, I think it’s right to recognise that the use of quoted share prices of comparable companies may actually be used to corroborate valuations of unquoted companies and businesses where there exist reasonable quoted comparisons. Whilst that’s not always the case, indeed, perhaps it’s more likely that there is not a comparable quoted company, if it so happens that there is the availability of that data is obviously something not to be ignored. If market quoted valuations are however to be used to corroborate valuations of unquoted companies then they may well need to be discounted to reflect not only the unquoted nature of the company and consequently the greater difficulty in securing a market for the purchase of shares in that company but also possibly for the potentially riskier nature of the unquoted company or business that’s being valued.

As I say, more often than not, when valuing interests in unquoted companies and businesses, primary reference is to be had to values achieved in sales of and investments in comparable unquoted companies and businesses. Data relating to comparable sales of unquoted companies and businesses may, of course, already be within the knowledge and experience of the particular expert valuer himself. It may, alternatively, lie within the knowledge of other members of his practice or firm.

Aside from those internal sources of comparative data, expert valuers also tend to rely on data that’s maintained and published by various accountancy firms. And my first question to you, Roger, is what sources do you tend to turn to for comparative data when assessing your initial determination of market value in any particular case?

Well, Andrew, as you quite rightly say, the best and most detailed data comes from quoted companies. But I’m always terribly wary of relying on the idea that any quoted company is genuinely comparable with most owner managed businesses. If you’re valuing a small security firm or even a reasonably sized regional security firm, trying to compare it with G4 seems to me to be fraught with difficulty. Similarly, valuing a retail business that’s family owned and comparing it with Tescos – they really bare no comparison whatsoever. So even if one tries to apply discounts for liquidity, the discount itself is so subjective and the comparable so weak that it seems to me that in most cases reliance on PLCs is of limited assistance and as you quite rightly say, a much better source of information are real world transactions of comparable unquoted companies. But of course, the problem there is that for most transactions, the data is much less readily available. Business owners who sell their businesses tend not to wish to trumpet about how much they’ve managed to realise. But there are databases available and one can obtain information but one often ends up, however, even in those circumstances, arguing about to what extent one business is comparable with another. And a lot of small businesses are in many senses unique and it is very difficult to find meaningful comparables. So by the time one has found companies that at least operate in the same sector and then whittle down that small number for the ones for which data is available you’re looking at a very, very small sample which to start with was skewed because of course there are many, many companies in each sector for which no data is available simply because they have never been bought or sold. And that again can cause problems. So, comparables – one needs to do one’s best to try and find them but I think treat them with caution.

I’m dealing with the case at the moment in which a group of companies over the course of a decade or two acquired a large number of subsidiaries. So one would have thought that the companies that it had acquired would be a great source of data because, firstly the information is available, the group knows what it paid to acquire those companies. Secondly, they are good comparables because they operate in exactly the right sector, albeit some of them were a bit smaller than the targets. But the range of comparables, even in those circumstances, was enormous, ranging from some cases where companies were acquired at net asset value, o effectively with no value attributable to goodwill, some with multiples of one or two and at the top end of the scale one transaction with a multiple of 75. So that shows just how fickle some of these statistics can be and how they have to be treated with significant caution.

And Roger, in terms of actually the databases themselves that are maintained by various firms of accountants. Are there any particular ones that you turn to?

Well, the one we use is an Experian one but they all obtain their data from the same public announcements. So they’re much of a muchness and one tends to find huge overlap. So whichever database you use tends to have the same source of data within it.

Thank you. Let me then turn to the subject of surplus assets and liabilities and its relevance to valuation of companies and businesses. Where a business is being valued on an earnings basis, any property assets or funds that are not actually utilised for the purpose of generating earnings are considered as surplus to those assets needed for the conduct of the business itself. Put another way, that property is not required by the company or the business to generate the future cash flows or the future annual maintainable earnings of the company or business that has been used to assess its enterprise value. Consequently, an adjustment needs to be made in respect of those surplus assets to give the value of the company or the businesses as a whole. In other words, the value of those surplus assets must be added to the value of the trading business, as it’s been determined on an income or earnings basis in order to establish the equity value of the company or the business.

And of course, the valuation of any surplus assets themselves may also have to be the subject of expert evidence and guidance.

In the Sunrise Radio case, a case to which I frequently make reference and which I think I’ve made reference to before in the course of these talks, it was recognised that an allowance might also have to be made for any specific liabilities that are to be paid off by the purchaser on or following completion. If such liabilities are paid off then the cost of paying them off will represent an additional cost to the notional purchaser and that additional cost should be recognised as part of the value of the business itself. Roger, again, turning to you, what sort of assets and liabilities typically comprise surplus assets or liabilities for which adjustment might be required?

Well, at first glance, you might think that this was relatively straightforward and in some cases it certainly is. So if you had a trading company that bought for its owners a villa in Tuscany that villa has nothing to do with the business. The value of the villa would clearly be a surplus asset. But in reality, the assessment of surplus assets is sometimes one of the most tricky anyone has to face. And if one, as is increasingly common these days, sees valuations based on earnings before interest, tax depreciation and amortization, EBITDA valuation theory says that if you multiply EBITDAR by the appropriate multiple the resulting product is what is known as enterprise value from which should be deducted the company’s net debt to give the equity value or the value of the shares. And that theory is supposed to reflect the fact that in the real world, commercial transactions take place on what’s known as a cash free, debt free basis. In other words, that any liabilities of the company are paid off before the company’s sold and if it’s got any surplus cash assets, they are distributed.

And one often sees, of course, in sale and purchase arrangements, agreements whereby, because it’s more tax efficient to get that cash out as a capital sum, it’s left in the business and paid on a pound for pound basis by the purchaser. And one sees completion accounts referred to in sale and purchase agreements and the agreement is often that completion accounts will be prepared after completion and any surplus assets paid back to the vendor. Now the problem that often arises, both in relation to completion accounts and in a theoretical world in relation to valuation, is working out actually how much of the cash is genuinely surplus. So if you consider a company with a very large book debt and the day before the valuation date that debt is collected, the cash balance suddenly goes up. Does that mean that the company has suddenly acquired a large sum of surplus cash compared with an identical company which collected that same debt the day after the valuation date? Well, clearly the two companies should be worth the same and all you’re seeing is the ebb and flow of working capital. And that is why you tend to see in company valuation something called a normalised working capital adjustment which seeks to assess how much cash the company needs just in the context of its ordinary trade which will ebb and flow with stock and debtors and creditors and liabilities to the taxman. And one of the particular challenges that we face at the moment is the fact that lots of companies are being allowed to defer their tax payments. So I was looking at a business a couple of weeks ago which had a £3 million cash balance but it also had a £3 million liability for VAT which was the deferred VAT payment. And if a valuer had approached that case and said: “Oh, great, look, there’s £3 million in the bank, that’s much more than is usually there. That’s a surplus asset.” It seems to me that that would be a very skewed valuation because it fails to recognise the corresponding VAT element. And the assessment of normalised working capital is, as I say, not just difficult in theoretical valuations, but also one typically finds it’s a bone of contention in negotiations between buyers and sellers in the real world.

It genuinely is. It can be one of the most difficult hurdles to overcome in bridging the gap between different positions on valuation. Let me turn to a situation which again is a fairly commonplace situation in this field and that is the situation where the fortunes of a business are considered generally by the owner to be dependent on the performance of a particular individual and often by the owner considered to be dependent on his own performance. When the fortunes of a company or business are intrinsically dependent on an individual who might possibly leave the company or business in the future then that, of course, is likely to be reflected in the final valuation of the company or the business. In particular, it’s likely to be either reflected in an application of a reduced multiplier or in the application of an increased required rate of return on capital invested. That approach is readily understandable in circumstances where that individual is not the same person as the vendor. In those circumstances, of course, account has to be taken of the risk to the underlying business that might be faced if that individual was to leave the business. It’s perhaps less easy to understand where that individual and the proposed vendor are one and the same person. In those circumstances, one might well anticipate the vendor to have entered into some contractual commitments to effect a careful handover of the business to the new owner. Well, Roger, how do you deal in practice with businesses that are considered dependent upon the performance of an individual?

In my experience, it’s very common for business owners to argue that their businesses are worth nothing or a very small amount because they’re entirely dependent on them. And in some cases, if one is looking at a self-employed pianist or a surgeon who trades on his or her own, then one has a lot of sympathy with that. And there probably is no goodwill, because all one is talking about is the skills of an individual person. But where you’ve got companies, albeit that they may be reliant on a single or a small number of individuals, it is often the case that the value of the business, unless it’s reliant on their particular skills, which are utterly irreplaceable, can be transferred. And a good example is that to be found within my own profession, the accountancy world. Accounting practices change hands regularly at significant sums, notwithstanding the fact that accountants would say that their relationship with their clients is intensely personal. Accountants build up relationships with clients, often over years and decades, but when an accountant retires it is common for him or her to be able to sell the practice. You’re not selling the clients per say but, if one says to one’s clients, “I’m going to retire, and I think that this practice is a great successor and you should you should trust them as I do to look after you, as I have done for many years.” The vast majority of the clients would at least give that successor practice ago. And that is where the value resides. And that is why accounting practices have value, because, they have recurring fees and, in practice, you only tend to get clients leaving in droves if they were unhappy in the first place. But if the clients are happy with the person who’s retiring, they will certainly at least allow the successor  practitioner to try and have one year to prove their worth. And if the service continues and the prices don’t go up, the value can be transferred. So I think one has to treat slightly sceptically those who say that their business is entirely reliant on them. The question I always come back to is that what I’m trying to answer is if that business person came in to see one of my corporate finance colleagues and said, I want to sell my business, what price could I get for it? That’s the question that we are seeking to answer. And in those circumstances, that business owner would be told, well, you can only sell your business if you agree to enter into restrictive covenants and agree not to compete. And, of course, if they’re minded to do so, most business owners can completely destroy the value of their businesses if they wish to do so by saying that they’re going to compete and set up a competition but one has to assume both willing buyer and willing seller.

So, Roger, in this analysis so far we’ve identified the market value of the company or business as a whole but, of course, the holding or interest that may need to be valued may not comprise the entirety of the issued share capital of the company or indeed complete ownership of the business concerned. And in those circumstances, it’s necessary to consider the proper approach to the valuation of the appropriate fraction of the issue share capital or to that part of the ownership that is to be valued. And this, I’m pleased to say, is a relatively straightforward exercise; one of the relatively straightforward exercises involved in valuation. The appropriate fraction, of course, simply depends on the percentage of the company’s share capital or the percentage of the business that’s owned by the proposed seller. It’s a mathematical exercise. An application of the fraction corresponding to the extent of ownership to the whole enterprise produces the fractional value of the whole that can be attributed to the shareholding or that part of the ownership of the business that’s under consideration.

Next, I’m going to turn to adjustments that then may need to be made to the fractional market value of the shareholding or to the business interest. That’s the subject of the valuation in order to achieve a fair or equitable value. Once that fractional market value has been achieved, there may still need to be further adjustments in order to achieve that “fair” or “equitable” value if that is what is required.

One adjustment that often falls for consideration is the necessity or otherwise of applying a discount to reflect the minority status of the relevant shareholding or other business interest in. In other words, in order to arrive at a fair value of a minority shareholding consideration needs to be given as to whether a discount should be applied to the fractional market value in order to produce a valuation that is reflective of its minority status.

Whether such a discount should be applied is often central to disputes in this area and it’s often, in my experience, the reason why negotiations towards settlement of these sorts of disputes frequently break down. That being the case, it’s somewhat disappointing to have to note the continuing uncertainty in this area as the correct approach that is to be taken. That being said, I think it’s perhaps right to say that the position is perhaps now significantly clearer than it was previously.

In the case of quasi partnership companies; that is a company where, broadly speaking, the shareholder generally has an ongoing participation in the conduct of the business and there exists a special relationship of trust and confidence between shareholders and directors or participants upon which the affairs of the company and the future successful conduct of its affairs is somewhat dependent, there appears to be a strong presumption against applying any discount to reflect the minority status of the shareholding. That has been established in a fairly long line of cases, beginning with perhaps the decision in Re Bird Precision and, most recently, having its expression in a case called Douglas v Douglas in 2019.

On the other hand, in the case of a company that’s not in the nature of a quasi partnership, the rule used to appear to be that ordinarily a discount was to be applied, as that was said to be properly reflective of the true value of the minority interest itself. Over the years, that approach has come under some degree of criticism; so that the current approach now seems to be that what is required for the purposes of a purchase order under Section 994 of the Companies Act, for example, is a “fair” valuation. It might now be described as an “equitable” valuation

A fair or equitable valuation should not be one that involves conferring any element of unjust enrichment upon the purchaser. That need to avoid unjust enrichment on the purchaser may mean that a fair valuation of an interest in a non quasi partnership might require valuation without the application of any discount to reflect the minority nature of the interest being acquired.

In broad terms, what the court is seeking to do here is to avoid a person who has been found guilty of wrongdoing in the form of the conduct of the affairs of the business or of the company or limited liability partnership or other business in a manner unfairly prejudicial to the other participants; the Court is seeking to deny that wrongdoer benefit from his wrongdoing.

It’s fair, I think, to say now that the courts’ approach in cases of non quasi partnership companies and limited liability partnerships now seems to be that there should be no presumption for or against the application of a discount to reflect the minority status of the interest that’s being acquired and that a discount should be applied if, but only if, the application of such a discount is required to arrive at a fair value in all the circumstances.

So the question then arises, of course, when might a discount be applied in respect of a minority interest in a non quasi partnership scenario? Well, a discount may be considered appropriate when determining a fair or equitable value if that interest was acquired purely as an investment rather than in circumstances that envisage the owner as having an ongoing participation in the conduct of the underlying business.

Likewise, it was suggested in a case called Blue Index that a discount might also be justified in valuing a minority interest in a non quasi partnership case where the vendor himself acquired his shareholding at a discount to its then market value.

Conversely, the position might, I think, reasonably be expected to be that if no such discount was enjoyed by the vendor when he acquired his interest, then ordinarily no discount ought to be applied when determining the fair value of that minority interest.

It also seems to be the case that when seeking to identify the value of a minority shareholding it may well be considered inappropriate to apply a discount to reflect that minority status if the circumstances of the case are such that the minority shareholder might, as an alternative to relief under Section 994 of the Companies Act have been entitled to a winding up order on the just and equitable basis. That approach seems to reflect the fact that if the circumstances are such as to justify the petitioner being afforded an order for the winding up of the company, he would, of course, obtain a proportionate part of the underlying assets following the winding up and realisation of the business and affairs of that underlying company.

In appropriate cases, when determining fair value of a shareholding, it may also be necessary to take account of the value of the minority shareholding to the actual purchaser himself rather than to any other hypothetical third party purchaser. So, if the acquisition of the shareholding that’s subject to valuation might result in a marriage value when combined with an existing shareholding, then that may result in the desirability of an application of a premium as opposed to a discount when assessing the value of that minority interest. Take, for example, a case where a 40% shareholder is found responsible for unfairly prejudicial conduct of the affairs of a company and ordered to buy a minority shareholders interest of 15%. That minority interests may be considered to have a fair value to the proposed purchaser, one who’s currently holding 40% of the issue share capital, in excess of the value that a simple 15% shareholding might have to anyone else in the market holding no pre-existing interest.

Perhaps what can be said with relative certainty is that when asked to identify a fair value, a court is unlikely to apply a discount where to do so would be to confer a windfall on the person ordered to purchase that interest, particularly if that person has been found culpable in some way as a precursor to the order being made against them for purchase. Consequently, where a marriage value exists that will benefit a perpetrator of unfairly prejudicial conduct, then a premium is, in my view, likely to be applied to the market value when determining fair or equitable value.

If it’s established that a discount or a premium is to be applied, the next issue that falls for consideration, of course, is the level at which that discount or premium should be fixed. The extent of any discount or premium is, of course, entirely dependent on the facts of any particular case and, in practice, the extent of discount or premium that is applied seems to me to vary fairly significantly. Roger, turning to you. How do you go about assessing what minority discount or premium ought to be applied in the circumstances as I’ve just described them?

Well, as you say, happily for people in my profession, there is a view that the discount does vary for every case. Wouldn’t it be simple if there were just a generally accepted table of discounts and one could look at what discount would apply for any particular shareholding? But the problem that arises is one needs to look at these transactions not just from the point of view, as you’ve said, from the vendor but also the value acquired by potential purchasers. The most obvious potential purchaser is the existing shareholders. So one then needs to consider, well, what are the other shareholdings and are there any shareholders who could acquire additional control by acquiring the shares in question?

And sometimes one needs to look at different permutations and combinations, which again will be very different in circumstances in which there are pre-emption rights. Because in those circumstances, assuming that all those who were entitled to take up shares that they’re offered under the pre-emption rights do so, the resultant shareholding will be very different from a case in which shareholders can compete for a parcel of shares. There are a few but given how long this matter has been argued in the courts relatively little published information about what are the appropriate levels of discount. There’s a technical guide that was issued by the HCA that many valuers refer to. Some people refer to something called the “Rule of 85”, which suggests that the sum of the discount and the size of the shareholding should always equal 85. So if you had a 5% shareholding, it should have an 80% discount and so on and so forth. I think that’s a bit of a noddy guide. Again, it doesn’t take into account the other shareholders but I have seen it used by reputable valuers on occasion at least as a yardstick or a test. It tends only to be used for smaller shareholdings.

But again, the commercial reality is that the real step change in value is between 49% and 50% and 50% and 51%. Valuers have spent a lot of time saying, oh, well, if you have more than 75% you can block a special resolution. But does that really have any great value? It has some value but it’s not significant. Whereas if one has 51%, it makes all the difference in the world. You can effectively run a company pretty much as you wish, albeit you can’t of course, prejudice the minority shareholders and most of the or many of the shareholder disputes that I certainly see are those where you have two shareholders each with 50%, and that can cause deadlock whenever there is a matter that the two shareholders can’t see eye to eye about. But, in those circumstances, of course, it’s very difficult to argue unfair prejudice because neither party is technically a minority. But the choice of discount does vary from case to case. Again, my principle is always to try and ask myself what in a real world transaction would each of the shareholders, if one is doing the valuation on a fair value or equitable value basis, where you take into account special purchasers, what would the vendor’s shares be worth to each of those identifiable parties and what extra value would they acquire were they to manage to get their hands on those shares?

I suppose, Roger, that the point at which this issue really comes sharply into focus is that which you’ve described. It is the 50:50 share split in relation to companies. That’s the point at which the acquisition by one 50% shareholder of the other 50% of shares might carry a significant premium. Much more so than, of course, the acquisition of 49% of the shares by a 51% shareholder.

Exactly. Exactly.

Thank you, Roger. Let’s go on to consider adjustments that might still be required to the valuation in order to achieve a “fair” or “equitable” valuation in the form of adjustments that might be required to reflect the consequences of any unfairly prejudicial conduct that has been established. So where relief is given in respect of unfairly prejudicial conduct of the company’s affairs in the form of a purchase order, that order will require the purchase to be made at a price equal to, as I say, the fair or equitable value of that interest. And that fair or equitable value may well need to be determined only after adjustment has been made to reflect the consequences of the unfairly prejudicial conduct that’s taken place. In such cases, the courts will generally identify the fair value as the value that shareholding would have had if the unfairly prejudicial conduct had not taken place and its effects had not been felt. So, for example, if it’s determined that assets or business opportunities have been misappropriated from the company or business, the value of those assets or business opportunities will need to be established and then credited for in the calculation of the fair or equitable value of the interest to be acquired. Once again, establishing the value of those misappropriated assets or business opportunities will inevitably present their own issues of valuation. And again, expert evidence is most likely to be required for this purpose in the form of forensic accounting expert evidence generally.

On the other hand, generally in my experience, adjustments are not made to reflect the degree of culpability or gravity of the perpetrator’s conduct. So, if it is the case that the unfairly prejudicial conduct complained of has not actually resulted in any financial loss to the company itself then, generally, it will be considered inappropriate to apply any adjustments, even if that unfairly prejudicial conduct might be considered particularly culpable or grievous, such as premeditated and patently wrongful exclusion of a minority participant from the affairs of a company. So, for example, where you have a misappropriation of a business opportunity, it will be necessary for the court, with the aid of the expert evidence before it, to value that misappropriated business opportunity and give credit for it in determining the fair value of the interest in the company or business being valued.

Let me turn then to the question of the appropriate date for valuation purposes. Again, like most things, this, of course, lies within the ultimate discretion of the court. The court has a fairly untrammeled discretion in this regard as well but I think generally it’s recognised that the relevant date for valuation purposes, for example, under section 994 proceedings is the date of the order of the court itself. That may be contrasted with the relevant date for valuation of a commercial agency, for example, where the relevant date will be the date of termination of that agency for determining its value for the purposes of calculating compensation payable under the Regulations. However, even in the context of Section 994 proceedings, as I say, the Court does have a discretion to move away from the usual date for valuation; namely the date of its order, where the circumstances justify another date as being more appropriate for the purposes of valuation. So, for example, if there’s been a significant deterioration in the fortunes of the company following or as a result of the unfair prejudice complained of then an earlier date of valuation may be fixed by the court.

Once a date has been fixed by the court, then certainly for section 994 purposes, events that take place after the date fixed for valuation are generally considered irrelevant to valuation. But whilst that’s the case for section 994 purposes, it doesn’t seem to necessarily be the case in other contexts. So again, take, for example, the valuation of commercial agencies for the purposes of assessment of compensation payable under the Commercial Agent Regulations; there it’s been suggested, at the very highest level, indeed the House of Lords as it was, that events that take place after the date of valuation might still be considered relevant to determination of the value of the agency at the pre-determined valuation date of the termination of that agency. Roger, whilst we’re on the subject of commercial agents. What’s your what are your thoughts on valuation of commercial agencies?

Well, my first thought is to wonder how long they’re going to be with us, because, of course, they were a construct of European law. I’m not a lawyer, so I make comments about the law with caution. But it seems to me that English law has always protected employees and it’s always protected consumers but it’s tended to be fairly cautious about seeking to impose protections on commercial entities entering into commercial arrangements between each other. And that’s exactly what the commercial agencies legislation does. It regulates commercial conduct between often companies but certainly commercial entities. And post-Brexit, one wonders whether there will be a wish to remove commercial agencies as a whole. But it seems to me that the government is likely to have other priorities, such that commercial agencies, I suspect, will be a long way down the list. And it also, from my experience, seems that they have now become a feature of the English legal landscape such that trying to unpick them might not be entirely straightforward.

So, assuming that that they continue to exist and happily that therefore we continue to be asked to value them, I think the issue that you raise, which is to what extent hindsight can be used in their valuation, is particularly relevant coming out of a global pandemic. If one were valuing a commercial agency now whose business was the sale of conference exhibition stands, for example, it seems to me that if one followed the reasoning of the House of Lords, as you say, one would need to recognise that that business would have collapsed during the pandemic which is a very different type of approach than would be used in other valuations. So I think that that use of hindsight does make a significant difference. And even absent the pandemic, I think when valuing an agency one has to look at the trajectory of the sector in which the agent operates. So an agent selling into the high street is likely to get less value for his or her agency than an agent selling into a market that is more buoyant and has better prospects than one that seems to be in the doldrums with little prospect of imminent recovery.

For my part, I can see little logical justification for the difference in approach between the valuation of companies for the purposes of Section 994 and the valuation of commercial agencies. But yet we’re left with some pretty clear guidance from the House of Lords that the post valuation date matters are relevant in the context of commercial agents and I think we have to respect that. I suspect there is going to be considerable reliance placed on post valuation date events as far as the valuation of commercial agencies is concerned.

Roger, just while we’re on the subject of commercial agents. Perhaps you might also give us the benefit of your insight into the approach that is taken by you and others as far as identifying appropriate notional costs of the services for commercial agents which need to be deducted when identifying future maintainable profits. I think it’s a subject we’ve touched on before but perhaps you could just help us with that particular aspect of the valuation of commercial agencies which is generally to the fore in such cases.

Yes. In our last webinar, we mentioned the survey that’s produced by Kroner of director salaries. In my experience that tends to be less relevant to commercial agency cases where often one turns to things like the annual survey of hours and earnings which tends to result in lower salaries because often commercial agents operate on their own and therefore lower salaries commensurate with what are paid to non directors and non managerial posts are a better yardstick. But once one has tried to estimate what salary might be reflecting the skills of the agent and the hours devoted to the agency, it’s necessary to consider whether all of that cost has to be apportioned to the particular agency in question because many agents conduct a number of agencies and, where they do, one has to try to come up with a fair apportionment that seeks to spread the cost between the agencies. And sometimes that can be done simply on a sales basis or a gross profit basis. But often there are factors which mean that the agent will spend more time on one agency Indeed, in in a case I looked at recently, there was one agency which was effectively an agency where the agent had to spend very little time on it, and yet it resulted in substantial amounts of legacy income. So one needs to consider each case on its merits. But first of all it’s a matter of assessing what the salary should be and then spreading it across the agencies.

Thank you, Roger. Lastly, I want to consider an issue that, again, frequently raises its head in practice, and that is the position where an agreement exists between the parties or protagonists in any particular dispute identifying a particular method or procedure for valuation that has been agreed in advance by the parties should apply in particular circumstances. I’m thinking, for example, of agreements in articles of association or shareholders’ agreements that detail the price that might be paid or the price that would be payable in the event, for example, that an employed shareholder might leave the employment of the company or a director may cease to be a director of the company. In several cases, the courts have held that if such provisions are contained in articles of association or shareholders’ agreements, in other words, if an agreed method of valuing a shareholding has been provided for a certain purpose, then that method might be applied not only for that purpose or in that circumstance but also when it’s otherwise necessary to determine the fair value or market value or equitable value of a shareholding for other purposes. So, for example, for the purposes of section 994 of the Companies Act and the determination of a price payable consequent upon a purchase order made under that jurisdiction. My experience is that more recently, that approach has found less favour with the courts. It now generally seems to me to be the case that if the relevant circumstances contemplated by the parties to the agreement do not actually pertain in on the facts as they’ve given rise to the dispute then the courts are less likely these days to determine a valuation in accordance with the provisions of that pre described methodology. Rather, the courts consider themselves at liberty to make a determination freed from any pre described or pre agreed methodology that may be contained within the shareholders’ agreement or articles of association. Roger, perhaps to finish, I might ask you for your experience as regards the application of pre-agreed methodologies as regards valuation in practice?

In my experience, they are quite compelling because often one asks oneself in what circumstances will the shares that are being valued ever be sold? And usually the answer is either they will be sold as part of a sale of the business as a whole or they will be sold pursuant to the articles or a shareholders’ agreement. And it’s usually those two circumstances that one considers because often where there are provisions in articles or shareholders’ agreement they will always apply other than in the event of a sale of the business as a whole. So I would struggle to think of a case where there was a procedure set down in a shareholders’ agreement or articles of association or what have you, which applied only in some circumstances and not in others. Now, of course, there are good leaver and bad leaver provisions that one regularly sees but usually a bad leaver valuation is somewhat trite because often that reduces the value of shares to par and the courts don’t need expert evidence to help them in those circumstances. So one is looking at a valuation that would apply absent those circumstances. So I would struggle to think of a case where I have thought it appropriate to ignore what was in the articles or in a shareholders’ agreement. Because as I say, in my view, it can be quite compelling. I suppose one example would be if there was an imminent sale of the business which was pretty certain one might say, well, that’s what’s going to happen and therefore one can ignore whatever is in the agreement because it’s unlikely to apply. But in those circumstances, the value is likely to be fixed by virtue of the price paid in the imminent sale.

I think what we can say, Roger, in this context is that the court’s approach has been to effectively refute any suggestion that they’re necessarily bound by pre agreed forms of methods of valuation. But yet, in practice, there is no doubt that there is a consideration of what a pre agreed methodology of valuation might generate as a result. And that is used in one sense as a comparator to the valuation that’s achieved irrespective of the methodology that’s prescribed by the parties in accordance with the agreements that they’ve reached. Yes. Roger, thank you very much for that.

I don’t know if you’ve had the chance to look and see if there are any questions that have been posed to us. I think that’s all we were planning to deal with in ordinary time, as it were. But shall we see if there have been any questions that people.

Well, I think there is time for questions. And we have one that’s, I think, a very good question, which is to what extent is a history of dividend payments important in valuations? And certainly in my experience, the problem with dividends is most owner managed businesses use dividends as a means to remunerate the directors for tax planning reasons. Very few companies rigorously operate under a dividend policy, so therefore the dividend yield method of valuing shares, which effectively values the shares with reference to the income stream that’s likely to flow from dividends tends to be relatively seldom used because few companies have consistent dividend policies and those that regularly act so as to distribute all their profits by way of dividends, as many companies do, are just as easily valued with reference to their earnings because effectively that is what is being done. The profits are all being distributed. So a dividend policy, if it exists, can be used to value certain minority shareholdings, but only if it’s consistently and rigorously applied and they’ve been sufficient profits to enable a constant stream of dividends or a consistent stream of dividends to be paid. Where one often sees significance of dividends are on unfair prejudice actions, of course, where dividends haven’t been paid, and one needs to impute what dividends should have been paid had those accused of taking excessive salaries not been paid and instead had at the available funds been distributed by way of dividend. And also in the context of SME’s, small, privately owned companies, whilst from time to time there may be agreed dividend policies that are agreed in in a particular set of circumstances as ones that the company wants to follow, those dividend policies may themselves be the subject of future change; particularly if circumstances don’t continue as they as they were when that dividend policy was agreed. So it may also be the case that the dividend policy itself may be considered as somewhat transitory and therefore unreliable for the purposes of valuation exercises.

Roger, thank you very much indeed for joining me in these talks. I hope our audience found them helpful. And as I say, we will be circulating a note of the matters that we have referred to and of the authorities for the propositions that we’ve made. You should anticipate that in the next day or so. Otherwise, I think there’s nothing further for me other than to thank you, Roger, again, for your involvement in this and to say thank you very much.

Thank you and goodbye. Thanks, everybody. Have a good day.