An interesting case study on a tricky valuation….
September 4, 2024
An interesting case study on a tricky valuation…
Welcome back! It’s rather appealing that the start of the month has just about coincided with the start of a week. We are together as a team in London for a few days which as always is proving stimulating and has given our new joiners a chance to spend some time with their colleagues.
FYI, we will be in Edinburgh on 23rd & 24th September, Manchester on the 7th & 8th October, Bristol on 28th & 29th October, and London on 11th &12th November – just in case you would like to have a face to face meet up.
Dealing with more tricky valuation scenarios has become a regular feature of our business in recent months. There’s nothing like a really tricky set of Articles with numerous share classes or a complicated shareholders’ agreement to get our brains whirring.
There are so many examples I could regale you with but I thought this week you would be particularly interested to see how we dealt with this tricky scenario.
A client came to us with a set of Articles with seven different share classes ranging from Preference shares and Ordinary shares with voting rights to several classes of non-voting Ordinary shares. The rights attached to each share class were about as varied as they could be, so the issue of control was not immediately obvious.
We had been asked to value each share class and to establish the value of another new share class that was being set up. The situation was clouded by the rights of some, but not all of the share classes to appoint directors to the board.
The only way to resolve the tangle of rights to control, dividends and distributions of capital was to be strictly logical and follow the arrangements as set out in the Articles.
In step one we valued the whole company which gave us the right starting point.
Then we looked at the order of a return of capital in the event the company was dissolved. Unsurprisingly the Preference share class was to be paid out first.
Then we worked through all the share classes establishing who would get paid out in what order. The value in the business was reallocated accordingly.
Having understood that, we then looked at the issue of control. Interestingly we found that the Preference and Ordinary share classes had rights to appoint board directors. Great. This created a reason to apply more value to these share classes at the expense of the other share classes which had no rights at all other than the right to receive a dividend (which could only be declared by the board).
Clearly there was a control premium attached to the Preference and Ordinary share classes which meant they had a greater right to value compared with the other share classes.
So we worked through that step to reallocate value more correctly to reflect the control premium.
Then we looked at rights to income (dividends). Interestingly the board could declare a dividend without putting it to a shareholder vote. The Preference share class had a fixed coupon, so no adjustment was needed for that class. The Ordinary share class was entitled to dividends but historically not much had been paid to this share class. So whilst it had the right to income, a question was raised about how often it was being taken. Meanwhile some of the other share classes had had large but intermittent dividends.
To understand what value could be attached to the right to dividends from time to time took an exercise in creating forecast cash flows based on historical precedents and then discounting them back to a net present value.
Then we could once again rebalance value across the different share classes.
Lastly, we looked at our final results and applied a sense check to make sure that everything hung together.
I often think of valuations as mathematics followed by arguments. In this scenario, the maths could have been nigh on impossible. But because we started by using arguments to identify a sensible flow of logic (based on the reality of the situation as shown in the Articles), we broke through the fog to sunshine!
I think we are all anticipating a pretty busy period up until the Budget in October and possibly we will all be even busier immediately afterwards.
If you are doing any planning or innovating around how share classes can be used in the future and would like some help understanding how words could translate into numbers and/or tax(!), do give us a call. With our larger team now trained up we have capacity to assist. And in the meantime if any of your clients have any valuations requirements, please get in touch and we can send over a scope and quote.
