How we dealt with a particularly curious valuation challenge

May 14, 2024

This is how we aligned with a client’s understanding of a company’s value vs. what the maths told us.

Many years ago I got the graduate job I wanted by answering the question

“What would you do if the client wants to do something you do not think it should?”

My reply was that I would examine all the evidence including what the client wanted to do and why and then I would present all the options to the client, explain why the best route maybe the one which was not what the client wanted to do, but ultimately I would do what the client wanted!” Some might say that’s corporate finance for you.  And of course, in doing what the client wanted I would have made sure that all the I’s were dotted and T’s crossed in the advice provided so as to mitigate the risks for all.

I was reminded of this the other day when a client wanted us to value a business at exactly the same price as they paid to buy it over a year ago.

When we ran the numbers the answer came out meaningfully higher, not least because of changes in the multiples due to recent better stock market performance.  Tricky!

As I so often say, the maths on its own does not necessarily provide the true answer to a valuation.  You have to think about the circumstances and the intangibles, as well as the risks and adjust accordingly.

However, in this situation, even were we to want to (which we wouldn’t), massaging the results to do exactly what the client wanted would not wash.  Time has passed, the situation has changed and sure as eggs are eggs HMRC might smell a rat if we did not fully argue what our opinion as to what the value really is now.  There would be no point in doing just what the client wanted to get a report out.  If we submitted to their request to value the company exactly the same as a year ago without proper examination of all the current issues, the report would be effectively worthless.

Our mathematical work showed a 20%+ uplift in the valuation of the company.  Good news many might say, but in this situation that was going to cause a problem because the client had made verbal commitments to both existing and new shareholders that the value would not change from the previous price.  A conundrum.

What did we do about it?

Firstly we explained why the value has appeared to have risen.  The client then provided us with more information on why they thought that the value could not have grown by as much as the numbers said.  In summary, their rationale was that although investment has been made in growth, the results have not yet appeared in the fundamentals of the business.  If you like the nutrients have been applied, but the plant has not yet produced any buds.  That is a good and relevant point.  Although the numbers reflect the better market opportunity generally, in reality this is still not evidenced in this particular case.   The company has “improved”, but the numbers were not reflecting the latent risks that this improvement will turn into increased sales and profits.  (It is worth mentioning that the investment had driven the company into loss). Risks have also increased; if the investment plan does not pay off, heads will roll.

There were other issues to consider but going into those is not necessary to make the point.

We agreed with the client that an examination of the increased risks resulting from investment in growth should be considered and quantified in the valuation.  We also explained (and they agreed) that value had improved since the acquisition; the issue was the quantum.  Articulating this would not only help the client to understand better where the value of the business was today, but would also help HMRC to understand it too.  So a good result.

We ended up proving, with evidence and arguments why the value was what it was.  The client could then explain this to all the other interested parties to get agreement from everyone.

This was a good result.  We used evidence and detailed arguments to support our valuation which the client accepted but also that HMRC (and indeed other third parties in the future) would find hard to challenge. That meant the client could get on with next steps and all of us can sleep at night without worrying that submitting to a commercial expediency had actually created more risk than was present before we started.

Helping clients to understand that private company valuations really do change day to day, month to month and almost certainly year to year, is a critical part of our contribution to the valuation debate.

If projects such as PICSES get off the ground, this debate will become more and more noisy!

If there is one recommendation  I have from this experience, it is to encourage companies to crack on with getting an independent valuation (and the resulting activity) as soon as possible after the date a valuation has been agreed between parties, IF you want to have the maximum chance of the valuation either not or hardly moving. The more time passes the more likely it will be that the price diverges from that set on the original date.