A business or one parties interest in a business may need to be valued for a number of reasons. The common ones are when anticipating:
(A) A retirement (planned or forced)
(B) A sale or on death of a member or valuation on divorce
(C) One parties potential insolvency.
The usual and sensible way whether the business operates as a partnership or a private company is to agree at the start a method of valuation. One contained in either the Partnership Agreement or a Shareholders Agreement but this is itself not free from issues. They may be or include:
(A) What assets are in fact owned, used or controlled by the business [Ham v. Ham a case with two decisions. The first dealt with how to value partnership assets where the decision was it would not be in that case an assessment of book value but real value. The second part of the case however was whether assets were partnership assets at all] or simply
(B) The nature of the interest or what may seem fair may change. So Senior Partners or Shareholders may want to allow a Junior in but not his/her life partner worrying about the effects of divorce or similar. As years pass that may be an unfair assessment or concern.
The bottom line is often expressed is that the business or part of it is only as good as the market but if there is no wish to sell on the open market that can raise problems.
If we look to value tangible business assets surveyors have often applied certain common valuation principles for commercial property. Originally contained in a “red book” those principles continue under that name.
But when seeking to put a price on a professional or less fixed asset business different strategies and words become apparent. So, we have:
“GRF”: or the gross recurring fees based approach. Where fees occurring and re-occuring are used as an indication of future performance. The problem often being is that accurate estimates of likely future maintainable fees.
“EBITDA”: or earnings before interest, tax, depreciation and amortisation. From which Accountants or similar try to work out what the business is worth net of those expenses.
“Normalised Levels of Profit”: are commonly mentioned words whereby the valuer seeks to take an EBITDA, make adjustments to try to find a correct or reasonable level of true profit. Typical issues being salary costs past, current and future. Tax adjustments, bad or good debts, estimates of private or other work costs. So, if one big fee client leaves an internal team’s profitability will change. As might a major member of the team with great personal contact leaving or worse opening up in competition taking clients with him/her.
“Awaited average approach”: is a step on the process in seeking to make a calculation of that anticipated or estimated value.
“Multiples”: with some businesses it is thought that if annual fees can be correctly assessed the value of the share in the partnership or shares in the company should be based on a number of years income from 1 – 3 or 3 – 5 in value of the GRF. Whether this is done against the GRF or the EBITDA to be fair at all and accurate in application certain “special factors” need to be allowed for. These may include:
(i) The nature of the business and the work undertaken
(ii) The likely sustainability of the business and its revenue sources
(iii) The business risks on profitability
(iv) Against its historic revenue sustainability and profit margins
(v) Geographical locations, such as competition or new internet competitors with likely effect on volumes and profit.
“Cross checks”: commonly occur as a way of justifying the valuation exercise. The notion being that if an Accountant or Valuer cross checks his GRF multiple against his profit multiple they should by comparing the two confirm or justify the methodology used.
“Open market value”: often an issue of dispute. More often a method of calculations specifically avoided under the Partnership or Shareholders Agreement wording. Although in many cases of open market value there is often now a buyer’s defence. Under it a buyer may agree a price but claim a reduction or “claw back” if the GRF is less than anticipated or claimed by the seller or equally a seller may agree a price on which there will be an increase if as the seller claims the fee income is maintained or will increase.
Rarely are forced or necessary valuations an easy thing to agree. Although fortunately many potential disputes are resolved by negotiation. However, as started it is better to avoid any negotiation at all by agreeing the method and basis of valuation at the beginning, then updating it or checking its need for updating when the annual accounts fall due or a major purchase or acquisition is made by the business. In this respect it must be remembered that Judges are not allowed generally to take a “middle for diddle” if two separate competing experts are used to value. In Court the Judge usually will have to decide which of two competing valuations he/she approves.
Each case is different both on fact and application of law.
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