When Expert Valuations are Invaluable
By Mark Ashburn
Posted: 18th March 2014 08:58Separations are a nightmare. Whether you are going through a divorce or breaking up a partnership, dividing up assets can be difficult and stressful. This is true enough of something like a second hand car where a value is easily obtained but what about assets where the value is harder to agree?
Whether as a result of a shareholder dispute, dividing up an estate, or marital breakdown here in the Channel Islands as with the rest of the world we are seeing increasing numbers of disputed valuations. Many of these are hotly contested by the parties involved and lead to extensive costly litigation which of course destroys value for both parties.
In extremis the cost of the litigation can exceed the value of the asset involved. A small but pertinent example involves a recent case between DHP Family (a live music business) and a photographer after DHP used a photo he took without permission. Although DHP admitted it had used the photo, in error, in marketing materials without permission, the dispute centred around the value attributed to that use. DHP offered £150, the photographer claimed £1,350. The judge ultimately (based on press association rates) valued the picture at over £5,000 and awarded costs to the claimant. Costs in a relatively minor dispute with only a single fact up for debate were over £14,000 more than 10 times the upper end of the valuation. The case is unusual and the amounts involved small but it serves to illustrate the danger of failing to have a solid basis for the value placed on an asset and in failing to communicate that reasoning effectively.
This is where valuation experts can help. Increasingly we are seeing clients asking for valuations or help with valuation models before disputes arise and even before agreements are struck. While it is by no means a foolproof approach, agreeing how an asset should be valued or at least how the valuation might be derived when tempers are cool and everyone is happy can go a long way to mitigating the time and cost involved in agreeing values when disputes arise. Involving an expert that all parties agree on at this stage makes it far harder for an aggrieved party to bring a challenge further down the line.
It should be stressed that while such foresight is commendable, it is not a panacea. Even expert valuations are subjective and assumptions that were valid at one time may not remain so forever. Shareholder agreements and similar documents should be revisited regularly to ensure valuation metrics such as EBITDA multiples remain current. Frequently we even see matters which appear superficially clear cut raised, such as how EBITDA is calculated (and this is also something that should also be addressed).
Clearly even with such preparation disputes and litigation will still arise. This happens most frequently when the sums involved are significant. However, the consequences of entering a dispute unprepared are far greater. The disparity in valuations can be huge; as a recent high court case between Charterhouse, one of the UK’s oldest Private Equity firms, and one of its former directors illustrated.
The director began legal action against the company and his current and former colleagues claiming that he was forced to sell his stake in the firm at a value which was considerably lower than its true value. According to the director the value of the company at time of the sale was up to £325m whereas a retrospective valuation of his share by KPMG (acting for Charterhouse) put the amount between £10m and £20m. The case has yet to conclude but given that it has already been in the court system for several years costs on both sides will be spectacular. In the Channel Islands we have seen and acted in many similar cases (albeit on a smaller scale.)
As we have already seen valuations are subjective (it should be noted that in the above case both sides employed experts) and values attributed to an asset can vary widely in the absence of the only true test – a sale between a willing buyer and a willing seller. So why bother with an expert?
The key here is not that an expert can produce a value that all parties will agree on but that the arguments, assumptions and techniques the experts bring to the problem will provide a far more persuasive case to put to a judge in the context of litigation. Even when disputes have not yet reached court, there is a role for this element of objectivity in meditating between parties and hopefully preventing the dispute escalating.
In the context of business valuations, one or both of the parties may have experience of the techniques required and even access to some of the more public statistical information needed to inform such work. However, the true value of the expert here is in the knowledge and experience they bring and the robustness this gives their work. No two companies are identical and most have their quirks. Understanding how to deal with these in the context of valuation requires far more than choosing an appropriate discount rate or normalising cashflows. The ability to point to previous examples of a particular technique or approach used in similar situations can be highly persuasive in resolving a dispute.
Ultimately expert valuations can provide objectivity and add considerable value in many situations, for example in defending directors of distressed businesses from allegations of wrongful trading, but it is in the context of litigation, where well-reasoned, robust valuations are truly invaluable.
Mark Ashburn is a senior manager in KPMG’s advisory practice in Jersey. Over the past six years his work has primarily been focused on working with financial services firms on M&A transactions within the Channel Islands and further afield, as well as a variety of other strategic projects for both public and private sector clients. Mark regularly advises on all aspects of valuations in both contentious and non-contentious situations.
Mark can be contacted on 01534 608418 or at firstname.lastname@example.org