Beware cheap valuations (or how to intentionally overvalue a company in three steps)

You get what you pay for, and cheap ill thought through business valuations could lead to costly strategic mistakes.

499-price-tag-shadow1Last year a London based business I was working with shared with me a formal valuation they’d had done for them by a UK national business which specialises in company comparison and (ostensibly) valuation.   It had cost them less than £500.   To be precise £499 + VAT which is a not-at-all cheesy way to price it!

Of course price doesn’t necessarily give any indication of quality, or value.    Usually such cheap valuations are machine driven, very mechanistic and only as good as the assumptions fed in.  Garbage in garbage out etc. 

But what really shocked me about this report was that the basis of calculation was just plain wrong.  It looked as if it was wilfully designed to generate as high a number as possible however meaningless. 

So what was wrong with it?  Here’s my 3 biggest objections to it, which could also be read as a three step method to produce a meaningless and overstated valuation:

STEP 1: Take profit and add back ALL directors’ costs.

Valuations need to be based on a considered view of the businesses sustainable underlying level of profitability.   It’s usual to make an adjustment to private company profit figures before using them for valuation to allow for one off costs or profits.   Most commonly one needs to adjust to make sure the profit is arrived at after deducting a fair cost for the directors actual economic input to the business.   Put simply you’d add back their actual emoluments and deduct the “going rate” for the actual role they were going.  

The offending valuation just adds back ALL directors’ costs and makes no deduction, on the spurious logic that the new owners will do things differently.   But surely the business still needs managed?

STEP 2: Apply after tax multiples to before tax profits

This is mixing apples and pears and is guaranteed to give the wrong answer.   The business being valued was successful and profitable and making a good return on its assets.  So taking an earnings multiple approach was fine.  

The valuation firm used PE (price Earnings) multiples, and cited its use as a metric in the stock market.  That’s fine but it needs to be applied to after tax, after interest profit as that’s how it’s derived and used in the quoted market.  To apply it to pre-tax, pre-interest, pre-directors profit is meaningless and overstates the valuation. 

The valuer also stated that “most valuations are done this way” – actually no.   Most unquoted businesses are valued on an Enterprise Value to EBITDA basis.  And a compelling reason for that is that otherwise you need to make complicated adjustments to reflect the funding structure and taxation regime differences between benchmark companies and those being valued.

STEP 3: Add total assets to your valuation

It’s correct to add surplus assets to an Enterprise Value but not any other assets.  The logic is that the assets are involved in generating the profit stream that you’ve valued so to add them to the valuation would be to double count.  If it’s a poorly performing business you might just use the true value of the net assets as a measure of valuation but that’s a different story.

To compound it all this valuation then took the result of step 2 above and added total net assets – which in this instance added a totally spurious 50% uplift to the valuation.

At the end of the day the business owners who purchased this valuation report hadn’t wasted much money on it – but the true cost of it could easily have been poor or downright wrong decision making based on its conclusions.    After all it probably overstated valuation by nearly 60% taking all three mistakes together!  As it happens we had a discussion with them about a realistic valuation range which they used as input to their strategic discussions on exit and succession planning.  

If you're interested in the topic there's more on valuations at PEM Business Valuations

A good time for business exit or succesion - high company multiples and before any scary tax changes?!

The latest Argos Mid-Market Index which shows movements in private company prices has just been published. It shows data up to Q3 2017 and indicates a record high of 9.5x.  As you can see from the graph it has been steadily climbing since 2009.   So if you're a business owner it's a good time to think about exit.  Or at any rate to make sure you have a credible exit or succession plan in place.   Many owners of private companies have much of their wealth locked up in their shareholding and so even an equity release transaction - perhaps by selling shares to a third party like a private equity house can help balance their personal portfolio.

ArgosThe other factor I now start to hear in conversation with business owners is concern about the tax regime that a new government might bring.    The capital taxes regime re the sale of company shares is particularly benign with Entrepreneurs' Relief effectively reducing the rate to 10% on the first £10M of lifetime gains.  Whilst Entrepreneurs' Relief was brought in by a Labour government there is an up swell of concern that a Corbyn led government might change things.

None of this may happen of course but it does underscore the need for every business owner to have a plan for exit and succession - even if it is explicitly not intended to happen for some time.

We're running our Business Exit Strategies Seminar in Stevenage on 23 November the day after the Chancellor Philip Hammond's budget speech.  So we should have clarity at least on his short term tax plans.

Our event, which is free, gives useful insights into a range of topics:-

  • The current M&A market
  • Strategic planning
  • How to build value in your business
  • Business valuation
  • How to achieve succession through a management buyout
  • Tax - how to mitigate and also how to use your tax affairs to build value in your company
  • Company sales - how to sell your business, pitfalls, why some companies don't sell

There are a few places still available - and the venue (Novotel just off the A1M) is easy to get to from Hertfordshire, Bedfordshire, Northamptonshire, Cambridgeshire, Essex and North London.  So have a look at our website for the full program and booking.





Upcoming event in Stevenage for those planning business exit or succession -

We're once again running our Business Exit Strategies seminar this time in Stevenage, Hertfordshire on 23 November 2017.

This is aimed at business owners who are beginning a planning cycle towards exit or succession or indeed those who plan an exit or sucession event in the short term.  It's an interactive and engaging morning that will send attendees back to base with useful insights. 

We've all been to seminars that are just overt sales pitches, or frankly boring.  So we set out to make sure our events are neither.   Our primary objective is to inform, and leave our guests feeling it's been a morning well spent.  Just ask any previous attendees.

We cover a range of topics including

  • Developing a workable ownership strategy
  • Succession buyouts and MBOs
  • Valuing a business for sale
  • Tax efficient exit planning
  • How to sell your business
  • Negotiating the deal

And the key benefits of coming along are

  • A practical overview of how to plan and implement your strategy for exit or succession
  • A clear understanding of the selling process
  • Understand how succession buyouts are an alternative to selling
  • Tax planning ideas for exit and succession
  • 60-page book exclusive to guests

If you would like to come visit our website Business Exit Strategies Stevenage Nov2017

Venue is the Novotel - so very easy to get to just off the motorway.


Novotgel sg












Unreliable forecasts - and how to spot them


Like Hercule Poirot you should be on the lookout for ulterior motivation.  Was the forecast prepared with one eye to selling the business (usually inflated) or getting a valuation for a matrimonial dispute (this often produces a low valuation if the business owner is the defendant).  Or perhaps it was prepared for bank funding – in which case be sure the bank will scrutinise and sensitise the forecast.

Forecasts graphPoor track record of forecasting

If the business has historically been poor at predicting its results which should it be different now?

The pattern of growth or margins look odd

It’s always possible to benchmark the figures against public companies or other data.  If the business producing the forecasts has wildly different growth rates, or margins one needs a good explanation as to why that should be.

Forecasts prepared in isolation by the finance director

The CFO or FD in the business needs to canvas inputs from the key mangers in the business before he or she can produce anything meaningful.

The forecast is based on a huge assumption

If there’s one or two huge assumptions that drive the forecast, such as being able to raise millions of pounds of equity finance, or winning a significant new contract then you should consider what happens if those assumptions don’t prove realistic.

Forecasts conjured out of thin air

Of course if there are no, or few, supporting assumptions to check out then the forecast will lack credibility.  I recently valued an early stage technology company where it quickly became clear that the forecasts beyond the first twelve months were just round figure guesses – so I had to discount them altogether in my appraisal.

No balance sheet

I do sometimes see forecasts based on a profit and loss account and some cash flow assumptions.     Without a balance sheet a vital logic check is missing.


Working capital management - can you ever have too much cash?

I was interested to read an article on East Anglian business website bizeast with the headline "Firms at risk from 'locking up too much cash' ".    What is too much cash?

The article was based on a Lloyds Bank report - Lloyds are pushing a working capital management product.   However if you read the Lloyds page it's clear that its not about having too much cash, but about having too much cash locked up in working capital.  As firms grow, unless you manage things tightly or have a very positive working capital cycle there's usually a suck in of cash as the debtor book and stockholding grow unless fully covered by creditor growth.   So a very misleading headline in bizeast.

Here's the Lloyds link

Art_moneywheelbarrowSo let's assume you manage your working capital tightly - can you still have too much cash?  Well yes sometimes.  Businesses often don't distribute all of their profits, and we see many firms with large cash balances.    This is partly for the "sleep at night" reason of having a cash buffer, and also often because of the high tax rates on dividends.

When you come to sell the company - typically subject to an arguement with the buyer about how much of the cash is surplus (this is where your M&A adviser can really earn their fee) you should expect to be paid £ for £ above the Enterprise Value of the company for any surplus cash.   That's all good.  The only circumstance where surplus cash can be too much cash, is in some circumstances where it's a disproportionaly large component of the price or the balance sheet you might run into trouble claiming Entrepreneurs' Releif.   So yes, in a few circumstances you can have too much cash - and this is where your tax adviser needs to help.

So just to string together a few cliches to finish - cash IS king, the cheapest way to fund your business is good housekeeping (ie working capital maangement) and don't beleive everything you read in the newspapers or on the internet!


Two experts can arrive at valuations of a business.  Experts aren’t in the business of advocacy, and shouldn’t two trained and experienced professionals come up with the same answer?  Here’s some good reasons they might differ.



Legal guidance                                     

Experts can be reacting to different legal guidance.

Differences in availability of information

Access to data may be unequal.  Valuers can only conclude based on the available evidence.

Access to Management

Sometimes the valuer for one “side” in the case is denied the level of access to management granted to the other expert. 

Using different valuation methods

Valuers make judgements as to which of the three main valuation methods to use.  The asset approach focuses on assets values, the income approach deals with income capitalisation or discounted cash flow and the market approach uses comparisons with public companies and with analogue transactions.   Valuers need to be aware of their merits and disadvantages. 

The asset approach is usually of limited use for profitable operating companies. 

The market approach is powerful but comparable companies and transaction need to be selected carefully, and for some businesses it can be difficult to find suitably close comparators.

In the income approach there is much subjectivity around future cash flows (especially the terminal value) and appropriate levels of discount.   

Judgements around these choices hugely influence the valuation opinion.

Different judgements, different assumptions

Experts providing business valuations must make assumptions and judgements on a wide range of issues:-

  • Asset methods – what basis to value the assets
  • Earnings methods – how to adjust and analyse the cash flows. Some element of judging the future from the past is required.  Adjustments need to be made to normalise profits and to reflect working capital changes.
  • Forecast assumptions for DCF – each difference of judgement shifts result. The terminal value in a DCF calculation can account for more than 50% of the value – so is it reasonably arrived at, what multiple is used?  What sensitivity analysis has been applied?
  • Public company comparables – is this method appropriate? Are the selected companies sufficiently comparable to reach a meaningful conclusion? Have differing growth rates and risk between the comparable companies and the company being valued been accounted for?
  • Analogue transactions –are the selected comparable transactions actually comparable to the subject company.
  • Premia and discounts – for example for control - or minority holdings - are they defensible?
  • Weightings assigned to the different methods – are they reasonable?


One would hope they’ll be discovered and corrected before anyone ends up before a Judge.


The court may also be swayed by the relative credibility of the reports and the testimonies of the experts.   Also, how compelling the conclusion is in comparison with other evidence?  Does it make sense?  

PEM Valuations also providing M&A advice to business owners, so we have the advantage of being able to apply the “gut test” to any valuation opinion.  In short do we believe that someone would pay that amount for the business being valued?

Valuation lessons from the High Court

This 2012 High Court case is interesting for the comments made by Justice Eder about Expert valuations.

High-Court-building-620-485x302Stabilus was a leading German manufacturer of gas springs and hydraulic vibration dampers used in the automotive industry which was the subject of a number of transactions. In 2008 it was bought by Paine & Partners LLC for €519M. Shortly afterwards got into financial difficulty and underwent a major restructuring in 2009 which carved up all the value to the Senior Lenders leaving nothing for the Mezzanine lenders.

Unsurprisingly – with €83M at stake in the Mezz layer – the Mezzanine lenders challenged the validity of the restructuring. Three different valuation firms gave opinions and three of the “big four” accounting firms were involved one way or another.

The judgement 100 pages long judgement had some key lessons for business valuation.

Use of previous valuations

If they’ve been prepared for internal reporting purposes rather than “fair market value” then they’re not suitable support

Business plans

Adjusting forecasts without considering the reasons for variations is not acceptable, and past variations from plan are not an automatic indication that there will be future variations.

Other Experts Reports

The Expert must request to see other Witness reports to check assumptions and any deviations from their viewpoint. Any deviations must be fully supported.

Judges-485x302Discount to EBITDA multiples relative to guideline companies

The judge was happy that EBITDA multiples should be discounted. He commented that applying a discount is qualitative rather than quantitative.

The Expert needs to compare the risk, size, growth pattern of the business being valued to the guideline company when estimating a suitable discount. Stabilius had a lower growth rate than the rest of the industry which justified a lower multiple.


The valuer must focus on the facts and business outlook as at the valuation date. Hindsight is not a sense check for assumptions at the valuation date.

Ultimately the Judge agreed for the most part with the American Appraisal valuation – that the mezzanine debt had no economic value at the date of valuation.




Tactics without strategy is the noise before defeat - or why you need a exit or succession plan

"Tactics without strategy is the noise before defeat" is a quote from the Art of War by Sun Tzu a 6th Century BC Chinese general and military strategist.  The Art of War, his book on military strategy, has become fashionable as a source of business wisdom, or at any rate quotes.

A recent US Survey found that 78 percent of small-business-owner clients plan to sell their businesses to fund their retirement. The proceeds are needed to fund 60 percent to 100 percent of their retirement needs. Yet, less than 30 percent of clients actually have a written succession plan.

We recently worked with a large and successful business which had become so by being very very good at what they did.   Clients recommended them, bigger and better projects came along and the business grew.   But there was no overall plan for the end game.   The board found it difficult to agree where they wanted to take the business, as a result of which they looked down at their feet to see what the next step or two might be for the business rather than lifting their heads to the horizon and developing a plan for growth and ultimately exit or succession.

It’s an oft repeated tale simply because day to day business is absorbing enough without planning for ones mid or long term future.  Yet without a plan, or an aiming point to paraphrase the Art of War quote each individual small step for the business might not be taking you where you want to go longer term.

If this resonates for you and your business, or clients of yours, you could benefit from attending our upcoming Business Exit Strategies Seminars in Cambridge (8 June 2017 - yes I know that's general election day, Teresa didn't consult with us!) and Norwich (22 June 2017).  Places are limited so I’d encourage you to book now at our events page

Good news in the last budget if you want to sell a subsidiary or trade from within a group of companies – changes to the Substantial Shareholders Exemption rules

Mr Hammond, in his recent budget, has made some rather helpful tax changes for those seeking to sell trading subsidiaries or part of a business by simplifying the Substantial Shareholders Exemption.

HammondSubstantial Shareholders Exemption (‘SSE’)

SSE allows companies to dispose of subsidiaries without paying corporation tax on any capital gain arising from the sale. As ever there are some key tests to be met to qualify for SSE. They have been: i) that the disposing company held more than 10% of the ordinary share capital; ii) that the disposing company is a sole trading company or member of a trading group, and; iii) the company being sold is also a trading company.

Before the changes, you also had to have held the shares for a continuous period of 12 months beginning not more than 2 years before the date of sale.

Issues with the “trading” test

SSE is not available if the disposing company fails to meet the test as a “trading” company or group. This used to mean then if any more than 20% of its activities (on various tests) were non-trading investment activity then you wouldn’t get the exemption.

Take advice

The above is a fair summary of the key aspects of SSE. But it’s an oversimplification and there are quite a few more detailed conditions to SSE. Do talk to a tax expert before trying this yourself!


The key simplifications to SSE which greatly facilitate deal structuring are that the “trading” test only has to be met in the subsidiary with effect from 1 April. This latter point would mean, for example, that in a group with only 30% “trading” versus 70% “investment” activity the trade one could hive down the trade to a subsidiary, dispose of it, and qualify for SSE.

Post-2002 Goodwill

There’s always a catch. And in this case, it applies to the disposal of a subsidiary where some or all of the valuation is “goodwill”. If that goodwill was created post-2002, it’s not impossible, but more difficult to do this without incurring a tax charge. If you’re in this position please get a business tax expert to walk you through the requirements.

Valuation Knows no Boundaries

That's the title of a recent PEMCF article in Acquisition International.  We covered the need for valuations, saleability, valuing early stage technology companies, and the need to get beneath the numbers.  Have a read here.  For more information have a look at the valuation section of our website here.

AI Valuation Article