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.

Hindsight

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.

Sun-Tzu-Final
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 http://www.pem.co.uk/corporate-finance/pem-events


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!

Simplification

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


Should I go ahead with selling my company during post Brexit uncertainty??

I was asked this question by a business owner very recently.   We had been discussing his exit options for some months, and not unreasonably he is trying now to work out the effects of a post Brexit world on his decision making, in particular how it should affect timing.

BrexitTiming is the key given that successful company sales are often significantly about getting the timing right; timing re your business, your sector, and of course one cannot ignore the overall economic outlook.

My considered opinion is that I think it is too early to tell.

But there are, as yet anecdotally, some positive signs. We have 3 sales on the go at the moment at Heads of Terms or legal stages, all with foreign buyers, all are unaffected.  Also we have another just begun where the directions asked themselves the same question – and decided to proceed, on the basis that if buyers are all running scared we’ll find out quite early on and they can pause the process.  

At a more general level if the purchase is strategic I think folk will push on, however there must be some buyers out there who will wait to see what happens. 

What about foreign buyers wanting an EU base – how will they behave? For some businesses that will clearly have an effect.   Again it will depend on the precise business being sold and the buyers specific motivation.  

Of course there is potentially a plus from exchange rates depending on how that pans out. We have clients which will do well from that, and those that are already hurting.

In short nobody knows – only way to be sure is to try it.

Finally, just as with the political campaign, we're seeing some daft statements associated with the post Brexit world.   I received a marketing flyer re a company sale today from another adviser which cheerfully concluded that the business was "Wholly UK focused, so not affected by Brexit".   Presumably any downturn in the UK economy due to Brexit would not affect this business despite being wholly UK focussed?!  Dubious logic that even Boris would have been proud of. 


Don’t drop the anchor. Avoiding bias in business valuations

AnchorsaweighIt’s a cliché that business valuation is both and art and a science.   Or as it’s been more aptly put it is a craft.   Either way it needs to be done thoughtfully.   You don’t need to look hard online to find sites that invite you to put your data in and I’ll value your company for a low fixed fee.  Trouble is that “under the bonnet” this is just some maths – this is a problem because you have no idea if the site is asking the right questions, and more importantly its only as good as the data input.   As they say garbage in garbage out.

But if you do treat valuation as a craft, to be conducted thoughtfully, making insightful and supportable judgements about the business at each step you need to guard against bias – and this can arise accidentally.

Anchoring is a well documented phenomenon.   There have been psychology experiments that have demonstrated this.   Business students are asked if they’d pay the last two digits of their national insurance number for each of several items.   Then they’re asked the maximum they’d be prepared to pay item by item.   Despite it being random students with higher NI numbers consistently indicated higher maximum bids.    The anchoring phenomenon can work to ones advantage – it’s a reason why it’s often helpful to go first in a negotiation – to try to anchor the debate at your end of the value range.    But it has no place in valuation as the valuer should form an independent judgement.     

So as a corporate finance adviser I’m keen to understand what my clients objectives are as input to negotiations. Conversely as a business valuer I need to be deaf to the client’s desired valuation.  This might be a business valuation for divorce purposes, or to do with shareholder exit, or tax.  But I need to avoid anchoring bias to make sure I arrive independently at my best judgement of valuation which is supported by the evidence and by my understanding of the business. 

For more information on our Business Valuations service have a look at our website - based in Cambridge we provide valuation services to business owners around East Anglia, in London, nationally and internationally. 


Valuing the Star Wars Franchise

Asman Damodaran of the New York University Business School had a go at valuing the Star Wars franchise.  Disney paid $4Bn for it – so did that turn out to be a good deal?

Business Valuation Star Wars Logo Style
Damodaran reviews the franchise to see where the revenues have come from.  Interestingly the original film is still the biggest grosser to date at nearly $4Bn.  But the other revenue streams are even more important; VHS/DVD/Rentals, Toys, Gaming, Books, and TV series.  These other revenues dilute Movie income to 20% of the whole alongside 23% for rentals, 15% for gaming and books, and a whopping 36% for toys and merchandise. Disney star wars

So how do you value it?  Like any other business, one needs to take a stab at future earnings potential.  In the absence of Disney’s,  no doubt closely guarded, forecasts Damodaran makes educated guesses.  Starting with Disney’s intent to make another two films he then assumes they’ll each gross something similar to “the Force Awakens”.  I’d have assumed some slight decline each time around (as the history suggests) but you have to start somewhere.  He judges that add-on revenues will continue be more important - streaming replaces rentals and he assumes $1.20/dollar v $1.14/dollar thus far, Toys continue to generate $1.80 for every dollar of movie income, Books drop 25% to $0.20/dollar, Gaming stays at $0.5/dollar, and he assumes that with the distribution power of Disney and Netflix (rumoured to be planning 3 live action series) TV rights will increase to $0.5/dollar. 

One needs to keep making assumptions, when the films will be released, inflation, and of course the margin levels on the income streams – he uses sector averages here, for example toys/merchandise at 15%.  Put it all together and you get an overall net income projection which he discounts at 7.61% being the average cost of capital for the entertainment sector.   Net result a valuation of $10M.   So Disney did a good deal.   If you want the full calculation Google “Galactic Finance: Valuing the Star Wars Franchise” which will take you to his blog.

It shows you can build up a cogent case to value almost anything, although I’d  have factored in some kind of discount just because of the existence of Jar Jar Binks. 

May the force be with you.


Succession Buyouts as a route to succession in Family Companies

Planning for exit and succession can be difficult in any business, but in family businesses there are additional factors to consider.   One of the problems with family succession planning is that the two key objectives – liquidity and preservation of the business legacy appear to be in conflict – how can you get cash without selling up?   A sale to a trade buyer may be unattractive if the plan is to keep things in the family, and this is where the idea of a sale to family comes in.  Family Business Cubes

This is a form of management buyout – the family members buying the business are very often the team running the company.    Often it goes beyond that to key managers – hence the occasionally used abbreviation the FAMBO. This is meant to mean Family and Management Buyout, or Family Buyout, although just to confuse things I’ve recently seen it used in East Anglia to refer to a Franchisee and Management Buyout.   It can also be called a VIMBO or Vendor Initiated Management Buyout – because the its usually (though not always) the older generation which initiates the sale to the younger family members.  At PEM we prefer to refer to such deals as Succession Buyouts – because that neatly encapsulates the overarching strategic intent of the deal.

Because family relationships are involved things can go wrong so as to delay the transaction or even kill it completely.  So here are some key thoughts on how to preserve family harmony whilst successfully completing a buyout.

Plan ahead and don’t rush each other. It is really important that harmony and trust is maintained. Nothing breeds suspicion more than the idea that one family member wants to take advantage of another, either by being pushy or appearing to scheme behind the scenes. This is true whether a family member is a buying or selling. An aggressive buyer almost ensures that the seller will react negatively; an aggressive seller communicates desperation and may undermine his or her own negotiating position.   Actually this is also true of Succession Buyouts amongst long standing colleagues who are not related.

Take account of peoples personalities Families ought to know one another pretty well. They know about personality traits or past circumstances giving rise to unusual levels of loyalty, or even resentment, or jealousy.   This might all come out in the run up to a transaction, sometimes they are deep-seated psychological feelings, and can be almost childlike—“Dad always preferred you.”   Being alert to such attitudes and steering the transaction in a sensitive way that respects feelings will help ensure success. Often the most important thing is to make sure everyone is listened to.

Get the business professionally valued If your shareholder agreement doesn’t prescribe a valuation methodology, it will be helpful to everyone involved in negotiating a transaction that there should be an independent assessment of valuation. Fairness is the key to completing the transaction and maintaining positive family relationships, and possibly sanity.  Neither buyer nor seller wants to looking back on the transaction with regret or suspicion.

Find some trusted advisors. Truly independent advisors who have the best interests of the family in mind can be hugely helpful in communications and facilitating agreement amongst the family. Each family member can get some independent advice, but its much better to select an adviser with a track record of brokering/facilitating such deals amongst close knit family or business groups to work for the company/family as a whole with the objective of reaching an agreement that works for all.  A skilled adviser will listen to all the agenda’s and try to manage any emotional pressures that arise during negotiations.

Tax and estate planning My tax colleagues would point out that it’s really important to consider the tax and financial affairs of the whole family, up and down the generations. And a deal like this is an opportunity to consider these things holistically.   Has the family provided for everyone as they intend and have they done inheritance tax planning?  Again these are things that need to be done early. One of the consequences of some buyout structures is that IHT planning becomes more important – don’t leave it to the last.

Family businesses are important to us all – according to INSEAD they account for 57% of US GDP.   There’s a general perception that many don’t make it beyond one or two generations. I’m not sure that’s true, INSEAD reckon there are 5,500 bicentenary family businesses around the world, and we’ve certainly worked with some family businesses which are now at fourth or fifth generation stage.  Visit our website to read about some of the family buyouts we've worked on.