The Fundamentals
What do we mean by value?
We can all recognise that business valuation aims to derive a value which is payable in cash on completion; we value at the cusp of a transaction taking place. Shares in a private company are likely to be very illiquid; however, the illiquidity in the current transaction is ignored due to the assumption of completion being imminent. The discount for illiquidity hard-wired into the valuation refers to the innate nature of the asset being transacted: conceptually it is the present value of the higher costs and delays which will be experienced in future changes of ownership.
This question was one of the questions to be addressed in the above case: this was an appeal from the case of WM and HM as decided by the renowned Judge Mostyn of the Family Courts. He had found the total family wealth to be £182 million after allowing for tax on disposal. With such value within the combined estates, the sharing principle was a major consideration of the Judges in both the High Court and the Court of Appeal.
The Points of Appeal
Both Mr Martin and Mrs Martin appealed. The grounds for appeal included:
- In considering the vexed question of the springboard inherent in the acquest brought to the marriage, Judge Mostyn had wrongly assumed a straight line graph as representing most fairly the growth in the business;
- There was no recognition given to the incomparability of liquid and illiquid assets;
- The Judge had not made adjustment for the fact that the husband owned only half of the company at the date of the marriage.
In addition to the above three points there were appeals relating to the way in which value was to be transferred between the parties and the timing of such transfers.
The Springboard
This is a vexed concept indeed, both for valuers and for the Courts. What is the value which is over and above that recognised in a professional business valuation to allow for exceptional future growth?
The first point to make is that we are in danger of arguing from different premises; in business appraisal it is axiomatic that a valuation is based only on information available up to the point of the valuation: the ugly duckling may or may not turn into a beautiful swan. The currency of the Family Courts is that of fairness; they are not forbidden the use of hindsight in their deliberations.
In this context the approach of Judge Mostyn is an attractive one; by applying a straight line of growth in value from the date of commencement of a business to the present he derives a value for the business at the start of cohabitation which incorporates the spring board. His argument is that efforts made in the early years of a business are as valuable as inputs made later. The highly successful business is therefore not valued by reference to its growth trajectory but in correlation with the years of effort expended in achieving the eventual successful outcome.
Judge Mostyn summarised his views in the Written Decision:
“In argument, I asked "how could it be said that a day's work in 1980 in creating this company was less valuable than a day's work last week?" In my judgment, the answer is that it could not."
There is an understandable concern that, absent some form of intellectual structure for valuing the springboard, it will be decided solely on the basis of judicial caprice.
Judge Mostyn described his approach as having
“the beneficial side effect of eliminating arid, abstruse and expensive black-letter accountancy valuations of a company many years earlier at the start of the marriage"
The Professional Valuer
The business valuer had been appointed as a single joint expert. He had been required to value the business both at the time of the trial and also at the start of cohabitation in July1986. For the latter valuation he provided a relatively wide range of £188,000 to £414,000 for the entire equity. His calculations can be summarised:
| Lower £'000 |
Higher £'000 |
|
|---|---|---|
| Maintainable EBITDA | 113.25 | 113.25 |
| Multiple | 4 | 6 |
| Enterprise value | 453 | 679 |
| Less debt, net of cash | (265) | (265) |
| Value of equity | 188 | 414 |
The Court noted that, as it was based on a maintainable EBITDA, the single joint expert had delivered a valuation which was prospective in nature. The husband had only owned 50% of the business in 1986. The relevant starting point for the value of the acquest is therefore 50% of the above figures.
The single joint expert had been asked how the valuation at July 1986 should be increased as a result of passive appreciation. It was his opinion that a relatively large sector of the FTSE should be used and he identified the Electronics and Electronic Equipment Sector as the most appropriate. This sector had increased by 540% between 1986 and 2016. The indicative non-marital property including passive appreciation to 2016 was therefore presumably £602,000 to £1,325,000.
The business valuer had also considered the value of the business in February 2017. Mr Martin and his wife now owned 100% of the equity as he had bought out the other 50% shareholder using the resources of the Company. As it was the resources of the company which had been used for the buyout of 50%, there was no need for adjustment – the effective interest of Mr Martin was the same throughout. The single joint expert’s calculations are summarised:
| Lower £ million |
Higher £ million |
|
|---|---|---|
| Weighted average historic EBITDA | 21.2 | 21.2 |
| Multiple | 7 | 9 |
| Enterprise value | 148.4 | 190.8 |
| Cash and other | 36.7 | 36.7 |
| Equity value | 185.1 | 227.5 |
The expert had clearly looked to provide the Court with full information by providing a range; he had also undertaken a valuation in 2016 and had derived rather lower values of £130.3 million to £166.4 million.
Another Outing for the Control Premium
In deriving his multiples from guideline public companies, the valuer had applied discounts of between 30% and 50% for a lack of marketability. He had then added on a control premium of 30% in both the 2016 and 2017 calculations.
The Decision of Judge Mostyn
Judge Mostyn took a current valuation of the company of £221 million. He then applied his method of assuming a straight-line growth trajectory; he derived a value, presumably including both springboard and passive appreciation, of 20% of this sum, namely £44 million as representing the non-matrimonial property.
Next
In the next article on this case we consider the nature of illiquidity and uncertainty and how it should be reflected in the division of liquid and illiquid assets.
Andrew Strickland
Consultant
