What is Illiquidity?
Judge Mostyn considered that there was no need to make adjustment to recognise that one party received a mixture of more liquid assets and the other shares in a family company. In a memorable phrase he described the difference between the two as being the sound of the auctioneer’s hammer.
The above comment is literally true if we focus on the assumed immediacy of the notional transaction. However, it does not deal with the whole issue. If the value of the shares is not equal to the value in the bank account, we may consider that we need to adjust the discount for illiquidity. However, this does not resolve the problem. Regardless of the size of the discount, there is no alchemy which can change the nature of the asset.
We can all recognise that there are various qualities within liquidity: they are the ability to sell an asset quickly, for a predetermined price, without the transaction moving that price, with a minimal bid-offer spread and with modest transaction costs. Shares in a family company generally have none of those qualities.
There were several issues in play in the deliberations as summarised in the Written Decision:
- The underlying volatility of a business interest;
- The subjectivity inherent in a valuation of unlisted shares, described as valuation uncertainty;
- The greater risk in a business asset compared to cash;
- The absence of liquidity.
The Court of Appeal
The Valuer, who was a single joint expert, had provided a range of values of the company at the start of the cohabitation. He had also undertaken valuations in both 2016 and 2017 and had provided ranges of value on both of these occasions. The Court of Appeal were troubled by the apparent range moving from a 2016 low of £130.3 million to a 2017 high of £227.5 million in such a relatively short period. There was no criticism of the expert valuer; rather the range of values indicated to the Court of Appeal that there was significant volatility and also measurement risk in respect of the shares in the company.
They recognised that business risk and illiquidity had been factored into the business valuation. However, the Appeal Court remained concerned about a reasonable split of assets between the “copper-bottomed” and the “risk-laden” assets.
Volatility and Valuation Uncertainty
We can all recognise that the professional valuer would have factored volatility into the valuation by use of the market approach: valuation uncertainty is a knottier issue. The intellectual analysis is that it must be as likely to understate as to overstate the value of an asset. If there is this symmetry about the mean, the overall impact is neutral.
The Decisions
The Court of Appeal referred on several occasions to a relatively recent case of Versteegh v Versteegh in which the difference between different asset classes had been highlighted.
The Court of Appeal made some major findings:
- They would not overturn the straight-line growth in value of the business as modelled by Judge Mostyn. This was despite the fact that the value of the acquest was so much greater than the evidence of the professional valuer. The Judge had considered all of the evidence; this decision was within the powers of discretion given to him to determine what was fair in all of the circumstances;
- They were more troubled by the different nature of shares in a private company when compared to cash. Cash was secure, accessible, stable and precise; shares in a family company were risk-laden, illiquid, volatile and oozed valuation uncertainty. There was a need to ensure a fair division of the very different asset classes. Judge Mostyn had failed to do that.
- They dealt with this point, not by reducing the value of the illiquid assets, as proposed by one of the parties, but by requiring that cash payments were made to the wife over a longer period. They disagreed with the comment of Judge Mostyn that the only difference was the sound of the auctioneer’s hammer.
Andrew Strickland
Consultant
