Any views expressed in this article are those of the author and should not be interpreted as ICAEW views or guidance.

Introduction

The Company had been headed by Mr Ansell and made models for the gaming world. Mr Pinfold had worked closely with Mr Ansell for many years. They had operated another company very successfully and had both enjoyed the fruits of that success on exit. Although Mr and Mrs Ansell owned 51% of the shares it had been agreed between them that the split of the beneficial interests was 50:50.

Mr Ansell was very well known and highly regarded in the niche market in which the company operated. Relationships became soured following the illness of Mr Ansell: his wife became more involved in the operation of the company, involved several family members into the busness and Mr Pinfold was excluded. He maintained that the company was a quasi-partnership and that the exclusions was unfairly prejudicial conduct.

The Business Performance

Mr Pinfold also maintained that the turnover and profitability of the company had collapsed as a result of changes introduced by Mrs Ansell. He stated that this due to several factors, including the abandonment of the regular discounted product offers, in particular in the run up to Christmas, in order to generate sales and clear stock.

The Deliberations of the Court

The Court referred to the foundation stone of equitable remedies in shareholder disputes, the House of Lords case of Ebrahimi v Westbourne Galleries [1973] AC 360.

It is often cited but the central paragraph of that decision is still worth repeating in full, as was done in the Decision in this case:

"The superimposition of equitable considerations requires something more, which typically may include one, or probably more, of the following elements: (i) an association formed or continued on the basis of a personal relationship, involving mutual confidence - this element will often be found where a pre-existing partnership has been converted into a limited company; (ii) an agreement, or understanding, that all, or some (for there may be "sleeping" members), of the shareholders shall participate in the conduct of the business; (iii) restriction upon the transfer of the members' interest in the Company - so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere."

Based on the evidence presented, the Judge decided that there was unfairly prejudicial conduct, and that the remedy should be the buyout of the interests of Mr Pinfold, and that his interests amounted to 50% rather than 49% of the equity in the company.

The Valuation Point

It is very common in such cases for a buyout to take place for a value to be established as at the date of trial or alternatively the date of petition. In this case the Judge decided, not without some hesitation, that the shares in the company should be valued as at the date of the exclusion of Mr Pinfold. The tacit point was therefore that Mr Pinfold should be shielded from the management decisions taken after his expulsion from the company. The Judge stated: “Fairness is the overriding consideration, and it seems to me that to choose a later date confers on Mr and Mrs Ansell, the wrongdoers, an unfair advantage at the expense of Mr Pinfold.”

The Valuation Evidence

A business valuer from a national firm was appointed as a single joint expert; he in turn relied on the valuation of certain specialist assets by a plant specialist.

We are fortunate as the written Decision provides us with a relatively clear window to view some of the valuer’s methods and assumptions. His valuation was primarily using the market approach.
The expert reached a valuation at the point of exclusion of £618,000, based on maintainable earnings of £103,000 and a multiple of 6. The earnings were based on a weighted average of recent results with those results being adjusted for relatively standard normalisation adjustments of management remuneration, arm’s length rental costs and one-off redundancy costs.

The earnings multiple of 6 represented a discount of 50% to the price earnings multiples of the nearest comparable quoted companies.

The valuer then used the cost approach as a cross-check: he commented that the implied value of the goodwill and intangibles was £257,000, so some 42% of the total value. The valuer considered that a tangible net asset backing to support the price of some 58% was appropriate in this case.

Comment

We can all recognise that an important starting point in business valuation is to consider the likely population of potential buyers: most buyers of small businesses do not have the opportunity to reduce risk by diversification. A high intangibles component is very commonly a feature of private equity and listed company transactions as the risks involved with this balance sheet shape can be absorbed.

For the smaller business buyer, the risks have to be reduced by other means: this can be achieved in several ways:

• In the retail space, including activities as diverse as insurance broking, pharmacies, newsagents and wealth management, there is a high level of predictability of income, together with established markets for the onward sale of the intangibles;

• For other businesses, a relatively strong balance sheet of tangible net assets can provide an escape route in the form of a Plan B if all else fails;

• If that is not present, the purchaser may fall back on an earnout arrangement.

It is evident that in this case the expert considered that the need for tangible net asset backing to support the price was an important consideration. 

Andrew Strickland, Consultant
Scrutton Bland

Any views expressed in this article are those of the author and should not be interpreted as ICAEW views or guidance.