Introduction

At its simplest, if the main value of a business derives from a form of private equity activity, should conventional valuation methods be employed?

The case also has interest as we are shown glimpses of the methods adopted by three business valuers: a national firm was appointed as a single joint expert; the wife and husband, each dissatisfied with parts of the valuation conclusions of the SJE, appointed their own experts.

As with divorce cases involving children, the wife and husband were anonymised as shown above.

The Family Wealth

The vast bulk of the wealth derived from a company described as R Limited. The husband and a business partner, coyly known as Mr E, initially held 50% each in the company. Further parties became involved, including a funder known as A Limited. At the time of the hearing the husband and Mr E each held some 40% of the equity.

R Limited

R Limited initially comprised a disparate group of companies; acquisitions were made with the intention of growth and sale. However the company was substantially under-capitalised; this meant that each deal was dependent on finding a high net worth individual who was prepared to fund it.

The capital base was increased by means of an investment by A Limited. This investment was in the form of a relatively modest equity stake together with some convertible loan notes. A Limited was also granted a put option, giving them a means to exit. It was agreed that the strategy for R Limited was for it to grow with the intention of sale or flotation.

Valuation Pointers

The International Private Equity Valuation Guidelines place considerable store in calibration; a very strong indicator of value is obtained by looking at a prior funding transaction. We may therefore anticipate that the terms of the 2017 funding by A Limited would provide a fixed survey point for the business valuers.

We also have evidence from a 2014 shareholder dispute case, Arbuthnott v Bonnyman, relating to Charterhouse Capital, that the Courts will ascribe a very low value to the equity of a private equity group if the rewards are almost entirely drawn as remuneration by the partners. The implicit assumption is that there is little in the way of residual value in private equity outside the profits made on each transaction as they are realised.

These lead us to two of the main concerns in this case:

• What was the status of the investment by A Limited and should it be used for the normal calibration process, which is central to private equity and venture capital valuation?

• The income approach was applied and the discounted cash flow method, using cash flows to March 2023. Was it appropriate to compute a terminal value for the business at the end of the forecast period and to discount this back to net present value?

The two points above may be considered as representing mainstream valuation orthodoxy in the normal course.

The Status of the Investment by A Limited

It was claimed for the wife that the 2017 transaction gave an indicative value to the entire company at that point of close to £100 million.

The counter-argument put forward was that this was no arm’s length transaction: the proprietors of A Limited were old, almost family friends. There is then a sentence in the written decision which I have found difficult to decode:

“How much they invested was largely immaterial as they had a “put” option by which they could require the company to purchase their shares if there was no liquidity event in 2022 at market value.”

For whatever reason the Judge was swayed by the evidence of the husband’s expert on this point: the transaction with A Limited did not point to a company valuation of close to £100 million in 2017. It also seems that this may have been the view of the single joint expert:

“It is fair to say that the report of [the husband’s expert] is considerably closer in methodology and outcome to that of [the single joint expert] than is the report of [the wife’s expert]”

The Terminal Value

This was by far the largest difference between the experts. The wife’s expert computed a terminal value of £18.8 million; for the husband it was stated that it was £nil. This was also the view of the single joint expert. The explanation of the wife’s expert was summarised by the Judge:

“The company will continue after the five year period at the end of which it will be sold or floated. It will not be wound up. Taking a terminal value allows one to build in the value of the likely future cashflow after 2023, as when the company is sold it will have an infrastructure in place and projects in progress that will not yet have flowed into the profit stream but nevertheless will be of significant value to the purchaser.”

The calculations were maintainable EBITDA of £14.1 million multiplied by 5.45, with the product being discounted by 50% for uncertainty to £38.4225 million. If the capital structure in the TV was wholly equity, the indicative annual discount rate from March 2023 to March 2019 is some 19.6%. This then gives the stated Terminal Value of £18.8 million.

The husband’s expert gave a complex, nuanced explanation as to why a terminal value was not appropriate: the forecast projections to March 2023 included many ongoing projects which were not even identified, let alone commenced. They were therefore totally uncertain. She did not discount these projects for their uncertainty as she says she would have done if she was to allow a terminal value.

The Outcome

The Judge was persuaded by the evidence of the wife’s expert which was in step with the view of the single joint expert:

“Not only do I find her arguments persuasive in themselves; the volatility of the business simply does not permit any accurate basis upon which a terminal value can be assumed.”

The Judge derived a value for R Limited of £52,690,000. This can be compared with the wife’s expert at £77.3 million and the husband’s expert at £48.9 million.

Discounts

The husband had a stake of 40%, as did his business partner. The experts agreed the unarguable point that there would be no discount in respect of a liquidity event for the entire company.

If a standalone holding of 40% was sold the range of discounts suggested was 20% to 30%.

If the sale was of a 20% holding, the discounts were more varied at 25% to “north of 50%”.

Again, the Judge was more swayed by the more convincing evidence of the husband’s expert: he concluded that the discount for a holding of 40% should be 30%.

Andrew Strickland, Consultant, Scrutton Bland