Part of the our current series of Professional Briefings for Owner/Managers of SMEs, the December briefing covered the "Dark art" of business valuation.

1. Professional Briefing –
Business Valuation and other “Dark Arts”
15 December 2011

2. Administration
Admin
Timetable
Presenters…

3. Business Valuation and other “Dark Arts”
• Why of interest?
– M&A
– Investment
– Other (but ignore)
• Dark Arts
– Business valuation
– Tax Securing the
– Legal “Best deal”
• Practicalities
– General guidance/ tips
• Q&A over breakfast

4. Business Valuation
– “the basics”
Richard Wadman ACA
Corporate Finance Director
Francis Clark with Winter Rule

5. How much would you pay?

6. Business Valuation – some “basics”
► “The value of an asset is the value of the
cash flow it generates”
► Price = Value
/
► Business Valuation is subjective
► “Balance Sheet value” = Value (generally)
/

7. Value of an asset…
• Value of cash flows = Net Present Value
• Net Present Value (NPV) involves assumptions
on:
– Future cash flows
– Discount rate to be applied (“£100 now worth
more than a £100 payable in the future”)
• Investment opportunities forgone
• Risk of non-receipt
• Example calculation

8. Valuation methods used
• Minority shareholdings
– Dividend yield?
– 100% value x % shareholding x Minority Discount
• 100% of a trading business
– Earnings
– Net Assets
– Net Present Value
– Discounted Exit Value
– Economic Value Added
But all should be rationalised against ‘Value of an asset is value of
its future cash flows’

9. The Tax Tale
Ian Pring CTA ATT
Senior Tax Consultant
Francis Clark

10. Tax tail…
• They say do not let the Tax tail wag the dog but a
“valuation” needs to be considered in the context
of…
– On a sale: Post Tax Receipt
– On a purchase: Post Tax cost
– On an investment: Post Tax cost

11. Purchaser: assets or shares?
Assets Shares
Capital allowances No tax relief
Goodwill amortisation tax relief No relief
Capital gains rollover No rollover unless EIS shares
SDLT (to 4%) on land & buildings SD at 0.5%
VAT payable – unless TOGC Exempt from VAT
Trading/capital losses not xfrd C/fwd provided no major changes
Can choose assets to take + leave Acquire company with liabilities –
liabilities behind warranties, indemnities,
guarantees, retentions, …
- Caveat emptor

12. Entrepreneurs’ Relief
Share disposal:
Throughout ‘relevant one year period’ individual must demonstrate
that:
• Employee or office holder of company (or member of trading
group)
• Own 5% of the ordinary shares AND exercise 5% of the voting rights
And be a trading company without substantial non-trading activities,
i.e. >80% trading activity
Check all shareholders qualify or establish why not to avoid difficulties
in due course!

13. Entrepreneurs’ Relief
Unincorporated business disposal:
1. Whole or part of the business where, at date of
disposal:
– Business owned for at least one year, and
– Disposal comprises at least one ‘relevant business
asset’, or
2. One or more relevant business assets where:
– Each of assets in use in business at cessation, and
– Asset disposal within 3 years of cessation

14. Deferred Consideration
Ascertainable (= quantifiable):
If quantum of proceeds determined by events occurring
by disposal date full proceeds taxed at disposal date with
no discount for delay in receipt – even if receipt
contingent on trigger event occurring after disposal date!
(S28 TCGA 1992)
S280 TCGA 1992 – postponement (> 18 months)
S48(1) TCGA 1992 – amendment to original asst

15. Deferred Consideration
Unascertainable proceeds – where events affecting the
quantum of proceeds do not occur until after the
disposal date
‘Chose in action’ – right to such unknown consideration
valued and taxed at disposal date
Any future payments resulting from right treated as
part-disposal of that right and create gains or losses in
the later tax year (S22 TCGA 1992)

16. Deferred Consideration - Unascertainable
Fred sells shares in A Ltd in 2010/11 for £800k with a further
sum payable dependent on A Ltd’s results. Contingent right
agreed to be worth £50k. Earn-out proceeds of £200k
received in 2011/12. Taxed as:
2010/11 £850k @ 10% (ER due & ignoring cost + AE)
2011/12 £150k @ 28% (assuming HR taxpayer)
Structure to tax £1m in 2010/11 @ 10% (as ascertainable sum
less contingent liability under S49 TCGA 1992)

17. Warranties & Indemnities
Warranty Indemnity
Statement of fact made about the Separately enforceable contract
tax affairs of Target company which reimburses loss and for
which Buyer relies on when which consideration is given:
entering the contract:
• Debt (primary liability)
• Damages
• Duty to mitigate loss • No duty to mitigate loss
• Limited by disclosure • Not (generally) limited by
disclosure
Payment from Seller to Buyer A means of allocating the risk of
(S49 TCGA 1992) an unforeseen tax liability
between Seller and Buyer

18. Enterprise Investment Scheme (‘EIS’)
• 30% income tax relief shares issued on investments of up to
£500,000 a year (to be increased to £1 million from 6 April
2012) - withdrawn if the shares are disposed of within 3
years
• Gains on the disposal of EIS shares are exempt unless the
income tax relief is withdrawn
• Gains arising on disposals of any assets can be deferred
against subscriptions for shares in any EIS company
• Shares do not have to have income tax relief attributable to
them in order to qualify for deferral relief
• The deferred gain will become chargeable in the tax year
when the subscription shares are disposed of

19. Business Valuation
– “practicalities”
Richard Wadman ACA
Corporate Finance Director
Francis Clark with Winter Rule

20. Francis Clark with Winter Rule approach (Desk Top)
Equity value (100%) = Enterprise Value ADD Non-
Trade Assets LESS Non-Trade Liabilities
Enterprise Value = ‘value of the trade’
(including working capital and P&M i.e., the ‘earnings
generators’)

21. Enterprise Value
• Maintainable EBIT x Multiple
• Maintainable EBIT
– EBIT per Accounts
– Adjust for Directors remuneration, rent on freehold,
one-off and non-arms length transactions etc
– Weightings across 3 -4 years
• Multiple
– Listed PER and apply marketability discount
– PERDA

22. Multiple trends…

23. Non-trade assets and liabilities
• Property
• Mortgage
• Directors Loans
• Cash
– Excess (add)
– “Commitments” (minus)

24. Pricing (slide stolen from SWAIN presentation)
Sales €2,000,000
Profit €200,000
Exit multiple 6x
Exit value €1,200,000
Sales €150,000
Loss €40,000
4 years 25% = €300,000
Invest €75,000
4 times return
25%

25. Implicit…
• Valuation basis
– Going concern
– Arms length
– Ignore any Special Purchaser
• Subjective
• Negotiation = key element
• Emotive
– Key the ‘end game’ in mind
– Know the deal breakers

26. Preventing ‘value seepage’ through
proper legal drafting
Chris Wills, Associate/ 15 December 2011

27. Protecting ‘Value’
• There are two key elements to protecting value for a
seller/company/existing shareholder to consider:
– ‘maintaining’ value on paper
– ‘collecting’ value in practice

28. Maintaining the value
• caveat emptor
• the delicate balance
– warranties/indemnities
– disclosure
• attitude to risk:
– remove the risk and pay now
– keep the risk and potentially pay later

29. Collecting value: Payment on completion
• ‘Cash is king’
• less may be more

30. Collecting value: Deferred consideration
• Why is some consideration deferred?
– unable to calculate price on completion
• stock valuation
• completion accounts
– purchaser wants to ‘buy now, pay later’
• earn out
• unable to raise all funds now
• In the seller’s/company’s/existing shareholder’s interests?
– ongoing control
– security

31. Has value been protected?
• Has value been maintained on paper?
– depends upon negotiating strength and attitude to
risk
– full disclosure of areas of concern
• Can value be collected in practice?
– maximise cash on completion
– maximise reward for deferred element
– suitable controls/security for any deferred element

32. For further information please contact:
Chris Wills, Associate
Telephone: 01872 226992
Email: chris@murrellashworth.co.uk
www.murrellashworth.co.uk

33. Value?

34. Breakfast and discussion...

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