Business and share valuations - methodologies, terminologies and practical tips

1. Business and share valuations – methodologies,
terminologies and practical tips
Breakfast Briefings – Winter 2018/2019 Welcome: Richard Wadman, PKF Francis Clark
5 February 2019

2. pkf-francisclark.co.uk
Administration

3. pkf-francisclark.co.uk
• An overview of how we value
companies, shares and businesses
• Jargon busting – what they are and
how we calculate them:
• The 'P/E' ratio
• 'Normalised working capital'
• 'Minority discounts'
• 'Discount rates' for net present values
• How can you enhance your
business’ value prior to investment or
sale?
What - Valuations

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• Multi-use:
• Business transactions
• Investments
• Share incentives, including EMI
• Matrimonial
• Dispute
• IHT, CGT
• Area of expertise.
• c 150 valuations in last 6 years
• Instigate and maintain PERDa
Why - Valuations

5. pkf-francisclark.co.uk
How - Valuations

6. February 2019
Business and share valuations
Ed Marffy – Francis Clark
Henry Maples – Murrell Associates

7. Introduction (and caveat)
• Valuation of shares in private companies is not an exact
science
• Our indication is therefore purely our opinion
• Others may place a different value on the shares (especially
if they are buying / selling)
Ultimately a company is worth what someone will pay for it

8. Methodologies
Net Asset Value (Asset based value)1
2
3 Net Present Value (Discounted free cash flow)
Comparative Earnings (P/E ratio)

9. Net Asset Value
Method
Assets
–
Liabilities
=
Equity value
Considerations
Appropriate for
1
• Investment companies
• Companies ceasing to trade
• When other methods result in
negative/low values
• Revaluating assets / liabilities
• No value for goodwill
• “Wind up costs”: Redundancy,
liquidator

10. Multiple (PER): 7.4
www.perda.net
Comparative Earnings
Method
“Maintainable earnings”
X
Price to Earnings Ratio
=
Enterprise value
Adjustments:
• Average over 3-4 years
• Remove exceptional costs / income
• Normalising directors remuneration
• Replace depreciation with CAPEX
+ Non trade assets
+ Cash
– Debt
+/– NWC adjustment
=
Equity value
2

11. Net present value
Method
What is the value today?
= Discount rate
Y 1 Y2 Y3 Y4 Y5+
3
+ Non trade assets
+ Cash
– Debt
+/– NWC adjustment
=
Equity value
Discounted future cash flows
=
Enterprise value
+
Terminal value

12. Potential reasons
• Whole company
transactions (vendor &
purchaser)
• Fundraising (equity)
• Probate
• Matrimonial
• Issue of share options
• Considering employee
share option schemes (EMI
etc)
• Periodical valuations for
shareholders
• Succession planning
• Gifting shares
• Shareholder exit
• Liquidation
• Restructuring
• Incorporation – value of
goodwill
• Brand valuations
• Contract / client book
valuations
• Secured lending

13. Transfers of individual shareholdings
Application of ‘valuation’ provisions in shareholders’ agreement/articles of association
• Voluntary/compulsory transfer provisions
• Growth share schemes / share option schemes
• Share transfer restrictions
Henry Maples
Partner
Murrell Associates LLP
henry.maples@murrellassociates.co.uk

14. Valuing Minority Shareholdings
Discounted future
dividends
Pro-rated &
minority
discounted
Or

15. Discounted Future Dividends
• Very similar to net present
value method for companies
Y 1 Y2 Y3 Y4 Y5+
Use if:
• Historic dividend income
stream relevant to a minority
shareholder
• Planned dividend income
stream
• Discount rate is key

16. 74%
26%
Pro-rated & minority discounted
“The valuation must reflect the
extent to which a potential
buyer of the asset can control,
influence and derive enjoyment
from the asset.”
HMRC Share and Asset division guidance
Shareholding Discount Note
>75% Nil Special resolution
50.1% to 75% 10% Ordinary resolution
50% 15%
25% to 49.9% 30%-50% Block special resolution
10% to 25% 50%-65% Demand audit
<10% 70%-80%
Total company value £500k
Pro-rate 26% £130k
Minority discount at 50% (£65k)
Minority Value £65k

17. Company / business sale events
Protecting value
• Split exchange and completion
• Warranties and indemnities
• Completion accounts v locked box mechanisms (share deals)
• Deferred and earn out consideration
― Covenant strength
― Calculation process and governance controls
Henry Maples
Partner
Murrell Associates LLP
henry.maples@murrellassociates.co.uk

18. Negotiating value / key issues
• Price Earnings Ratio
• Discount rate
• Normalised working capital adjustment
A
B
C

19. Multiple (PER)
www.perda.net
Comparative Earnings
Method
“Maintainable earnings”
Price to Earnings Ratio
Enterprise value
X
=
Adjustments:
• Average over 3-4 years
• Remove exceptional costs / income
• Normalising directors remuneration
• Replace depreciation with CAPEX
+ Non trade assets
+ Cash
– Debt
+/– NWC adjustment
=
Equity value

20. Factors influencing PER
Company
• Size of the company
• Dependency on owners
• Customer concentration
• Supplier concentration
• Current trading / future prospects
• Volatility in trading results
• Onerous contracts
• Protection (intellectual property)
Market
• General trends
• Competitors
• Barriers to entry
• Types of customer (one off / re-
occurring)
A
PER used = PERDa value adjusted for company / market factors

21. Discount rate: Net present value
Method
Discounted future cash flows
+
Calculate “terminal value”
=
Enterprise value
What is the value today?
= Discount rate
Y 1 Y2 Y3 Y4 Y5+
+ Non trade assets
+ Cash
– Debt
+/– NWC adjustment
=
Equity value

22. Discount rateB
Weighted
Average Cost of
Capital (WACC)
Capital Asset
Pricing Model
(CAPM)
Or

23. Discount rate: Weighed Average Cost of Capital (WACC)
Stage of
development
Overview Typical
target rates
of return
Seed Idea/product concept deverlopment stage 50-70%
Start up Prototyping and early customer sales 40-60%
Growth Expansion and market development 35-50%
Mature Proven model and management pre trade sale/IPO 25-35%
Source: Aswath Damodaran, New York University
B
Private equity targeted returns
Capital Cost
Equity Dividends / growth
Debt Interest
Total Weighted average
£m Cost (%) £m
1 35% 0.35
2 10% 0.1
3 0.45
Example “Mature” Company
15%
Discount rate

24. Discount rate: Capital Asset Pricing Model (CAPM)B
Discount rate = Rf + (Rm- Rf)
Discount rate = 14.44%
Risk free
rate
Yield on a 10 year
UK government bond
1.14%
Market
premium
Average UK equity
risk premium
6.65%
Beta (Asset
sensitivity to market)
Derive from listed
industry comparators
2
+ x

25. Net working capital: Net present value
Method
Discounted future cash flows
+
Calculate “terminal value”
=
Enterprise value
What is the value today?
= Discount rate
Y 1 Y2 Y3 Y4 Y5+
+ Non trade assets
+ Cash
– Debt
+/– NWC adjustment
=
Equity value

26. Net working capital adjustment
What is working capital?
• Buy raw materials, on credit, from Farmer for £40
• Sell the product to Tesco for £45
• Make £5 profit
Balance sheet
Debtor (Tesco) £45
Creditor (Farmer) (£40)
Working capital £5
Key issues
• What is included in
working capital?
• Strip out exceptional
figures
C
• Your £5 of profit is “stuck” in the company until the
debtor and creditor are paid.
• The Company needs a certain level of capital in it
that is “working”.

27. Net working capital adjustment
• Debtors collected quickly
• Creditors paid later
• Working capital has
effectively been converted
in to cash
• Difference ~ £150k
Total company value £800k
Normalise working capital (£150k)
Adjusted value £650k
C
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Debtors 500 550 530 502 500 520 510 520 505 485 450 420
Creditors (300) (370) (340) (350) (320) (370) (370) (320) (340) (340) (380) (400)
Working capital 200 180 190 152 180 150 140 200 165 145 70 20

28. Next…
Q&A and/ or discussion
• With opportunity for Q&A for presenters
Future breakfasts – 1st Tuesday of the month
• Pre-year end tax planning for individuals and investors
• CIOSIF update
• “Equity for tech businesses”
• Recruiting and keeping key staff
Other dates for the diary
• Finance in Cornwall – 25th June 2019 (with British Business Bank,
Cornwall Lenders Forum, Plymouth University and Invest in Cornwall?)
And do not forget our blog, which contains details of new funds/ sources of
SME funding that come to our attention, and our Finance in Cornwall
factsheet.
pkf-francisclark.co.uk

29. Q&A and/ or discussion
pkf-francisclark.co.uk

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