Valuations are generally performed on a ‘market’ value
basis, which is the price the shareholding might reasonably be expected to
fetch, in money or money’s worth, in a sale between a willing buyer and a
willing seller, each of whom is deemed to be acting for self-interest and gain
and both of whom are equally well informed about the Company and the markets
within which it operates.
The FTSE100 stock index opened the year at 7,542 but
suffered its second worst single day decline on record in March, falling
briefly to below 5,000 points. It has since partially recovered on the back of
stimulus packages and support from the government, alongside some positive
sentiment from large business speculative about a recovery. This volatility and
overall decline in the stock markets cannot be ignored and should be considered
when performing valuations of private companies, particularly under a market
value approach.
Private trading companies are often valued on an earnings
basis where a multiple is applied to the level of future maintainable earnings
(‘EBITDA’ being earnings before interest, tax, depreciation and amortisation,
is a commonly used metric of this). The assumption is that the cashflows
accruing to the shareholders equate to the maintainable earnings. The impact of
COVID-19 will need to be considered in determining the level of underlying
maintainable earnings, with a valuer looking at both historical earnings and
forecast results in making this assessment. Historical results may no longer
represent maintainable earnings, and forecast results may have increased
uncertainty and require adjustment and monitoring in light of recent events. As
the market recovery continues it will be crucial for a valuer to assess the
forecast results against current management accounts to support the reliability
of the forecast data.
Valuation multiples should be linked to market data and
therefore fluctuations and volatility in stock markets, as discussed above,
must also be reflected in private company valuations. We would expect to see a
discount applied to current valuation multiples for most industries. Ultimately
increased uncertainty brings increased risk for shareholders which can reduce
company values.
While earnings based valuations reflect expected trading
profits, asset based valuations provide a useful benchmark and are sometimes
the primary basis of valuation if a business is loss making. However, an
entity’s reported net asset position may not be reflective of the fair values
of the respective assets and liabilities. In times of recession, asset values
are often suppressed or assets become irrecoverable, requiring impairments to be
made. It is imperative that a valuer recognises such adjustments in restating
the balance sheet to its fair value. External experts may be required where the
valuations of such assets has a material impact on the overall valuation.
