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Share valuations – obstacle and opportunity

Mark Gearing


United Kingdom

Analysing a private company's value is tricky at the best of times, but as the COVID-19 pandemic continues to provide uncertainty for many businesses, that task has become even harder. Share valuations are important for private companies operating incentives arrangements and we deal with those below.

When converting to employee ownership, typically through a sale to an employee ownership trust (EOT), obtaining a third party valuation of the business will provide comfort to the trustees of the EOT that they are not overpaying for the shares. Likewise, founders often feel that the independent valuation allows them to discuss the move to employee ownership with staff without the price becoming contentious. When the pandemic first hit the UK, we found that many independent share valuers were reluctant to provide and sign off on formal business valuations, given the uncertainty of future trading that almost every business experienced (whether that was a predicted fall in revenue, in sectors such as tourism, catering and leisure, or a spike in turnover in sectors such as food retail). Six months on, valuers are having to get to grips with this continuing uncertainty, as we experience strong deal flow for transactions involving a sale to an EOT. One area of debate is whether to treat COVID-19 as an exceptional item, basing the valuation on pre-COVID levels of turnover and profitability, which may overvalue the business, or use a post-COVID multiple, which may result in an undervaluation, if the business bounces back more quickly than anticipated, once Government restrictions are lifted.

A remaining issue for EOT transactions is the need to stress test what the business can realistically afford in cash terms in what is an uncertain trading environment. The level of free cash in excess of working capital requirements, that could potentially be used to provide contributions to the EOT in normal circumstances to pay upfront consideration to selling shareholders, may now need to be reviewed, in light of the business's ongoing operations. More than ever, founders must exercise caution when undertaking their financial modelling.

Another area that relies on robust share valuations is the grant of equity awards under employee share plans. Now could be a good time for companies to grant options or share awards to employees as the value of the shares may be lower than in previous years, providing an opportunity to benefit from future gains with minimal income tax exposure. The acquisition of shares by employees and office holders will normally trigger an upfront income tax charge unless the individual pays a market value for the shares. It is therefore important to assess that valuation in advance of the share acquisition, so the individual is aware of any potential income tax charge before it is triggered. Professional valuations and in particular comprehensive (and costly) valuation projects are not always required.  For example, PAYE best estimates might be dealt with in-house where appropriate. Although the grant of share options will not trigger the same potential upfront tax charge, a share valuation may still be necessary, both to set the exercise price, and in the context of a tax-advantaged plan, to assess the number of option shares that can fall within one of the statutory limits. For tax-advantaged share plans, the valuation can be agreed with HM Revenue & Customs (HMRC) in advance of options being granted, and although HMRC's approach to accepting ultra-low share valuations has hardened in recent years, it should still be possible to agree a discounted valuation to take account of small minority holdings. HMRC valuations are often based only on the information relating to the business that is in the public domain. However, that principle may mean that the full impact of COVID-19 will not be reflected in the valuation, given the delay in most companies publishing their annual financial statements.

The COVID-19 pandemic has certainly made the task of share valuation more challenging, but presenting a robust valuation remains as important as ever, whether in relation to a sale of a majority interest to an EOT, or for the grant of equity incentives to employees.

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