Top seven issues in contentious valuations of private businesses

The capitalisation of profits approach is commonly applied in business valuations of private businesses in Australia, particularly where there is little forecast financial information available. This requires the assessment of a single figure to represent ‘the economic benefits from a business that may be maintained over the long term, notwithstanding the vagaries of the economic cycle’.  

The simplicity of being required to assess only a single earnings figure and a multiple is a strength and weakness of this approach. In an environment of fluctuating and evolving sales, costs and profits, a single figure may no longer appropriately represent the earnings over the long term. Careful review of the reasoning (both quantitative and qualitative) leading to the assessment of the earnings amount is therefore critical. Users of valuation reports should remember that the assessment of a business’ earnings is not a simple calculation exercise, it requires a broad range of considerations.  

When considering valuation multiples derived from trading or transactions, it's crucial to question their comparability and relevance to the specific circumstances of the business being valued. Valuers face the challenge of objectively determining appropriate multiples, thereby moving beyond subjective opinions to concrete evidence. However, there are many issues that make trading and transactions multiples poor reference points for private businesses. This quest for objectivity can be at the expense of determining reasonable multiples. Therefore, the comparability of multiples and their reliability should be carefully assessed.

Assumptions, limitations, and instructions should be clearly stated in a valuation report, as they directly impact valuation outcomes. Transparency is crucial, especially regarding the impact of assumptions and whether further work or evidence should be obtained to reduce their impact. It's essential for users of a valuation report to understand how assumptions affect the valuation. Reviewing the entire report and recasting a valuation using different assumptions, can reveal the sensitivity of valuation conclusions to the assumptions which may be greater than realised or considered appropriate. 

Establishing a specific valuation date is a key valuation requirement (and a necessity under APES 225 Valuation Services). Valuers often provide a valuation as at the date the report is issued. However, there's often a gap between this report date and the currency of information used. During times of evolving economic conditions or uncertainty, ensuring the most recent financial data is available must be carefully considered and planned.  Engagement with relevant parties can help minimise this gap and ensure financial information available to the valuation is both timely and accurate. Caution is advised against fixing a valuation date too early, as it may overlook crucial financial information and not account for lags in the provision of information.  

Valuation is a matter requiring significant judgment and rigorous analysis. Provision of a valuation opinion as a range of values, while common in transaction-style valuations, can cause a further impediment to resolution in contentious valuations, particularly if the range is too broad. Where the Valuer does provide a broad range as to value, clarification should be sought, as to whether any further information would allow them to either narrow the range of values or determine the most appropriate value.

Valuations can take time and rely on a range of financial and non-financial information. In many contentious valuation cases, much can be done before instructions are sent and information requests are provided by the expert valuer. In situations where a party has control over the provision of information, most information could be collated and available to the valuer before the instructions are finalised. This is similar to business owners preparing to sell their business by opening data rooms and preparing information and documents for due diligence. Preparation is key, and it is important to ask the right questions of the business owner or management team. A timeline of the valuation process should be established, and key areas of information should be communicated early.  

While draft reports offer an opportunity for refinement and adjustment of a valuation based on new information or allow for correction of misinterpreted facts, there are different schools of thought on whether they truly aid the valuation process, particularly in a dispute scenario. 

Some argue that draft reports are useful for identifying factual errors and refining the valuation, but they shouldn't be another platform for extensive debate on conclusions. If draft reports become impediments to progression, they should be bypassed, allowing the parties to address any issues using established procedures. However, in the right circumstances they can be helpful. Parties seeking valuation reports should consider early on whether they wish the Valuer to provide a draft report as well as the types, nature, and timing of submissions they will allow.  

These seven issues highlight the complexity and nuance involved in contentious valuations. A granular approach to earnings assessment, a willingness to accept a range of values, and a deep understanding of the specific circumstances of the business being valued are all crucial to the determination of an accurate valuation.