The Importance of an Accurate Valuation

Posted On September 24, 2018 By mhauk

Valuation

Companies are being routinely valued every day for a variety of reasons. In most cases all parties concerned, relying on valuations, are content with the outcome. However, a negligently prepared valuation can cause at least one party to suffer considerable financial loss.

Here’s a real-life anonymised case study that recently came across the desk of our Forensic team and is quite typical of the kind of work our teams regularly carry out.

There are lessons to be learnt from this situation.

Case Study

Mr and Mrs Smith owned a successful consultancy business. Mr Smith owned 30% of the business and Mrs Smith the other 70%. The couple had built up considerable wealth, however their marriage fell apart. As part of the divorce proceedings a schedule of marital assets was needed so that their combined assets could be split equally.

The valuation of the company was the only item in the list of assets that had a significant degree of subjectivity or judgement.

Flaky & Co representing both Mr and Mrs Smith, carried out a simple valuation of the business. They also acted as mediator over the division of marital assets and thereby removed all challenge to their valuation.

Their valuation of the company was very high. The court ruled that Mrs Smith hand over to Mr Smith, as part of the equalisation of assets, one marital property, a car, cash and 5% of the company, with the instruction that she must buy back the 5% she had given to Mr Smith and his original 30% holding, using the value calculated by Flaky & Co. The purchase of shares had to be carried out within 18 months and interest would accrue during that period.

To raise the funds to buy Mr Smith’s 35% stake in the business, Mrs Smith resorted to selling a rental property, cashed in a pension policy early at great cost and sold other assets generating taxable gains, putting herself under enormous stress and financial pressure. Her health suffered. Needless to say, Mr Smith was very happy with the arrangement!

One lesson to be learnt is to get a reputable firm to value your business, one that is experienced in this kind of work, rather than one that is “willing to have a go”. It is vital to obtain specific advice from a corporate finance specialist.

Some years later, we were asked to look at the valuation.

Upon first glance, the method used by Flaky & Co seemed sensible enough, but some of the assumptions that they used were fundamentally flawed and some of the points they had failed to consider were highly significant and these deficiencies, in our opinion, resulted in a significantly over inflated value being placed on the company by Flaky & Co.

The Forensic team suggested to Mrs Smith that there was a strong case for bringing a professional negligence claim against Flaky & Co. and a report was commissioned, outlining the significant deficiencies in the original valuation and providing a revised valuation that would have been more appropriate to put before the courts. The report showed the impact of using the revised valuation on the division of marital assets instead of the punitive adjustments dictated by the court, Mr Smith should have handed over to Mrs Smith all of his 30% share of the company and made a substantial cash payment.

The report concluded that Mrs Smith had suffered considerable financial loss as a result of a negligent company valuation.

Aside from Flaky & Co’s insurance excess, it would be their insurance company that would pick up the bill for any claim against Flaky & Co.

Insurance companies reply to reports like this using their own highly experienced expert witnesses, well versed in defending claims. In search of a quick win, they often respond dismissing any claim aggressively.

Mrs Smith got a letter from the insurance company’s expert accountant almost a year after the original report was submitted to them. It dismissed the report as pitiful, questioning the competency of those that wrote it and rubbished the claim completely.

Mrs Smith was distraught and ready to give up, however, the Forensic team calmed Mrs Smith and assured her that her claim had merit and that they knew how to respond, outlining flaws in the aggressive letter and pressing again on unanswered key deficiencies mentioned in the first report. The team picked apart the response and sent a further letter.

Another dismissive letter was sent to Mrs Smith. Again, she was distraught. This time the expert had unknowingly backed himself into a corner, a trap had been set. A further letter from the Forensic team, making the checkmate move, brought the insurance company to the table to settle and Mrs Smith was able to agree to a substantial compensation settlement.

Conclusion

Don’t be like Mrs Smith. Make sure you get a reputable firm to carry out your valuation in the first instance to avoid the potential for loss and the stress experienced by Mrs Smith. However, if you are in a similar position to Mrs Smith and feel that advice in the past may have caused you to suffer financially, then we can help. All the MHA firms have stories just like this one and through their expertise, they can help by analysing, quantifying and articulating the impact of sorry tales like Mrs Smith’s and others that are far more complex and will help get a good result for those that have suffered loss.

If you have any questions or would like to discuss any of the issues raised in more detail, please contact Hannah Farmborough or call on 0207 429 4147 to be put in contact with a member of our Forensic Accountancy Team.