Hindsight in a Business Valuation

I recently came across a Business Valuation case where the accountant had provided a pretty solid calculation, in my view.

The instructing solicitor for the other side queried why the valuer had seemingly ignored the projections prepared by the company in producing his valuation.

It is a fundamental tenet of valuation that hindsight is to be ignored.

“I must enter into a dim world peopled by the indeterminate spirits of fictitious or unborn sales.  It is necessary to assume the prophetic vision of a prospective purchaser… and firmly to reject the wisdom which might be provided by the knowledge of subsequent events (in Re Holt [1953] 2 all ER 1499)”.

A standard rubric in our valuation reports is to state that a valuation of a company is dynamic and a valuation on one day will inevitably change as more information becomes available.

A small company, unquoted in any market place, will be particularly susceptible to shifts in valuation when the next set of financial or management accounts are released. Nevertheless, it may not always be clear as to what extent subsequent events may be admissible.

“The company must be valued in the light of the facts that existed at 24 March 1981.  But regard may be had to later events for the purpose only of deciding what forecasts for the future could reasonably have been made on 24 March 1981”.  (Buckingham -v- Francis [1986] 2 all ER 738).

They are not to be used to determine what actually happened.

In this particular case, the company was new, still in its start-up phase, having traded for just 2 or 3 years.  It was starting to produce some profits. There were projections which indicated that there would be a dramatic uplift in profits.  In the event, when the next set of financial statements were produced, the outturn showed that these projections had been reasonably accurate.

The solicitors queried why the projections had not been used in the calculation of sustainable earnings, given their accuracy.

I am not sure what the response was but I think the accountant was justified.  The following reasoning might be deployed:

1. The company was still young and immature and earnings were not stabilised.
2. The directors were salesmen and hence their projections were sales based and tended to be optimistic.
3. Earlier projections had proved to be overly optimistic and actual performance had not met budget.

Taking these established facts into account, I would have viewed the projections with a healthy degree of scepticism.  That the projections had eventually turned out to be a realistic would have been irrelevant, in my view.

The solicitor is looking at the valuation several months after or indeed a year after.

The projections were in play at the date of the valuation so the prudent valuer might note, in the text of his report, why he had chosen not to place weight on their presence.

This case just shows how challenging producing a valuation is, particularly for a young start-up business with potential.

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