Issue of Shares for Non-Cash Consideration

Independent Valuation of Shares Allotted as Non-Cash Consideration

Companies Act Section 593, Chapter 6, Part 17 (Sections 1150 to 1153), Statutory Auditor, Independent Valuation

When a company allots shares as part of non-cash consideration for an acquisition, the acquirer has obligations under Section 593 (Chapter 6, Part 17) of the UK Companies Act 2006, which states that:

“A public company must not allot shares as fully or partly paid up (as to their nominal value or any premium on them) otherwise than in cash unless:

• the consideration for the allotment has been independently valued in accordance with the provisions of Chapter 6 – Part 17 of the Act;
• the valuer’s report has been made to the company during the six months immediately preceding the allotment of the Shares; and
• a copy of the report has been sent to the proposed allottee”.

In practice this gives rise for an independent opinion of the market value of the private company shares acquired and a comparison of the market value of this to the allotted public company shares paid as consideration, in order to satisfy the requirements of the UK Companies Act, specifically the provisions of Sections 1150 to 1153 of the Act.

In accordance with Section 1150(1) of the Act, American Appraisal is, through its chartered accountant trained employees, eligible for appointment as a statutory auditor under the rules of the Institute of Chartered Accountants in England & Wales (ICAEW) and meets the independence requirement set out in Section 1151 of the Act.

Share Valuation

Share valuation techniques include:

• Discounted cash flow
• Comparable Transaction Multiples
• Comparable Publicly Traded Company Multiples

Other less frequently applied share valuation techniques include the LBO Methodology and option pricing models.

Depending on the size of the equity interest being valued and the type of company to which the equity interest relates, together with the valuation methodology employed and the nature of the data used to arrive at a preliminary valuation conclusion, it may be necessary to apply premia or discounts, as follows:

• Premium for Control
• Discount for Lack of Control (Minority Discount)
• Discount for Lack of Marketability (Liquidity)

Discounted Cash Flow Valuation Approach

The DCF Approach measures economic value through the analysis of cash flows, rather than accounting-based indicators which are subject to distortion by accounting conventions that may not adequately reflect the realities of investment markets. Since sophisticated investors define “value” in terms of cash flows, this approach is widely utilised in the financial community.

After establishing the cash flows to be used, the DCF Approach typically involves:

• estimating the terminal value of the business at the end of the explicit forecast period;
• determining an appropriate discount rate to reflect the present day value of money and risk; and
• discounting the free cash flows and the terminal value to arrive at their NPV.

The discount rate applicable to the free cash flows and terminal value is usually the WACC.  The WACC is an estimate of the overall after-tax rate of return required for equity and debt holders of a business.  The WACC is computed by calculating a company’s cost of equity and after-tax cost of debt.  These two calculations are then weighted based on the company’s target capital structure to arrive at the WACC.

Market Multiples Valuation Approach

The Market Multiples Approach involves capitalising the earnings, or cash flows, of a business at a multiple that reflects the risks of the business and the stream of income that it generates.  These multiples can be applied to a number of different earnings and cash flow measures, including EBITDA, EBIT or net profit after tax.  These are referred to respectively as, EBITDA multiples, EBIT multiples and price earnings multiples. 

Application of the market multiples valuation methodology involves:

• estimation of earnings or cash flow levels that a purchaser would utilise for valuation purposes having regard to historical and forecast operating results, non-recurring items of income and expenditure and known factors likely to impact on operating performance; and
• consideration of an appropriate capitalisation multiple having regard to the market rating of comparable businesses, the extent and nature of competition, the time period of earnings used, the quality of earnings, growth prospects and relative business risk.

Selection of an appropriate earnings multiple is usually the most judgemental element.  Historic transactions, or even indicative offers, for a particular asset or business can provide reliable support for selection of an appropriate multiple.  In the absence of such data, it is necessary to infer the appropriate multiple from other evidence.

The analysis of comparable transactions and equity market prices for comparable companies will not always lead to an obvious conclusion as to which multiple, or range of multiples, will apply.  There will often be a wide range of multiples and the application of judgement becomes critical.  Moreover, it is necessary to consider the particular attributes of the business being valued and decide whether it warrants a higher or lower multiple than the comparable companies.

Our Work

American Appraisal performs 100s of business valuations annually.  American Appraisal consultants, both in the UK and across our network of global offices, have skills across all industries and extensive experience of business valuation and applying business valuation and share valuation techniques including.

• Discounted Cash Flow
• Market Multiples

Within these models we use our extensive databases and experience to select the most appropriate valuation inputs such as:

• Discount rate
• Long-term growth rate
• Sustainable working capital and CapEx requirements
• Maintainable earnings
• Capitalisation multiple (EBITDA multiple, PE multiple etc)

American Appraisal consultants are active in:

• the ICAEWs Valuation Special Interest Group
• HMRC’s Shares & Asset Valuation Fiscal Forum
• the International Valuation Standards Council
• the Appraisal Issues Task Force
• the FASB’s Valuation Resources Group
• the Appraisal Foundation
• the American Society of Appraisers
• the American Institute of CPAs

This involvement ensures our knowledge of current valuation standards, practices and procedures. Valuations of shares allotted as non-cash consideration performed by American Appraisal result in:

• Independent, objective and supportable market value opinions
• Clear, comprehensive valuation reports

Please feel free to contact one of our experts to discuss any valuations of shares allotted as non-cash consideration needs.