In the last 12 months, while most UK businesses have been addressing the challenges of Covid, investors have become disorientated. Fortunately there are now signs of confidence returning, but assessing investment opportunities is nevertheless difficult, especially in the private company world.
However, two things are certain:
- the UK’s entrepreneurial spirit, creativity and innovation is exceptional…but it requires funding.
- the appetite for corporate merger and acquisition activity will continue as our economy rebalances post-Covid.
In the USA, equity markets have been performing strongly and corporate activity is high. Special Purpose Acquisition Companies (SPACs) are attracting a lot of interest as pools of capital are raised with the purpose of buying private entities – valuations are widely debated as the process of ‘price discovery’ unfolds.
In the UK, public equity markets continue to provide market participants with valuation reference points, sentiment indicators and liquidity. However, while private markets remain open, the price discovery process is only now beginning to regain momentum. For a business owner looking to raise capital, a potential seller of a company or an investor looking for assurances about fair value before making new commitments, there is a lot to consider. Poor judgement can have expensive consequences, and acting in haste is rarely a sound strategy. That said, the pandemic has undoubtedly unsettled the status quo and accelerated the rate of change in certain sectors.
As a case in point, it has become very challenging to assess the value of the many SMEs driven by talented entrepreneurs requiring access to external capital to finance their ambitions. Through no fault of their own, the pandemic has impacted these ambitious companies in a variety of ways as we all attempt to readjust to the ‘new normal’. Businesses once favoured by investors have suddenly found themselves at the financial cliff-edge, others have moth-balled their ambitions, and a new breed of Covid beneficiaries has emerged.
The competition for capital is rising, but it would be understandable if investor appetite is somewhat suppressed, and the U.K. economic recovery may suffer as a consequence. The investment implications of macro changes need to be further digested.
The issue is not that there is a shortage of investment opportunities nor a shortage of available funding, but there is a lack of clarity over valuation. Investors look to understand risk-adjusted returns and obtain good value. Successful business owners are rightly proud of their achievements and tend to resist dilution; however, they must appreciate that investors rarely provide capital and walk away. There needs to be a dialogue around a business’s progress. The value of long term shareholders cannot be underestimated.
Pre-Covid, the momentum of commercial life typically provided a mechanism which readily ascertained fair value for many private companies under the widely recognised International Private Equity & Venture Capital Guidelines (‘IPEV’). These focus attention on key principles such as the Price of Recent Investment, comparable company transactions and the valuation outcomes of techniques such as discounted cash flow analysis, but also allow for subjective judgement.
Due to Covid, a great number of current private company valuations are predominantly constructed on the modelling basis, because of the lack of real world reference points. In a world where risk-free rates of return are negligible, DCF can produce valuations that do not appear credible to all market participants, which clearly hinders progress.
This raises the need for extra scrutiny and potentially a second valuation opinion, so it is not surprising that the requirement for independent expert opinions is rising. This is not a daunting nor time-consuming process. For corporates, advisers and investors a fresh pair of eyes can be invaluable, and can potential identify alternative funding solutions.
There are two approaches to providing an independent opinion: a brand new (‘primary’) valuation, and a ‘secondary’ valuation that challenges an existing primary assessment. Providing a credible valuation is also not just a computation – it requires an awareness of real world dynamics and the forces that drive change for the business under evaluation. There are also a number of valid methodologies to consider; this may not be widely appreciated. All of these can be applied to aid decision making and reduce the risk of poor outcomes.
It’s time to consider the value of an independent private company opinion.
Richard Angus is theHead of Business Development at Hardman & Co