There are several private company valuation indices which are often quoted by business owners, valuers, and advisers. While useful in highlighting trends, such reference tools should be used with caution and relying on them is likely to undermine the credibility of a business valuation.
Take your pick
Amongst the range of private company valuation indices the most commonly used are:
- BDO’s Private Company Price Index (“PCPI”).
- The Price Earnings Ratio Database (“PERDa”) produced by the Leading Edge Alliance.
- The UK 200 Group’s Small and Medium Enterprises Valuation Index.
- The Argos Soditic Mid Market Index.
The table below summarises the reported valuation multiples from each of these indices as at June 2016.
A foul caseThe PCPI and SME Valuation Index both reported a trend of increasing deal multiples while the other UK index, PERDA, showed pricing to be static. The Argos Soditic report is a European index and the softening in prices paid by buyout firms appears to have been the cause of the drop in the index. Although at 7.0x EBIT the level is relatively high compared with recent history.
In the long-running case of Foulser and Foulser v HMRC the appellant’s valuation adviser used the PCPI as the sole basis for determining the earnings multiple to be used in the valuation. The tribunal found serious flaws in this adviser’s methodology, commenting, “There is no transparency of the PCPI. No information is available as to the number of private company acquisitions on which the average P/E ratio is based. Nor is anything known about the companies concerned, including their activity and size. It is thus impossible to take any view on comparability”.
These comments neatly summarise some, but not all, of the dangers in relying on such valuation indices. There are, in fact, three main issues with such indices:
The companies and deals included in the index may be exceptionally diverse and are unlikely to be comparable to the company being valued. During one expert determination assignment I reviewed the valuations completed by each party’s accountant and highlighted just this issue. One accountant had used the P/E ratio for the FT All Share Index, a market capitalisation weighted average of the ratios of all companies listed on the London Stock Exchange, to value a private transport and logistics company. The problem here is that the industrial transportation sector of the index only represents 0.5% of the total market capitalisation of the FT All Share Index!
Accuracy of transaction data
Compilers of these indices generally rely on reported deal values, which may not be correct or comparable with other transaction announcements. It can be uncertain whether the deal price is on a “cash and debt free” basis or not, or if contingent payments and earn-outs have been included. It is not until sometime later when the accounts of the acquirer are published that the facts about the acquisition might be gleaned. A number of indices and databases calculate valuation multiples including contingent consideration but using historical profit data which will inevitably inflate ratios.
Out of date and incorrect trading data
Deal multiples are usually calculated using historical reported profits from the target’s accounts. Given private companies in the UK can file their accounts nine months after their year end, the accounts from which the deal multiples are calculated could be almost two years old.
The underlying profitability of the acquired business may, in any event, not be evident from the company’s accounts. Profits may be suppressed by high owner remuneration, non-recurring costs, and very “prudent” accounting policies. Therefore, again the calculated and reported deal multiples may be materially higher than the underlying figures.
The devil is in the detail
For the above reasons, when using comparable deals to determine a capitalisation ratio for our valuation projects we always drill down into the detail of specific transactions. Published data should never be accepted as a given and rigorous investigation of both deal data and underlying trading information is necessary to produce a robust valuation, whether for commercial, litigation, or tax purposes.
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