Introduction

I am an accredited expert witness and am instructed on 40 to 50 matrimonial cases each year. A significant number of these instructions are as single joint expert (SJE) or party expert providing an opinion on the valuation of a business or shareholding. I also act in cases requiring an expert determination on valuation. In addition to instructions as expert, I am regularly instructed as shadow adviser to assist lawyers and clients in assessing the financial disclosure by the other party or to review the SJE’s report.

This article shares my practical guidance as a valuation expert for family lawyers and barristers in three areas:

(1) Selecting an appropriate SJE.

(2) Top considerations when reviewing the SJE’s report.

(3) Engaging a shadow adviser.

Selecting a single joint expert

The SJE is typically selected either from a shortlist of three quotes obtained by the lawyers acting for one party or by the parties agreeing whom to appoint. Although understandably the quoted SJE fee for the report is likely to be a significant factor in selecting the expert, here are my tips for selecting your expert. Typically, SJEs are appointed in family law cases to provide:

(1) A view on a business valuation or a company shareholding including the tax consequences of a disposal or transfer of the interest.

(2) Liquidity, i.e. how capital can be extracted and the associated tax consequences.

(3) The likely future maintainable earnings of the party who retains the business or interest in it.

(4) The tax consequences of the sale and/or transfer of other property and/or assets between parties.

Expertise and experience

In cases other than simple tax calculations, I recommend instructing an accredited expert witness rather than simply a qualified accountant. The role of an expert witness is very different from the advisory role of an accountant in practice; in my view it is not sufficient to read the Part 25 Directions. It is advisable to select experts who are accredited by the Academy of Experts or Expert Witness Institute as they will have undertaken formal training.

The pool of experts undertaking business valuations in family cases is relatively small. They may be in larger accountancy firms, in large consultancy businesses and in small niche forensic accounting practices. The role is a personal appointment and so it is the individual who is key as opposed to the corporate entity.

For larger cases it is important to check that the expert has experience of giving evidence in the witness box.

When valuing private companies, an experienced business valuer should be competent to value businesses across a broad range of sectors; few sectors need specialist knowledge or input. However, it is key that the individual is experienced in business valuation and understands both the International Valuation Standards and the fundamentals of valuing businesses in matrimonial cases.

Valuation is subjective and there can be a range of opinions depending on the assumptions made by the expert. I occasionally see valuations prepared by accountants which have fundamental flaws in the methodology such as valuations based on capitalising future maintainable earnings that are based on operating profit, rather than Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA). The valuer then applies an EBITDA multiple to the operating profit. The resultant valuation may be significantly understated due to this methodological flaw. There are other errors that I regularly see as shadow adviser and I explain some of these below.

Not all business valuers are experienced in tax and occasionally I am asked to assist in cases where the SJE has given a view on business valuation but has not given a view on the tax implications of the valuation, capital extraction and future earnings. This can result in delays and increased costs and can be avoided by checking the expert’s credentials at the outset.

Cost-proportionate

Clients and courts are keen to ensure costs are proportionate. Inevitably, the cost of using experts from large consultancies and Big Four firms reflects their overheads. Independent firms may be more cost-effective and more of the work will be performed by the expert directly. For larger cases, regardless of whether the expert is working in a large practice or independently, check that they have access to support to deal with holidays and the inevitable peaks of work.

Getting fee quotes

To avoid nasty surprises later and to ensure your client can make an informed choice of expert, it is critical to provide the expert with sufficient information when getting a fee quote. To provide a reliable quote I need to know the scope of the anticipated instructions. For business valuations it is helpful to know the sector in which the business trades and an indication of its size such as turnover, number of employees and net assets. Typically, on family matters, I expect to give an opinion on valuation, liquidity and future maintainable earnings. If there are further points on which the parties require an opinion such as diversion of profits or trade, the additional work will increase costs and it is helpful to outline the likely instructions at the outset.

Instructing the selected expert

Provide the experts with sufficient notice regarding when they are likely to receive the instructions and ensure enough time is allowed for sending information and the completion of the report, as well as time for the parties to raise questions ahead of any FDR hearing or meeting.

It is important that the instructions clearly identify the issues on which the expert will be giving an opinion. Do not assume that the expert will include commentary on tax issues, liquidity or maintainable earnings if this is not specified.

It is helpful if the instructions on a business valuation include copies of the full financial accounts including detailed profit and loss accounts for the previous 3 years. Providing these with the instructions will help expedite the work and will allow the expert to affirm or revise their fee quotations before work commences.

If additional instructions such as those covering diversion of trade or other financial investigations are to be included, it will be helpful to liaise with the expert as to what can realistically be achieved and the likely cost.

Paying the expert

If the law firm is not going to be responsible for the expert’s fees and the parties will be settling the invoices, it is important that this is clear in the letter of instructions. In such cases it is likely that the expert will raise fees upfront and be paid at the outset to mitigate the risk of having to spend time chasing unpaid invoices many months after the work is completed.

Top considerations when reviewing the single joint expert’s report

Here are my tips on how to review the SJE’s report. These are what I consider when instructed as a shadow adviser to give my opinion on another expert’s report.

Has the expert given an opinion on all matters in the original instruction?

Typically, I review the introduction to see if the instructions are accurately extracted from the letter of instruction. I then look at the summary/conclusions section to see if each instruction has been addressed adequately. For example, I occasionally come across SJE reports on family cases where the tax implications are omitted.

At what date is the valuation given?

I would expect the report to state the effective date of the valuation (this is typically the balance sheet date) at which reliable accounts were provided. This can be several months or even years in the past and, if so, it is possible the current valuation is significantly different. I will review the expert’s report to ascertain if he has obtained any information to give confidence that the valuation is still relevant and any limitations are explained.

What valuation methodology has the expert adopted?

Below are the typical valuation methodologies and where they are used.

Future maintainable earnings

In family law cases we are typically valuing trading private companies and the valuation will be based on capitalisation of future maintainable earnings. In this context we are assessing the market value as the future return the business is expected to return to the owners. The valuers assess what they feel is a reasonable estimate of future EBITDA and apply a multiple to this figure to give the business’ enterprise value. The multiple is broadly the number of years that an investor might expect to wait to get a return on their investment; a risky investment will attract a lower multiple. The enterprise value is then adjusted for long-term debt and non-trading assets (including surplus cash) to give the equity value attributable to the shareholders. An example is shown below.

The key assumptions that the expert is making are A, B and D:

• the assessment of the future earnings, the EBITDA figure;
• the selection of the multiple applied to the EBITDA;
• the assessment of the adjustment for debt and surplus assets.

Valuation is inherently subjective and it is important to determine if the expert’s judgment is within a reasonable range or whether it can be challenged.

Common issues I come across when reviewing SJE reports on valuations using future maintainable earnings are:

• An estimate of EBITDA that does not adequately adjust for exceptional trading years or changes to the business.
• A failure to adjust for a commercial salary for the business owners. Typically, family shareholders draw most of their earnings as dividends rather than salary. To calculate the adjusted EBITDA a commercial salary must be deducted.
• A failure to add back discretionary or other non-commercial expenses in the profit and loss account. Family businesses can have significant costs that an acquirer of the business would not continue, including family wages, non-essential travel and hotel costs and refurbishment of the family home. I have sometimes identified non-business expenditure in the accounts that amounts to tens of thousands each year. An adjustment of, say, £20,000 with a multiple of 5X impacts the valuation by £100,000.
• An inappropriate multiple. It should be clear which sources the expert has considered when choosing a multiple. For example, have the experts relied on generic data such as UK200 data or BDO PCP reports, have they used sector analysis or have they identified appropriate transactions in sufficiently comparable companies. The selection of the multiple is subjective but I am looking for the reasoning and whether, in my view, the multiple is within a reasonable range. For example, if the multiple selected is 7X but in fact 4X is more appropriate then with an EBITDA of £500,000 the impact on the business’ valuation is £1,500,000.
• Applying an EBITDA multiple to operating profits or to profits after tax rather than EBITDA. Operating profits are stated after deducting depreciation and can be significantly lower. It is important that the source of multiple is consistent with the earnings to which it is applied.
• Adjusting the enterprise value by adding the business’ net assets rather than deducting debt and adding surplus assets. The enterprise value already includes the value of the assets used in the trade so this is double counting.
• The impact of an overdrawn director’s loan account. Normally, the equity value assumes the overdrawn loan is repaid and so this should be considered when assessing the parties’ overall assets and liabilities.
• Failing to check the equity value against the net assets valuation. The net assets valuation is effectively the baseline value that implies that it has no goodwill. It is not the value that could be obtained if the business ceased trading and value was returned to shareholders by selling the assets and winding up the business, because this would require many assets such as stock to fall in value when trade ceases and similarly there are often liabilities such as redundancy costs and lease early termination penalties that arise on a cessation of trade. If the valuation based on maintainable earnings is lower than that based on net assets, the latter should be adopted.

Net assets valuation

This is described as a cost approach where the business is valued on the value of its net assets without reference to future profits. There are typically fewer areas where the expert must use judgement. An example is shown below:

A review should consider the following points:

• Has the valuer assessed the latent corporate tax (deferred tax) relating to the property values? Typically, the properties are shown in the accounts at the historical cost and in calculating the net asset value the adjustments include the uplift to current market value. Also worthy of consideration is how to deal with the inherent tax were the business to dispose of those properties and whether an adjustment should be made for this and, if so, by how much. Ultimately this is a matter for the court but typically I would expect to see the calculations presented and normally 50% of the latent tax is deducted in the valuation.
• If the valuation is based on the balance sheet in the last accounts, has the expert assessed the likely retained profits after that date in the current valuation? If so, is that calculation reasonable and has it considered the impact of dividends and tax?
• Are there other historic assets or liabilities which are not in the balance sheet at realistic values? For example, I have seen significant discrepancies on stock figures and wildly exaggerated provisions for future liabilities.

Discounted cashflow

This is the ultimate income approach where future projected cashflows are converted to a current value using a risk adjusted discount rate.

Entry cost method

This is another cost approach and looks at the estimated cost to set up a similar business from scratch.

Dividend yield

This method is an income approach adopted to value minority shareholdings.

Industry precedent

In certain industries there are guidelines used such as a multiple of income or numbers of customers.

Minority discounts

When valuing a minority shareholding experts should have considered the applicability of a minority discount or control premium. The subject of minority discounts is complex and beyond the scope of this article but, briefly, a shareholding of less than 100% may be a simple pro-rata of the value of the whole business or may be discounted to reflect the rights and risks associated with the minority holding. I would expect the expert to have considered:

• the impact of the Articles of Association and any shareholders’ agreement. These may spell out in general terms whether a discount should be applied;
• the size of the shareholding relative to other shareholdings;
• the relationships between the shareholders;
• the relevance of the concept of a quasi-partnership;
• the published guidance on the size of minority discount. Currently I am only aware of the ACCA Technical Guidance 167 giving a guide to typical discounts. Whilst not prescriptive I would expect it to be discussed;
• the application of discounts in any previous transactions;
• the normal approach by the Family Court in this area.

The impact of the minority discount can be significant. For example, if a pro-rata valuation of a 25% shareholding is £500,000 and an appropriate discount is 50% this gives a discounted value of £250,000 if a discount is applicable.

Future maintainable earnings

If the experts have given a view on the future maintainable earnings of the party retaining the interest then they should have considered not just what the party previously received as dividends and salary but also what is available. In other words what is being drawn may be far lower than what is available or, conversely, might not be sustainable.

Extraction of capital

Where the instructions cover the extraction of capital the expert should have considered any available cash reserves in the business and any funds that could be raised by borrowing. When assessing surplus cash, namely cash more than that required as working capital, the expert will normally have considered any available cashflow projections and the normal trend of cash in the business such as the month-end balances over an extended period. The tax implications of withdrawing a lump sum should be estimated.

Limitations arising from information disclosed

In addition to reviewing the contents of the report, the reviewer should consider the potential impact of any limitations that the experts have encountered in their work. The expert should have explained the potential impact of any discrepancies in the information provided. For example, there may be concerns about whether there is undisclosed discretionary/non-business expenditure in the accounts. In this case, the potential impact on the valuation and future maintainable earnings should be outlined. If further information and analysis might resolve an issue this should be explained.

Engaging a shadow adviser

A shadow adviser can assist clients and their legal advisers in reviewing the report of the SJE and suggest questions to be raised. Typically, a shadow adviser’s involvement is confidential and not disclosed to the other parties’ advisers. For larger or more complex cases, I would recommend choosing a shadow adviser who is themselves an experienced SJE.

Normally the timetable to raise questions on an SJE report is 10 days. I recommend considering an approach to your shadow adviser before the SJE report is received to ensure they are available to assist.

Whilst shadow advisers are usually engaged for higher value cases, they can also be cost-effective on smaller cases.

When instructed as shadow adviser on a business valuation we will consider the following points:

(1) Has the SJE answered the instructions?

(2) Did the SJE request and receive sufficient information to reach a view on the valuation and other instructions?

(3) Was the appropriate valuation methodology chosen?

(4) What key assumptions did the SJE make and what was the impact of these on the valuation?

(5) If the party has a hunch that the valuation may not be fair or material information has not been provided or considered by the SJE, these concerns can be considered by the shadow adviser.

(6) Is the valuation opinion fair bearing in mind that valuation is inherently subjective?

I have already explained the key points I would consider when reviewing the report of an SJE and these are the areas a shadow adviser will consider.

In our experience, the modest cost of a shadow adviser can be a worthwhile investment to ensure the client understands the SJE report, can raise appropriate questions and has peace of mind knowing they have a second opinion.