Deciding how much a business is worth is a headache even for experienced operators. Within the UK legal system, cases often require accurate valuations of corporate entities to deal with all manner of civil and criminal cases, and that’s where expert valuation witnesses come in.
But how do expert witnesses figure out how much a business is worth?
Business valuations are notoriously challenging at the best of times. Expert valuation witnesses use a range of various validated methods used to come to a final figure they can present in their reports. If you’re hiring an expert valuation witness to support you, here’s what you need to know about the methods they employ.
How do valuation expert witnesses work in business valuation?
Valuation expert witnesses use various established methodologies to determine the value of a business. They are objective, independent professionals who provide expertise inside and outside the court system to resolve disputes.
Many of these experts also draw on their knowledge from other disciplines to help them value businesses, including:
· Accounting
· Economics
· Industry-specific knowledge
Any legal dispute involving a business may require an expert valuation witness to provide their knowledge. This applies both to civil and criminal cases.
For example, the UK acquired £4.4 billion in foreign companies in Q1 2024. If one of these businesses experienced a dispute regarding the value of a company, an expert valuation witness could have been called in to resolve the issue.
These experts prepare detailed reports outlining their conclusions and how they reached them. In court, they present their reports and submit them for cross-examination by the opposing counsel. However, they can also be found outside courtrooms in arbitration and meditation sessions.
Remember, business valuations are not an exact science. Two expert valuation witnesses may come to different conclusions regarding how much an entity is worth. and put any personal biases aside to maintain the legitimacy of the UK’s legal system.
Valuation methods used by expert witnesses
Expert valuation witnesses are prized for their wisdom because they use validated methodologies to determine how much a business is worth. However, there’s no single methodology one of these experts might use.
Every method has its own approach and may be chosen based on the business, why the valuation has been ordered, and how much information is available. Let’s cover the three most common approaches expert witnesses take.
The income approach
The income approach establishes a value for a business based on future economic benefits. This could be in the form of earnings or cash flow. Generally, it’s employed for businesses with predictable, consistent income streams.
Expert witnesses opt for one of two methods if they take the income approach: discounted cash flow analysis and capitalisation of earnings.
· Discounted Cash Flow Analysis – This is a projection of future cash flows. It’s then discounted back to their current value using a discount rate. An expert witness will choose the appropriate discount rate based on the level of risk.
· Capitalisation of Earnings – A division of the business’s expected earnings by a capitalisation rate. The capitalisation rate is the opposite of the discount rate. Expert witnesses usually choose this option if they predict future earnings to be stable and predictable.
But how do expert witnesses predict future cash flows? Generally, they’ll use historical performance, company forecasts and their knowledge of broader industry trends.
Market approach
The market approach values a business based on comparable selling prices in the marketplace. If there are a high number of mergers and acquisitions within a specific niche, expert valuation witnesses will use this data to determine the value of an individual business.
Again, there are two methods experts rely on when using the market approach:
· Comparable Company Analysis – A comparison of a business to other publicly traded companies. What counts as “similar” involves examining metrics like the price-to-earnings ratio.
· Precedent Transactions – If valuing a private company, expert witnesses may examine other transactions from the last few years. They’ll pay particular attention to businesses of a similar size and scope.
Obviously, the value of the market approach relies on a sufficient number of recent transactions. Moreover, special attention will be paid to which companies an expert witness has used in their comparisons.
Asset-based approach
The asset-based approach examines a business’s assets and liabilities. Since it relies on valuing assets accurately, it’s best done for business with tangible assets, such as property, machinery and vehicles. Valuing businesses with significant intangibles, such as trademarks and other intellectual property, is best done with another method due to the uncertainty involved in valuing intangibles.
So, how do expert witnesses value based on the asset-based approach?
· Book Value – The book value is the value of assets on the balance sheet with adjustments to allow for things like depreciation.
· Liquidation Value – The liquidation value imagines a scenario whereby a business’s assets are sold off as part of a forced sale. In other words, how much money would be generated if the business was forcibly sold tomorrow?
· Replacement Cost – The replacement cost is a valuation based on how much it would cost to replace all of a business’s assets with ones of a similar utility.
Factors considered in expert witness valuation
Expert witness valuation begins by establishing which method is most suitable for the business being valued.
For example, if a company is in a highly niche industry, there might not be enough data for the market-based approach. However, it’s up to the expert witness to search for data like this in the first place to establish which method matches up. Moreover, expert witnesses may use several methods and then compare the numbers.
Other factors expert witnesses might consider when coming to their valuations include:
· Financial performance
· Macroeconomic environment
· Industry conditions
· Market position
· Asset base
· Workforce
· Management
· Growth potential
· Risk factors
· Legal disputes
· Regulatory compliance
· Capital structure
Courts respect valuation witnesses because of the depth they must go into to create an accurate valuation. On the other hand, a valuation is only as accurate as the data. Without sufficient data, expert witnesses will struggle to produce a valuation in which a court can have confidence.
If you are in need of an expert witness in connection with a business valuation, speak to the team today.
