Valuing shares in private companies

The valuation is always the subject of discussion as unless there is a third party sale of the entire company the value cannot be determined. However, for the purposes of paying tax on a disposal or transfer of shares a valuation is needed to establish your liability. That is where we help in guiding you on how much tax you will pay.

Starting point with private company share valuations

In some cases the articles or shareholders agreement sets out the formula to be applied. In other cases the entire company is being sold and this determines the price per share. But for the many share transactions the value is negotiated on a case by case basis. We find that debate about the price of shares in private companies is most likely to arise:

Where the company is planning to buy back shares held by a shareholder and then cancel the shares uplifting the shareholdings for the remaining shareholders;
If the company is planning on a re-organisation and swapping shares in one company for shares in another; or
Where a shareholder is exiting the business and either wishes to sell shares or is forced to sell shares on leaving under the articles.

How we can help

We are a highly experienced team of corporate law specialists. Our experience means we can advise and assist not only on the underlying transaction but also in the key planning stage. Our share valuation expertise is relied on by clients for matters including :-

Mergers and Acquisitions
HMRC Advance Clearances - advance clearance for complex transactions under various provisions including share reorganisations, demergers, substantial shareholding exemptions, and capital vs revenue treatment determinations.
Corporate Restructuring - demergers, spin-offs, capital reductions, and group reorganisations, ensuring compliance with company law requirements and optimising tax and commercial outcomes
Share Buybacks
Share Scheme Implementations - Design and implement employee share schemes, management incentive plans, and equity-based remuneration structures while ensuring regulatory compliance and tax efficiency
Management Buyout Structuring - Design MBO transactions with appropriate share classes, ratchet mechanisms, and preference structures while obtaining necessary HMRC clearances for tax-efficient implementation
Share Valuation Disputes - expert legal advice on valuation methodologies for shareholder disputes, compulsory purchase situations, and fair value determinations under Companies Act provisions or partnership agreements

Approach for valuing shares in private companies

The job is made difficult by the fact there is little published data available relating to private company share transactions as this is confidential to the shareholders concerned. There are no fixed rules and experts will arrive at different conclusions. There can be multiple valuation methodologies to consider.

We can help you formulate the most suitable methodology to achieve your desired outcome.

The background to the share transaction should be considered as this influences pricing. For example:

A share valuation for investment purposes will focus on the commercials and anticipated growth. Under the more formal methods of valuation the company may be worthless especially if the business has not yet gone to market - but investors are prepared to pay a premium based on the potential value.
A share valuation for the purposes of an internal transfer of shares will usually be more focused on present day value. The achieved value per share can be displaced by the identity of the purchaser and seller and their willingness to transact.
A share valuation for the purposes of agreeing with HMRC a tax liability will take a fiscal approach. A fiscal approach usually produces a lower valuation than a commercial valuation would as there is less emphasis on goodwill and hope value.

Type of valuation needed

There are 4 main types of business valuation used to establish the value of shares in a private company.

Dividend basis - adopted for a shareholding where the main benefit of holding shares is the right to receive dividends. It is usually used for minority shareholders of mature businesses. The dividends basis looks at the company’s past dividends, dividend growth patterns, fluctuations and the likely dividend policy going forward. The influence of the minority shareholder is not considered. However, where the majority shareholder is also a director with the power to determine if dividends are voted that level of influence should be considered as it could reduce the chances of receiving dividends.
Loss making businesses -In loss making businesses or businesses still in investment mode the dividend basis of valuation is not appropriate. Similarly, if the shares are non-dividend bearing, alternative methods of private company share valuation will need to be found.
Earnings basis - the earnings basis of valuation is popular and often used when a business is being sold. It looks at the future profit-generating potential of the company after tax, interest and dividends are paid out (known as ‘maintainable profits’). The maintainable profits are capitalised and multiplied by a quoted company equivalent ratio to give the present value of the company. The earnings basis is mainly used to value majority shareholdings or entire businesses where one shareholder has control over the future of the business.
Asset basis - the asset basis valuation is used either on company’s liquidation or where the company’s asset backing is greater than the capitalised value of dividends and earnings. It is supported by the idea that the asset backing of the business must be reflected in the share price. Investment companies such as property companies are valued on an asset basis.

Other factors and variables

In order to arrive at the value of the shareholding the value of the business needs to be discounted to reflect commercial and legal aspects of the business such as :-

Size of shareholding - the importance of shareholding size is primarily in terms of control over company’s decision making. Minority shareholding discounts can range from around 5 – 90% depending upon the facts.
Voting rights - have inherent value because voting power offers influence over how profit is enjoyed, whether assets (including the business) are sold, how the company is managed and how the internal market in the shares is operated. However, voting power is only indicative of control and does not need to correspond to the number of shares held. If it can be shown that a majority shareholder has no effective control over the company it will be taken into account. 51% + shareholders are presumed to have control over the company’s affairs.
Marketability - plays a role in valuation. How easily can the shares be sold? Are there any restrictions on the sale of shares in the corporate documentation? The degree of influence depends upon a range of factors, both legal and economic and can vary significantly from company to company. For example, one company may permit shares to be transferred to non-members while another may impose restrictions on transfer. Any restrictions on transfer decrease the value of shares as marketability of shares is low.
Future income potential - e.g. when an IPO is planned or imminent, will impact the value of the shareholding.

Articles of Association/Shareholders agreement

Articles of Association set out the rights attaching to shares as well as restrictions on the transfer of shares. A review of Articles of Association is one of the first steps in share valuation.

Matters to look out for impacting on share pricing

In addition to point set out above you may need to consider:

Casting vote – a casting vote swings an otherwise deadlocked vote. A casting vote gives control to a shareholder in a 50-50% share split and can carry a premium.
Dividend rights attaching to shares. Dividend entitlement which is fixed, e.g. preference shares, increases the value of shares.
Capital rights – as with voting rights the greater entitlement to the company’s capital the higher value of shares.
Transferability – Articles often specify who the shares can and can’t be transferred to which impact marketability of shares. Restrictions increase the discount and lower their value.
Fair value provisions – Articles or a shareholders' agreement often provide mechanisms explaining how company shares should be valued upon transfer. This can work for or against a higher valuation depending upon the wording and actual circumstances.
Drag and tag along rights – the rights to allow a minority shareholder to benefit from the same rights and protections as the majority shareholder on business sale. If the company only has standard articles downloaded upon incorporation drag and tag rights will not be present. This will decrease the private company share valuation for a seller.