The Financial Technology Ventures II v ETFS Capital decision offers a sharp reminder of how DLOC, DLOM and equitable value can radically reshape minority valuations—reviving debates on control premiums and exposing just how far methodologies can pull valuations apart.
Introduction
DLOC and DLOM
Should these two discounts be considered separately, possibly using special measurement techniques? Alternatively, are the concepts so conjoined that separation is not practically possible?
If viewed separately, the valuer is driven into the arms of computational methods, especially in respect of the DLOM. If taken together, the natural focus is more on precedent and external guidance as to applicable discounts for non-control holdings.
In the renowned case of Estera Trust and Singh (Edwardian Hotels Group), one expert concluded that the concepts were so intertwined that they needed to be considered together. His discounts therefore combined the two concepts.
This can be contrasted with the equally interesting case of McArthur and HMRC (Baa Bar Group plc). In that case, one valuer used computational methods for the calculation of the separate discounts, including the protective put option model in respect of the DLOM.
In this case, the written decision reads: “Both experts agreed that it was appropriate for the DLOM and DLOC to be considered together to produce a single discount….”
Values and discounts
The experts were relatively close in respect of the whole equity value, at $420 million to $450 million. The yawning gulf was in respect of the discounts applicable for the valuation of combined interests of 35%:
| Expert 1 | Expert 2 | |
| Pro rata | 0% | 0% |
| Equitable value | 0% to 5% | 43.8% |
| Market value | 2.5% to 5% | 55% |
Expert 1 focused on the nature of the assets on the balance sheet of the company. These were cash and shares in a public company. The balance sheet liquidity drove the conclusion of very modest discounts as shown above.
Expert 2 prepared a table showing expected levels of discounts from various sources. These included the ACCA and some governmental bodies. The court was positive regarding this approach: “We found [the expert’s] table, upon which he was cross-examined, setting out the expected level of discount for minority shareholdings in terms of the guidance available from public bodies in the United Kingdom, Ireland and Australia, including guidance from HMRC, to be of assistance.”
Equitable value
This is one of six IVS valuation bases and is defined as follows:
“Equitable value is the estimated price for the transfer of an asset or liability between identified knowledgeable and willing parties that reflects the respective interests of those parties.”
The pivotal words in my view are “respective interests.” This is a valuation basis relating to the circumstances when a buyer gains a lot more than the seller gives up. There have been at least three cases in which it has been taken to be the mid-point between the discounted minority valuation and the pro-rata valuation of a block of shares:
- Ingram and Hall v Ahmed
- Estera Trust and Singh
- Monaghan and Gilsenan
In this case, expert 2 applied a different calculation. This is how it is described in the written decision:
[Expert 2] “initially sought to apportion this uplift in value between Mr Tuckwell's and the Plaintiffs in proportion to their respective shareholdings, which resulted in a premium to fair value of the Plaintiffs' shareholding of 46.6%. This, in his experience, he regarded as unrealistically high because Mr Tuckwell was the only buyer of the Plaintiffs' shares who would be prepared to pay any premium at all. Therefore he selected what he regarded as being a more realistic premium, in this case 25%, resulting in a discount from NAV for the Plaintiffs' shareholdings on the equitable valuation basis of 43.8%.”
This is the source for the figure of 43.8% in the table above.
The fair value of the shares held by the plaintiffs was considered to be 45% of the pro-rata value. This was then increased by a factor of 25%, giving a revised equitable value of 56.25% of the pro rata value. This is a discount of 43.75% (~43.8%) from the pro-rata value.
If the approach of the three cases cited above had been followed, the discount would have been 27.5% and the equitable value would be 72.5% of the pro rata value.
The control premium… again
The concept of the control premium will not die, it seems, despite various attempts to afford it a decent burial.
It was as long ago as 1995 that Eric Nath first postulated the Nath Hypothesis that bid premiums in the markets should not be viewed as control premiums. This intellectual line was then pushed firmly into the mainstream with the publication by The Appraisal Foundation in the USA of their financial reporting advisory, “The Measurement and Application of Market Participant Acquisition Premiums,” in September 2017.
There remains a sizeable business valuation school trenchant in their support of the control premium as a continuing valid concept.
In this case, it was used in a novel way. The text above refers to a more realistic premium of 25%. This is a referring, I understand, to a premium to be applied to a discounted, non-controlling valuation. It then transubstantiates from market value to equitable value. One of the supports used by expert 2 for the 25% uplift was a study showing that the median control premium paid by buyers ranged from 25% to a little over 39% in most years.
The view of the court
The court found much of the evidence of expert 2 to be attractive. In respect of the metamorphosis from market value to equitable value they stated: “We do regard the extent to which he discounted the marriage value in this case as excessive.”
In the next article, we consider the valuation of the shares in Wisdom Tree Inc, the measurement of illiquidity in its shares and the overall conclusions of the court.
*the views expressed are the author’s and not ICAEW’s