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Proprietary trading and market making – valuation challenges: The case of G and T EWHC 1613 (Fam) [2020]

Author: Andrew Strickland

Published: 29 Mar 2023

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The challenge

How should a business engaged in trading in the markets be valued? This was the question faced by the Court in the anonymised case of G and T.

The husband is English, and the wife is South American by birth but is now a British citizen. Both are currently 45. They met in 1998 and married in September 2000.

The company began trading in 2011. It now has some 190 employees. This is therefore a substantial trading business. We can all recognise that the conventional tools to be used for the valuation of a well-established and profitable trading business are to establish future trading profits or cash flows, consider normalisation adjustments for shareholder remuneration, and derive a present value. Depending upon the way that the figures fall there could be the prospect of a significant intangible component in the valuation.

Clearly this use of the income approach springs from the essential truth that the valuation of any business is the present value of its future cash flows.

Two professionals

A single joint expert (“SJE”) had been appointed to undertake the valuation of the interests of the husband in the company and had duly concluded on value. It was this valuation which stood in the way of the divorce being resolved before trial. The SJE had been diligent and had reported, responded and updated regularly during the previous 18 months.

The wife had appointed a shadow expert who has acted in several very high-profile divorce cases. Due to the lateness of the application to the Court, he was not permitted to prepare an alternative valuation report. In consequence he was not called to give oral evidence. However, he had undertaken a critical evaluation of the methodology used by the SJE and his letter of comment was allowed in evidence. In addition to this the two professionals had discussed matters and had prepared a joint statement.

The valuation points at issue

The shadow expert had raised two main concerns in his letter of comment:

  • The SJE had valued the husband's shares at their pro rata interest in the net asset value ("NAV") of the company. However, the shadow expert believed that the SJE’s valuation framework was internally inconsistent; it also placed too much reliance on the prices observed in the internal share market for the company’s shares; and
  • The SJE had then assessed the liquidity of the husband's shareholding. However, in so doing she excluded what he considered to be the most realistic means by which he can extract value from his shares (dividends and bonuses). Instead, she had focused on what he considered to be the unrealistic assumption that the husband either sold his shareholding through the process set out in the company’s shareholders' agreement over a period approaching 20 years, or the company was wound down.

These points were put robustly to the SJE by Counsel for the wife. She did not retreat under such pressure but remained firmly in her reported position. She maintained that the use of any earnings methodology would be highly subjective in terms of both the company’s maintainable earnings and an applicable multiple. These two subjectivities would blend to provide an unreliable result. There was little guidance given by the markets as there were only two guideline companies and they were both rather different from the company.

The view from the bench

The Judge recognised all of the valuation difficulties. He also fully understood the concern expressed by the shadow expert regarding a valuation based on net asset value:

it doesn't appear on its face to capture the fully rounded value to the shareholders of an edifice which has been remarkably successful at generating profits over the 9 years of its existence to date. That concern is only compounded by the husband's frank evidence that he would not want to sell his shares now, at NAV, because of course they are worth more to him than that.

Despite these concerns, the Judge did not consider that he had any evidence to support the move away from net asset value as the valuation technique:

I am not persuaded, on the evidence before me, that a proposed entrant or current participant into the market who had a fund in excess of say £200m with which to start to trade would pay a premium to the directors of an established trading house to buy an operation such as this, absent the acquisition of secured or at least likely prospective financial benefit from so doing.

When is remuneration excessive?

The husband had been paid in excess of £5 million in 2016. In later years his earnings had been somewhat lower but were in excess of £1 million in most years. The business model was based on the employment of traders who were paid significant sums in bonuses in the event that they generated sufficient profits. It was this business model that meant that adjustments for remuneration levels were not considered to be in point.

A fractional interest

The husband was the largest shareholder in the company and held some one third of the total equity. The husband and his two senior colleagues held nearly two thirds of the shares in the company. There was no evidence in the written decision as to any perceived differences between the value of the entire equity and the valuation of a non-controlling holding.

Similar transactions – a pattern emerges

This case has some similarities with other financial services businesses which have no underlying regular income stream. Two examples of which I am aware are summarised below:

In the 2014 case of Arbuthnott v Bonnyman and Others, a highly profitable private equity business, Charterhouse Capital Limited, was valued in connection with a shareholder dispute. The valuations of the two experts were a low of £20 million and a high of £321 million for the entire equity.

The profits were almost wholly extracted in the form of remuneration The extremely wide divergence between the two valuers was centred on one simple question: should the profits be adjusted to reflect the extremely high rewards paid to the owners of the business?

The Judge was aware that other shareholders had retired from the business and had exited on the basis of the net assets on the balance sheet. This was a strong reason for deciding on the lower value range.

In the 2019 divorce case of FW and FH [2019] EWHC 1338 it was again a private equity business that required valuation. There was an SJE and also a valuation expert for each of the husband and wife.

In this case the argument centred on the use of DCF and the inclusion or otherwise of a terminal value: two of the valuers believed that the valuation should be based only on the cash flows arising from the run-off of present transactions. There was no further value to be attached to any underlying business. This was the view that prevailed with the Judge.

*The views expressed are the author's and not ICAEW's.