Reasons for valuations (3)
- Fiscal transactions eg tax liability
- Legal valuations
- Commercial transactions
Discount applied to valuation for restrictions on transferability
20%
< 10% shareholding
- No other influence on company’s affairs
- Rarely any benefit other than dividends and possible capital growth
10 - 25% shareholding
- If > 15%, right to appeal to the court on a variation of rights
- > 20% allows the inclusion of an associated company’s results
25 - 49.9% holding
- Right to prevent special resolution being passed
- Closer proximity to 50% increases prospects of acquiring further shares to create a controlling interest
50%
- Associate
- Percentage >50% is required for control
- Gives the power to block any resolution put to a general meeting
75%
In addition to control, ability to pass any resolution (including special resolution such as winding up)
90% or more
Full control with no hindrance
Can make mandatory offer for shares of remaining minority (squeeze out)
Four main methods of valuation
- Dividend method
- Earnings method
- Discounted cash flow method (DCF)
- Asset valuation
Dividend method (2 ways)
- Dividend valuation model
- Dividend yield model
Dividend valuation model step 1
Calculate the present value of the stream of future dividend payments
Dividend yield method - value of share =
Dividend per share / required dividend yield %
Problems with dividend valuation model
Hard to determine factors such as expected growth rate/ required rate of return
Comparable quoted company
Quoted company with similar characteristics to the unquoted company such as similar industry and risk profile
Adjustments to yield made to reflect differences between CQC and unlisted company (4)
- Marketability (unlisted companies find it harder to find buyers for shares)
- Transferability (share transfer restrictions may exist)
- Size (smaller companies less able to withstand market shocks)
- Other factors (positive factors eg strong competitive advantage, exceptional prospects for profit growth, short term expectation for future flotation)
Adjustment for negative factor > dividend yield method
Added to dividend yield
Adjustment for positive factor > dividend yield method
Deducted from dividend yield
Lack of marketability %
20%
Potential flotation %
10%
The earnings method determines
The maximum annual cash dividend that the ordinary shareholders could pay themselves out of current year profits
Earnings basis removes
The uncertainty of a company’s dividend policy from the valuation exercise
Problem with the PE method
Relies heavily on having a PE ratio for an unquoted company’s shares (which is not readily available)
Adjustment for negative factor > PE method
Decrease PE ratio
Adjustment for positive factor > PE method
Increase PE ratio
