EXPERTS GIVING EVIDENCE IS “NOT A GAME”: £1.4 MILLION VALUATION FOUND TO BE £3,230
Another interesting part of the judgment of ICC Judge Barber in CSB 123 Ltd, Re [2021] EWHC 2506 (Ch) is the judge’s findings in relation to the expert evidence. It is rare for a judge to state to an expert witness that giving evidence in court is “not a game”.
“One of his responses in cross examination was so astonishing that he had to be reminded by the court that he was giving evidence under oath and that the court process was ‘not a game’. He twice apologised to the court for his answer after that intervention.”
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THE CASE
The applicant liquidator sought an order under s.212 of the Insolvency Act 1986 that the respondent transferred company business and assets for no consideration. The application was unsuccessful, the applicant failing to establish key elements of its case and the judge finding the respondent to have acted reasonably “and with the greatest integrity”.
THE VALUE OF THE BUSINESS
The applicant’s case was that the business had a value of £1.4 million (and, indeed, that was the sum sought from the respondent. This depended, in part, on the applicant’s expert evidence. Both parties called expert evidence. Their evidence as to the value of the business valued (£1.4 million as opposed to £74,743 and £3,23). The judge preferred the evidence called by the respondent.
THE JUDGE’S OPENING OBSERVATIONS ABOUT THE EXPERT WITNESSES
Expert Witnesses
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Each side presented expert valuation evidence as to the value of SC1 as at 22 October 2012 and as at 31 January 2013. Mr Trevor Slack of Griffins appeared for the Applicant and Mr Ben Hobby of Baker Tilly appeared for the Respondent. I shall comment on specific elements of the expert evidence as and when relevant during the course of this judgment. At this stage I shall confine myself to some general observations.
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Mr Slack did not fare well in the witness box. His report did not stand up to close scrutiny and he had no persuasive answer to a number of key questions put to him in cross-examination. There were also points in his oral testimony at which he failed to comply with his overriding duty to assist the court. One of his responses in cross examination was so astonishing that he had to be reminded by the court that he was giving evidence under oath and that the court process was ‘not a game’. He twice apologised to the court for his answer after that intervention.
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In contrast, Mr Hobby presented as an entirely credible expert witness with a keen awareness of his oath and his duty to assist the court. His report was extremely thorough. In cross examination, he very properly stayed within the bounds of his report and research. I am satisfied that Mr Hobby did his best to assist the court to the best of his ability.
THE JUDGE’S OBSERVATION ON THE VALUATION EVIDENCE
The Experts
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Having considered the FSPG valuation, I turn next to the expert evidence adduced by the parties in these proceedings. Mr Slack’s report is dated 6 November 2020 and was produced for the Applicant. Mr Hobby’s report is dated 6 November 2020 and was produced for the Respondent. The experts were required to value SC1 at two dates: (1) 22 October 2012 (the First Valuation), being the date of the FSPG valuation; and (2) 31 January 2013 (the Second Valuation), being the date that, at the time expert evidence was directed on 1 April 2020), the Applicant alleged that loss was sustained.
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Mr Slack’s report
‘Due to time restrictions and in the interests of proportionality and an upcoming mediation between the parties, the valuation/s have been done at a ‘high-level’. This means that there has not been an in-depth analysis of various valuation metrics and evaluation model/s are not detailed or comprehensive.’
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For the purposes of his report, Mr Slack adopts the market approach, which treats SC1 as a going concern. His report is prepared on the basis that, whilst the Respondent ‘was not contractually bound to work indefinitely for [SC1]’ the Respondent (who was 37 at the First Valuation Date) ‘would … have continued to be involved in [SC1] up to the date of her retirement, if not for this dispute’; and that ‘by the date of her retirement,….. [SC1] would have established a succession plan so it would remain a going concern’: (para 1.8).
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In preparing his valuations, Mr Slack used the operating profit shown in the financial accounts for SC1 (prorated) to estimate future maintainable operating profit (the multiplicand). At para 2.1.3, he explained ‘For high-level valuations, I use a multiple range of between 4x-8x EBITDA.’ He decided that SC1 ‘should attract a 5x multiple’ (para 2.1.4). He then applied an operating profit multiple of 5x to arrive at a value for SC1 of £1.38m as at 22 October 2012 and £1.42m as at 31 January 2013: (para 5.1).
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In cross examination, Mr Slack accepted that when valuing a private company, earnings multiples are best suited for sectors that have relatively stable earnings and that, if historical earnings are not stable, they will not be a good basis for future projections. He struggled to explain how 2 years’ trading in a company of the size of SC1 provided a sound basis for projected earnings in the future. He said that his understanding was that the Respondent had been operating the business for a number of years, but admitted that he had not looked at any of her prior earnings figures as a sole trader and knew nothing about them.
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Mr Slack had no persuasive explanation for using a multiple of 5x either. He repeated that it was a ‘high level’ valuation and the FSPG valuation of £1.4m was a ‘clear indicator’. When it was put to him that when choosing a multiplier and calculating value, it was unacceptable to look at someone else’s valuation and do a reverse calculation, he responded ‘that’s one way of approaching it’.
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Mr Slack was pressed to justify the 5x multiplier, particularly given SC1’s high dependence on the Respondent. He and Mr Hobby had agreed in their joint statement that, without the Respondent, SC1 would have no business. Mr Slack had acknowledged in his report that the Respondent ‘was not contractually bound to work indefinitely for [SC1]’. Yet for the purposes of his report, Mr Slack had proceeded on the basis that the Respondent (who was in her forties) would work for SC1 until retirement (para 1.8). When challenged in cross examination, he claimed that the 5x multiplier reflected the risk that she would leave.
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When asked why he had not used comparables when preparing his report and considering the multiple to apply, he said that he didn’t consider it ‘proportionate’ and that he ‘had a feel’ for the multiple. Whilst accepting that, in a ‘detailed valuation’, it is a common or useful practice to use comparables, he said that ‘because of the nature of my instructions, my experience, and the fact that the company sold for £1.4m, I felt that a multiple of 5 was appropriate.’
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After exchange of expert reports, however, Mr Slack did produce ‘comparables’. The ‘comparables’ which he produced bore no resemblance to SC1. They included (1) CVS Group plc, a nationwide veterinary practice, established for over 20 years, with an annual revenue of over £100m, (2) Dignity plc, a FTSE 250 company owning 600 funeral locations with an annual revenue of over £200m; and (3) John Swan & Sons plc, livestock auctioneers established for over 100 years. When asked in cross examination what the point was of producing these examples, Mr Slack replied that the companies in question were all ‘specialist retailers’, adding that ‘if SC1 was listed’, this was the sector that SC1 would end up in. This was clearly not an adequate justification for use of such ‘comparables’.
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Mr Slack had made no adjustment in operating profit for salary either. He accepted that he was valuing on the basis of a sale to an arms length purchaser and assumed continued engagement of the Respondent, but took no account of the fact that in each of the two years he had used as the basis for his calculations, the majority of the Respondent’s remuneration was paid by way of dividend, not salary. The figures were stark; and even FSPG’s one page valuation had allowed a deduction of a notional salary of 89k for the Respondent. When pressed to justify his failure to adjust for salary, he eventually responded: ‘because the 1.4m should be treated as capitalised wages. She got 10 to 15 years wages in advance’. As Mr Trollope remarked at the time, this was ‘utter and total nonsense’. It was at this stage that I reminded Mr Slack that he was under oath and should not treat the giving of evidence in court as a game. He apologised.
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Overall, Mr Slack’s report was an unimpressive, results-driven piece of work. His attempts to defend it in oral testimony were entirely unpersuasive. In my judgement, very little weight can be placed on Mr Slack’s written and oral expert evidence. His failure to address personal goodwill when considering the method of valuation to adopt, his assumption that the Respondent would work for SC1 for the rest of her working life, his unjustified use of a 5x multiplier, his rearguard use of entirely inappropriate ‘comparables’, his failure to deduct a notional salary and his attempts in cross examination to justify that failure, have led me to conclude that his evidence is not a reliable guide to the value of SC1 as at either valuation date.
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Mr Hobby’s report
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Mr Hobby qualified as a chartered accountant in 2000. He is a fellow of the Institute of Chartered Accountants in England and Wales and a partner in the London office of BTVK Advisory LLP, which trades as Baker Tilly US. He has specialised in claim evaluation and the financial analysis of claims on behalf of both claimants and defendants for the past 16 years.
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For the purposes of valuing the equity value of the SC1, Mr Hobby adopted Fair Market Value (‘FMV’) as the basis of value. He defined FMV as the highest price available in an open and unrestricted market between informed and prudent parties, acting at arms length and under no compulsion to act, expressed in money or money’s worth.
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At section 4 of his report, he set out the three main approaches that could be used to calculate a business’s valuation; these being assets approach, market approach and income approach. In determining the approach to adopt in relation to SC1, he correctly considered the impact of personal goodwill, stating at 4.21 and 4.22:
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“‘4.21 Personal goodwill is therefore an intangible value that arises from the efforts or unique reputation of a business owner or other individual, the value of which is only associated with that individual and not to the business itself. It is not an intangible asset of the business, but is instead an asset attributable to the individual, not the company. Therefore, personal goodwill should not form part of the purchase price paid for a business and, as such, should not be included on the acquiring company’s balance sheet (as Accounting Goodwill or otherwise) following an acquisition.”
4.22 In valuation, the exclusion of any benefit to the business attributable to personal goodwill in the valuation of a business is analogous to the application of ‘key person discount’. A ‘key person discount’ recognises the dependence on a single key person or a few key people. “…The actual death or potential loss of such a person, whether by death, disability, or resignation, entails risk of adverse consequences. Such consequences can include a variety of losses, as suggested by that key person’s unique attributes …. Some of the key person attributes that may be lost include: Relationships with suppliers; Relationships with customers ….” [‘Business Valuation : Discounts and Premiums’ (2nd ed) Shannon P. Pratt]’
‘4.24 As discussed at paragraphs 4.05 to 4.12 above, there are three main approaches that could be used to calculate a business’ valuation – asset approach, market approach and income approach.
4.25 I consider each of these below for the purposes of valuing [SC1] at the Valuation Dates:
(a) Asset approach
(i) As [SC1] had a positive balance sheet as at both 30 June 2012 and 31 January 2013, the latest available record of [SC1’s] accounting affairs at the Valuation dates, the asset approach provides a basis on which to calculate the ‘minimum’ equity value of [SC1], as a going concern.
(ii) Given my understanding that (a) [SC1’s] ongoing business was dependent on the Respondent’s personal relationships and unique connections; and (b) the Respondent was not contractually obligated to continue to work for [SC1], I do not consider it suitable to value [SC1] on a going concern basis, as without the Respondent’s guaranteed continued involvement, there would be no ongoing business. Therefore, the asset approach can also be used to value [SC1] on a break-up basis.
(b) Market approach
(i) Although [SC1] appears to have generated profits before tax of £235,929 for the nine months ended 30 June 2012 and of £404,440 for the 16 months ended 31 January 2013, I understand that this was only achieved with the benefit of the Respondent’s personal relationships and unique connections….’
[Having examined the evidence in support of that, he continued]:
‘(viii) I consider that the Respondent’s personal relationships and unique connections [are] representative of personal goodwill, as defined above at paragraph 4.19.
(ix) The fashion expertise, client connections and fashion house relationships were those of the Respondent and not of [SC1]. The contribution that the Respondent makes to the business is not something that can be replaced by [SC1] appointing a new managing director or employee, which highlights the extent to which the business depends on the personal goodwill attached to the Respondent.
(x) Without these key attributes, [SC1] is not a going concern. To value [SC1] on a going concern basis attaching any value to these key attributes, which are the Respondent’s and not [SC1’s], would represent an overstatement in the value of [SC1].
(xi) Given that (a) [SC1’s] ability to continue as a going concern is dependent on the Respondent’s personal relationships and unique connections; (b) the Respondent is not contractually obligated to continue to work for [SC1]; (c) the Respondent’s personal relationships and unique connections are representative of personal goodwill; and (d) personal goodwill is generally not included in the calculation of fair market value in an open market context, I do not consider it appropriate to value [SC1] on a going concern basis and so do not consider the market approach to be suitable in this case.
(c) Income approach – notwithstanding my view that it is not appropriate to value [SC1] on a going concern basis, there is no forecast and/or cash flow information for [SC1], so the income approach is not a viable alternative in this case. However, even if sufficient forecast cash flow information were available to me, I do not consider it appropriate to value [SC1] on a going concern basis and so do not consider the income approach ( which implicitly assumes [SC1] to be a going concern) to be suitable in this case.
4.26 In conclusion, I consider the asset approach to be the most appropriate basis for valuing [SC1]’.
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In the light of my earlier findings on goodwill and having considered the expert reports and underlying evidence with some care, I am satisfied that Mr Hobby was correct to apply the asset approach on a break-up basis in this case. The market approach is clearly inappropriate as it assumes that SC1 is a going concern and in a steady state. SC1 was not a going concern without the Respondent’s continued involvement and she was not obliged, contractually or otherwise, to continue to work through SC1. Moreover as noted by Mr Hobby, SC1 was not in a steady state; as at the valuation dates, it had only been active for two years.
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