Challenges in disputes over valuation of shares

Godknows Hofisi

Introduction

I have written several articles on the valuation of businesses or shares or on disputes involving the same.

In this article I give some insights on some challenges that may be encountered when attempting to resolve disputes on the valuation of shares.

Challenges

These may include the following:

Lack of understanding of valuation of businesses or shares.

Goodwill

Lack of information required for valuation of shares.

Difficulty in verifying available information.

Delaying tactics used by parties.

Lack of understanding of valuation of shares

Parties may genuinely not appreciate what is involved in the valuation of shares. It is a specialist area. It is subjective and requires judgment. Parties may not understand how an expert or arbitrator values a business or shares.

Parties may not even appreciate the valuation methods that can be used. Most people are aware of the Net Asset Method (NAM), which is akin to a liquidation valuation method.

This method involves compiling a list of a business’ assets and then deducting the business’ liabilities therefrom to arrive at net assets or net worth.

The net assets are then divided by the number of ordinary shares to arrive at the value of each ordinary share. In such situations, it may be easy to verify the assets and liabilities through confirmations or the use of audited financial results.

Some people struggle to understand valuation methods based on earnings, for example, the Net Present Value (NPV) or Discounted Cashflow Method (DCM), which looks at the future potential of the business. Other methods such as Price – Earnings ratios are not well understood.

Goodwill

Another source of problems is where the Net Asset Method is being used but one party insists on providing for goodwill. It is usually very difficult for parties to agree on a figure for goodwill.

Goodwill normally comes from the good brand of a business. The difference between the Net Asset Method valuation and that based on the NPV or DCM valuation partly comes from goodwill.

Lack of information required for valuation

Different valuation methods require different information. For example, the NAM requires a business’ total assets and liabilities. Assets may include an estimate of goodwill. All of these have to be shown at fair value. Intentionally or unintentionally, assets or liabilities may be overstated or understated.

The situation can even be worse in the case of earnings-based methods such as NPV or DCM. Such valuation methods require financial and non–financial information such as the future outlook of the economy, of the particular industry, and of the business itself.

Information such as a business’ strategic plans, and annual budgets might be required. Important will be information such as market share, volumes, prices, costs, borrowing rates, and taxes.

In the past, I have encountered situations where there is no reliable financial information.

Where there is financial information, parties may not agree on say the list or value of assets, the completeness or otherwise of liabilities. Parties have differed on projections for volumes, prices, costs, etc.

Capital expenditure to maintain or increase capacity is not agreed upon.

Lack of such information affects the quality or even ability to make future financial projections of cash inflows or outflows. Obviously, this affects the valuation of a business or its shares.

Verification of information

Even if information is available it may be difficult to verify it. This may include verification or valuation of immovable assets such as mining claims. It may be difficult to verify the fair statement of liabilities.

As regards the NPV or DCM it may be difficult to test the reasonableness of the projections or the figures used to make the projections.

Delaying tactics

At least one of the parties may intentionally want to delay the resolution of the dispute. This may happen if a party does not want to pay the other if the valuation of shares is being done for purposes of disposal by an aggrieved party.

Some of the dilatory tactics include the following:

A party may delay providing important information, for example, financial information. This may be done by the party in control of the financial information.

A party may simply delay paying the valuation expert or the arbitrator to frustrate the process or handing down of valuation results or the arbitral award.

A party may make unwarranted objections or seek unjustified postponements.

Conclusion

Challenges experienced during attempts to resolve disputes over the valuation of shares may include lack of understanding by parties, differences over goodwill, lack of information required for valuation, difficulty in verifying available information, and delaying tactics by parties.

Disclaimer

This simplified article is for general information purposes only and does not constitute the writer’s professional advice. It does not target any known individuals or entities.

Godknows (GK) Hofisi, LLB(UNISA), B.Acc(UZ), Hons B.Compt (UNISA), CA(Z), MBA(EBS, Heriot- Watt, UK) is the Managing Partner of Hofisi Partners Commercial. Attorneys, Chartered Accountants, Insolvency Practitioners, Registered Tax Accountants and advises on deal and transactions. He has extensive experience from industry and commerce and is a former World Bank staffer in the Resource Management Unit. He writes in his personal capacity. He can be contacted on +263 772 246 900 or ghofisi@hofisilaw.com or gohofisi@gmail.com. Visit https://hofisilaw.com for more articles.

Herald