“With the light before him why should he shut his eyes and grope in the dark?” Lord Macnaghten1
One of the few joys of reading case law is reveling in some of the more flowery and evocative language of judges. As accountants embroiled in the numbers of valuation and the even-handed presentation of expert views, it’s a rare treat. But what do the words of Lord Macnaghten here refer to and what can they teach us about hindsight in business valuation?
When it comes to valuing a business at a historical date, the prima facie rule is that only information likely to have been known at that date should be taken into consideration. On the face of it, it’s a straightforward rule and there are many examples in UK case law where hindsight has been rejected. But is it so simple in practice?
There are two important caveats to consider regarding events after the valuation date. The first relates to subsequent actual transactions in the shares and the second relates to subsequent actual performance of the business.
Actual transactions in the shares of the business after the valuation date
From our review of case law, and in our experience, a court will on occasion render hindsight admissible to guide its view. We have seen this in US and Australian tax-related cases, as well as the case alluded to above presided over by Lord Macnaghten. In these instances, transactions subsequent to the valuation date were taken into account, provided that they were sufficiently comparable.
So, just as prior transactions will often be given a strong weighting in business valuation, subsequent transactions must also be considered and may bear weight if nothing significant has changed in the business and its market.
If the business has moved on, or the subsequent transaction involved a special conditions or special buyer, hindsight is unlikely to be accepted, as in the case of Foulser and Foulser v HMRC, 20152. Here a subsequent transaction in the shares of the business in question was deemed “not to reflect a warm light back” onto the earlier date, as it involved a special purchaser.
Actual performance of the business after the valuation date
Hindsight based on actual performance after the valuation date may be permissible in order to confirm what forecasts could have been reasonably made at the valuation date as stated in Buckingham v Francis, 19863: “Regard may be had to later events for the purpose of deciding what forecast for the future could reasonably have been made.” But indeed the devil is in the detail, as can been seen in Joiner v George, 20024 where the Court of Appeal rejected the proposition that trading results after the valuation date should be preferred to its trading results actually achieved.
It may also be permissible where minimal information is available regarding expectations for the business at that time. In certain circumstances, subsequent actual performance might be considered but this should really be a last resort.
Where subsequent actual performance is the only possible proxy for expectations of the business at the historical date, here are some important factors to consider:
What was the distribution of possible outcomes at the time? When valuing start-up companies, or pharma companies with products in development, there is a huge range of possible outcomes. The probability of success or failure of the business is almost binary. It would be all but impossible to predict the actual performance outcome. Here applying actual performance as a proxy for forecasts at the time is likely to be inadmissible
Has anything fundamental changed in the business and its market between the valuation date and the subsequent actual performance? Any fundamental changes are likely to render subsequent performance irrelevant
As experts in contentious business valuation, we often find that we are asked to develop valuations in situations where there is meagre information. Usually there is something that can shine a light on the situation, but we may have to dig a little deeper to find it.