The FCA’s private market valuation assessment is long overdue, but it’s nothing without changes to the Companies Act
Thursday, November 02, 2023
If, as Donald Trump would currently attest, valuations are far more art than science then current approaches to valuation resemble a child's finger painting, not a Monet. The Financial Conduct Authority (FCA) is finally scrutinising private market valuations, a long overdue move. As with the Chancellor’s Mansion House Speech earlier this year, the idea is welcomed but it’s imperative they are eventually backed up by operable solutions. With this in mind, there are worse places to start than with significant amendments to the Companies Act, which hasn't been updated since 2006. Changes there could not only help add a little more science to the valuation equation, but give the UK the it needs to get back on the front foot in the global economy.
Private markets are an entirely different beast in 2023 than 2006. Employee equity is commonplace. All the bulge bracket banks have disbanded their AIM desks. There’s been a global financial crash. The LSE is pushing for an ITV, technology which companies such as Asset Match already use. It’s here that changes to the 2006 Companies Act can help – starting with regulation on valuations.
When it comes to valuing an early stage business, entrepreneurs often make grandiose promises to attract investment or drive up exit prices. No regulation, no problem. Even if a valuation uses the data provided, there are just too many variables to consider, let alone finding a methodology that is “right.” So perhaps it’s understandable that so many investors accept that they are putting a finger in the air.
We believe that companies should state their estimated share price in their accounts and audits, perhaps following the 'going concern' statement. This, says Modwenna Rees-Mogg, CEO of Athla Capital Management – who we used for our recent valuation – could go further. Companies should also provide “a share price for each share class as the devil is in the detail when the cap table is complicated.”
Of course, there would be legal considerations here, she points out. “Valuation for tax purposes can be very different to a valuation for investment purposes and it's important not to get caught in that trap. Many directors who are not experts in this arena would be wise to hire an independent valuer who can make sure the job is done right. Hiring an independent valuer means you can rely on their PI cover rather than the company’s D&O policy.”
But, as she concludes, “by having pricing visibility, much more activity around private company share transactions will emerge – everyone will profit from that. Secondly, and even more excitingly, whole new markets around share transactions will start to emerge.”
These changes should be supported by two further amendments, both of which better reflect the private markets of today.
The Act should recognize that shares traded between willing buyers and sellers often come with an illiquidity discount, which should be deemed appropriate by the buyer. The seller isn’t forced to sell and, as we frequently see at Asset Match, the actions of a few minority holders means absolutely nothing to the overall value of a given company.
Finally, after a certain period, say seven years, there should be a visible equity event. Many factors can prompt a shareholder to cash in; death, divorce, loss of job, or just a change of mind, should not be disregarded on the whim of a Board, that eagerly took an investors money, but the business plan has faltered, or worse. This, explains Modewnna, can be “a nightmare for shareholders. When an exit is required but the business plan and articles are silent on the issue, resolutions are expensive, time-consuming, stressful and, more often than you think, gets to the court door if not actually into court.”
While it's unlikely that anyone will want to put their name to a valuation without a litany of disclaimers, there are firms that provide solid valuation work. The cost of such a valuation is a fraction of the annual costs of an AIM listing and would be invaluable for boards and investors alike.
Valuations will always be subject to swings in perception. However, this should not prevent shareholders, whether in the public or private sector, from exercising their right to buy or sell shares. As we watch the footwear sector—Dr Martens, Allbirds, and now Birkenstock— , dare I say it, tread the path of downward valuations, it's clear that regulatory changes are needed to protect investors and facilitate market activity.
Fortunately, there are signs we’re coming to the bottom of that cycle. Wouldn’t it be great to begin the next one with a Companies Act that isn’t almost two decades out of date.The UK Government talks often about backing startups and growth businesses, an aspiration it has not quite achieved. A regulatory framework that encourages small company liquidity could be a real differentiator for UK PLC.
We await the FCA's next move, but let's not forget that without changes elsewhere, any efforts to stabilise private market valuations will be incomplete at best.