BIG 4 Questions of Valuation: The BIG-4 London Power Panel.

Detailed Summary of the Business Valuation discussion that took place during BVIUK’s 2nd Annual Conference on 15th November 2024 in London.

Hosts: BVIUK

Facilitator: Graham Antrobus (BVIUK)

Panellists: Katrina Hallpike (Partner, PwC), Matthew Warren (Partner, KPMG), Andrew Robinson (Partner, Deloitte), and Sandra Mossios (Partner, EY).

The Evolving Economic Landscape and Its Impact on Valuation Methodologies

The discussion began with an examination of how recent economic volatility, including fluctuations in interest rates, inflation, geopolitical uncertainties, and supply chain disruptions, has influenced business valuation.

• Adapting methodologies: While traditional valuation approaches remain relevant, professionals increasingly rely on cross-checking, scenario analysis, and commercial sense checks to ensure conclusions remain robust.

• Investor perspective: When valuing highly volatile businesses, it is useful to reverse-engineer valuations based on investor expectations regarding risk, anticipated returns, and future exit strategies.

• The role of discount rates: Valuations are incorporating more corporate finance and M&A principles, considering target rates of return rather than solely relying on CAPM or WACC-based models.

• Managing expectations: A key challenge in valuations, particularly for high-growth or volatile companies, is balancing stakeholder expectations and addressing different perspectives on value.

Challenges in Valuing Complex Financial Instruments

The conversation shifted towards the valuation of complex financial instruments, such as different share classes, liquidation preferences, and structured financing arrangements.

• Increased complexity: The decline in enterprise values has made liquidation preferences more significant, necessitating more precise valuation techniques.

• Economic rights and pricing signals: In a market where financial instruments sometimes obscure pricing realities, careful economic rights analysis is required to interpret true valuation signals.

• Considerations at exit: Valuations must account for how instruments will behave at the time of an exit, rather than assuming a static valuation snapshot.

• Methodology selection: The choice between option pricing models, common stock equivalents, and current value methods depends on expectations of how equity will be distributed over time.

• Governance and structuring risks: Financial structuring changes can have a substantial impact on valuations, often requiring frequent re-evaluation.

The Role of Market Data and Comparable Transactions

The discussion also covered the reliability of market returns and transaction data, particularly given the lack of comparable transactions in certain industries.

• Assessing market returns: Firms typically establish total market return estimates using a combination of historical trends, forecast data, and insights from brokers.

• Adjusting risk-free rates: There has been debate over whether to use spot risk-free rates or long-term averages, with many firms adopting a three-month trading average of government bonds.

• Comparability issues: Valuers frequently encounter inconsistencies in transaction multiples across different market databases, necessitating thorough due diligence.

• Caution with transaction multiples: Transaction values should be treated with scepticism, as public disclosures often lack context regarding synergies, financing structures, and adjustments made by corporate finance teams.

• Survivorship bias: The absence of data on failed transactions distorts the view of achievable market multiples.

The Use of Alpha Factors in Valuation

The application of alpha factors as adjustments in valuation models was another key point of discussion.

• Subjectivity in alpha factors: While commonly used, alpha factors must be carefully calibrated rather than arbitrarily applied to address perceived risks.

• Calibration with market transactions: Rather than applying discretionary alpha adjustments, calibration techniques using actual investor return expectations offer a more reliable benchmark.

• Presentation considerations: Some clients prefer alpha factors to be incorporated within discount rates rather than embedded in cash flow adjustments, though these adjustments must be supported by clear reasoning.

Artificial Intelligence in Business Valuation

Artificial intelligence (AI) was discussed as a growing influence in valuation practice, with an emphasis on balancing efficiency and professional judgement.

• Efficiency gains: AI is improving data collection, standardisation, and report generation, allowing valuation professionals to focus more on interpretation.

• Limitations of AI: AI struggles with predicting human behaviour, making it unlikely to replace valuation professionals for complex, judgment-heavy assignments.

• Risk of over-reliance: While some firms are experimenting with AI-driven models, the lack of context-specific judgement limits their effectiveness in complex valuations.

• Automated report writing: AI tools are already being used to streamline valuation report preparation, improving consistency and compliance.

The Role of Valuation Standards in Client Trust and Industry Credibility

The discussion underscored the importance of valuation frameworks such as the International Valuation Standards (IVS) and the International Private Equity and Venture Capital Valuation Guidelines (IPEV) in building trust and consistency.

• Improved stakeholder understanding: Standardised methodologies help lawyers, regulators, and investors to assess valuation work with greater transparency.

• Growing market demand: Investors are increasingly requesting valuations that explicitly align with IVS or IPEV standards.

• Evolving best practices: Regular updates to valuation guidelines help ensure that industry standards remain aligned with current challenges.

• Preventing misuse: Adherence to structured methodologies mitigates the risk of valuations being manipulated or misinterpreted.

The Impact of New Entrants and Boutique Firms on Valuation Quality

The rise of boutique valuation firms and technology-driven solutions was examined in relation to pricing pressure and industry credibility.

• Quality versus cost: While increased competition drives innovation, concerns remain over lower-cost providers delivering valuations that lack rigour.

• The role of established firms: Larger firms maintain high-quality standards, though not all clients require comprehensive multidisciplinary valuation teams.

• Technology-driven solutions: Some semi-automated valuation models currently in use lack credibility, leading to potential mispricing risks.

ESG Considerations in Valuation

Environmental, social, and governance (ESG) factors are now considered a fundamental part of valuation analysis rather than a separate assessment.

• Sector-specific versus universal relevance: While the energy transition is an obvious area where ESG influences valuation, its impact is felt across all industries.

• Regulatory changes: The introduction of the Corporate Sustainability Reporting Directive (CSRD) in the EU is driving greater ESG disclosure requirements.

• Social risks: Some industries, such as gambling, face heightened social and regulatory risks that must be factored into long-term cash flow projections.

Hybrid Working and Its Impact on Valuation Teams

The discussion concluded with reflections on hybrid work models and their influence on valuation teams.

• Hybrid work expectations: Most firms have adopted a two to three days per week in-office policy, aiming to balance flexibility with collaboration.

• Challenges for junior staff: New hires risk falling behind without in-person exposure to mentorship, client interactions, and informal learning opportunities.

• Impact on productivity: Some firms have observed a decline in knowledge sharing and real-time collaboration, reinforcing the importance of structured in-office interactions.

Conclusion

The discussion covered a wide range of valuation challenges and trends, with a focus on evolving methodologies, market influences, regulatory requirements, and technological advancements. The key themes highlighted the growing complexity of valuation work, the increasing need for professional judgement, and the role of valuation frameworks in ensuring accuracy and credibility.

Thank you to our panellists and to all the participants.