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Valuation for ERS

Valuation for ERS

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Hi all,

A client is looking to restructure ownership between their current 4 shareholder / directors, currently at 25% each. It will end up with A: 35%, B:35%, C:15%, D:15%. The reason for the change in ownership is to reflect their work and involvement in the company in the past and in the future, hence, I believe, an ERS issue.

The company hasn't raised any investment, and so far is loss-making, as they're doing a lot of early-stage R&D. They're before the point where the R&D can be commercialised. They have a small amount of revenue, but this is to do 'outsourced R&D', not for having commercialised their product.

On the other hand, they are talking to potential investors about an investment into the company, which would value the company at around £1m.

What are people's experience on HMRC's view on the valuation for ERS purposes in situations such as this? I would suggest a valuation of zero for ERS, following any of the normal valuation approaches. However, does the fact that a potential investor is being talked to impact this, in HMRC's eyes?

Thanks a lot,

Oliver

Replies (15)

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By David Heaton
24th Oct 2019 12:06

This is a hard question. The company is loss-making, but there are potential investors, so the IP is presumably worth something, albeit not reflected in the results. Look at Tesla: loss-making, no dividends, but valued at $45bn, and they've been manufacturing and selling for years.

Realistically, though, a small UK startup making losses, where no external investment has in fact been secured, is worth no more than its net asset value, and each minority member's share is discounted as well. They'll need to disclose the discussions with investors, but until there's a signature on an investment agreement, you can't put a concrete value on hope.

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Hitch photo
By Kevin Kavanagh
24th Oct 2019 13:47

Do shareholders C and D know their shares might soon be worth £250K?

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By The Dullard
24th Oct 2019 14:03

You're valuing a 10% holding (twice). Somebody buying 10% wouldn't know (and wouldn't be able to obtain any information to confirm) that the company was talking to external investors. Nobody in their right mind would pay anything more than par for the shares.

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By Tax Dragon
24th Oct 2019 14:33

With respect, The Dullard is either slightly misrepresenting the test or has forgotten that it changed about 50 years ago. The information is not what the purchaser would (or wouldn't) be able to obtain, but what the prudent purchaser might reasonably ask for. (If you were looking to maximise the proceeds of selling the 10% (twice), you might be only too happy to blab about the interest from other parties... but this is not relevant either.)

HMRC knows all the above, including the points DH makes. In practice, you will get a low value agreed (because the value is likely to be low) – but it's only prudent to tell HMRC all and agree that low value.

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Replying to Tax Dragon:
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By The Dullard
24th Oct 2019 15:31

Not at all. The hypothetical seller (of the 10%) might be only too keen to tell the hypothetical prudent purchaser (of the 10%) about the potential investors (if, indeed the hypothetical seller was aware), but the hypothetical prudent purchaser (of the 10%), being prudent, would want to corroborate this information and would probably find himself unable to do so, even if he did think it reasonable to ask, because he's only purchasing 10%, and the hypothetical seller might be unable to provide such corroborative material if he only had a low shareholding (like, say, 10%). That was my point.

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Replying to The Dullard:
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By Tax Dragon
24th Oct 2019 15:42

The purchaser and the sale may be hypothetical. Is the seller? I'm not so sure... in fact, there's one called C and the other is called D.

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Replying to Tax Dragon:
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By The Dullard
24th Oct 2019 15:58

For the purposes of valuing the shares, one is seeking to determine the price at which they might reasonably be expected to fetch on a sale in the open market (because that's what the legislation says).

In doing so, one is necessarily assuming a hypothetical sale ("MIGHT SELL") in the ("POSTULATED") open market, with the effect that both the purchaser and the seller are necessarily hypothetical.

We do have to fill some parts into the legislation. We are told that the (hypothetical) purchaser is prudent and that the (hypothetical) seller is willing (to sell if the price is right), and we are left to assume both that the (hypothetical) purchaser is willing (to purchase if the price is right) and that the (hypothetical) seller will also not act recklessly.

The legislation says, or implies, all of that, quite clearly, I think. It just chooses to use less words.

https://www.gov.uk/hmrc-internal-manuals/shares-and-assets-valuation-man...

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Replying to The Dullard:
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By Tax Dragon
24th Oct 2019 16:10

Fewer.

And phew! That's a long paragraph. At leased we can all agree (by the time we get to the end) that the landlord is real.

(Sorry... puny pun. Can you tell I struggle with real life, let alone the hypothetical ones?)

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Replying to Tax Dragon:
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By The Dullard
24th Oct 2019 16:44

Tax Dragon wrote:

Fewer.

Agreed.

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Replying to The Dullard:
Psycho
By Wilson Philips
24th Oct 2019 16:14

But does the case referred to towards the end of that commentary not sort of contradict your words? (Although the sale is hypothetical the actual facts and circumstances, eg attributes of the vendor, should be taken into account.)

Ignore that - I didn’t read it properly

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Replying to Wilson Philips:
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By Tax Dragon
24th Oct 2019 16:35

I'm wrong anyway aren't I? It's not C and D that are making the disposal. This (for some reason) is being done by a reorganisation. Does that make a difference?

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Replying to Tax Dragon:
Psycho
By Wilson Philips
24th Oct 2019 16:58

I don’t think it makes a difference. If I recall correctly the ERS provisions make reference to CGT valuation principles

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By ocooper
24th Oct 2019 15:08

Thanks all, really helpful. Anyone else with a view on this?

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By Tax Dragon
24th Oct 2019 16:50

Re Lynall 47 TC 375 talks about information being provided by the board. In the context of a reorganisation, and shares being issued by the company, I wonder whether that is a factor. Even hypothetically.

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By Clinton Lee
24th Oct 2019 18:07

On a different matter, they'd be wise to disclose to the potential investor the intention to restructure ownership. Investors are nervous about such changes happening just prior to the acquisition. Late stage changes can scupper deals.

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