Competing forecasts, conflicting valuations
How should experts decide?
Summarized
- Competing management forecasts can lead to significantly different share valuations in shareholder disputes.
- Management's financial interests may influence forecasts, making it essential to critically assess assumptions and historical performance.
- Party-appointed and court-appointed valuation experts face different challenges when evaluating conflicting forecasts and expectations.
- A robust valuation analysis examines supporting evidence, challenges key assumptions and quantifies how alternative scenarios affect share value.
Introduction
In shareholder disputes, business value often hinges on competing forecasts. Majority shareholders may anticipate declining profitability, while minority shareholders may expect growth. Both may present credible forecasts yet reach vastly different valuations.
Who is right?
Although management knows the business best, it may have a financial interest in its valuation. Experts are expected to challenge the forecast assumptions, despite not running the business or being better able to predict its future.
Party-appointed experts may gain deeper insights through their clients but have limited access to opposing views. Court-appointed experts can hear both sides but must reconcile rather conflicting expectations.
The fundamental question is how far experts can reasonably scrutinise management forecasts when the evidence supports competing views of the future and those providing the information may have a financial interest in the outcome.
Management knows the business. But is its forecast reliable?
Management understands the company's customers, competitive position and growth opportunities. More importantly, it sets the strategy and makes decisions shaping future performance.
Yet management forecasts may be influenced by financial interests in the dispute. A majority shareholder seeking to acquire a minority stake may favour conservative assumptions, while the minority shareholder emphasises growth. Both view the business differently.
A valuation expert can analyse historical results, challenge assumptions and benchmark forecasts against industry peers. But external research cannot replicate management's business knowledge.
The challenge is distinguishing genuine commercial expectations from assumptions influenced by the dispute, particularly without direct knowledge of daily operations.
Contemporaneous business plans, forecasts and valuation reports can reveal earlier expectations. Comparing historical forecasts with actual performance may expose biases and help assess revised assumptions, although neither provides a definitive answer.
Party-appointed experts: closer to the business, closer to the dispute
Party-appointed experts may engage closely with founders, management and shareholders, gaining insights into strategy, customer relationships, investment needs, operational risks and alleged financial irregularities that prejudice minority shareholders.
However, closer access does not guarantee reliable information. Shareholder disputes can intensify financial incentives, leading parties to emphasise assumptions that support their respective positions.
Each party may present different views of the company's prospects, genuinely believing they are right. Experts can challenge the information received but may have limited opportunities to verify it with the opposing party or against market evidence.
The greatest contribution of a party-appointed expert is not producing a valuation that meets the instructing party's expectations, since such an approach risks entrenching positions and prolonging litigation.
Instead, experts should identify weaknesses in assumptions, assess competing views and quantify their financial implications. This helps lawyers and clients evaluate litigation risks and settlement opportunities.
Court-appointed experts: reconciling opposing views
Court-appointed experts must evaluate financial information from parties with opposing interests.
One party may anticipate strong revenue growth and improving margings. The other may forecast weaker demand and rising costs. Both may present plausible arguments.
Historical performance, budgets and industry benchmarks can help assess these views. However, even extensive analysis may not establish which forecast is more likely to materialise.
Where neither party's evidence is clearly more persuasive, adopting assumptions between the opposing forecasts may appear reasonable. However, a midpoint is not necessarily the most likely outcome. The selected assumptions must not represent a compromise.
When management changes its forecast
Forecast revisions during a dispute present a particular challenge.
Suppose management approves a business plan anticipating strong growth. Six months later, during shareholder exit proceedings, it presents a much weaker forecast.
The revision may reflect deteriorating conditions, lost contracts or new information, but also changed financial incentives.
How should the expert distinguish between these explanations?
The starting point is to establish what changed, when and why. Contemporaneous budgets, board papers and investment decisions may reveal management's earlier expectations.
Comparing the original and revised forecasts can identify changed assumptions and their supporting evidence.
Management's forecasting record matters. Where past forecasts have been reliable and close to actual results, substantial revisions warrant explanation.
Where revisions materially affect value, clear court instructions on the valuation date and treatment of subsequent information can help the expert.
Can hindsight reveal which forecast was reasonable?
Persistent deviations between forecasts and actual performance may cast doubt on management's forecasting reliability. But hindsight requires caution.
A forecast that proves inaccurate was not necessarily unreasonable when prepared. Unexpected market developments, customer behaviour or management decisions can change outcomes. The agreed price of an asset at a given point in time does not change with the flow of subsequent information.
Hindsight can inform the assessment of forecasting reliability. It should not replace expectations at the valuation date.
What is typically expected from valuation experts?
The objective of a valuation expert is not to identify the one correct forecast.
Five questions are particularly important:
1. Which assumptions drive value?
Experts should focus on parameters that materially affect the valuation, not on every assumption.
2. What supports competing forecasts?
Historical performance, contemporaneous business plans, operational and market evidence should be examined.
3. How reliable is management's forecasting record?
Comparing contemporaneous forecasts with actual results can reveal systematic optimism or pessimism, or provide evidence of a consistently reliable forecasting process.
4. Why have forecasts changed?
Experts should establish when revisions occured, what justified them and whether contemporaneous evidence supports them.
5. What if an assumption is rejected?
Experts should quantify reasonable alternatives. An argument may have good prospects of success but carry significant financial risk if rejected.
Experts must exercise professional judgement: select the best-supported assumptions, explain credible alternatives and where possible already assess the opposing views.
The Enterprise Chamber's guidance emphasises transparent assumptions, reasoned conclusions and sensitivity analysis. But transparency should not undermine a focused opinion.
An expert report should acknowledge uncertainty without leaving every unresolved valuation judgement to the court. An expert conducting extensive sensitivity analyses can produce widely dispersed valuations, offering courts little guidance.
Conclusion
Management knows the business but may have a financial interest in its valuation. This may affect the credibility of the forecast used by an expert when valuing shares in a dispute. Party-appointed experts gain deeper insights but face information asymmetry. Court-appointed experts must assess competing narratives that are difficult to reconcile.
Neither can predict the future with certainty. The expert's responsibility is to test evidence, challenge material assumptions and explain where professional judgement is required.
The strongest valuation is not necessarily the one with the narrowest range or most scenarios, but the one that explains which assumptions deserve greater weight, and how value changes if they prove wrong.
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