Achieving a Fair Value for Your Equity

As we approach the last quarter of the financial year, those parties looking to retire, sell down equity, or depart a firm, will often start considering the potential value of their equity. All too often we hear a comment along the lines of ‘I just want to do what is fair for all parties’ or ‘we just want to recognise a fair value’. Many negotiating a transfer of equity are able to reach agreement amongst themselves. However, others, who want to ensure that they or the other side are not being disadvantaged, will seek external confirmation of firm value from recognised experts.

Of late, we’ve have had several conversations with parties around goodwill values, some of which represented differing opinions to our own. Thus, we thought it may be pertinent at this time of year to share some of our views around determining a ‘fair value’. As long term valuers of goodwill for over 40 years and 10,000 + valuations of professional firms, we feel our experience may be of some benefit.   

The first misnomer for us is that whatever someone sold their whole practice for in the open marketplace should equate to what someone should pay me for my equity. We get to hear this often and that is a big negatory for us. Yes, as valuers, we certainly give some consideration to external market forces, however these represent two totally different transactions, which therefore have different outcomes. We are very strong believers in differing purposes for valuations will have differing outcomes. A prime example would be preparing a valuation for a deceased estate. The value under this purpose will be so different to other scenarios.

The next approach that we hear all too often is that a firm’s proprietorship or partnership agreement sets out a specific cents in the dollar or multiple to be applied to any transaction. Our concern with this one is that no other asset retains its same value into perpetuity, hence such agreements are underpinning this approach. It’s not overly dissimilar to the view the whatever I paid when entering partnership in terms of cents in the dollar, should be the same cents in the dollar upon my exit.

Many of the large professional firms have abolished the recognition of goodwill, rather preferring to work on a capital contribution approach, which in part was because incoming parties couldn’t afford to buy in. In many instances, this was because the firm was recognising its value based on a dollar for dollar of fees and the underlying performance of the firm didn’t provide a sufficient return with a satisfactory payback period to support this, thus rather than revising their approach to determine a ‘fair value’, the recognition of goodwill was simply disregarded all together.

Another discussion we had with a practice went along the lines of ‘we recognise a multiple of ‘X’ in our proprietorship agreement, however when we apply that in this instance it doesn’t provide a satisfactory or acceptable value, so we’re going to increase the multiple to provide a better outcome’. We get to see this one, or something similar, quite often when it comes to reviewing valuation calculations. Upon the supply of feedback in terms of how the outcome was achieved, the outcome doesn’t change, but the means of getting to that outcome does. It’s kind of a way to reverse engineer the desired value, that is, this is the outcome we want and we’ll tinker with the approach, methodology, formula etc to produce this end result. We’re not sure this is really achieving a ‘fair value’.

It is our strong view that the value of a practice does not remain constant throughout its lifecycle, it ebbs and flows in accordance with the decisions being made and how these impact its performance. Therefore, it is those equity holders at the time that should benefit, or otherwise, from these decisions. That will come in the form of ongoing profits, and the payment thereof, as well as a future equity value. However, if decisions have been made that impact firm performance, or the number of parties that benefit from that, then it is those parties that should be the recipients of such outcomes, in our opinion.

Thus, as we wrap up our thoughts on achieving a ‘fair goodwill value’, a couple of points to consider. Firstly, establish an indicative value early. Even if it’s not the final value, it will provide some insight as to what the likely value will be, thus underpinning the decision to sell or not. All too often the party selling discovers the ‘fair value’ for their equity is not what they thought at the eleventh hour, then deciding that they no longer want to sell. Secondly, as an equity holder, hold yourself and your colleagues accountable for making sound decisions throughout your tenure that will underpin firm value. After all, it will be your decisions as a collective that impacts upon ‘fair value’ at the various times of your departures. If we can assist with your firm valuation needs in anyway, please reach out to discuss our valuation services via (02) 9233 4333 or services@robknights.com.au.