Publications - Corporate
June 2005
Share valuation provisions - are you providing
an alternative to the auditors?
Background
Articles of association and sometimes agreements made between shareholders and investors often contain provisions setting out the way the value of shares is to be determined. Most commonly these are seen in pre-emption clauses which provide for shares to be offered for sale to existing shareholders before being transferred to third parties.
Often these valuation provisions require value to be determined and certified by the company's auditors.
The logic behind providing for the auditors to determine the value of the shares is generally that they are already familiar with the financial position of the company and can therefore carry out a valuation relatively quickly and cheaply.
However, as a result of a change in the professional rules governing accountants, there is now a risk that this form of valuation provision, and the pre-emption clause of which it is part, will be unworkable.
The new ethical standards
The Auditing Practices Board issued new ethical standards for auditors, which came into effect for all accountants on 6 April 2005. Among other things, these prohibit auditors from providing valuation services to audit clients where the valuation would involve a high degree of subjectivity, and have a material effect on the financial statements.
There is an exemption for small entities that covers unlisted companies satisfying two or more of the following criteria:
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Not more than £5.6 million turnover;
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Not more than £2.8 million balance sheet total; and
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Not more than 50 employees.
As a result of this new prohibition, auditors will in many cases be obliged to decline to provide valuations to their audit clients.
If the auditors do decline, and the articles do not provide an alternative valuation mechanism, there will be no pre-defined procedure for determining the value of shares and the price at which shares are to be offered. In the absence of co-operation between the parties, they may be left with the prospect of applying to the Court for assistance, with the risk that the Court would itself decline to substitute its own alternative valuation machinery.
Suggested action
Companies that have valuation provisions written into their articles (or indeed other agreements) and investors who are party to agreements which require valuations to be provided by the auditors should now:
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review the adequacy of such provisions in light of the new prohibition; and
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where necessary, amend them to include an alternative valuation mechanism. This might, for example, provide for value to be determined and certified by an experienced valuer or independent accountant appointed by the President of the Institute of Chartered Accountants, in the event that the auditors decline to act.
Otherwise they risk problems every time a shareholder wants to sell his shares.
Contact details
We are happy to field any queries arising on this note. Please feel free to contact Duncan Holden (whose details are below) or your normal contact at McGrigors.
Duncan Holden duncan.holden@mcgrigors.com
or
DDI: 020 7054 2759
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