A valuable tool to ensure due diligence by directors – by Johann de Lange, MD of Worth.Business
Directors have a fiduciary duty to act with care, skill and diligence in the execution of their duties. Accordingly, they must take reasonably diligent steps to become informed about any material matter they encounter and base decisions taken in this regard on a rational belief that they are in the best interests of the company. Information is “material” when its omission or misstatement could have an influence on economic decisions.
This fiduciary duty further extends to various events such as acquisitions, restructurings, B-BBEE transactions, employee share schemes, annual assessments of investments at fair value, raising capital and other merger activities. The directors must ensure that they are adequately informed on the fair value of the business for such actions taken, so that they protect the interests of all their shareholders and stakeholders. This article briefly looks at some of the different situations that require a business valuation, as well as the main objective of the valuation in each of these situations.
Acquisitions
When the company is interested to acquire another business, but overpays for the new business, it affects the reserves and places an undue burden on the company. And if it is financed with debt, this debt must be repaid. This in turn affects the outflow of cash resources, which is necessary to maintain a financially healthy, sustainable company. In instances where there is a share swap, there is a risk that the shareholder value may reduce if the swap ratio is based on the incorrect values of both the acquirer and targeted company.
Restructurings
Group restructurings are often undertaken to facilitate an investment, management buy-outs, B-BBEE transactions, share employee schemes, succession planning, internationalising ownership or even for business rescue purposes. Business value should always be at the centre of these actions to ensure an optimal outcome for all the parties and to minimise any adverse tax consequences.
B-BBEE transactions
B-BBEE transactions are often vendor-financed and if this is done at below the fair value, it eradicates the shareholder value. B-BBEE transactions may also be debt-financed, which potentially exposes the company to an elevated level of debt that cannot be serviced. This in turn affects the shareholder value and the ability of the company to distribute dividends. In extreme cases it can even impact on liquidity and lead to bankruptcy, which naturally affects all stakeholders in the business; employees, suppliers and shareholders alike.
Investment fair value assessment
The fair value refers to an asset’s rational and unbiased price in the marketplace, as typically determined by a willing buyer and seller (market participant’s view). Users of financial statements need to understand if investments are stated at fair value. Unlisted investments are subject to directors’ valuation. If they are over-stated, shareholders and stakeholders such as banks and creditors could grant unrealistic credit limits. As such, an annual impairment test must be done and adjustments need to be made if stated at above fair value. Simply put, an impairment test is a process which reviews the values of the assets on the company’s balance sheet and determines whether those values are fair. If not, they need to be impaired.
Raising capital
Capital is the lifeblood of the business, and when a company needs to raise capital to fund its expansion or the continuation of its operations, this needs to be done at fair value. Once again, when this is done at below fair value, it dilutes the shareholder value. It may also pose the risk of not raising enough to fund all the budgeted activities and initiatives.
Ensuring accountability of directors
Whilst business valuations provide a wealth of useful data to enable informed business and management decisions, it eventually comes down to ensuring accountability of directors. When the directors engage in any critical transaction or decision, they need to apply their minds and ensure their decision are well-informed and in the best interest of the shareholders and stakeholders. It is their duty to ensure a business value that is credible and anchored in reality.
How can businesses unlock the value of business valuations?
(SA)UEO has entered into a collaboration with Worth.Business via The Game Influencers, as Worth.Business has engineered a pioneering online application {“app”} which makes it possible for business valuations to be conducted at a fraction of the usual time and cost.
This is supplemented by training and consulting services and end-to-end business valuation solutions, all of which are rendered to members and organisers of (SA)UEO at an exceptional preferred rate. So, you’ll have the choice to use the app to conduct your own business valuations, get some training to use the app, have your own evaluation independently reviewed by Worth.Business or let Worth.Business handle the entire business valuation for you.
To leverage opportunity and get the negotiated discounted rates, you can simply email johann@worth.business, then enter ‘referred by (SA)UEO in your subject line, and CC info@erefer.co.za.