How do you value an EIS company in the post-Covid world?

High-growth businesses are desperate for cash, despite Covid-19. But how do you value an EIS portfolio company post pandemic?

The COVID-19 lockdown has dislocated the Enterprise Investment Scheme (EIS) funding world and the anticipated inflows of investment fell sharply in March at the end of the last tax year – the period in which traditionally we see a lot of activity.

Some portfolio managers were no longer able to make some planned new investments nor to provide follow-on funding that some portfolio companies were relying on.

Essentially the dynamics of the marketplace were sufficiently disrupted to cause investors to pause for breath.

Small, high-growth businesses need regular funding to support their ambitions. Many, but not all, companies which were priced for growth earlier in the year were suddenly struggling for cash in April and May.

These companies are desperate to attract more funding, but investors remain reticent to invest unless and until they know that they are providing capital to companies at fair value. This point did not take long to gain recognition.

>See also: Why government needs to boost EIS tax relief to 80% to save our start-ups

On March 31 the International Private Equity and Venture Capital Valuation Guidelines (IPEV) were updated with Special Valuation Guidance from the board in the light of the impact of xoronavirus. They wrote:

“It may no longer be appropriate for recent transaction prices, especially those from before the expansion of the pandemic to receive significant, if any, weight in determining fair value

“Greater uncertainty translates into greater risk and increased required rates of return, which generally would indicate that multiples will decrease, even in the absence of recent transaction data.”

How do you value an EIS portfolio company?

In the pre-pandemic private equity market, fair value would typically be determined by competing investors keen to take part in further funding rounds. However, in today’s market, there may be a lack of suitors looking to invest in follow-on funding, leaving potentially just one existing shareholder willing to provide the extra cash. In this situation, their dilemma is how to price the shares for the follow-on funding.

Consequently, there is an urgent need for valuations of private companies to be reconsidered, both at the fund level and on an individual basis. This is required to provide a realistic guide for transactions, to support portfolio reviews, and, importantly, to restore investor confidence.

In these circumstances, an independent valuation can be of considerable value to an investment committee or a board of directors – and a third-party assessment provides an additional layer of due diligence. And is just as important for investors.

We believe that using independent valuations to inform each interested party is an important step in restoring confidence to the EIS markets.

The valuation of private companies has been in the headlines in recent years, once private companies were included in daily priced funds such as Oeics and investment trusts which are available to retail investors.

The issues related to valuation of illiquid private companies in portfolios managed by Woodford Investment Management affected many individual investors who supported the firm’s open-ended and closed ended funds.

This is a major issue for many EIS and Seed EIS funds. But what has happened to cause the problems?

‘The market has been dislocated by Covid-19 and investors have lost confidence’

Quite simply the market has been dislocated by Covid-19 and investors have lost confidence.

Quoted companies have clearly lost a lot of value in the current crisis, and so have many private EIS companies – but what people don’t know is by how much.

Investment trust Scottish Mortgage, managed by Baillie Gifford, provided a simple solution in April by cutting the value of private companies in its portfolio to recognise the fact that private company valuations are not insulated from public markets.

There are particular problems when deciding value for the EIS industry. Let’s look at two examples:

Generally, EIS managers provide a portfolio review to quantify value every six months. If a company is struggling for cash in today’s market, then it needs to be priced for survival, rather than for growth.

In another example, in a buoyant market, such as we saw at the turn of the year, there will often be several EIS funds keen to take part in follow-on funding, and between them they agree a fair price for the funding round. In a depressed market, there may be only one interested investor, and there is no obvious benchmark for agreeing what is a fair price.

It has been normal practice that if a company has raised capital recently, perhaps within the past six months, then the transaction price is accepted for the time being.

At the end of March this year, IPEV came out with its guidelines to address fair value issues: in other words, valuations were in the spotlight and, at the very least, needed to be  re-examined.

New investments into EIS fell off a cliff in March, as investor confidence took a hit, and uncertainty ruled. There is a desire, I believe, to restore confidence in investing in EIS and venture capital funds with independent third-party valuations based on the IPEV guidelines, which are used by the fund managers, the investors and professional advisers such as wealth managers and IFAs.

>See also: Total EIS funds down by one third in 2018

I would argue there needs to be a three services to help the various parties assess fair value:

Primary –a valuation from the ground up based on an independent assessment of the investee company’s growth prospects, it’s competitive positioning and the appropriate methodologies

Secondary – the review of a valuation calculated by a third party and a critique to allow the clients (investors and/or their advisers) to potentially challenge the primary computation.

Regular monitoring – so after an initial review, it is agreed with the client the factors that need ongoing assessment in proactively monitoring the portfolio and addressing fair value issues on a regular basis.

In general, there needs to be greater transparency about valuation which will help restore confidence in the short-term and encourage more capital to flow back to growth businesses. This is absolutely essential as the economy rebuilds post-Covid.

In addition, independent on-going third-party monitoring will help more ambitious businesses successfully negotiate the challenges they inevitably face.

Richard Angus is head of business development at Hardman & Co


Richard Angus

Richard Angus is Head of business development at Hardman & Co. His primary area of focus has been US equity capital markets and he has been involved predominantly in the development of growth companies.