The taxman values a majority shareholding by imagining that you have sold your shares to a third party. This hypothetical sale is then used to determine the value of the company. This will involve looking at factors such as the company’s financial performance, comparable price/earnings ratios, dividend yields and whether you are a controlling shareholder. If you’re selling a controlling interest in the company, then the new purchaser will have control over the direction of the company. Therefore, when valuing a controlling interest, the shares valuation division will look at the estimated future profitability of the company.
In most cases they will therefore look at the going-concern value of the company by estimating future earnings.
By contrast, if the future prospects for the company are not as rosy, they may just take a break-up value by estimating what you’d get for the assets if the company was liquidated.
In most cases, though, the break-up basis would not be suitable and majority shareholdings are usually valued by reference to the earnings of the company. However, they will discount the share value according to the element of control that the shares will give.
This is because you would not expect a 100% shareholding to have the same value per share as a 51% shareholding. Although both are technically controlling interests, a 100% shareholding would provide absolute control, whereas a 51% shareholding would still be reliant on other shareholders — for example, to pass any special resolutions (which would require 75% shareholder agreement). Therefore there is a system of discounts, roughly applied as follows:
50% Shareholding = 20%-30% discount
51%-74% = 5%-15% discount
75%-89% = 0%-5% discount
90%+ = 0% discount
James owns all of the shares in Major Ltd. The market value of the shares is £1,000 per share.
If James was to transfer 50% of the shares to his son, Revenue and Customs could be expected to value the shares at £700-£800 per share.
Therefore, if the share capital consisted of 1,000 shares the value of a 50% interest would be in the region of £375,000.
When looking at a minority shareholding, the value is more difficult to ascertain as the purchaser is not obtaining any rights or control over the future direction of the company. Effectively the value of the shares is arrived at by looking at the return that those shares will generate.
There are two main ways that can be used to look at the value of shares in such circumstances.
Firstly, the taxman could look at the dividends that are paid. This would involve looking at past and future dividend projections as well as earnings (as the company would need to have sufficient profits to pay the dividends).
They may look at the dividend yields of other comparable quoted companies. The dividend yield is the dividends per share expressed as a percentage of the share price. Therefore if a company in the same field as yours has a dividend yield of 5% and you paid dividends of £10,000, this would put the value of the company at £200,000. If you were transferring 10% of the shares this would equate to a share value of £20,000.
Another way to ascertain a value may be to use an earnings basis by looking at the price/earnings (P/E) ratio of quoted companies in similar fields to yours. This is often a more accurate valuation yardstick, particularly in the case of non- or low-dividend-paying companies.
For example, a company with earnings per share of 10p and a share price of £1 would have a P/E ratio of 10.
In a similar way to the dividend yield method above, this could then be used to work out the valuation of any shares transferred.
You should note that share valuation, as well as being complex is not an ‘exact science’. Therefore, frequently the techniques above would be used to produce a range of values that would then be applied to the company in question.