The Valuation of Distressed Companies - a Conceptual Framework

Abstract

A version of this paper appears in two parts in (2006) 3 International Corporate Rescue, Issues 2 and 3.

It is often crucial to ascertain the value of a distressed company. Those interested in the company's undertaking require this information to determine what should be done with the company's business, and how the value in the company's estate should be distributed amongst them. This article, addressed primarily to the parties to corporate reorganisation proceedings in the UK and their advisers, provides a conceptual framework within which these questions might be answered.

The first part of the article identifies the bases on which a company's business might be valued. Drawing upon economic theory, empirical evidence, and the principles evolved by US courts with long experience of dealing with such issues, it explains the circumstances in which one or other of these bases might appropriately be adopted. The onset of corporate distress creates unique additional problems in attempting business valuations, whether carried out in a court context or out of court. Focusing particularly on the incentives of those interested in the outcome of reorganisation proceedings, the article seeks to distinguish between the 'structural' and the 'strategic' factors giving rise to these problems, and explains how these might impact upon the valuation process. It then draws on the US jurisprudence on business valuation to outline three methods for putting a value on a 'going concern'. It is submitted that the principles developed by US courts will prove helpful and persuasive as UK courts grapple more and more frequently with valuation issues. The second part of the article consists of a detailed analysis of the recent judgment of the English High Court in In re MyTravel Group Plc, which is employed as a case study in the application of the conceptual framework laid down in the first part.

Keywords: Motivation costs, coordination costs, goving concern value, liquidation value, enterprise value, market value, economic distress, financial distress, fire-sale, adverse selection, large-block stock transactions, market comparison approach, comparable company approach, discounted cash flow approach

JEL Classification: K20, K22, K29, K30, K41