How should vendor loan notes be treated when valuing a business?
If one is using the Asset Approach to value a business, possibly as corroboration of other methods, it’s important to adjust the assets.
Just looking at company’s balance sheet can be quite misleading – are there property assets that need revaluing, what about costs to realise, tax, unrecorded liabilities, and treatment of intellectual property? Quite apart from this how should one treat the effect of liabilities included in the Net Asset position?
Net bank debt/cash is relatively straightforward although the calculation of net cash/debt after working capital adjustments can be tricky.
In contrast “loan notes” issued to parties other than regular banks will often have non-standard terms. And the funder could have a different agenda – it may be the former owner who has issued Vendor Loan Notes, or perhaps the Loan Notes arose as part of a management buyout.
So how should they be treated?
Loan notes could be considered to be positive if they represent “soft funding” yet they are still a debt to be deducted in the equity valuation. This was considered in Findlay’s Trustees v IRC (1938). Lord Fleming said:
“the circumstance that a considerable part of the capital required to run the business can be raised at a low rate of interest cannot depreciate the value of the goodwill – it might increase its value. But this does not mean that their existence is to be disregarded in fixing the value – they are a debt of the business and must be deducted from its value.”
To judge whether the notes are a positive or negative, it’s even more important that the valuer reviews the financial impact of the terms. Are there provisions to roll up interest? Or redemption premia? Either could bust the business if they build up to onerous levels and at any rate need proper consideration in any cash flow calculation used in an Income Approach valuation.
Find out more about our multidisciplinary approach to business valuation.