The complete guide to company valuations for share schemes

Whichever share scheme you're considering, a company valuation is critical for creating one that functions as expected in the real world. 

Plus, proper valuations ensure the tax benefits of HMRC-approved schemes are upheld. Skipping them could cause your share scheme to implode! 

Valuations aren’t just numbers or hoops to jump through though. They provide trust and transparency for everyone participating in the share scheme, ensuring all relevant parties are aligned. 

Read on to explore the ins and outs of valuations, what they entail, how they work, and the best practices for obtaining one. 

What is a company valuation?

In the business world, 'valuation' means many different things depending on the context.

Broadly speaking, the valuation process involves examining your company's finances, comparing it to similar businesses, and forecasting future growth. 

For share schemes, we're talking specifically about determining the value of shares or options for tax purposes. This differs from commercial valuations used when investing in or selling a business.

In the shortest terms, it's all about getting tax treatment right. If you get the valuation wrong, it could lead to incorrect calculations for your company and your employees.

Why do I need a valuation to set up a share scheme?

Share scheme valuations help you:

• Set a fair price for shares or options in your scheme
• Ensure compliance with tax regulations
• Make sure your team knows exactly what they're getting

You'll need HMRC to approve your valuation for tax-advantaged schemes like the Enterprise Management Incentive (EMI).

Again, this isn't just a formality – it's designed to safeguard against future tax complications. Get it wrong, and you could lose the tax benefits these schemes offer.

Setting up a share scheme without knowing the value of your business is like trying to slice a cake without knowing how big it is.

Let’s break it down in a bit more detail:

1. Fairness

A valuation ensures that you're offering shares or options to your employees at a fair price. This maintains trust and transparency within your organisation.

2. Tax compliance

Some HMRC-approved share schemes come with tax benefits for both the company and the employees. However, these benefits are often contingent on the shares being valued correctly.

3. Planning

Knowing your company's value helps you plan how much equity to set aside for your share scheme. It allows you to make informed decisions about how many shares or options to offer and at what price.

4. Following best practice

If you plan to sell the business in the future, a history of professional valuations can be very helpful in negotiations (and will act as a tick on any due diligence checklist, particularly if the valuation is approved by HMRC).

5. Employee motivation

Truly specifying the value of the shares is key to building effective, incentivising share schemes. Participants can see in concrete terms how their work contributes to the company's growth and how they might benefit financially.

As we can see, a valuation isn't just a number - it's a tool that helps you make strategic decisions about your company's future and how you reward your team.

Which schemes do I need a valuation for?

All share schemes can benefit from a professional valuation, but in some cases, it’s vital for protecting the tax advantages attached to HMRC-approved schemes. 

A valuation is essential for the following schemes:

Enterprise Management Incentive (EMI)

It’s strongly encouraged to obtain an HMRC-approved valuation for EMI schemes. Failing to do so is risky (basically, there’s little benefit in opting for an HMRC-approved share scheme to then not get a professional valuation to protect its tax advantages). 

Company Share Option Plan (CSOP)

Like the EMI, getting a valuation for CSOPs is highly advisable, as it provides certainty on the options' tax treatment. More on that later.

Share Incentive Plan (SIP)

A valuation is generally viewed as a requirement for HMRC-approved SIP schemes, particularly when determining the market value of shares for free shares, partnership shares, and matching shares.

Growth shares

Growth shares are valued differently due to the hurdle rate, but a valuation is still necessary because of how they work. More on this shortly.

One more thing - the type of valuation you need might differ depending on the jurisdiction.

For instance, if you want to award share options to employees based in the US, you'll need what's called a 409A valuation. We'll discuss this in more detail later.

How do I get a company valuation?

You have a few options:

1. Do it yourself
2. Hire a specialist firm
3. Use a platform like Vestd

While online tools and calculators are available, they often don't capture the full complexity of a business's worth, which makes doing it yourself risky. Unless of course, this isn't your first rodeo! 

You could leave it in the capable hands of a specialist firm, but they often charge thousands of pounds per valuation.

Alternatively, we offer company valuations as standard with our share scheme plans, making share scheme management far more cost-effective.

How much does a company valuation cost?

The cost of a company valuation can vary widely depending on who you ask and the complexity of your business.

Some companies charge upwards of £10,000 per valuation, which can add up quickly, considering how often you might need new valuations over your company's lifetime.

Factors that can affect the cost include:

• The size and complexity of your business
• The purpose of the valuation (e.g., EMI, CSOP, SIP)
• Whether you need HMRC approval
• The experience and reputation of the valuation provider

Vestd customers don’t need to worry...

How are businesses valued?

There are stacks of techniques and approaches, but the three fundamental ones are:

1. The market approach
2. The income approach
3. The asset approach

Let's start from the top.

1. Market approach

The market approach determines the value of your business based on the prices at which similar businesses have been bought or sold in the open market.

It's similar to valuing your house based on what similar houses in your area have sold for recently. Methods under the market approach include:

• Guideline public company method: This involves comparing your company's financial metrics to those of similar publicly traded companies. It's most useful when your company is similar in size and operations to public companies in your industry.
• Guideline company transactions method: This looks at the prices paid for similar businesses in recent transactions. It can be particularly useful if there have been recent sales of companies similar to yours.
• Backsolve method: This method derives the implied equity value from a transaction involving your company's own securities. For example, if you recently raised capital by selling 10% of your company for £1 million, this would imply a total company value of £10 million.

While generally reliable, one limitation of the market approach is finding truly comparable companies, especially for privately held or early-stage businesses.

2. Income approach

This assesses a business's value by estimating its future income or cash flows. It's based on the idea that a business's value is equal to the present value of the future economic benefits it will produce for its owners.

The most common method is discounted cash flow (DCF). This involves forecasting the future cash flows your business is expected to generate and then discounting them back to present value using a rate that reflects the risk of those cash flows.

DCF relies heavily on the accuracy of future projections, which can be challenging, especially for young or rapidly growing companies.

3. Asset approach

The asset approach determines value by analysing your company's underlying net assets.

While it's considered the weakest approach conceptually, it can be useful as a "sanity check" or in situations where data for other approaches is limited.

Key methods under the asset approach:

• The asset accumulation method estimates the net fair value of a company's assets and liabilities. It's most useful for businesses with significant tangible assets.
• The replacement cost method estimates the cost required to create a replica of your business. It can be particularly relevant for companies with intellectual property or specialised equipment.

Each method has strengths and weaknesses, and the most appropriate method (or combination of methods) will depend on your specific business and the valuation's purpose. 

What can affect the value of my business?

Remember that a valuation is merely a snapshot of your company's worth based on the information available at the time.

Numerous factors can influence this value, some of which are within your control. Here are the key factors that affect your business's value:

1. Cash flow management

How well your company manages its cash can significantly impact its value. Strong, consistent cash flow is viewed as a positive indicator of a company's health.

2. Financial performance

This includes factors like revenue growth, profit margins, and overall profitability. A history of robust financial performance typically leads to a higher valuation.

3. Market conditions

The state of the economy, industry trends, and the performance of similar companies can all influence your company's value.

4. Company reputation

Intangible assets like brand recognition, customer loyalty, and overall market reputation can substantially impact value.

5. Tangible assets

The value of your company's physical assets, such as property, equipment, and inventory, contributes to its overall worth.

6. Intellectual property

Patents, trademarks, and proprietary technology can significantly boost a company's value, especially in tech and innovation-driven industries.

7. Management stability

A strong, stable management team can increase a company's value by instilling confidence in its future performance.

8. Growth potential

Investors often pay a premium for companies with high growth potential, even if current profits are low.

9. Customer base

A diverse, loyal customer base can be a valuable asset, particularly if there are long-term contracts or high switching costs.

10. Regulatory environment

Changes in laws or regulations that affect your industry can impact your company's value.

Bear in mind that unexpected events or changes in the business environment can quickly alter a company's value.

What's a HMRC-approved valuation?

When you're setting up tax-advantaged share schemes, HMRC steps in to review and approve the value you've assigned to your company's shares in the interest of:

• Tax efficiency: You'll ensure that you grant share options or awards at a price agreed on by HMRC - crucial for keeping the tax advantages of schemes like EMI, CSOP, and SIP.
• Legal compliance: You'll qualify your scheme for the intended tax benefits. Without an HMRC-approved valuation, you risk losing those benefits, rendering your tax-advantaged incentive scheme rather pointless!
• Transparency: You'll provide certainty for both your company and employees about the tax treatment of shares or options. This is super important when your employees come to exercise their options or sell their shares.
• Risk mitigation: You'll reduce the risk of HMRC challenging the valuation later, which could land you with unexpected tax liabilities - not to mention the massive headache of sorting it all out.

When do I need HMRC to approve my valuation?

When you really ought to get HMRC's approval and why:

If you're setting up an EMI scheme

• Tax implications: You'll set the exercise price of the EMI options based on the agreed valuation. If you grant options at a discount to the actual market value (AMV), your employees may be charged for the difference when they exercise their options.
• Qualifying conditions: You'll ensure you stay within the £250,000 individual limit on the value of unexercised options, which helps you maintain the options' tax-advantaged status.
• Future planning: You'll establish a benchmark for future option grants, helping you structure subsequent rounds and estimate tax for both your company and employees.

If you're setting up a CSOP

• Tax certainty: You'll ensure that you grant the options at unrestricted market value (UMV). If you don't, then those options will lose their tax-advantaged status. 
• Staying within the limits: CSOPs have a maximum option grant limit of £60,000 per person - a valuation ensures that options remain within this limit.
• Risk mitigation: You'll protect against HMRC reclassifying the options as non-tax advantaged if they later challenge your valuation. This could result in income tax and National Insurance charges on exercise, potentially dating back to the grant date.

If you're setting up a SIP

For SIPs, you need a company valuation in several instances:

• Free shares: You'll determine the market value of free shares you award to employees, ensuring you comply with the annual limit of £3,600 worth of free shares per employee.
• Partnership shares: You'll accurately calculate the exact number of shares employees can buy with their contributions, given the limit of £1,800 or 10% of salary per tax year.
• Matching shares: You'll ensure the ratio of matching shares to partnership shares complies with the scheme rules, which can be up to two matching shares for each partnership share purchased.

In addition to the above, SIP valuations affect your company's corporation tax deduction (based on the market value of shares used) and your employees' tax position (determining the value of their tax-free benefit).

What to include in a valuation report for HMRC

When submitting a valuation report to HMRC, you need to provide two key values:

1. Unrestricted Market Value (UMV)
   
   This is the value of the shares, assuming there are no restrictions on them. Restrictions include the risk of having to forfeit the shares, restrictions on the freedom of retaining or disposing of the shares, and any ‘potential disadvantages’, where an employee faces a disadvantage if share rights were exercised.
   
   
2. Actual Market Value (AMV)
   
   This is the value of the shares, considering any restrictions on sale or transfer. For example, if employees can't sell their shares for a certain period, this would typically reduce the AMV compared to the UMV.

AMV reflects the fact that you are subject to restrictions, whereas UMV imagines a scenario where you’re no longer subject to them.

As well as the UMV and AMV, include the following in your valuation report:

• Executive summary: A brief overview of the valuation, including the proposed UMV and AMV.
• Company overview: Information about your company's history, business model, and future prospects.
• Financial information: Recent financial statements and projections.
• Share capital structure: Details of different share classes and their rights.
• Valuation methodology: Explanation of the valuation method(s) used and why they were chosen.
• Comparable company analysis: If using market-based approaches, details of comparable companies and transactions.
• Discounts applied: Explanation of any discounts applied (e.g., for lack of marketability for a minority interest*).
• Conclusion: Summary of the valuation results and any key considerations.

Top tip

Don't rush or send an incomplete draft - the quality of your valuation report can dramatically impact how quickly HMRC processes your application and whether they agree with your proposed values.

Depending on the scheme, there’s also specific paperwork to submit alongside the valuation report (e.g. VAL231 for the EMI). 

Just another reason why it's so much easier to use a service like Vestd!

How long does it take to get HMRC's approval?

Typically, HMRC approves a share scheme valuation in 3-6 weeks. However, this can vary depending on HMRC's workload and the complexity of your valuation.

To help speed up the process:

1. Ensure your valuation report is comprehensive and well-structured.
2. Respond promptly to any queries from HMRC.
3. Consider using a professional valuation service with experience in HMRC submissions (like yours truly).
   

Warning: HMRC valuations expire

HMRC valuations don't last forever. They typically expire after:

• EMI: 90 days
• CSOP: 90 days
• SIP: Up to six months

Timeframes seem on the short side? That’s because company values can change quickly, especially for high-growth startups. If you don't grant the shares or options within this timeframe, you'll need to get a new valuation. 

When do I need a new company valuation?

Besides them expiring, there are other situations when you’ll need to prepare a new valuation report, too.

For HMRC-approved schemes, that includes any ‘material change’ to a company, which HMRC defines as:

• Any alteration (completed or planned) in the company’s share or loan capital
• Any arm’s length transactions (completed or planned) involving the company’s shares
• Negotiations or preparations for an initial public offering (flotation) or a takeover
• Any declaration of dividends on any class of the company’s shares
• The release of any new financial information by the company, such as annual accounts, interim results, or announcements

It's always better to err on the side of caution. If you're unsure whether you need a new company valuation, it's best to ask a professional.

For all share plans generally, you'll need a new valuation whenever:

• Your company takes on new investment
• When there's a significant change in your company's structure or shareholders
• If market conditions change dramatically
• Before a new round of share or option grants
• Annually, for US companies requiring 409A valuations (also subject to the above rules; e.g. you need a new one if your company takes on investment or experiences other material changes).

You can see how the pounds add up if you're going to a specialist firm charging £10k a pop (which is not unheard of). Customers on our Guided plan can request multiple company valuations per year at no extra cost.

Do I need a valuation for my growth share scheme?

Yes, you need a company valuation for growth shares because of how they work.

Growth shares are a special class of ordinary shares designed to participate in a company's future growth only above a certain threshold (the 'hurdle').

This structure makes them particularly attractive for incentivising people while minimising immediate tax implications.

Here's a deeper look at how growth shares are valued:

• Setting the hurdle: Growth shares only share in the capital growth of the business from the point they're issued. The hurdle is typically set at a premium of 20-40% above the current market value of ordinary shares.
• Tax implications: The purpose of using growth shares is to limit the recipient's exposure to Income Tax on the award. If issued at the suitable hurdle, recipients are only exposed to Capital Gains Tax (CGT) on the eventual sale of the shares.
• Potential risks: If HMRC determines that the shares were undervalued at issue, they could charge Income Tax on the determined difference in value at issue.
• Share issuance: Growth shares must be issued at nominal value and fully paid up upon acceptance. The recipient must pay the company nominal value for their growth shares when they accept the issue.
• No HMRC approval: It's important to note that HMRC doesn't pre-approve valuations for growth share schemes. It's purely for your benefit and the recipient's. 

When do I need a 409A valuation?

If you're granting share options to employees based in the US, you'll need what's called a 409A valuation. A 409A valuation is required to:

• Set the strike price for stock options
• Ensure compliance with US tax laws
• Avoid potential tax penalties for your US employees

Unlike HMRC valuations, 409A valuations must be updated at least annually or whenever a material event that could affect the company's value occurs.

The great news is that Vestd can also provide 409A valuations for a small fee, making us a one-stop shop for companies with international teams.

What about unapproved options?

While not essential, it's also a good idea to get a company valuation for unapproved option schemes. It's very useful for setting the exercise price for the options and understanding the tax implications.

The bottom line

Company valuations play a fundamental role in setting up an effective share scheme. 

Whether you're considering EMI, CSOP, SIP, or growth shares, getting the valuation right ensures your scheme is compliant, tax-efficient, and works as you expect it to in the real world for you, your company, and your team.

The easiest way to get a company valuation

If you're looking for a straightforward, cost-effective way to get your company valued for a share scheme, for EMIs, growth shares, CSOPs, and more, then look no further.

Our Self-Serve and Standard Plans include one company valuation per year.

We understand that as your company grows, you'll need new valuations, potentially multiple times yearly - so we've got you covered on that front.

We offer up to four annual valuations for customers on our Guided plan.

Our in-house analysts are specialists in share scheme valuations, ensuring you get a valuation that meets HMRC's standards. This saves you thousands compared to traditional providers.

And remember, we do 409A valuations too!

We’ve already helped thousands of companies tap into the immense benefits of share schemes and get the valuations they need.

So if you're ready to take the next step, book a free share scheme consultation for a time that suits you.

 

Disclaimer: the information on this page was correct at the time of writing and may be subject to change. If in any doubt, seek professional advice.