Overview
Determining a value for the shares you own in a public company is simple - the stock is listed on an exchange (like the TSX) at a price which reflects the current market value of that individual share at that point in time. Arriving at a value for your private company shares however, is much more complex. In fact, the value you have in mind may be very different from the actual amount that a prospective buyer is willing to pay for your business. For that reason, knowing the value of a business well before a sale is even contemplated offers owners a level of security and leads to customized choices over the best planning options available for the business and the family. Without a reasonably accurate value for your business, you cannot plan effectively for a sale or eventual transition.
Why do you need an accurate value?
A valuation of the shares (or assets) of a privately held business may be required for a variety of reasons aside from an impending sale. Such reasons might include: debt or equity financing or re-financing, corporate reorganizations, tax and estate planning, or determining a value at the date of death of the owner which is necessary when filing a final tax return.
Arriving at an estimated value for private company shares is not an exact science; it is an extremely subjective process. Despite this, the estimated value is required to be “reasonably” accurate as the CRA often reviews business transactions to ensure that the value attributed to the shares does not result in an unfair tax advantage to either the seller or the buyer. While measuring a company’s value is best undertaken by a certified professional who can develop a well-documented and verifiable valuation, the following outlines some common approaches in arriving at a value.
Common approaches to valuing a business
There are several ways to value a business. Each method uses different financial information and assumptions and hence leads to different values. Determining which method is right for your business will depend on a number of factors including the type of business up for sale.
Asset-Based techniques
Asset based approaches determine a business’s value from the value of all its net assets (total assets less total liabilities).
1. The book value method assigns the company’s value to the net worth or equity of the business as shown on the financial statements. This is calculated simply as the book value of total assets (the historic cost of the assets less any related accumulated depreciation to date) less total liabilities. The main drawback with this method occurs when the underlying assets are ones that have increased or decreased dramatically in market value over the years (e.g. real estate property, computer hardware, etc.), making the book value extremely unreliable as a method of reflecting actual market value.
2. The liquidation value method reflects the value assigned to a business in order to satisfy its creditor claims. This method is often used if a business is undergoing financial difficulties and values different assets in different ways. Tangible assets such as real estate would be given a value close to their current market value, whereas assets like inventory or accounts receivable would be valued at their net realizable value, which can often be less than their book cost. The value is then the difference between this distressed value of assets and book value of liabilities.
Earnings and Cash Flow-Based Techniques
Earnings and cash flow approaches determine a business’ value based on an ongoing anticipated stream of future earnings or cash flows.
1. The discounted cash flow method makes predictions on future cash flows and then adjusts
for the investor’s risk at a “discount rate” that reflects the investor’s risk tolerance level and the
wait time involved for a return to arrive at the value for the business. The accuracy of this method depends on the preciseness of the cash flow projections and discount rate being used. Unlike other methods, this particular technique takes into consideration the unsteady pattern of revenue over a period of time.
2. The going-concern value methodwill calculate value based on the company’s capacity to produce streams of cash flow in the future. The higher these future expected projections are, the greater the business’s value today. The current investment is compared to future cash inflows based on revenues from previous years to make projections about future revenues assuming they will not change over time.
Comparable Business Technique
This approach attempts to establish a range in the value of the business by comparing it to similar businesses within your industry that have recently sold. Of course, this method is reliable only if there are a sufficient number of similar businesses within the same industry to compare against and may be inappropriate for specialized businesses.
Other considerations that impact business value
The existence of any minority interest shareholders will impact the business’s overall value and likely result in a discount for prospective buyers on that value compared to a business with only a sole shareholder who is looking to sell. On the other hand, a strategic buyer may be willing to pay a premium if the target company has a complementary product or service, or is more established in a market the buyer is targeting.
Who can provide a formal business valuation?
The Canadian Institute of Chartered Business Valuators (CICBV) is the only professional body that is recognized by Canadian courts to provide formal valuations. Its designated professional members have either the CBV (Chartered Business Valuator) or EEE (Expert en evaluation d’éntreprises) designation and must meet the requirements of the CICBV. Valuations by these certified professionals give credibility to the process undertaken and the actual value that is established.
To determine a value for a business, a professional valuator will look at all the assets and liabilities that contribute to the company’s value, including both tangible assets, such as property or equipment, along with intangible assets, such as patents or trademarks. The valuator will also look at industry trends and standards, and analyze both historic and projected business data in arriving at a formal value.
An official valuation of this kind may be needed whenever there are significant changes that occur within the business which may materially impact the overall value.
Conclusion
Whether you are considering a sale, re-financing, or just looking for some guidance, determining a value for your business is not any easy task. We can help you identify some of the key considerations that may impact the value of your business and provide insights that may give you a better appreciation for the potential value of your business. For a formal valuation, we will be happy to refer you to a qualified individual.
Scotia Wealth Management is an innovative team-based approach to wealth management that addresses the entirety of your life – your family, your business, your future – one facet at a time. Together, our Scotia Wealth Management specialists bring their skills and expertise to the consideration of what you’ve accumulated – and how best to administer it through life’s changes. From financial counsel on managing your wealth to the careful contemplation of how to transfer it to future generations.
The value I bring to you is my team of specialists within Scotia Wealth Management. These specialists can provide counsel in the areas of Private Banking, Tax Advisory, Family & Business Advisory, Trust & Philanthropic Advisory, Will & Estate Planning, Risk & Insurance, and Investment Management.
My “team of experts” & I will work together to develop solutions for your issues and challenges. We work for one goal.. your family’s financial goals.
Advice, expertise, and solutions to manage your family’s wealth.
Solutions beyond investment advice!
Jim Eng, Wealth Advisor, Scotia Wealth Management
204-946-9207 | 1-800-324-0266
