October 1999 volume 3, issue 3 

When calculating the value of a company in today’s marketplace, the sum of the whole often differs from the sum of its parts. Simply put, the numbers on a balance sheet may reflect what an owner has put into a company, but they don’t necessarily reflect that company’s true value.

This is where a business valuation can prove useful, providing you with a reliable indicator of your company’s current worth. Specifically, a valuation report helps determine the fair market value of your business by carefully analyzing its assets, liabilities and most importantly, its ability to generate future cash flows.

A business valuation is particularly useful when buying or selling a business. When buying a business, for instance, a valuation report can provide you with important information, including pertinent facts about the industry in which the company operates. A valuation report should also provide a strong indication of how much you should be willing to pay for the business interest.

When selling a business, a valuation report can assist you in setting an asking price, and provide insight into what potential purchasers look for when assessing value. In doing so, a business valuation can help to increase the perceived value of your business.

With the recent trend toward consolidation in many industries, there is an increasing possibility that owners of small to medium sized businesses will be approached to sell their interest. If and when this happens, a business valuation can help ensure that you receive the highest price available for your investment.

A valuation report can also be an extremely important tool when planning for the intergenerational transfer of a business. When an interest in a business is passed on to a family member (other than a spouse), either by gift or at death, the Canada Customs and Revenue Agency deems the transferor to have sold the asset at fair market value; this approach can result in a significant tax liability, even though an actual sale has not occurred. By determining the current value of the business interest, it’s possible to estimate the ultimate tax liability. This allows the owner to make appropriate plans to fund the payment, ensuring that they and their heirs are not burdened by an unexpected obligation to the Canada Customs and Revenue Agency.

In cases where a company requires additional capital, a business valuation can provide potential investors and lenders with invaluable information to assist them in their investment decision. In addition, valuation reports may also be required for matrimonial litigation; estimating losses for insurance purposes; valuations under shareholder agreements; financing negotiations; and in asset expropriation situations.

When it comes to determining the value of a business interest, the method of calculation will depend on the nature of the company. If the business is a holding company, assets — such as real estate and securities — are reflected at their current market values, less disposal costs and taxes that would be paid on a disposition at the valuation date.

Operating companies present more of a challenge, however, since their value hinges on their ability to generate future cash flows. The value of the business ultimately depends on the future cash flows it is expected to generate, discounted at a rate of return that reflects the risk associated with those cash flows, relative to other investments available on the market. By projecting cash flow, a business owner can determine what his or her company is worth at a particular point in time.

Understanding what is involved in a business valuation and when it may be required is useful for any business owner. Most importantly, a business valuation provides an independent opinion of a company’s value, and allows owner managers to better plan for their future and the future of their business.