Business Valuations Overview

Horsley & Associates can provide you with the credibility, reports and advice needed to help you successfully achieve your objectives and preferred end results.

With the right information properly presented, clients and their professional advisors are better equipped to make informed decisions.  Our goal is to prepare reports that are easily understood by judges, lawyers, and their clients. This often leads to negotiations and settlement.

The work we complete on your behalf involves skillful research and analysis, and is prepared in accordance with the objectivity, independence and professional standards required to ensure credibility – a critical factor that can help increase the likelihood of a positive outcome.

We have been successfully involved in numerous family law Collaborative Assignments, mediations, arbitrations, and settlement conferences.

Business Valuation Reports vary in length, depth and content according to the degree of assurance required and the complexity of the business and industry.

Business valuation reports are prepared for a broad range of purposes pertaining to numerous industries, professions, partnerships and unincorporated businesses.

  • Family Law
  • Income Tax
  • Shareholder Transactions & Disputes
  • Estates
  • Family Succession
  • Management Buy Outs / Buy Ins
  • Sales of Business Valuations
  • Purchase of Business Valuations

How much do Valuation Reports Cost?

Typically the cost of a valuation report is determined based the estimated hours times an hourly rate.  We have an experienced valuation technician which can reduce the cost of completing a report.  Factors that affect the estimate of hours to complete a valuation report include:

  • Type of engagement – estimate report versus comprehensive report
  • Industry of the business
  • Size and complexity of the business.
  • Volatility of both the business and industry.
  • Quality of the accounting records.
  • The number and complexity of the accounting adjustments necessary to normalize the financial information
  • Level of cooperation received in obtaining data and access to management.

When will I get my Valuation Report?

A typical assignment is completed in about 5 weeks. It takes the client about two weeks to supply information to us and have a management meeting and it takes us about 3-4 weeks to prepare a valuation analysis and report.

If receipt of a valuation report is very urgent, this time can be compressed into client sends us the data in 2-3 days and we complete our report in 5 days to total about 8 days.

The time to complete a report can be lengthened caused by management unavailable to provide data to us, receipt of non-credible data, delay in obtaining real estate appraisals and our identification of unusual accounting or accounting errors that need correcting.

The typical valuation report process can be explained by the following steps;

  1. Meet client to obtain information about business (includes review of financial statements), industry, problems, opportunities, future outlook in order to determine valuation approach, hours budget, fee quote and fee deposit.
  2. Prepare request for information document and obtain data from client, accountant, industry sources, bankers and lawyers.
  3. Input data into business valuation financial model and review.
  4. Perform management interview and business tour and review notes.
  5. Perform Industry and Market Research.
  6. Prepare second request for information based on review of all data received to-date.
  7. Input additional data into business valuation financial model, initial preparation of business valuation report and review.
  8. Touch base with client on preliminary conclusions, facts relied on, what will be necessary assumptions and ask how reliable the assumptions are, identify any additional issues that need resolving.
  9. Preparation of valuation report, schedules to report.
  10. Present draft valuation report to client and obtain letter of representations.
  11. Issue Valuation Report.

How is a Business Valued?

Generally a business valuation will include an assessment of value based on income, market or assets. Within these three approaches there are many difference valuation methods. If it is assumed the business will be sold to any hypothetical buyer then the standard fair market value definition is used. A special purchaser is a buyer of a business that has unique attributes that make the business worth more to them than a buyer without these attributes.

If it is assumed the business will be sold to an identified special purchaser, then a synergy valuation calculation may be appropriate in the circumstances.

Fair Market Value

Fair Market Value is defined by the Canadian Institute of Chartered Business Valuators as:

“the highest price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts”

For family law purposes, the term “value” is undefined under the Family Law Act and while fair market value may be used as an initial guide in valuation calculations, the intended result is a fair value and equitable settlement between spouses.

Adjustments to Financial Statements.

Private companies are often managed to suit the needs of their particular owners and the existing financial statements reflect these needs. As an example, the business owner may pay himself/or spouse a salary based on their personal income tax planning needs and not based on what a third party would earn.

When completing a business valuation analysis it is necessary to interview the owner/management, the accountant and to review the accounting records in order to determine what adjustments are to make the financial statements on a comparable basis to anticipated future operations managed by a new purchaser. These adjustments are referred to as a normalization adjustments.

Normalization adjustments are typically made for five reasons:

  • The expense/revenue is not expected/necessary to be incurred by a new third party owner i.e. discretionary expense (i.e. significant donations in the business not necessary for business operations – i.e. salary to non-working spouse).
  • The expense/revenue is unusual or non-recurring and not expected to repeat itself on a regular basis in the future (one time sale of an investment).
  • The actual expense/revenue is not recorded at the future arm’s length amount and an adjustment is necessary to make actual equal to the future anticipated amount (below market wages to manager in a business).
  • The expense/revenue is related to redundant assets/liabilities that are being removed as part of the valuation calculations and therefore the expense/revenue will not be incurred in future operations. (i.e. Interest income on term deposit, which is a redundant asset that will be removed from the business).
  • There is a new expense/revenue that will be incurred in the future and needs to be added to historic information in order to make them comparable to anticipated future operations. (i.e. costs of new environment reporting not required in the past).

The purpose is to estimate future maintainable cash flow that a purchaser would be acquiring based on all information known and reasonably foreseeable up to the valuation date.

In certain situations, historical financial data is used as a reasonable estimate of future maintainable cash flow. In other circumstances, due to trends or anticipated changes in the future, prospective information (such as financial forecasts) is used as a reasonable estimate of future maintainable cash flow.

Rules of Thumb – Broad Estimates May Miss Big Adjustments

Business managers requiring a ballpark estimate of value for their business will often use rules of thumb such as multiples of revenue, earnings, and assets to estimate the value of a business.

The rule of thumb approach has the advantage of being straightforward, economical to apply and is sometimes useful as a preliminary tool for general planning purposes.

It is important to ask how the rule of thumb developed, by whom, what locations/size of business is it applicable in and what assumptions/adjustments are necessary to make it applicable in the circumstances.

Applying the rule of thumb without understanding the assumptions implicit in the calculations or not adjusting for changes in the market place participants, technology, industry developments, economy or local factors may derive an inaccurate conclusion.

Certain assets, liabilities, synergies, the amount of working capital required by the business, whether outstanding debt needs to be adjusted for or unique risk factors applicable to the business in question might not be considered at all and this may derive an inaccurate conclusion.

CBV’s may use a rule of thumb adjusted for current factors to test the reasonability of conclusions derived from other a more detailed fulsome approach. Normally a prudent business manager would not solely rely on a rule of thumb for a conclusion because of the potential for significant errors as explained above.

Using a rule of thumb may open one’s self to criticism that the valuation was not prepared by a credentialed valuator in accordance with the prerequisite standards of the profession and with the level of rigour and analysis required by prudent business managers or the courts.

Personal Goodwill

Personal goodwill has no commercial value because it is not transferable and therefore is excluded in calculating fair market value.  Some small businesses are in essence an incorporated one person business.  Without the owner, the business would be reduced to its tangible assets and therefore the business should be valued on an asset basis or liquidation basis.  Non-competition clauses are very relevant to businesses where personal relationships with the customers or business knowledge are significant to the continuity of the business.  Using the willing vendor theory hypothesis a valuator can assume normal commercial terms that would be included with a sale such as non-competition agreements and consulting contracts in order to facilitate the sale of the business including goodwill.

Continuity Of The Business

Continuity and certainty of the future revenue stream and business is important and should not be over looked.  Care should be taken that the future business will profitably continue long enough to provide both a return on invested capital and a return of the invested capital.  Changes at competitors, technology, cyclical markets, completion of customer contracts on hand, pending government legislation, new alternative products, etc. could cause an unaware purchaser to pay a going concern value for a short term business opportunity.  A common example is a construction company where there is typically very limited value to the going concern assumption as to valuation.

Redundant Assets/Liabilities

Redundant assets/liabilities are valued separately from the operating business.  A redundant asset by definition is an asset that is not required in the operation of the business.  Therefore, if the owner of that business wished to sell it, he could remove those redundant assets beforehand and not impair the value of the business operations.  Conversely, if he left these redundant assets in the company when he sold out, he would require compensation for these redundant assets over and above what would be received for the business operations.  Redundant assets include, for example, excess cash, term deposits or excess land. An example of a redundant liability would be management bonuses payable.

Valuation Approaches

In valuing a business, there is no single, standard or specific mathematical formula.  The particular approach and the factors to consider will vary in each case.  The two major approaches are the liquidation approach and the going concern approach.

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