Canada: 7 Questions You Should Ask A Valuation Expert

Every business owner should engage a Chartered Business Valuator (CBV) because they are professionals specifically trained in the field of valuation. This gives them the skills necessary to appropriately consider all the nuances of your business, including the quantitative and qualitative factors that influence your value. However, it also helps if clients have some understanding of the relevant issues, as this puts them in a better position to get the answers they need. But before you can get those answers, you need to make sure you’re asking the right questions.

Question 1 - How can I adjust my business, so it’s consistent with the way an arm’s length party would run it?

Particularly with small owner-managed businesses, the way businesses are operated isn’t necessarily indicative of how an arm’s length party would run it. With that in mind, you need to consider the impact that might have on your operational results. The adjustments — what we call “normalizations” in the valuation world —  change what a prudent investor would see as the discretionary cash flow that operations can deliver. It’s not just a matter of taking a multiple of your income statement profit. There are many factors that need to be considered to arrive at what a prudent arm’s length investor would be willing to pay for that business.

Question 2 - What’s the difference between an operational asset and a redundant asset?

It’s important that you determine what your various business streams are and the assets related to those operations. Take a manufacturing company that obviously engages in manufacturing industry operations but also owns a building for manufacturing purposes; people commonly think of that building as part of the operations, but in the valuation world that building would likely be seen as a redundant asset. The asset is valued on its own and you end up normalizing the operational cash flow for what an imputed rent would be because, in theory, not every business owner is going to own a building. You need to differentiate between the assets that are actually necessary for operations and those that are not.

Question 3 - Am I over-valuing my operations?

Many businesses have misconceptions about the ways value is attributed. Savvy business owners understand that their business delivers a certain amount of profit, but can easily miss the fact that the building they own offers them savings that might not be available to a future owner. In valuing your business, you have to decrease operational results to allow for the future owner’s rent payments, as mentioned earlier. As well, you need to ensure your efforts in the business are properly represented in an adjusted or notional salary they would otherwise have to pay to a third party to fulfil those duties. You as an owner can potentially over or under value your operations if these and other common issues are not properly considered.

Question 4 - Am I making the appropriate adjustments to determine value?

Besides the adjustments we’ve already discussed, business owners don’t necessarily consider the implied disposition cost of a redundant asset or the tax impact of those redundant assets when selling. You also need to look at the way your business is operated and compare it to industry standards to make sure the appropriate adjustments are made, to determine value that is reflective of an objective operator.

Question 5 - What additional costs will the business’ future owner face?

You need to consider how your business is being operated and how it would be operated in an optimal situation. For example, some business owners take out dividends, rather than a salary, but they obviously do work for the business. If the purchaser has to go and hire somebody to fill those duties this will erode their profit line, which reduces the prospective discretionary cash flow on which value is most often based.

Question 6 - What do my recent financial statements reveal about the future value of my business?

When CBVs do a valuation of a standard owner-managed business, they most often look at the financial statements of the last five years and compare them to the best industry data they can obtain. The history is used as a theoretical measure of the prospects for the future, which is what value is all about. If the history is stable, it can be used to get an idea of what to expect in the future. If the business’ results have been quite sporadic or volatile in the last five years, the future prospects might look unnecessarily grim. Assuming the business is making strategic management changes to stabilize future profit, past performance might not be indicative of what’s to come and the approach to valuing the business is not just a multiple of cash flow anymore.

Question 7 - How can I prevent CRA valuators from getting involved in my business?

When you enter into an engagement with a CBV, your efforts to accurately value your business are documented in a professional capacity. The resulting report is your best defense against CRA interference. If a business does not engage a CBV, it would be difficult to demonstrate that all the qualitative and quantitative factors have been considered and the value determined on an objective, arm’s length basis.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.