Valuing a Business

Introduction

Clients often approach us inquiring about what a business valuation entails. Their interest stems from many situations that include: (i) a lender has asked for a valuation to facilitate a loan, (ii) an advisor has requested a valuation as part of a tax planning objective, (iii) a new shareholder of the business is being considered, (iv) the business was approached for a potential acquisition, or (v) a general interest to determine what the business is worth today. Regardless of the reason, we have put together this guide to inform users about how business valuations work.

Context

For this guide, we are referring only to a valuation of a business, consisting of a conclusion as to the value of its shares or a part-interest in the business. Valuations of assets or other parts of a business follow different methodologies and are not discussed here.

Furthermore, we are excluding businesses that are undergoing liquidation or have no alternative but to do so. Like assets and other parts of a business, valuing businesses in a liquidation framework follows a different approach which is only applicable in certain circumstances.

Our walkthrough of a business valuation is written in context of the standards prescribed by the Canadian Institute of Chartered Business Valuators as well as the International Valuation Standards Council. While we aim to cover the most-critical steps, this guide is inherently limited as it is not a comprehensive write-up of those standards.

Common misconceptions

Many shareholders identify “rules-of-thumb” that their peers use to establish a preliminary value for a business. They are often expressed as a multiple of revenue, expenses, assets, number of customers, etc. While rules-of-thumb can sometimes result in a fair approximation of a business’ worth, often they yield large differences from a professionally calculated value.

To explain these differences, we often point to what rules-of-thumb omit. Businesses have unique characteristics such as: (i) real estate that is separate from operations, (ii) investments which are not common in the industry, (iii) shareholder loan balances, (iv) the size and stage of business’ life cycle, and many more specific characteristics. Rules-of-thumb contemplate an “average” business. While rules-of thumb- may be useful tool for a secondary check on a business’ value, they are not sufficiently persuasive for most professional applications.

Approach

Since each business is unique, as is the reason for each valuation, we develop the most appropriate approach to fit your specific circumstances. Some factors that we consider in arriving at the approach include: (i) whether the business is in a mature stage where historical results approximate its long-term potential, (ii) whether the business derives its value mainly from assets or from its operations, (iii) if there have been strategic changes and a forecast will be most-indicative of future performance, (iv) whether the business is capital intensive or not, etc.

The result of these, and other, considerations is the determination of whether your business is most appropriately valued using the asset approach, income approach, or market approach. Often, we consider more than one approach in arriving at our conclusion. While we may focus our work on the most-appropriate approach, we perform a secondary check on our conclusion using an alternate approach.

Once a primary approach is selected, the calculation methodology can be applied.

Methodologies

There are many methodologies available to perform calculations required in arriving at the value of your business. Some examples are: (i) capitalized earnings, (ii) discounted cash flows, (iii) adjusted net book value, and (iv) capitalized cash flows. Each methodology requires us to normalize results that are not indicative of the business’ performance in the normal course. While each methodology is unique in the way that the calculation is performed, the result of each calculation is a range of values for the business.

In completing our calculations, we rely on core finance concepts like the weighted average cost of capital, return on equity, public company multiples, recent transaction multiples, and many other considerations. Similar to the approach selected, we adjust these values to reflect specific characteristics of your business. Our reports, where required, outline the assumptions we used and the unique aspects of your business we considered in performing our calculations.

Taxation

Our firm does not perform our valuation calculations in a vacuum. Tax considerations are key to proper decision-making and to understanding the after-tax value, especially in an acquisition context. Your valuation may have several parts that are tax-effected in order to provide the most meaningful valuation conclusion. Working with our in-house tax experts, we leverage the most current legislation and common law outcomes to ensure that our assumptions on tax outcomes are well-supported.

Concluding on value

Throughout the general framework described above, we work hand-in-hand with clients to ensure that each step is well-understood, supported, and each alternative is sufficiently explored. A thorough valuation captures the key essence of a business, and a collaborative approach is a key strategy in achieving this outcome.

Concluding on value (cont’d)

By the time that we release the final draft of the valuation, we would have had several collaborative sessions with you to obtain information, ask questions, give you an opportunity to provide feedback, and explain our assumptions and logic behind the conclusions reached. Before we finalize the valuation, your team should have a thorough understanding of the process and the reasons behind the conclusions reached.

The valuation report is a professionally prepared valuation performed by a Chartered Business Valuator, and is driven mainly by a bespoke approach to your specific business and care taken to capture the factors and characteristics that drive its value. Your journey through the valuation process will be unique and customized to the nature of your needs and objectives.

Other considerations

It should be noted that valuations can be prepared at three levels of detail: a calculation of value, an estimate of value, and a comprehensive valuation. The differences between each level depend on the level of verification that must be done at each stage of the valuation described above. The level of detail appropriate to you is going to depend on the purpose of the valuation and will be agreed upon before the work is started. For example, if the valuation will be used in a legal proceeding, a comprehensive valuation approach may be appropriate. Conversely, for a “sense-check” of a non-committal offer on your business, a calculation of value may be more appropriate.

Another aspect of each valuation is whether it is prepared independently or not. This is a consideration that will depend on any existing engagements we may have with your business as well as if the valuation is required to be performed independently. While the process described above does not change, the contents of our valuation report are adjusted for the role that we assume. As part of our scoping process, we will determine our role in the context of the purpose and use of the valuation report.

Impact of economic and industry trends

Understanding the influence of broader economic and industry-specific trends is vital in business valuation. These factors can significantly impact a business’s future earnings and risks. For instance, a business in a rapidly growing industry might have a higher valuation due to the potential for increased revenue, while businesses in declining sectors might face lower valuations. Our analysis includes examining industry reports, economic forecasts, and market trends to assess how these elements might affect your business’s valuation. This consideration is especially crucial for businesses sensitive to economic cycles or those operating in volatile markets.

Role of intangible assets

Intangible assets, such as brand reputation, intellectual property, customer relationships, and proprietary technology, often constitute a substantial portion of a business’s value. These assets, though not always easy to quantify, can significantly influence a company’s competitive advantage and earning potential. Our valuation process includes methods to appraise these intangibles, often requiring specialized approaches. We assess the strength, durability, and financial impact of these assets to ensure they are adequately reflected in the overall business valuation.

Valuation for mergers and acquisitions

In the context of mergers and acquisitions (M&A), business valuation takes on additional layers of complexity. Factors like the expected synergies post-acquisition, strategic fit, and potential restructuring costs are considered. Our approach to M&A valuation includes not only assessing the standalone value of the business but also analyzing how its valuation changes when synergies and strategic advantages are considered. We collaborate with you to understand the specific dynamics of the proposed transaction and reflect these in our valuation analysis.

Risk assessment and sensitivity analysis

An integral part of our valuation process involves assessing the various risks associated with your business and conducting sensitivity analyses. This step helps in understanding how changes in key assumptions, such as revenue growth rates, cost structures, or market conditions, could impact the valuation. Our risk assessment includes an analysis of both internal factors, like operational efficiencies, and external factors, such as market competitiveness. Sensitivity analysis provides a range of possible outcomes, giving a more nuanced understanding of the valuation under different scenarios.

Reporting and communication

Our commitment to clarity and transparency extends to how we report and communicate our valuation findings. Our reports are detailed, yet accessible, outlining every step of our valuation process, the methodologies used, and the rationale behind our conclusions. We ensure that our communication is clear, avoiding jargon, and focuses on making the complex aspects of business valuation understandable. Regular meetings and updates are part of our process, ensuring you are well-informed and involved at every stage.

Continuous monitoring and updates

Valuation is not a one-time event but a process that may require updates and revisions as the business and market conditions evolve. Our firm offers continuous monitoring services to ensure that your business valuation remains relevant and accurate over time. This service is particularly useful for long-term strategic planning, ongoing financial reporting, or in rapidly changing industries. We provide periodic updates and may revise our valuations to reflect the latest market conditions, business performance, and strategic changes in your business.