Business Valuation: an Art and a Science

So you've made the decision.  You realized you will eventually need to transition your business to new ownership and a plan must be in place to protect the wealth you have accumulated for your retirement and family. You lean back and take a big breath before instructing your tax advisor to start the tax planning.    She tells you that she can begin the work just as soon as you advise her how much your business is worth.  Your breath stops short and beads of sweat form on your brow.  How would you know how much your business is worth? 

The good news is your accountant knows a good Chartered Business Valuator (CBV).  Having your business valued is an essential part of your estate and wealth management planning. 

In restructuring your business interests to meet your estate planning needs, your tax advisor will recommend a number of transactions between you, your corporation and members of your family.  Tax legislation requires that all these transactions occur at fair market value. Fair market value is a term defined by common law as the highest price in terms of cash that would be paid by an informed and prudent investor, acting at arm's length, under no compulsion to transact, in an open and unrestricted market.  Essentially, fair market value is a reasonable price that an unrelated person would pay for your business.  A business valuation will help to determine this reasonable value and ensure tax-planning initiatives are appropriate for your overall net worth.

The Canada Revenue Agency (CRA) has increasingly relied on CBVs in assessing valuation issues when reviewing tax-planning initiatives. The CBVs employed by the CRA are bound by the same standards and guidelines as all CBVs.  Having your business valued by a CBV will reduce your risk of a reassessment because the valuation will be prepared using standards and valuation techniques familiar to CRA valuators. 

Many of the transactions included in your estate plan will contain a price adjustment clause.  This clause reduces your exposure to tax and double taxation by retroactively adjusting the value of a transaction if ever reassessed by the CRA.  The CRA will honour a price adjustment clause if certain conditions are met, including the bona fide intention of the parties to transact at fair market value and the determination of fair market value based on a fair and reasonable method.  An independent business valuation helps in this process by:

1. documenting the intention of the parties to transact at fair market value;
2. ensuring the basis of fair market value is fair and reasonable; and
3. ensuring the CRA will understand the valuation approach.

In addition, an independent business valuation prepared by a CBV will ensure that you have done your due diligence with respect to your tax affairs and avoid some of the more adverse income tax consequences that might occur in the absence of a proper valuation. 

In addition to the tax benefits of having your business valued, a valuation can help enhance the value of your business by:

1. giving you an understanding of the considerations and variables that affect value;
2. providing feedback on operational issues;
3. reviewing the efficiency of your business' capital structure;
4. benchmarking your business risks relative to industry standards, and helping to mitigate those risks; and
5. helping to streamline business capital.

The result is that most business owners stand to improve significantly the value of their businesses with the help of a business valuation. Whether an art or a science, business valuation is a key element of an owner's succession and estate plan as well as a very useful operational tool.

Dave Clarke is a senior manager in Collins Barrow's Ottawa member firm.