In the course of your company’s life cycle, numerous transactions involving share capital may take place. These transactions occur mainly for legal or tax reasons, or as part of a transfer of share ownership. In all cases, it becomes essential or even mandatory to carry out these transactions at the fair market value (“FMV”) of the shares traded. Business valuation is the process by which this fair value is determined.
Business valuation context
Valuation of the fair value of a company’s share capital is required in the following scenarios:
- Opportunity to sell the company: to initiate negotiations with a buyer and determine a selling price that will suit all parties, you first need to know the value of your company’s shares;
- Transferring your business to your children: to properly assess the tax impact of a transfer, you first need to know the fair value of the shares being transferred. What’s more, as related parties, you are required to deal at FMV;
- Shareholder disputes or divorce: the valuation of your business is necessary to buy out the shares of one of your partners or to settle divorce proceedings;
- Tax or estate planning: assessing the fair value of your company’s share capital enables you to foresee the tax impact of future share capital transactions. It can also be used to “freeze” the value of shares when setting up a management company or trust, for example.
Type of assessment report
Depending on a number of factors, the completeness of the assessment report may vary. Here are the main types of report available:
- Share value calculation report: this type of report offers a minimum level of assurance and is the most common type of valuation report. This type of report contains less detail on the company and the market, and is usually suitable for preliminary business valuations, tax purposes or smaller transactions.
- Estimate of share value report: the estimate of share value offers a medium level of assurance and a higher guarantee than the calculation of value. The valuation report is usually used for business acquisitions or larger transactions.
- Comprehensive share value report: this is the most comprehensive type of report, offering the highest level of assurance. Comprehensive reports are much less common, due to their complexity. This report is used more for very large transactions or in litigation.
Business valuation method
Based on the reality of your business, there are three possible valuation methods:
- Asset-based approach: this approach is useful for companies whose value is based more on their assets, such as real estate companies or holding companies. The enterprise value is determined by subtracting the value of liabilities (debts) from the fair value of assets. In some cases, real estate appraisers will be required to determine the fair value of assets. For most companies, the asset approach is used to determine the minimum value you could obtain from a sale of shares.
- Yield-based approach: if your company has been generating profits for many years, or expects to generate profits in the future, this approach will be used. The company’s value is based on the cash flow generated by your business. This approach also takes into account the value of your company’s surplus assets, as well as the value of the debts it has to pay. This method is widely used to determine the value of shares.
- Market approach: this is a corroborative method to ensure that the value obtained is reasonable. Usually, this involves comparing the value of your company with certain ratios and with other recently sold companies, using databases.
Benefits of business valuation
With a business valuation, you’ll be able to :
- Maximize the value of your investment in your company;
- Assessing the value of a company you wish to acquire ;
- Protect you in the event of a dispute, particularly in the event of an audit by the tax authorities;
- Comply with tax laws and requirements;
- Properly record the transaction in your company’s books;
- Settle shareholder disputes more easily or complete your divorce proceedings;
- Assess and allocate the value of your intangible assets.
Over its 30-year history, Amyot Gélinas has developed expertise in business valuation. Our experts can help you calculate the value of your business and guide you through subsequent transactions.
An article by Gustave Legault-Brousseau, CPA Director – Consulting Services
