How Should Redundant Assets be Treated in a Business Valuation?

Posted on July 18th, 2023 in Business Valuations

Assets owned by an operating company can be divided into three broad categories in a business valuation:

1. Tangible assets (i.e., assets that have a physical substance) required for day-to-day operations of the business;
2. Goodwill and intangible assets such as patents, tradenames/ brands, or customer lists which do not appear on the balance sheet unless they have been acquired in a transaction; and
3. Redundant assets which are typically physical assets not required by a business for ongoing operations.

In a business valuation, tangible assets, goodwill, and intangible assets usually form part of the going concern value, which is the value of a business enterprise that is expected to continue to operate into the future.

However, redundant assets do not form part of the going concern value as they are not required for operations. A potential buyer considering purchasing a business would only be interested in purchasing the assets that are used by the business to generate operating income. Therefore, redundant assets are not included in the value of the business operations. Instead, the value of redundant assets are added in addition to the value of the business operations to determine the fair market value of the en bloc share value or equity value of the business.

Examples of typical redundant assets:

• Excess working capital
• Marketable securities
• Due from shareholder/related companies
• Personal assets (i.e., artwork, vehicles, etc.)
• Real estate
• Life insurance policies

Redundant liabilities

Redundant assets increase the en bloc share value of the corporation. Conversely, redundant liabilities are items that reduce the en bloc share value of the corporate and can include non-operating loans such as loans to purchase a personal vehicle or due to shareholders/related parties. Identifying redundant assets or liabilities In some situations items that are typically redundant assets may actually be required for operations of the business depending on the nature of the business and its operations. For example, a life insurance policy which is needed as part of a loan covenant/ external lending requirement. As a result, the particular life insurance policy may not be considered redundant.

Real estate as a redundant asset

Generally, when a company does not directly rely on its real estate (i.e., land and building) to generate its revenue, real estate is often considered redundant. However, consideration must be given to the business industry and availability of rental space for operations, among other factors.

In a notional business valuation situation, businesses with real estate typically engage the services of a professional real estate appraiser to determine the fair market value of the property. In addition, when assessing the value of a business using the income approach, an adjustment to normalized cash flow should be made for the amount that would need to be paid if the operating space was rented at market rates from a third party.

Excess working capital

Working capital, (i.e., accounts receivable, prepaid expenses, inventory, less accounts payable) is the amount required to keep operations running and meet short-term daily obligations. If a business does not have sufficient working capital, it may require additional funding/investment to operate. Therefore determining the required level of normal working capital is essential and involves a review of the business, industry ratios, and banking covenants.

Once a required level of working capital is identified, any excess working capital is deemed redundant and removed from the business. During a sale of a business, if there is a deficiency in working capital, a reduction to the transaction price will be made to retain cash in the business. Working capital considerations are discussed in greater depth in our Fall 2022 FSAT Newsletter.

Tax consequences

In a disposal of redundant assets (often during an asset purchase of a business), disposal cost and tax consequences need to be considered such as taxable capital gains/losses, recapture/terminal loss, and income taxes. When a notional business valuation is prepared, the tax consequences are also considered, but may require some discount to account for the fact that the redundant assets will likely be sold at some point in the future, and not at the valuation date.

Conclusion

Proper identification of redundant assets/liabilities and determining an appropriate level of working capital are some important factors in determining an accurate value of a business.

If you would like more information on the topic or assistance in determining the value of your business, please contact our valuation specialists.