Category: 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.

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.

 

When a dispute or litigation arises the people involved will often need to seek the advice of several professionals. While their lawyers will often act as their advocates, other professionals are frequently retained as independent experts. Depending on the nature of the dispute, this type of expert may include psychologists or social workers, medical doctors, real estate appraisers, actuaries, Chartered Business Valuators (CBVs), forensic accountants and economic loss experts.

These experts are expected to assume an objective, neutral and independent role. In matters that proceed to court, the experts will be expected to serve as a neutral expert in order to assist the court. It is important for experts to maintain their independence not only in fact but also in appearance. If a judge believes that an expert has failed to maintain their independence and has assumed the role of an advocate on behalf of the party who hired them, they may either refuse to accept their report and testimony or, if accepted, give it less weight in their decision.

Several years ago, the courts expressed concern about the role of experts and what they felt was an increasing trend for some experts to assume the role of an advocate. This concern led to a requirement for any expert appearing in an Ontario court to sign a form in which they acknowledge that, regardless of which party hired them, they have duty to the court to provide an opinion that is fair, objective, non-partisan and related only to matters that are within their area of expertise. The expert also acknowledges they are required to assist the court and that these duties prevail over any duties or obligations to the party that hired them.

The issue regarding independence was highlighted in a recent court case (Plese v. Herjavec, 2018 ONSC 7749). This case was a matrimonial dispute in which CBVs were retained as independent experts. The judge was critical of the CBV’s retained by each party to value Mr. Herjavec’s business, stating:

“Both valuators signed the requisite acknowledgement of their duties as experts, namely to provide opinion evidence that is fair, objective and non-partisan. As was the case with the real estate appraisers, their opinions squarely align with the interests of the party who retained them. Again, I am astonished that there should be this kind of disparity between them. I wonder if their results would have been the same had they been retained by the other party. This case highlights in very stark fashion the continued problems with expert evidence. Notwithstanding the experts’ clear duties, they nevertheless end up supporting the position of the party who hired them. The changes to the expert rules, and the requirement for experts to acknowledge their duties of independence and impartiality were supposed to solve the problem of experts simply being ‘hired guns’. Sadly, the problem remains. I must therefore approach each expert’s opinion with a certain degree of caution and skepticism.”

When retaining an expert to assist you, it is important for the expert to maintain their independence and to provide a balanced, objective opinion. While it is natural for the party retaining the expert to want that expert to act as their advocate, doing so may ultimately be of limited use as that opinion may be rejected.

An alternative to the ‘traditional’ model of each party hiring their own experts, involves both parties jointly retaining a single expert. Where an expert is jointly retained, both parties are involved throughout the process, both provide their input and raise any questions they have with the jointly retained expert. In our experience, this approach often leads to a better exchange of information and is less costly than each party retaining separate experts. This approach is used extensively in matrimonial disputes for which the parties agree to and follow a collaborative model. Under the collaborative model, the parties agree to work with their lawyers outside of the court system and to jointly retain any experts that are required to assist them in the collaborative process.

DJB is frequently retained to act as independent experts both by an individual party and on a joint retainer basis. Please contact us if you wish to discuss our role and how we may be able to assist.