10 Steps to Reviewing a Business Valuation Report

Chartered Business Valuators (CBVs) support the business and legal communities in matters which include, but are not necessarily limited to, business valuation, value enhancement, exit planning and litigation support.

 

CBVs are frequently retained as independent experts to provide a business valuation report in situations where there is an immediate need for a valuation.  This could be in the context of an actual transaction (e.g. purchase or sale of a business, financial reporting, shareholder buyout, etc.) or in the context of a legal dispute (e.g. matrimonial, shareholder or commercial dispute).  Business valuators are also a valuable member of a business owner’s succession planning team since a valuation report is useful for tax and estate planning as well as for providing a benchmark for value enhancement initiatives.

 

Business owners and lawyers would benefit from being able to effectively review a business valuation report.  Doing so allows for better communication with the valuator through having a better appreciation for the valuation process.  In addition, being able to question the business valuator regarding key underlying assumptions can provide a business owner or lawyer with more comfort that the valuation conclusions are reasonable and supportable.

 

A survey discussed in CA Magazine showed that 91% of litigators that had retained experts retained them to review opposing expert reports (likely including business valuation reports). [1]  When served with a business valuation report, it is beneficial for litigators (and their clients) to have an effective process for reviewing that business valuation report in an efficient manner.  This helps to identify when it is appropriate to involve an independent valuation expert and enables effective communication with the expert in order to manage costs for the client.

 

The 10 step process for reviewing a valuation report containing a conclusion as to the value of an equity interest in a business (i.e. a controlling interest or minority interest) is summarized below:

Step	Description
1.	Identify the type of valuation report.
2.	Review the author’s credentials and qualifications.
3.	Identify any scope limitations underlying the conclusions.
4.	Identify and assess the valuation approach(es) adopted.
5.	Assess the reasonableness of the projected cash flows and/or historical normalization items.
6.	Assess the reasonableness of the capitalization rate, discount rate or valuation multiplier.
7.	Identify any redundant assets owned by the business as at the Valuation Date.
8.	Ensure income taxes have been properly considered.
9.	Assess the reasonableness of the conclusions, including the implied intangible value.
10.	Retain a CBV for an independent perspective.

This is the general approach I take in reviewing and critiquing another business valuation report.  Follow me over the coming weeks as I explore each of the above noted steps in more detail.

 

If you require an independent business valuation or recognize the importance of having professional valuation advice for your exit planning, contact us at www.vspltd.ca.

 

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[1] Source: http://www.camagazine.com/expertwitnesses/default.aspx.

Preparing for the Unprecedented Transfer of Wealth to Come

Implementing an effective value enhancement program will increase the attractiveness of your business to a potential purchaser and provide a significant return on your investment.  Implementation, however, is the key.  Many business owners appreciate the importance of a good action plan, but successful business owners excel at implementing the action plan.

"According to CIBC, an estimated $1.9 trillion in business assets are poised to change hands over the next 5 years, $3.7 trillion over the next 10 years – the biggest transfer of Canadian business control on record." [1] 

The increasing supply of businesses for sale over this time period will create a buyers’ market putting downward pressure on sale prices.  Without the implementation of a proper plan, business owners will find themselves selling for a significant discount to those that come to market prepared.  Your business exit and continuation plan should address, among other things, how to enhance and maximize the value of your business. 

At VSP, we have developed a 6-step process that provides business owners with a systematic and effective approach to increasing the value and salability of their business.  It is, however, a process and it does take time.  Therefore, it is vital to begin the process at least 3 to 5 years prior to the intended exit.  The 6 steps are as follows:

	Value Enhancement Step	Description
1.	Benchmark business valuation	-  Independent baseline valuation -  Potential purchaser perspective -  Meeting to discuss valuation
2.	Detailed value driver analysis	-  Complete Sellability Score questionnaire -  Detailed management interview -  Value factor analysis
3.	Prioritize the key value drivers	-  Each value factor is rated in terms of its relevance and impact -  Identify top 5 key value drivers -  Meeting to discuss key value drivers
4.	Develop action plan	-  Strategic planning session to identify goals and brainstorm obstacles -  Identify strategies to overcome obstacles
5.	Implement, monitor and follow-up	-  Assign tasks and responsibilities to key individuals -  Develop short-term targets/objectives -  Quarterly meetings to monitor progress
6.	Updated business valuation	-  Updated business valuation to measure progress

Steps 1 to 4 can be completed within a very short period of time.  The implementation under Step 5 will vary depending on the owner’s time horizon.  Step 5, however, is the crucial step as it is the ongoing quarterly meetings that ensure the implementation of the action plan.
 

To illustrate the significant return on investment of an effective value enhancement program, let’s consider a business with revenues of $4.0 million and after-tax cash flow (pre-debt service costs) of $400,000.  With a current multiplier of 4.0 times (i.e. 25% capitalization rate), this would imply an enterprise value of $1.6 million (i.e. $400,000 x 4.0 times).
 

Now let’s assume that the business invests $40,000 in professional fees over a two year period (i.e. $20,000 per year, or 5% of annual after-tax cash flow) towards the above noted value enhancement activities.  Let’s also conservatively assume that the value enhancement program leads to an increase in the valuation multiple from 4.0 to 4.5 times (which does not take into consideration any increase in value associated with an increase in annual cash flow or a decrease in the outstanding debt).  The enterprise value of the business has increased to $1.8 million (i.e. $400,000 x 4.5 times), or an increase of $200,000.
 

With an investment of $40,000 over a two year period and an increase in business value of $200,000, this represents a return of 500%.
 

You may not be looking to exit your business in the coming year.  However, if you are planning your exit within the coming decade (i.e. alongside over 500,000 other business owners in Canada) and would like to maximize the price you receive, you must begin your planning now.  Contact us at www.vspltd.ca to help develop a targeted value enhancement program and work with you to ensure a successful implementation.

 

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1.  Ottawa Citizen, November 13, 2012. 

 

Enhance Value, Manage Wealth, Avoid Costly Legal Disputes

This past week I presented to a group of business owners on the importance of having a professional business valuation.  In addition to many situations where an independent business valuation is required (e.g. estate freeze, shareholder or matrimonial dispute litigation, purchase or sale of business, etc.), a business valuation can also be a very powerful planning tool.

 

Speaking as a professional business valuator, obviously I am biased.  However, you will find that others agree, as evidenced by the following:  

"It is important to get a professional business valuation, since owners may grossly overestimate or underestimate the value of their business." [1]

"At present, being able to measure the value of the business is a critical aspect of the business succession plan." [2]

"In preparation for the annual update of this blueprint I will arrange for an updated valuation of this business." [3]

All business owners will one day sell or exit their business.  If you want to build a business for a successful transition, you need to start thinking like a potential purchaser.  Getting your business professionally valued can help you think like a potential purchaser.  The top 5 reasons to have your business professionally valued include:

 

 

	Reason	Benefit of Having a Business Valuation
1.	Enhance business value	A valuation provides a benchmark from which to measure value enhancement The valuation process helps to identify key value drivers Documenting the increase in value over time increases a business’ attractiveness, which will help maximize price
2.	Manage shareholder / family wealth	Privately held business value often represents a significant portion of a family’s wealth Cannot manage and protect family wealth without first knowing the value of the family assets (including the business) A valuation prepares the family in the event of receiving an unsolicited offer
3.	Prevent costly legal disputes	Shareholder, matrimonial and tax disputes can be costly, time consuming and emotionally draining Business value is often a major issue in these disputes A professional valuation enables the parties to discuss and agree upon value before potential disagreements arise
4.	Tax and estate planning	A business valuation is required for estate freezes, share reorganizations, deemed dispositions on death, related party transactions, etc. A valuation provides support for the value and acts as insurance for potential disputes with the CRA Price adjustment clauses may be disregarded by CRA if it determines that a reasonable attempt at value was not conducted at the time of transfer
5.	Shareholder life insurance	Shareholders obtain life insurance for income replacement, key person, fund buy/sell clause, fund income taxes on death, etc. A valuation provides third party evidence for ensuring adequate coverage This is turn provides the shareholders with peace of mind and comfort that their families and/or businesses are sufficiently protected

You may not have an immediate need for an independent business valuation, but if you are interested in enhancing business value, managing wealth and avoiding costly legal disputes, an independent valuation is a necessity.  Contact us at www.vspltd.ca to obtain an independent business valuation or to learn more about the valuation process in general.

 

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1.   RBC Business Succession Planning: Your Essential Road Map.

2.   Canadian Federation of Independent Business (CFIB) Research – Survey results on small business succession planning. November 2012.

3.   Question #7 of The Family Blueprint – Every Family’s Business, Tom Deans, PhD. March 2009.

Critiquing an Expert Report: The Final Step – Consult a CBV

You have now completed your review of the expert report on damages by considering:

1. The author’s credentials and qualifications;
2. Any scope limitations in the report;
3. The underlying assumptions;
4. The nature of the conclusion as an opinion or calculation;
5. The damages approach;
6. The damages period;
7. Whether future damages has been appropriately discounted;
8. The contract; and
9. Mitigation.

The final step involves consulting an independent Chartered Business Valuator (CBV). In addition to providing a second opinion, consulting a CBV can provide the following benefits:

1. Receive an independent and objective viewpoint;
2. Specialized knowledge and experience in damage quantification and business valuation;
3. Verbal communication of issues and concerns with the plaintiff’s expert report;
4. Help ascertain the defendant’s potential financial exposure;
5. Assistance with examinations for discovery of the plaintiff;
6. Assistance with quantification of damages in a counterclaim or crossclaim, if applicable;
7. Assistance with cross examination of the opposing expert;
8. The provision of independent expert testimony (e.g. at mediation, arbitration or court) if needed;
9. Preparation of a Limited Critique Report for use at trial, mediation, arbitration or settlement discussions; and
10. Preparation of an independent Expert Report for use at trial, mediation, arbitration or settlement discussions.

According to the Canadian Institute of Chartered Business Valuators (CICBV), a Limited Critique Report is defined as "any written communication containing comments on a report containing a conclusion as to the value of shares, assets or an interest in a business, or a conclusion as to the quantum of financial gain/loss, or any conclusion of a financial nature in the context of litigation or a dispute, that does not itself contain a valuation conclusion or conclusion as to the quantum of financial gain/loss, or any conclusion of a financial nature in the context of litigation or dispute." [1]

 

A Limited Critique Report can be very helpful for identifying weaknesses in the plaintiff’s damages claim, which can help facilitate settlement discussions.  However, if an independent assessment of damages is required, the CBV will have to provide an independent Expert Report.  An Expert Report is defined by the CICBV as "any written communication other than a valuation report, containing a conclusion as to the quantum of financial gain/loss, or any conclusion of a financial nature in the context of litigation or a dispute, prepared by an expert acting independently". [2]

 

If you are acting for the defendant in a breach of contract or other legal dispute and have just been provided with the plaintiff’s expert report on damages, contact us at www.vspltd.ca.  We can help by providing some preliminary comments, a Limited Critique Report, an independent Expert Report or any of the other benefits outlined above.

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1.  CICBV Professional Standard No. 410, 420 and 430 – Limited Critique Reports.
2.  CICBV Professional Standard No. 310, 320 and 330 – Expert Reports.