cando 23rd annual national conference a guide to ...audit | tax | advisory 44 impact of shareholder...

www.crowemackay.caAudit | Tax | Advisory

CANDO 23rd Annual National Conference

A Guide to Business Valuation. What’s it worth?

by Hugh G. Livingstone CPA, CGA, CBV

October 6, 2016

2Audit | Tax | Advisory

Introduction of Crowe MacKay LLP

Iain MacKay started the firm in Whitehorse in 1969

Almost 50 years of experience and relationships in

the North

Offices in Whitehorse, Yellowknife, Edmonton,

Calgary, Regina, Kelowna, Surrey and Vancouver

Associated with Crowe International for cross-

border work


Practice areas of Crowe MacKay LLP

Accounting

Auditing

Tax compliance and planning

Forensic auditing, restructuring and insolvency

Business valuations

Litigation support


Aboriginal services provided by Crowe MacKay LLP

Working with First Nation, Inuit and Métis communities for

over 40 years

Financial reporting

Training

Governance

Economic development

Management support

Internal control review

Bookkeeping services


Introduction of Hugh

Born in Vancouver

White Pass railway connection

Coming to Whitehorse for 30 years


Introduction of Hugh cont’d.

Fished on the Teslin river near Johnson's Crossing

Fished Little Atlin lake

Fished on the Nakina river


Introduction of Hugh cont’d.

Professionally a Chartered Business Valuator

Done numerous business valuations in the north

(hotels, stores, mills, bulk fuel distribution, airlines)

Taught local lesson early re Air North vs. Air

Canada

Mostly for purchase or sale of business, some

redemption of shares


Today’s presentation

What is a business valuation?

When do you need valuation services?

Why choose a Chartered Business Valuator

(C.B.V.)?

Professional standards

Valuation principles

Valuation definitions


Today’s presentation cont’d.

Valuation approaches

Capitalized earnings example

EBITDA multiples

Pitfalls

Impact of shareholders agreements

Income taxes

What to look for when acquiring a business


What is a business valuation?

A business valuation is an independent examination

towards rendering an estimate or opinion of the value

of either the shares or assets of a business, at a

given point in time.

Vendor’s preference for share transaction

Buyer’s preference for asset purchase


When do you need valuation services?

Buying or selling businesses

Shareholder disputes

Business interruption claims

Corporate reorganizations

Information to stakeholders

Financing


Why choose a Chartered Business Valuator (C.B.V.)?

The Canadian Institute of Chartered Business Valuators is the

only recognized professional valuation organization in Canada.

Chartered Business Valuators are fully qualified to serve as

independent expert witnesses when valuation matters arise

before courts, security commissions or other regulatory

bodies.

www.cicbv.ca


Professional standards

Types of financial statements

• Audit

• Review

• Compilation (Notice to Reader) – “GIGO”

} useful to valuator


Professional standards cont’d.

Types of valuation reports

• Comprehensive Report (highest assurance)

• Financing larger acquisitions

− Real estate appraisals

− Environmental reports

− Market studies

− Borrowing > $1,000,000

− Reliance on audits


Professional standards cont’d.

Types of valuation reports cont’d.

• Estimate Report

• Calculation Report (lowest assurance)

• No reports or studies

• Reliance on compilations

• Borrowing < $50,000


Valuation principles

1. Value is determined at a point in time

2. Valuation is forward looking

3. The market dictates the appropriate rate of return

4. Higher tangible asset value supports higher going concern

value

5. Not all value is transferable

6. Higher liquidity = higher value

7. Minority interest less than pro-rata value


Fair Market Value

The highest price available in an open and

unrestricted market between informed and prudent

parties, acting at arm’s length and under no

compulsion to act, expressed in terms of cash or

cash equivalents.”(This definition of fair market

value relates to a notional marketplace)

Fair market value is generally expressed in a

range


Fair Value

A definition held by the Courts to mean fair market

value without the application of a minority

discount.

Oppression remedies

Value to Owner

Community building


Minority Discounts

Discount applicable due to lack of control

A 40% shareholder is unable to elect a majority of the

Board of Directors

A 5% shareholder is unable to block a special

resolution

Corporate legislation does provide some relief

Articles of incorporation

Shareholder agreements

Restrictions on transfer of shares


Price

The price at which a transaction occurs. Price is

influenced by:

Relative negotiating strengths

Desire to “do the deal”

Community or social issues

Access to information

Deep pockets vs. need for cash

Vendor take-backs


Goodwill and Tangible Asset Backing

Goodwill

Commercial vs. personal

Key man

Assessment of management

Tangible Asset Backing

The fair market value of net tangible and identifiable

intangible assets (includes patents or royalties, but not

goodwill) used in the business.

Down-side risk


Special Purchasers

Possible economies of scale

Strategic fit

Vertical or horizontal synergies

Reduced competition

Experienced management


Special Purchasers cont’d.

New customers and/or sources of supply

Acquisition of existing facilities rather than having

to build new facilities

Desired result: 1 + 1 = >2

Community or social issues


Redundant Assets and EBITDA

Redundant assets are assets that are not required

in the business, e.g. raw land, excess cash

Land used in business treated as a redundant

asset

EBITDA (Earnings before Interest, Taxes,

Depreciation and Amortization)


Going Concern?

NO YES

Liquidation

approaches

Going

Concern

approaches


Liquidation approaches

Orderly

Liquidation

Forced

Liquidation


Going Concern approaches

Net

Assets-Based

approach

(no goodwill)

Capitalized

Earnings or

Cash Flows

approach

(goodwill likely)


Valuation approaches

Going Concern approaches

Capitalized Earnings

Capitalized Cash Flow

Discounted Cash Flow

Market Comparables

Rules of Thumb

Net Assets Based Method; no goodwill


An earnings approach to value

Maintainable earnings from operations

x

Price/Earning Multiple

=

Going concern value of operations

+

Redundant assets

=

Fair market value of the shares


Capitalized Earnings Approach

Balance sheet of target company

(000’s) (000’s)

Cash $ 500 Payables $ 200

Receivables 300 Bank loan 800

Trucks 1,000 Equipment loan 300

Licenses 500 Equity 1,000

$ 2,300 $ 2,300


Tangible Asset Backing

(000’s) (000’s)

Equity per financial statements (book value) $ 1,000

Adjust: FMV of licenses $ 700

Book value of licenses 500

Excess 200

Tangible asset backing $ 1,200

(fair market value of operating assets)

Capitalized Earnings Approach cont’d.



Income statement analysis 2016 2015 2014

(000’s) (000’s) (000’s)

Net income (loss) per f/s (five years) $ 300 $ 210 $(280)

Adjustments:

- spouse’s salary 50 50 40

- bonus to owner 150 80 -

- loss from discontinued operations - - 350

- income taxes (recovery) 40 30 (40)

Adjustable earnings before taxes $ 540 $ 370 $ 70

Maintainable earnings before taxes $ 500

Capital replacement -

Income taxes 100

Maintainable earnings from operations $ 400



(Multiple is the inverse of the rate of return required for the RISK of the cash flows)

Factors considered in multiplier:

Size of business

Nature of industry

Market position

Growth prospects

Long-term contracts

Value of operating assets

Many others…..



LOW HIGH

(000’s) (000’s)

Maintainable earnings from operations $ 400 $ 400

Earnings multiplier (25%; 20% return) 4 5

Capitalized earnings 1,600 2,000

Tax shield on existing assets 50 50

Going-concern value of operations 1,650 2,050

Redundant assets - -

Leverage adjustment - -

Estimated fair market value $ 1,650 $ 2,050



Goodwill

NOTE:

Goodwill is 1.1 – 2.1 times maintainable earnings from operations.

LOW HIGH

(000’s) (000’s)

Going concern value of operations $ 1,650 $ 2,050

Less tangible asset backing 1,200 1,200

Goodwill $ 450 $ 850


Capitalized Earnings approach using

EBITDA

(000’s)

Maintainable earnings from operations $ 400

Add: Interest 55

Taxes 100

Depreciation and amortization 15

EBITDA $ 570


Capitalized Earnings approach using

EBITDA cont’d.

(000’s) (000’s)

EBITDA $ 570 $ 570

EBITDA multiple 5 6

Enterprise value 2,850 3,420

Less: debt 1,100 1,100

Equity value $ 1,750 $ 2,320


Capitalized Earnings approach cont’d.

Is the EBITDA real? What’s the impact of errors when

you use a 5 times multiple?

$15,000 of spouse’s car expenses

$50,000 quasi-personal travel

High income to support owner’s lifestyle

Low income for owner’s tax planning


Capitalized Earnings approach cont’d.

Accounting policy that capitalizes small tools of $100,000

Short-term vs. long-term impact of aggressive pricing

Inflate current profits and lose customers long-term

Rent, exchange amount

Treat real estate as if a redundant asset


Pitfalls

Does goodwill make sense?

Banks won’t lend on goodwill because they can’t seize it

and sell it

What could make the goodwill disappear?

Source of supply cut off (vendors, roads)

Are contracts signed?

Relationships without contracts more at risk


Pitfalls cont’d

Does goodwill make sense?

Change in competition

Change in management

Environmental accident


Pitfalls cont’d

Did we identify all redundant assets?

Valuing business or shares?

Did we select the appropriate EBITDA multiples

i.e., rate of return for risk?


Impact of Shareholder Agreements on Value

Third party offers• Restrictions on who can buy the shares

• Right of first refusal

• Tag-along and Drag-along provisions

Shot-gun clauses• Good for “deep-pocket” shareholders

• Agreement should specify process and timing


Impact of Shareholder Agreements on Value cont’d.

Problems with ‘3 times prior year’s earnings’

Often useful to state ‘fair value’

Prefer ‘to be determined by CBV’


Income Taxes

Buying shares vs buying business

Accrued capital gains e.g. real estate

Accrued losses; transferrable?

When will taxes be triggered?


What to look for when acquiring a business

Management team running the business• Will they be replaced?

• Are they happy?

• Are they treated well?

• Engaged employees rarely steal

Ensure long-term arrangements in contractual

form; assess quality of relationships• Suppliers

• Customers

• Management

• Premises


What to look for when acquiring a business cont’d.

Consider environmental issues

Consider accounting records

• Audits vs. compilations

• Number of year end adjustments

Legal issues/structure

Governance issues/structure

Financing issues/structure; consider earn-outs

Consider having vendor remove non-operating assets

Do tax planning early


THANK YOU!

Contact: [email protected]

(604) 697-5238

cando 23rd annual national conference a guide to ...audit | tax | advisory 44 impact of shareholder...

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