Why Knowing the Purpose of the Valuation Engagement is Important

Why Knowing the Purpose of the Valuation Engagement is Important

Before starting down the path of valuing your business, it is important for the client and business valuator to have a good understanding of why the business is being valued. There are many reason why you may need to determine the value of your business. Some of the more common examples of why you may need your business valued are: marital dissolution, litigation and ownership disputes, buy/sell agreements, business planning and estate, gift and tax planning purposes.

There are potentially different users of a valuation report, including:  company shareholders, potential purchasers, the Courts and the Canada Revenue Agency (CRA)

A valuation report prepared for one purpose is not necessarily appropriate for another purpose. The purpose for which the valuation report was prepared can have a significant impact on the determined value and whether or not it will be accepted by the users of the report.

Understanding the purpose of the valuation report will, amongst other things, help you determine:

The Valuation Date:

The underlying concept of value is that value is determined as at a point in time.  The purpose of the valuation will have an impact on the valuation date.

The valuation date for family law purposes will usually be the date of separation, while the date of valuation for business planning can be any date the business owner chooses. If a business owner determines the value of his/her business as of December 31, 2018 he/she may not be able to use this valuation report for family law purposes, where the date of separation maybe October 20, 2016.

Typically, CRA will not accept a valuation report with the valuation date greater than one year old as value can change significantly over time.

The Need for Valuation Analyst to be Independent:

If the valuation is for business planning purposes and the valuation analyst is serving as an advisor to the business owner, the valuation analyst may not be considered independent and therefore, the report being issued would be considered an Advisory Report not a “Valuation Report”.

An Advisory Report is not considered a valuation report by CRA, the Courts or under the standards of the Canadian Institute of Chartered Business Valuators. These governing authorities require the valuation analyst to be independent for the report to be considered a valuation report. Therefore, the Advisory Report would not be acceptable for family law purposes, CRA purposes or for litigation purposes.

The Standard or Definition of Value:

Relying on the wrong standard of value can result in very different values. A valuation report prepared for income tax purposes would use the fair market value (“FMV”) standard of value. However, a report prepared for shareholder oppression purposes would rely on the fair value standard. The fair value standard, typically, does not allow the application of discounts for lack of control, while FMV typically does.

Determining value for shareholder oppression purposes using FMV as the standard of value could possibly result in the dismissal, by the Courts, of the value determined in that valuation report altogether.

Type of Valuation Report:

 In Canada there are three recognized types of valuation reports. The reports are distinguished by the scope of review and analysis, the amount of disclosure and the level of assurance.

The Comprehensive Valuation Report provides the highest level of assurance and can be compared to the Audit Report for financial reporting purposes. This report is used where there are going to be a significant number of users relying on the report and or the reason for the valuation is due to a contentious litigation matter.

The Estimate Valuation Report provides a level of assurance that is less than the Comprehensive Report and is equivalent to the Review Engagement Report for financial reporting purposes. This report is used where there is going to be reliance on the report, but the added cost and assurance of a comprehensive report is not warranted.

The Calculation Valuation Report provides the lowest level of assurance and is equivalent to a Compilation Report for financial reporting purposes. This report is typically used for planning purposes or for making preliminary interim assessments in an extended matter. However, we have seen this type of report being accepted for Family Law and CRA purposes.

Due to the scope of analysis and review the value determined by a Calculation Valuation Report may be different than the value determined by an Estimate Valuation Report and a Comprehensive Valuation Report. The report may not be accepted by some or all of the users.

Valuation Discounts:

Is the interest being valued a controlling interest or a minority interest?

Typically, when a valuation is prepared for litigation purposes, where the fair value (not fair market value purposes) standard is used, a discount for lack of control is not applied. If a valuation is done for CRA purposes and the related transaction is non-arm’s length CRA may not allow a discount for lack of control. Whereas, for other non-court or CRA valuations, a discount may be appropriate.

The application of a discount for lack of control will usually have a significant impact on value.

Conclusion:

As shown above, the purpose of the valuation report can have a significant impact on the determined value and whether or not it will be accepted by the users of the report. Therefore, preparing a valuation report for one purpose and using it for another can be costly to the owner of a business. Accordingly, all the items discussed above should be understood before the engagement starts and summarized as part of the Engagement Letter.