What is Value? Part III: Selling a Business - Valuation

Est. Reading: 4 minutes

What is value? This is not an easy question to answer. “An amount, as of goods, services, or money, considered to be a fair and suitable equivalent for something else.” Seems like a reasonable definition, but begs the question “considered fair” by whom?

The first thing that must be understood is that in general, value is wholly subjective. During the course of a transaction, the real skill of a business broker is to make the buyer’s and seller’s value agree. Often the question of goodwill is the hinge on which a deal turns. A set of contacts that has been a goldmine for the vendor may be of dubious use to a purchaser who does not share in the same personal relationships or guarantees that some or all of them will continue to provide the income the goodwill defines.

Asset Class
Business, Business and Property, Commercial
Greater Vancouver
February 24, 2023
Klein Commercial
Acquisition & Disposition, Consulting, Asset Advisory Services

The valuation of business assets is not always easy to gauge; I advise clients where necessary to bring in a professional appraiser; equipment, machinery, inventory, raw materials, and vehicles should all be evaluated by an appraiser, especially in the scenario where these represent a large majority of the assets. There is usually room for flexibility in valuing assets. Most of the time the overall price paid for a business or its assets reflects how eager the parties are to make a deal, not how much each item is worth. The allotments of value to each of the major assets occur after the fact. Obviously, these allocations have tax significance to both parties — but especially to a buyer.

Example: Bob Buyer purchases ‘Power Hot Rods’ from Sue Seller for $100,000. After hiring a business appraisal expert, they agree to allocate the purchase price as follows: $40,000 for inventory, $20,000 for machinery, $10,000 for goodwill and $30,000 for a patent right. This is reported to the Canada Customs and Revenue Agency by both parties when they file their tax returns. In the event either Bob or Sue is audited, they can produce a report from the appraiser backing up their allocations.

Professional appraisals are a good idea — especially if the price of the business purchased is over $100,000. If you are ever audited, the Canada Customs and Revenue Agency (C.C.R.A.) may question the asset valuations. If the numbers are not supportable, the C.C.R.A. can reallocate values. This usually results in your having longer depreciation periods assigned to the assets, which decreases your annual depreciation deductions. You will no doubt get an audit bill for the C.C.R.A.’s efforts.

A buyer and seller should agree on the allocation of the purchase price to the assets as part of negotiating the agreement to purchase the business. Because there is almost always flexibility in valuing assets, the buyer should propose the allocation of purchase price in a way that provides the most tax benefit.

Typically, a buyer will want to allocate as much of the purchase price as possible to assets with the fastest tax write-offs — that is, those with the shortest depreciation periods. If it’s at all realistic, attribute the lion’s share of the price to business equipment. Usually equipment and fixtures can be depreciated over three, five, seven or ten years. Assign smaller values to intangible assets, because they have a longer tax write-off period. Commercial real estate (the buildings only), with the longest depreciation period, also means a long time to write off your costs. If the business has been a loser, you are likely buying its tangible assets only; there won’t be any goodwill or an intangible asset allocation to worry about. The inclusion or purchase of the liabilities/losses of the business can offset future incomes.

Work with a commercial investment specialist who specializes in business brokerage and can thoroughly detail a company’s position. A good business broker who knows the market well provides an understanding not only whether a particular business is a sound investment, but how it compares against other businesses in the same genre and against businesses in other genres.

Business Specialists

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