Canada: What Is My Business Worth?

Last Updated: September 18 2012
Article by Dennis Leung

When determining the value of a business, an assessment must be made as to whether the premise of value should be based on a going concern approach or a liquidation approach. A going concern approach is generally adopted when the business being valued is deemed to be economically viable. Where a business is forecast to generate minimal or negative operating cash flow for an extended period of time, a liquidation approach may be warranted.

While there are several methodologies to determine value under a going concern approach, the most common methods are the capitalized cash flow methodology, the discounted cash flow methodology and the multiple of EBITDA methodology. Under the liquidation approach, value is determined based on the net realizable value of the business' net assets (assets less liabilities). We discuss each of the approaches below.

CAPITALIZED CASH FLOW METHODOLOGY

Under the capitalized cash flow methodology, an estimated range of maintainable discretionary after tax cash flow is "capitalized" by a rate of return. Adjustments are then made for the present value of existing tax pools, redundant assets, and outstanding interest bearing debt and equivalents to derive the en bloc equity value of the shares of a business. This methodology inherently assumes that the business will generate relatively stable discretionary cash flows into perpetuity. As such, the capitalized cash flow methodology is generally applied to:

  • a mature business with relatively consistent discretionary cash flows;
  • a business where the average discretionary cash flows through business cycles can be reasonably estimated. In situations where the average discretionary cash flows cannot be reasonably estimated into perpetuity, the discounted cash flow approach may be more appropriate to determine the value of a business (discussed below); and
  • a reliable cash flow forecast is not available.

The primary components of the capitalized cash flow methodology are discussed below.

Maintainable Discretionary After-Tax Cash Flow

To determine the maintainable discretionary after-tax cash flow, the estimated range of maintainable cash flow from operations, normally defined as earnings before interest, income taxes, depreciation and amortization ("EBITDA") is determined. The estimate is generally based on an analysis of historical, current, and when available, projected results, as well as the company, industry and economic factors that may impact a business' ability to generated cash flow in the future. Income taxes at the prevailing tax rate are deducted, along with the sustaining capital reinvestment, which represents the annual cash required to purchase fixed assets in order to sustain the maintainable discretionary after tax cash flow.

Rate of Return

The maintainable discretionary after-tax cash flow is "capitalized" by a rate of return or "capitalization rate" to determine the capitalized discretionary cash flow of a business. The capitalization rate reflects anticipated future discretionary cash flow growth and the perceived level of risk of achieving the estimated maintainable discretionary after-tax cash flow. The perceived level of risk is a function of the prevailing and forecast economic conditions, the nature of the industry, and company-specific factors. Company-specific factors may include customer dependency, supply risk, and reliance on key employees.

En Bloc Fair Market Value under the Capitalized Cash Flow Methodology

To determine the en bloc fair market of the shares of a business, adjustments to the capitalized discretionary cash flow are made for:

  • existing income tax pools, which normally include the undepreciated capital cost of assets utilized by the business at the valuation date and available tax losses, and other prospective tax benefits not accounted for as a component of discretionary cash flows;
  • redundant assets (or non-operating assets), which are assets that are not required by a business to generate the prospective discretionary cash flow;
  • other items not reflected in the capitalized discretionary cash flow. These may include one-time costs or benefits that are not included in the determination of the maintainable discretionary cash flow; and
  • outstanding interest bearing debt and interest bearing debt equivalents. As the interest on outstanding debt is not deducted in the determination of the maintainable discretionary after-tax cash flow it is deducted from the capitalized discretionary cash flow.

DISCOUNTED CASH FLOW METHODOLOGY

The discounted cash flow methodology is in essence an extension of the capitalized cash flow methodology. The primary difference is that the capitalized cash flow is based on one annual maintainable discretionary cash flow amount and assumes that the annual discretionary cash flow remains at the same level into perpetuity. The discounted cash flow adopts a forecast of the prospective discretionary cash flow a business is expected to generate over a period of time (generally three to five years). The forecast cash flows are discounted by a rate of return to determine the net present value of the forecast discretionary after-tax cash flow. Beyond the forecast period, an estimate is then made of the value of the annual maintainable discretionary cash flows, which is capitalized to determine the terminal value and then discounted to the valuation date to reflect the net present value. The discounted cash flow methodology is generally applied in situations where a reasonable forecast has been prepared.

The primary components of the discounted cash flow methodology are discussed below.

Present Value of the Annual Discretionary Cash Flow during the Forecast Period

To determine the present value of the annual discretionary cash flow, the annual prospective cash flow from operations (EBITDA) is estimated, generally for a three to five year period (the "Forecast Period"). Income taxes at applicable rates and the capital investment requirements are deducted over the Forecast Period. Adjustments are then made for incremental net trade working capital requirements. The annual prospective cash flow after deducting income taxes and the capital investment requirements and adjusting for incremental net trade working capital requirements result in the forecast annual discretionary cash flow.

The forecast annual discretionary cash flow is discounted to a present value amount using a discount rate. The discount rate reflects the risk of achieving the projected annual discretionary cash flow during the Forecast Period, and takes into consideration the prospective economic conditions, the outlook of the industry that the business operates in and company-specific factors.

Terminal Value

The terminal value is calculated by estimating the annual maintainable discretionary cash flow beyond the Forecast Period, then dividing it by a capitalization rate (similar to the capitalized cash flow methodology). The terminal value is discounted to its present value using the discount rate applied to the annual discretionary cash flow over the Forecast Period

En Bloc Fair Market Value under the Discounted Cash Flow Methodology

The en bloc fair market of the shares of a business under the discounted cash flow methodology is the sum of the present value of the annual discretionary cash flow during the forecast period and the terminal value. This results in the net present value of all prospective discretionary cash flow. Existing income tax pools and redundant assets are added and outstanding interest bearing debt and debt equivalents are deducted from the net present value of all prospective discretionary cash flow to determine the en bloc fair market value of the shares of a business.

MULTIPLE OF EBITDA METHODOGY

Under the multiple of EBITDA methodology, an estimated maintainable EBITDA is multiplied by an EBITDA multiple to derive an enterprise value. Redundant assets are added and outstanding interest bearing debt and debt equivalents are deducted from the enterprise value to determine the en bloc fair market value of the shares of a business.

This methodology does not specifically address the valuation implications of income taxes and capital expenditure requirements, both of which are considered in the capitalized cash flow methodology and the discounted cash flow methodology. As such, while the multiple of EBITDA methodology is frequently utilized, it is fraught with challenges if it is not properly applied.

LIQUIDATION VALUE BASIS

When it is determined that a business is not viable as a going concern, value is typically determined on a liquidation value basis. This methodology may also be appropriate in the infrequent circumstance where the expected liquidation value exceeds the en bloc fair market value of a business. Liquidation value is calculated as the net realizable value of each asset, net of disposition costs (i.e. sales commission), less the fair market value of liabilities and all liquidation related costs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
PwC Management Services LP
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
PwC Management Services LP
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions