In this section, CAV has compiled a list of frequently asked questions about business valuation, financing and transaction matters.
The Chartered Business Valuator (“CBV”) designation is the premier credential for professional business valuators and litigation support advisors in Canada. CBVs are financial professionals governed by the Canadian Institute of Chartered Business Valuators (“CICBV”). The benefits of engaging a CBV are that he/she as the appropriate training and experience and must follow the professional standards and Code of Ethics set by the CICBV.
Fair market value is defined as the highest price available in an open and unrestricted market between informed, prudent parties acting at arm’s length, neither party under any obligation to transact, expressed in terms of money or money’s worth. The determination of fair market value is done in the context of a notional market, and therefore it considers conditions specific to the entities in question, industry and economy which may affect the associated profitability and risk of an investment therein. It is important to understand that an arm’s length, third party purchaser may be willing to pay a price other than the fair market value. Only when an asset or business interest is exposed for sale, can the impact on “price” of arm’s length, third party purchaser synergies be quantified. Without exposure to the market, we cannot be certain that the price that would be obtained in the open market would not be different than the fair market value.
The capitalization rate is the rate of return required by a potential purchaser which reflects the risks, opportunities and returns associated with the projected maintainable cash flows. When it is expressed as an absolute number, its inverse is referred to as the multiplier (e.g. 12% rate is equal to a capitalization multiple of 8.3).
Leverage is that amount of debt that a company would reasonably expect to obtain from creditors or investors to maximize returns available to equity investors.
As set out in the Practice Standards of the Institute of Chartered Business Valuators in Canada, there are three types of valuation reports: (a) comprehensive valuation report; (b) estimate valuation report and (c) valuation calculation report. The reports differ on the valuator’s scope of review, the amount of disclosure provided and the level of assurance being provided in the conclusion. A comprehensive valuation report provides the highest assurance and the valuation calculation report provides the lowest.
There are three basic generally-accepted approaches to valuing a business which include the income approach, asset approach and market approach. The value of the business will vary based on the type of company, approach adopted, timing and risk associated with the business, industry, and investment. Valuation requires objectivity and independence. As an independent advisory firm, we offer the accredited valuation expertise, professionalism, and objectivity essential to arrive at an appropriate indication of value.
Banks, lenders and investors will require detailed financial projections which support the business strategies. A common oversight by companies seeking financing is that a complete set of financial statements (i.e. income statement, balance sheet and cash flow statement) should be prepared. Ideally, the financial model will be constructed monthly, allowing investors to assess details of a ramp-up period for revenues and corresponding projected expenses. Without a proforma balance sheet, it is difficult for an investor to assess the working capital requirements of the company, taking into consideration cash constraints during growth stages. Ultimately, investors will look to cash flow to measure their return. Cash flow statements highlight the capital requirements of the business including one-time and ongoing expenditures.
An investor who is contemplating a private transaction will look for a clear course of action for liquidity of their equity investment. Liquidity generally comes through future rounds of financing, initial public offering, and strategic sale. Sources of financing will have different expectations of timelines for liquidity or exit strategies based on their individual and/or corporate risk and return profiles. Investors will look for a well thought out exit strategy for a company in a plan and expect to divest its equity interest within 3 to 7 years.
Investors are looking for management’s passion, ability to execute and ‘investment’ in their business. A proven track record of transforming business ideas into highly successful companies is a key strategic advantage to securing the sought-after capital for growth. A well-rounded and experienced management team will instill confidence in the investor that a return on their investment will be achieved.
A financial advisor will provide the expertise to manage and direct transaction processes and improve the effectiveness of a financial transaction. You can leverage the financial advisor’s expertise to manage the transaction process allowing you to focus on the performance of the business, building business value, and creating a return for all stakeholders. At CAV, we offer our clients the knowledge and transaction expertise to successfully meet your financial objectives.
A financial audit confirms that financial statements prepared by management “fairly” present the financial position of the company at the year-end (subject to materiality) and are prepared in accordance with the relevant accounting standars. It does not analyze every transaction or look for instances of fraud. A forensic audit is not limited by materiality and uses different techniques and approaches. While there may be some overlap (e.g. identification of internal control weaknesses), it is designed to detect fraudulent activity or irregularities.
An income statement shows the company’s performance as a measure of revenues less its expenses, but business owners often complain that despite profits, they have limited “cash”. A company’s cash flows is the most critical component in decision making. It involves a deeper understanding and management of how cash is received and spent in an organization.