Quick Read: What “Value” Needs To Be Determined?

One of the first issues to consider in any valuation assignment is what “value” term is to be utilized. Some of the options include:

• Book Value;
• Depreciated Replacement Value;
• Fair Market Value;
• Fair Value;
• Going Concern Value;
• Liquidation Value (orderly or force);
• Net Book Value;
• Value in Use; and
• Value to Owner.

There are also other value terms that have not been listed above.

Fair Market Value (“FMV”) is possibly the most common value term that is utilized. It is found in number places in the Income Tax Act (for example, to determine notional proceeds on deem disposition on death, to determine the value of preference shares in cases of estate freezes, etc.) and is generally applicable for the Family Law Act of Ontario (to determine the value of business interests in calculating a spouse’s net family property in marriage dissolution), but not in all cases.

 The generally accepted definition of FMV is as follows:

  “The highest price available in an open and unrestricted market between informed and prudent parties, acting at arms length and under no compulsion to act.”

The FMV definition above contemplates a theoretical price that could be obtained from a notional purchaser under certain assumptions, as follows:

• Transaction occurs in an open and unrestricted market;
• Parties are under no compulsion to act;
• There is a willing and rational pool of potential purchasers; and
• All relevant information is available.

The FMV of non-controlling interests are generally less than the corresponding pro-rata share of ‘en bloc’ FMV. In simple English, a 10% shareholding in a corporation with FMV of $100 is often less than $10. The appropriateness and quantification of such minority and liquidity discounts (or in some rare cases, a control premium or premium for forceable taking) is a complex and case-driven determination and would be the subject of a separate Quick Read.

In our experience in oppression and appraisal remedy cases, “Fair Value” is the appropriate value term. which is typically interpreted to mean the ratable portion of ‘en bloc’ fair market value applicable to an individual shareholding (i.e. without the application of any discounts or premiums).

Certain assets may have a FMV of $nil but still have value to their owner. Examples include discretionary trust interest (capital, income or both) and employee equity rewards (employee stock options, RSUs, PSUs, etc.; whether vested or not). In these examples, a particular asset may have a $nil FMV because these interests are not transferrable to any potential purchaser.

Unlike the Income Tax Act which specifies FMV in numerous places, the Family Law Act, Ontario uses the term “value” in assessing a spouse’s net family property. In our experience, where the FMV is $nil because of transferability issues, “value to owner” can be an appropriate approach. Value to owner is generally determined to be the price an individual would pay not to be deprived of the ownership of an asset or assets.

Many years ago, a highly regarded family law lawyer analogized value to owner to the story of a goose that laid golden eggs. Imagine a farmer that had a goose that would lay golden eggs but only for that specific farmer. The FMV of the goose would be nominal but there would be significant value to the farmer (i.e. value to owner).

Other value terms such as replacement value, depreciated replacement value and value in use generally fall into equipment appraisers or other appraisal expert’s area of expertise. Business valuators generally deal with FMV, Fair Value and Value to Owner. Which value term is appropriate should be discussed at the onset of any valuation assignment along with other considerations such as the valuation date, type of report required and any restrictions or limitation on available information (i.e. scope limitations).

If you or your colleagues have any business valuation questions, it would be our pleasure to speak with you and assist you in any way we can. For more information, please contact Wayne B. Rudson, CPA, CA·IFA/CBV, ASA, CFE ([email protected]) or Vincent Lam, CBV, MAcc ([email protected]) at 416-598-4500.