For those of you who are working with clients who need business valuations for CRA, Divorce, or other purposes you may or may not know that the only legislation in Canada on Business Valuation comes from the The Income Tax Act and the Canada Revenue Policy Paper on Business Equity Valuations. They refer to different asset classes but they are clear that some asset classes should be given more weight depending upon importance. We believe this means the intangible assets that now make up on average 90% of business value should be considered in proportion to their contribution to company value.
We have a Methodology developed to facilitate the demands of the Income Tax Act as it pertains to the intangible assets. It is called “25 Factors Affecting Business Valuation”
We give each relevant factor a weight or dollar value and this is how we calculate “fair market value”.
The old methods from 1975 are now redundant;
Hard Assets Approach – (This might only represent 10% of a company’s value in 2022)
Income approach – (the multiple many use has no connection to the wealth creation factors)
Market approach (comparable sales) – This would be like relying on data coming out of Venezuela.
- Who interviewed the Seller?
- What was the real reason for the sale?
- Was the price manipulated by an agent who knew the owner’s wife had a serious illness?
- What were the real sale and financing g terms?
- How deeply did they look at the workforce?
- How was the client base measured?
Revenue Canada sets the rules and if your clients valuation has ignored 60% to 90% of the value in the company (intangible assets) the valuation might not do so well on review. When parameters have changed like this precedent can no longer be relied upon.
There are some serious issues with much of the data used in generating “comparable sales” as we noted above.
The 1975 Business Valuation Methodology might be compared to a broken clock; (correct twice a day) but is that the way you want your client to have their business valued?
The weighing of Intangible assets in finding fair market value is reflected in Point 7 in the Tax Act Policy Paper “Depending on the nature of the corporation’s business, certain of the relevant factors may be accorded greater weight. In some businesses, earnings may be the primary determinant of value, while in others it may be asset value. The valuator must consider a different combination of factors in each case in determining fair market value”.
“Certain of the relevant factors may be accorded greater weight.”
This is significant because for the last 15 years or more intangible assets have been by far the largest asset component in the average business. Most reports suggest in the range of 90% today.
Currently business valuators are hoping that precedent will protect their 1975 methods of business valuation. However it is abundantly clear the parameters of the debate have fundamentally shifted. Any good lawyer can easily show a court the chart on the fundamental change and how the Canada Income Tax Act Policy Paper requires all asset classes to be weighed.
Precedent and stare decisis
The doctrine that lower courts must follow the decisions of higher courts is fundamental to our legal system. It provides certainty while permitting the orderly development of the law in incremental steps. However, stare decisis is not a straitjacket that condemns the law to stasis. Trial courts may reconsider settled rulings of higher courts in two situations: (1) where a new legal issue is raised; and (2) where there is a change in the circumstances or evidence that “fundamentally shifts the parameters of the debate”.
The lawyer arguing that “stare decisis” is not a straitjacket will have to be experienced and competent.