A Canadian private corporation supplying specialized measurement equipment to research and industrial customers, with a product development arm run alongside outside collaborators. Projected revenue of roughly $3,247,000 in the valuation year against a three-year average nearer $2,600,000, so the business was growing quickly. Operating expenses ran at 84% of revenue, leaving pre-tax income of $520,000. Wages and salaries were the largest single expense at about 45% of total operating costs.

Six employees across technical support, operations, sales support and quality control. Two principal shareholders at 34% and 33%, with the remaining third split among four individuals and no shareholders’ agreement in place. A board that proceeds by unanimous vote, though as an understanding among the directors rather than anything written down. A United States branch opened during the year to move operations closer to the person running them.

One fact drives the entire valuation. A single individual is technical lead and business lead on every significant project. The business is profitable, growing and genuinely valuable, and it is also dependent on one person in a way a purchaser would have to price.

The shareholders asked: “We’re restructuring for tax reasons and we need a number for the company. What is it actually worth, and will that number hold up if it gets questioned later?”

Restated technically: what is the en bloc fair market value of the common shares of an owner-dependent Canadian private corporation at a specified valuation date, determined and documented to a standard capable of supporting a non-arm’s length transaction undertaken for income tax purposes, where fair market value is the highest price obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties dealing at arm’s length under no compulsion to transact?

The purpose is not incidental. A value produced for a sale negotiation, for a shareholder dispute, and for a tax reorganization are researched the same way but defended differently. As section 6 explains, the purpose is what decided which of two supportable numbers was adopted.

Two independent methods, not one

The company was valued twice, on an assets basis and on an earnings basis. Running both is not belt and braces. Where two methods disagree, the size and direction of the disagreement is itself a finding, and here it turned out to be the finding that mattered.

Restating the balance sheet, not just reading it

The asset-based figure is an adjusted net asset value, not book value. Each line was restated to estimated fair market value, and a notional tax liability recognised on the net upward adjustment, on the basis that the uplift would be realized as income on a disposition.

Normalising reported earnings to economic earnings

Reported profit is not what a purchaser buys. Four adjustments were made and each is listed separately so it can be challenged on its own: owner compensation restated to market, two categories of non-recurring cost added back, and amortisation adjusted to the level of capital reinvestment the earnings actually require.

Building the capitalization rate rather than borrowing a multiple

The rate was constructed from a risk-free rate, an equity risk premium, a size premium and an industry adjustment, plus a company-specific risk premium assessed factor by factor, less expected long-term growth. The resulting rate is inverted to give the multiple. Every component is visible, so a reader who disagrees with one can see exactly what it costs.

Keeping the rate and the earnings on the same tax footing

A build-up produces an after-tax required return, so it is applied to earnings after tax. The report says so and shows the tax line in the calculation. Applying an after-tax rate to pre-tax earnings is a common and material error, and stating the basis is how you demonstrate it was not made.

Separating the cash the business needs from the cash it happens to hold

Cash inside a company is not automatically part of operating value. The analysis established how much this business genuinely needs, then treated the remainder as a redundant asset added to the capitalized earnings figure.

Excluding what could not be supported

The shares were not exposed to the market and no purchaser was identified, so no special purchaser premium was included. The report states that omission rather than leaving a reader to guess.

• A written estimate of en bloc fair market value of the common shares, with the definition of fair market value stated on the face of the report and the purpose named in the opening paragraph.
• A summary of findings showing both methods side by side and the value concluded.
• A scope and restrictions section covering what was and was not done, what was relied on without verification, the limits on circulation, the basis of fees, and an explicit statement of which professional standards do and do not apply.
• Full workings for both approaches, including every normalisation adjustment, the complete capitalization rate build-up, and each redundant asset quantified.
• Seven numbered assumptions and an explicit statement that the conclusion is en bloc and must not be used to value a minority block.
• Seven supporting schedules carrying the summary of value, the capitalization rate, the capitalized earnings calculation, the normalisation working, the adjusted net asset value, the redundant assets, and the information relied upon.

The report runs nine numbered sections and seven schedules across thirteen pages. Every figure below is reproduced from the sample, so the depth can be assessed without downloading anything.

Sections 1 and 2. Mandate, and the definition of value

The opening section names who asked, what was asked, and what the answer is for: an internal corporate reorganization and a non-arm’s length transaction that will need to be supportable to the Canada Revenue Agency. It then names what the report is not for, which is the sentence most reports omit. It has not been prepared for a sale process, a financing, a shareholder dispute, or any matrimonial or litigation matter.

That matters because a valuation is not a fact about a company. It is an answer to a specific question asked for a specific reason, and a reader who does not know the reason cannot judge whether the answer is appropriate. The definition of fair market value follows in full, in its standard form.

Section 3. Summary of findings

The conclusion appears on the first page, before any reasoning, with both methods shown together so the gap is visible immediately rather than emerging thirty paragraphs later.

Section 4. Scope and restrictions

Three things in this section are worth pulling out.

The first is a plain statement of which professional standards apply. The report says it has not been prepared in accordance with CBV Institute practice standards, that it is not a Comprehensive, Estimate or Calculation Valuation Report as CBV Institute defines those terms, and that no member of the engagement team holds the Chartered Business Valuator designation. It is an estimate of fair market value prepared by a CPA Ontario registered practice for a stated limited purpose. Saying precisely what a document is not is how a reader knows what it is.

The second is the scope limitation. The financial information was relied on, not audited, reviewed or verified. The company was not exposed for sale. No independent appraisals were obtained. No enquiries were made of customers, suppliers or others in the industry. A more extensive engagement would have required further procedures and the conclusions might have differed.

The third is one line that most people skim: fees are based on time incurred and are not contingent on any action or event resulting from the use of the report. In valuation that is not boilerplate. A valuator paid more for a higher number has an interest in the outcome, and stating the absence of one is part of what makes a conclusion usable by a third party.

Section 5. Nature of the Company

Six numbered paragraphs, selected for their bearing on value rather than as a general description. What the company does, the ownership split and the absence of a shareholders’ agreement, the concentration of technical and commercial leadership in one individual, the unwritten unanimity convention on the board, six employees across four functions, and the new United States branch.

Four of those six are risk factors written as facts, and all four reappear later when the capitalization rate is set.

Section 6. Valuation methodology

Both families of method are explained before either is applied, which lets a reader disagree with the approach separately from the arithmetic. The asset discussion states that the adjusted net asset value method is being used, with each line restated to fair market value. The earnings discussion covers why the earning power of a going concern normally exceeds the sum of its assets, and the four categories of normalisation adjustment.

One paragraph in this section is doing quiet work. It states that the capitalization rate is derived on a build-up basis, that it is an after-tax rate, and that it is therefore applied to maintainable earnings after income taxes so the rate and the earnings base sit on the same tax footing. That single sentence forecloses the most common technical objection to a capitalized earnings calculation.

The section closes by stating that a capitalized earnings method was used rather than a discounted cash flow, because sustainable reinvestment is expected to approximate amortisation, and that if reinvestment requirements change materially the basis would need revisiting. The condition under which the shortcut holds is disclosed, so a reader knows which conclusion to reopen if it stops holding.

Section 7 and the schedules. The analysis

The asset side. Book net assets are $2,050,165. Three restatements are made: an allowance against receivables aged beyond 120 days, a write-down of obsolete and superseded inventory to net realizable value, and an upward adjustment of $92,300 to equipment and leasehold improvements, because those assets have been depreciated for accounting purposes faster than they have declined in value. A notional tax liability of $10,944 is recognised on the $41,300 net upward adjustment. Adjusted net asset value is $2,080,521.

Maintainable earnings. Reported pre-tax income of $520,000 is normalised to $297,100 through four separately stated adjustments:

Flexed 15% in each direction, that gives $252,500 at the low end and $341,700 at the high end.

The capitalization rate. A risk-free rate of 3.28%, an equity risk premium of 5.75%, a size premium of 5.41% and an industry adjustment of 0.75% give a baseline required return of 15.19%. The company-specific risk premium is then built factor by factor, and it is disclosed as a range of 9.60% to 17.85% rather than a single number. Dependence on the primary operator alone carries 8.50% to 11.50% of that. Recurring contracted revenue and a sustained profitability record are deducted as credits. After removing 2.25% for long-term growth, the capitalization rates are 30.79% and 22.54%, giving after-tax multiples of 3.25 and 4.44.

Redundant assets. Cash of $1,118,400 against a requirement of $585,000 to fund three months of operations, leaving $533,400 excess. Plus short-term deposits of $48,750 held outside the operating account, prepaid income taxes of $7,460 and sales tax receivable of $4,515. Total $594,125.

The $585,000 requirement is the figure worth reading closely, because of where it comes from. It is not a months-of-expenses convention. Since 2018 the company has never run more than four consecutive months of net losses, and the average loss across its loss runs of three months or more has been approximately $585,000. The reserve is sized to the worst this business has actually done.

Combining the three: after-tax earnings of $221,695 and $300,013, capitalized at 3.25 and 4.44, plus $594,125 of redundant assets, gives an indicated equity value of $1,314,634 to $1,926,181, midpoint $1,620,408.

Sections 8 and 9. Conclusion and assumptions

Two supportable numbers, $460,000 apart, and a written explanation of which was adopted and why. That reasoning is the substance of section 6 below.

Seven numbered assumptions follow, each one a thing that was not verified and would change the answer if untrue. The list closes with a statement that the conclusion is en bloc, that no discount for lack of control or lack of marketability has been applied, and that it must not be used to value an individual minority shareholding. With two shareholders at 34% and 33%, somebody will otherwise try.

The earnings method valued the business below its assets, and the reason was the owner’s salary. Reported pre-tax income of $520,000 became maintainable earnings of $297,100, a reduction of about 43%. The largest single cause was restating the primary operator’s pay from $138,000 to the $312,500 that would be required to engage an arm’s length person to do the same combined technical and general management job. A purchaser cannot buy the owner’s willingness to work below market. They would have to hire at market, and what remains after that is the profit they would actually receive.

Owners routinely read that as the valuation being unfair. It is the opposite. It is the first time the business has been measured on the basis a buyer would use. For this company the effect was large enough to pull the earnings value below the value of the underlying assets, and at that point the logic of the earnings approach stops applying, because a purchaser is buying assets rather than earnings.

A second adjustment cost the business more than most owners would expect. Recorded amortisation was $78,400, but sustaining the current earnings base requires roughly $186,000 a year of reinvestment given the age and replacement cycle of the equipment. The $107,600 gap is deducted, because capitalizing earnings that do not carry the full cost of sustaining them overstates value. Depreciation schedules are set for accounting and tax purposes; they are not a statement about what a business needs to spend to keep earning.

The higher of the two numbers was adopted, and that was the conservative choice. This is counter-intuitive until you remember why the report exists. In a reorganization carried out for income tax purposes, where value must be supportable to the CRA, understating value carries greater risk to the shareholders than overstating it. Adopting $2,080,000 rather than $1,620,000 is conservative in the only sense that matters for the purpose the report was commissioned for. A valuation prepared for a different purpose could reasonably reach a different conclusion on the same facts, and the report says so.

Key person risk was priced three times over, not mentioned once. It appears as a fact in the description of the business, as the single largest component of the company-specific risk premium at 8.50% to 11.50%, and as the driver of the $174,500 compensation adjustment that reduced maintainable earnings. A risk noted once in a paragraph of narrative changes nothing. A risk that moves both the rate and the earnings has been priced.

The width of the risk premium was disclosed rather than smoothed away. A company-specific premium spanning 9.60% to 17.85% is wide, and the report says why: pricing a business whose technical and commercial leadership rests entirely with one person is genuinely uncertain. Presenting a narrow range you cannot defend is worse than presenting a wide one you can.

$533,400 of cash was released to value on the strength of the company’s own trading history. Cash held in a corporation is argued about constantly and quantified rarely. Sizing the reserve from how badly this specific business has performed in its worst stretches, rather than from a generic ratio, is what makes the figure survive a challenge.

Scope decisions are part of the work, and each of these was made for a reason.

• No audit or independent verification. The financial information was relied on, with enquiries made to test its reasonableness. That reliance is stated on the face of the report, because the difference between a valuation and an audit is a difference in what a reader is entitled to conclude.
• No claim to standards that do not apply. The report states that it is not prepared under CBV Institute practice standards, that it is none of the three report levels CBV Institute defines, and that nobody on the engagement holds the designation. Borrowing the terminology of a standard you are not working under is the kind of thing that survives right up until somebody checks.
• The shares were not exposed to the market. No special purchaser premium is included. If a strategic buyer with particular reasons to want this business exists, they would likely pay more, and the report says so rather than quietly benefiting from the ambiguity.
• No independent appraisal of the equipment. The $92,300 uplift rests on management’s estimate of replacement cost less physical deterioration, and the report identifies it as such rather than presenting it as an appraised figure.
• No discounted cash flow. A capitalized earnings calculation was used on a stated condition, and the condition is disclosed so a reader who disagrees knows which conclusion to reopen.
• No minority discount analysis. The mandate was an en bloc value. What an individual 34% or 33% block is worth, with the discounts for lack of control and lack of marketability that would attach, is a different question and was not the one asked.
• The reorganization itself was not designed here. The valuation supplies the number. The structure, the steps and their tax consequences are separate work.
• Fees were not contingent on the outcome. Stated in the report, because a valuator with a financial interest in the answer is producing something other than a valuation.

The engagement involved establishing en bloc fair market value on the standard definition of the highest price obtainable between knowledgeable, informed and prudent parties at arm’s length under no compulsion; applying and reconciling two independent approaches that produced materially different answers; restating a balance sheet from book value to estimated fair market value across receivables, inventory and depreciated capital assets, and recognising a notional tax liability on the net upward adjustment; normalising reported earnings to economic earnings through separately identified adjustments for owner compensation restated to market in a business where wages represented roughly 45% of operating expenses, for non-recurring foreign exchange losses arising on a change of functional currency, for the one-time costs of establishing a foreign branch, and for the gap between recorded amortisation and the capital reinvestment required to sustain the earnings being capitalized; constructing maintainable earnings from a projected year built partly from actuals and partly from pro forma figures, with that composition disclosed; flexing maintainable earnings to express a range rather than a point; developing a capitalization rate on a build-up basis from a risk-free rate, equity risk premium, size premium and industry adjustment, plus a company-specific premium assessed factor by factor across key person dependence, customer and supplier concentration, management depth and succession, and a constrained specialised labour market, less credits for recurring contracted revenue and sustained profitability; maintaining the capitalization rate and the earnings base on a consistent after-tax footing; identifying and quantifying four categories of redundant asset; sizing the operating cash reserve from the company’s own historical pattern of consecutive loss months and average loss magnitude rather than a generic convention; determining whether a special purchaser premium could be recognised absent market exposure or an identified purchaser; a shareholder group with two near-equal principal holdings, no shareholders’ agreement, and a board operating on an unwritten unanimity convention; and selecting between two supportable conclusions on the basis of the purpose for which the report was commissioned.

Relevant services

• Corporate tax planning and reorganizations
• Advisory and fractional CFO services
• Accounting and tax for owner-managed businesses
• Holding company structures and corporate reorganization

Related case studies

• Canada-US expansion: branch, subsidiary or sister corporation
• Personal tax planning and retirement bonus timing
• Not-for-profit board reporting and variance analysis

Supporting work sample

The full report is available below. It follows the approach and report format we use on actual valuation engagements. The company and all financial figures in it are constructed from an existing client and anonymized. The sample is provided so that the depth of the analysis described above can be verified. It is not advice, it is not a valuation of any actual business, and it is not a template for use without professional consultation.

Thirteen pages. Nine sections and seven supporting schedules, covering both an asset-based and an earnings-based estimate of fair market value.

Includes:

✓ Mandate, stated purpose, and what the report is not for

✓ Definition of fair market value applied

✓ Summary of findings across both approaches

✓ Explicit statement of which professional standards do and do not apply

✓ Scope limitations, reliance and basis of fees

✓ Adjusted net asset value, restated line by line with notional tax

✓ Four normalisation adjustments with supporting notes

✓ Full capitalization rate build-up, including the company-specific risk premium factor by factor

✓ Four categories of redundant asset, each quantified

✓ Operating cash reserve sized from the company’s own loss history

✓ Seven numbered assumptions and an en bloc limitation

✓ Seven supporting schedules

Prepared by Zenbooks Tax Services Professional Corporation, a professional corporation registered with CPA Ontario. The work described is a business valuation prepared to support a corporate reorganization. It has not been prepared in accordance with the practice standards of CBV Institute and is not a Comprehensive, Estimate or Calculation Valuation Report as those terms are defined by CBV Institute. It is not an audit, review or other assurance engagement, and no assurance is expressed on any figure. Fair market value conclusions depend on the purpose for which they are prepared, the valuation date, and the facts and assumptions disclosed. The downloadable sample follows the format of our actual engagements; the company and all figures in it are constructed and do not represent any actual business. This page describes the approach taken on one engagement and is not a representation that comparable results are available in other circumstances. Anyone requiring a valuation should obtain one prepared for their own purpose and facts.