How Is a Small Business Valued for Sale in Ontario?

Before you list or negotiate, you need a number you can explain. Buyers will test it, and if the sale is to a related person, the tax authorities may test it too.

Valuation is part science and part judgment. This article explains the common approaches, what the Canada Revenue Agency (CRA) looks at, and how to prepare so your price holds up.

What "fair market value" means

For tax purposes, the CRA defines fair market value as the highest price obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm's length, with neither party under compulsion to transact. In plain words, it is what a well-informed stranger would pay when nobody is being pushed to do the deal.

The CRA's guidance on business valuation is a policy statement, not a law. It shows how the CRA tends to think, but the facts of your business still drive the result.

The two main methods

The CRA treats the earnings method and the asset value method as the two most generally accepted bases of valuation.

The CRA also says fair market value is generally the greater of liquidation value, used where the business is not viable as an ongoing operation, and going concern value, used where it can earn a reasonable return on investment.

Factors that justify a price

The CRA lists many factors for justifying a price. They include the nature and history of the business, industry outlook, balance sheet, earnings record and earning power, dividend capacity, goodwill and other intangibles, prior share sales, the size of the block, comparable public company prices and underlying asset value.

It also considers control versus minority interests and buy-sell agreements. Multiples reflect risks such as management depth, competition and ease of entry into the market.

Market multiples used in practice vary by industry, and there is no single official table of them. That is one reason an independent valuation or accountant's opinion can be useful.

Making your number easier to defend

• A business that depends heavily on you personally may be worth less, because buyers look at management depth.
• Clean financial statements make your earnings record easier to prove.
• Documented goodwill and intangibles, such as customer relationships, support the part of the price above asset value.
• Earlier share sales can be evidence of value, so keep records of them.

If the buyer is related to you, or the price looks unusually high or low, expect more questions. A written valuation prepared at the time of the deal helps.

From value to price: allocation and tax

A valuation gives you a total. In an asset sale, the next question is how that total is split among the assets. Where an amount can reasonably be regarded as partly paid for property, services or a restrictive covenant, each part is treated separately.

If the sale agreement sets reasonable prices for individual assets, the CRA uses those prices. If it does not, the price is allocated to each asset at fair market value, then to inventory, and the remaining balance to goodwill.

• For the buyer, fixed assets go into capital cost allowance classes and goodwill goes into Class 14.1, so the split changes future deductions.
• For the seller, if sale proceeds credited to a class make its undepreciated capital cost negative, the excess is included in income in full, so putting more of the price on equipment can raise your tax.
• In a share purchase the buyer buys the corporation itself and the tax values of its assets do not change, which is why buyers often prefer assets.
• A share purchase is generally not subject to GST/HST, while an asset purchase can be, unless the parties elect.

Only one-half of a capital gain is taxable. Whether other relief, such as the lifetime capital gains exemption, applies to your sale depends on your situation, so it is worth confirming with a lawyer or accountant before you settle on a structure.

What to do next

• Gather three to five years of financial statements and tax returns.
• List your assets, including equipment, inventory and any intangibles.
• Note which of your income depends on you personally and what a buyer could take over.
• Ask an accountant or valuator which method fits your type of business.
• Speak with a lawyer about how the price will be written into the agreement and allocated among assets.

Frequently asked questions