The Global Damages Review: The Financial Damages Model for Loss of Value

I Introduction

Damages are generally calculated as either (1) a loss of income or (2) a loss of capital. When damages are determined on account of a loss of capital, it is often necessary to perform a valuation of an asset or business.

This chapter is intended to provide an overview of business valuation principles, concepts and methodologies, and to explain how they apply to the calculation of damages. Although the valuation of any particular asset or business will depend on case-specific factors, the general principles outlined herein can be broadly applied. That said, there is no valuation formula or rule and the determination of value is inherently subjective. It is generally advisable that parties engage a qualified business valuation professional where a formal business valuation is required.

II Definition of fair market value

The first step in any valuation process is to clearly understand what exactly is being valued. A valuator may be tasked with valuing a business in its entirety, including both its equity and debt components (enterprise value), specific equity or debt interests in a business, or specific assets of a business. Establishing what is to be valued is a critical first step in the valuation process.

The valuator must also establish the definition of value to be adopted. In general, business valuations typically focus on the determination of 'fair market value'; however, other definitions of value may be relevant in certain case or fact situations.2

The definition of fair market value varies to some extent by jurisdiction. In the United States, fair market value is defined as: 'The price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts'.3 In Canada, the generally accepted definition of fair market value is: 'The highest price available in an open and unrestricted market between informed and prudent parties, acting at arm's length and under no compulsion to act, expressed in terms of cash'. Although the definition of 'fair market value' varies to some extent by jurisdiction, the general underlying components of the definition remain consistent.

i Highest price available

Conceptually, a buyer and a vendor will only transact at a price and upon terms to which they both agree based on their own motivations and self-interest. The transaction price is the price at which the vendor's interest, which is to maximise the selling price, and the buyer's interest, which is to minimise the purchase price, are in equilibrium. Fair market value determined in a notional context reflects the highest price available.

ii Willing buyer and willing seller: no compulsion to act

The fair market value definition assumes that the parties are willing participants in the transaction and neither party is forced to transact. In reality, a business owner may be compelled to sell their ownership interest for a variety of reasons including personal health or financial difficulty.

iii Knowledge of relevant facts

The fair market value definition assumes that both the vendor and the purchaser are informed with respect to all material facts important to the value determination and will act prudently.

All information that would or should have been available at the valuation date is assumed to have been available in the notional market value determination. It is generally accepted that hindsight information, information that could only be expected to have been known after the valuation date, is not considered in the fair market value determination.

iv Acting at arm's length

The definition of fair market value assumes that the buyer and seller are arm's-length parties and will negotiate in accordance with their self-interest.

v Open and unrestricted market

Fair market value assumes an open and unrestricted market that includes all potential acquirers. All potential purchasers with the will and resources to transact are included in the valuator's considerations. Any restrictions that may influence the marketability of a business are assumed to be temporarily lifted for the purpose of determining value in a notional context. To the extent restrictions exist, the valuator may consider the impact of the restrictions by applying a reasonable discount to the value that has otherwise been determined.

vi Expressed in terms of cash or cash equivalents

Fair market value is expressed on a cash equivalent basis and assumes the transfer of the rights and risks associated with the business at the valuation date. This is often in contrast to open market transactions, which are frequently consummated based on non-cash consideration, such as the transfer of shares, or involve payments over a period of time (an earn-out).

III Open market price versus notional fair market value

Price and value are two distinct concepts that are often confused in consideration of a valuation.

The price of a business or asset is based on the negotiations of a buyer and seller in an open market transaction and reflects the actual terms of a sale.

Value is generally determined in the context of a notional market, where the enterprise subject to valuation has not actually been exposed to the market for sale. The notional market is intended to replicate what may be expected to occur in a rational, fully informed and liquid marketplace without exposing the business interest for sale.

Notional fair market value is generally determined on an intrinsic (stand-alone) basis without the consideration of the potential synergies or economic benefits that may accrue to a subset of the potential purchasers of a business. Certain purchasers may be willing to pay a price that is different from intrinsic value because of their specific circumstances and the specific benefits they may receive from an acquisition. These purchasers are commonly referred to as special interest purchasers.

Quantifying the premium that a special interest purchaser may be willing to pay for synergies is often difficult in a notional market context as the information necessary for the valuator to accurately assess synergies is generally unavailable. As a result, the price arrived at in an open market transaction may be different from the value conclusion reached in a notional market valuation at the same valuation date.

Notional fair market value may also differ from price because of the following:

Information asymmetry. Open market transactions are negotiated between parties with varying degrees of knowledge and as a result the transaction price may be different from the 'highest price available' as determined in a notional market context.

Compelled parties. A vendor may be compelled to sell their business as a result of personal health, financial or other reasons. Forced open market transactions may result in a price that is lower than notional fair market value.

Non-cash consideration. Open market transactions often involve non-cash consideration or other forms of compensation including earn-outs and employment contracts that impact the price paid.

Imprudent decisions and human emotion. A purchaser or vendor may negotiate an open market transaction based on human emotion that does not reflect the 'highest price available'.

IV Valuation principles

The following seven valuation principles are widely accepted as general foundations of business valuation.

i Principle one: value is determined at a specific point in time

Value is determined at a specific point in time based on information that was known or knowable at that point in time. The value of a business interest is based on the market's perception at a specific point in time of the business' future prospects and in particular the future cash flow that the business is likely to generate.

The prospects for a business change from day to day as new information becomes available. Both external and internal factors continually impact the value of a business and, as such, value is determined at a specific point in time.

Consistent with this principle, hindsight information is generally excluded from consideration when determining value. In negotiating an open market transaction, the vendor and purchaser do not have the benefit of future information. The same principles are applied to valuation in a notional context, where value is to be based only on information that was known or knowable at the time of the valuation.

ii Principle two: value is a function of the future benefits to accrue from ownership

Value is principally a function of the prospective future cash flows of a business. Potential acquirers evaluate a business based on expectations of the cash flow that will accrue to them following the acquisition. As the saying goes, 'cash is king'.

Value is therefore based on expected future performance as measured by the discretionary future cash flows to be received from the investment in the business. Value is a function of the prospective cash flows and the risk of achieving the future cash flows in the amount and timing anticipated. In assessing prospective cash flows, historical financial performance can be informative to the extent it is representative of future performance; however, a valuator must consider evolving industry and economic trends.

iii Principle three: the market dictates the rate of return

Conceptually, the value of a business is equal to the present value of the business' anticipated future cash flows. The rate of return used to determine the present value of the future cash flows is derived from market rates of return. At any given time, investors must weigh an investment of capital in a business or asset against other potential investments available in the marketplace.

Market rates of return are based on general market forces, which include:

  1. general economic conditions, including short- and long-term borrowing rates. Borrowing rates impact the acquisition and divestiture activities of investors and the rates of return required by purchasers on their invested capital;
  2. the market's perception of a certain industry and the risk profile of the industry. This includes the market's perception of the risks, opportunities, competitive landscape, regulatory environment and growth prospects of an industry;
  3. the types of purchasers in the market, their investment objectives and motivations; and
  4. company-specific risk factors unique to the business being valued.

The market-driven rate of return reflects the rate of return necessary to motivate investors to deploy capital in the business given the associated risk and opportunities of achieving the projected cash flows. At any point in time, a market-driven equilibrium exists whereby the rate of return offered by a particular investment vehicle reflects the market's perception of the investment risk of that vehicle. Investors seek to maximise their return while minimising their risk.

In determining business value, the prospective cash flows of a business and the rate of return applied to those cash flows are interdependent. The higher the risk of realising the cash flows, the higher the required rate of return.

iv Principle four: value is influenced by liquidity

In general, the greater the liquidity of an investment, the greater the value of that investment. Liquidity is a measure of the ability to convert an investment into cash. A liquid investment is one that can be quickly converted into cash. Greater liquidity reduces the risk of an investment by providing the potential purchaser with a greater ability to access their capital and exit their investment.

The liquidity of an investment in a private business is often restricted by certain provisions contained in shareholders' agreements or corporate articles. It is not uncommon for shareholders' agreements to limit the ability of shareholders to transfer their shares. In such circumstances the valuator may assess the impact of such provisions on value and, if appropriate, reduce the value by applying an appropriate 'liquidity' discount.

v Principle five: value of a minority interest versus a controlling interest

The value of a minority interest is generally less than the value of a controlling interest considered on a pro rata basis.

A controlling shareholder is generally defined as a shareholder that through their ownership interest can elect the majority of the board of directors and in turn govern the business operations. The fair market value of a controlling interest is generally determined on a pro rata basis by applying the ownership interest percentage of the controlling shareholder to the 'en bloc' fair market value.

A minority shareholder does not have the same ability to influence the business decisions and operations of the business or dictate the amount or timing of dividends or the terms and conditions and timing of the eventual sale of the business. As such, the value of a minority interest may be less than the pro rata portion of fair market value.

A minority discount is considered when arriving at a value conclusion for the minority interest to account for the minority interest's inability to influence and control the operations of the business. The quantum of the minority discount, if any, is fact and case specific and based on the valuator's consideration of the ownership structure, relationship between the owners, agreements between the owners, statutory provisions on business governance and shareholder rights, the typical financial buyer's ability to augment the business' cash flows (if any), as well as other relevant information.

vi Principle six: value is influenced by the underlying net tangible assets

Tangible assets consist of a business' physical assets and include working capital, inventory, property, plant and equipment. In general, all else held constant, a higher tangible asset base reduces the risk profile of a business and supports a higher business value.

A higher tangible asset base generally reduces the risk associated with the business because it:

  1. provides a natural barrier to entry. The large capital investment required to enter capital intensive industries often serves as a natural barrier to entry for potential new competitors and limits the risk of competition;
  2. increases a business' collateral and provides greater access to debt financing. Lenders are generally more comfortable extending credit to businesses with strong collateral. Increasing the relative proportion of debt in the company's overall capital structure can lower the company's overall cost of capital (because the cost of debt financing is generally less than the cost of equity financing); and
  3. reduces downside risk. If all else fails and the business is not successful, a potential acquirer has lower downside risk in an investment in a business with a high net tangible asset base as the assets of the business can be sold, thereby limiting the total loss of the failed enterprise.

vii Principle seven: commercial and non-commercial value are distinct

Successful companies have, to a greater degree than less successful companies, intangible qualities that result in the business earning comparatively larger cash flows and returns. The incremental value created by these intangible qualities is commonly referred to as goodwill.

Goodwill is an intangible asset that reflects a business' established brand, reputation, customer loyalty and other intangible factors that cannot be separately identified or quantified. Goodwill consists of both those assets that can be transferred to a potential purchaser and are commonly referred to as commercial goodwill, and those that cannot be transferred and are commonly referred to as personal or non-commercial goodwill.

The commercial value of a business is derived from the business' assets and operations and includes commercial goodwill. The non-commercial component of value is a function of the personal abilities or relationships of an individual and do not accrue to a potential acquirer. A potential acquirer will generally not pay for personal goodwill as it is non-transferable.

V Fundamentals of business valuation

i Enterprise value versus equity value

Enterprise value and equity value are two value terms that are often misunderstood. The value of a business interest consists of two components: (1) the value of the business' equity; and (2) the value of the business' outstanding debts. Together these two components comprise the enterprise value of the business, which represents the value of the business in its entirety including its equity and debt components. Enterprise value is not affected by how a business is financed.

In contrast, the equity value of a business represents the value of a business' equity (i.e., the value of the shares) and is equal to the enterprise value less the value of the business' net debt. The equity value is affected by how a business is financed.

The enterprise value of a business comprises the value of interest-bearing debt and equivalents, plus the value of the business' net operating assets (cash, inventory, receivables less payable and fixed assets), plus the value of identifiable intangible assets (brand names, trademarks) and non-identifiable intangible assets (commercial goodwill). Equity value excludes the value of interest-bearing debt and equivalents and represents the shareholder's or owner's claim to the business' assets.

VI Valuation Approaches and Methodologies

i General value approaches

There are three generally accepted approaches to valuing an asset or business.

Income or cash-flow approach

The value of the asset or business is determined based on the expected future cash flows to be generated by the asset or business. The prospective future cash flows are discounted or capitalised at an appropriate rate of return reflective of the risks inherent in realising the cash flows.

Cost approach

The value of the asset is determined based on the historical cost of the asset or the cost to replace the asset. The cost approach is typically reserved for the valuation of specific assets rather than in the determination of the value of an active business as a whole.

Market approach

The value of the asset or business is determined based on the application of comparable market valuation metrics. The underlying premise is that the metrics associated with a comparable asset or business reflect the inherent risks of that asset or business and are applicable to the business subject to valuation.

ii Liquidation approach versus going concern approach

The first step in assessing the value of a business is to assess the viability of the business. The valuator must assess whether the business is expected to realise a reasonable rate of return on the value of the net assets employed in the venture. This analysis will inform the valuator's decisions of whether to employ a going-concern approach or a liquidation approach.

Going concern approach

The value of the business is determined based on the underlying assumption that the business will continue to operate and generate positive prospective future cash flows.

Liquidation approach

Represents the estimated net proceeds that would remain following the disposition of the business' underlying assets and settlement of its liabilities.

Selection of valuation approach

A business that is considered to be economically viable is generally valued on a going-concern basis implying that the business will continue to operate into the future. A going-concern valuation approach focuses on the future economic benefits (the prospective cash flows) that will accrue to the ownership group.

A business that generates recurring negative cash flows, or where the business is not expected to realise a reasonable rate of return on its invested capital, will typically be valued on a liquidation basis. A liquidation approach assumes that the business' assets will be sold, its debts repaid, and any proceeds will be distributed to the equity holders. The premise underlying a liquidation scenario is that the maximum value to the shareholders will be realised not by continuing to operate the business, but rather by converting the net assets of the business back to cash so that the shareholders can redeploy this capital into another (more promising) business venture. When value is to be determined pursuant to a liquidation approach, an asset-based valuation methodology is generally used. Liquidation analysis may be either on an orderly basis, meaning the business is assumed to have a reasonable timeline to wind down its operations and maximise value, or forced, where an expedited timeline is assumed.

iii Valuation methodologies

Asset-based valuation methodology

Pursuant to an asset-based valuation methodology, the value of a business interest is determined based on the value of the business' underlying assets and liabilities. Asset-based valuation methodologies are most commonly employed when valuing holding companies (companies whose primary function is to hold investments in other businesses) or when the valuator determines that an operating company is not viable (and a liquidation valuation approach is therefore employed as the primary valuation technique).

The most commonly employed asset-based valuation methodology is the adjusted net book value methodology. Pursuant to the adjusted net book value methodology, the valuator adjusts the reported book value of the subject business' assets and liabilities to reflect fair market value at the valuation date.

It is important to understand that the book values reported on a company's balance sheet often reflect historical cost amounts or may not reflect the true economic value of an asset or liability. For example, reported asset values on a balance sheet often reflect the initial purchase price of an asset that may or may not be indicative of fair market value at the valuation date.

In general, the adjusted net book value methodology involves adjusting the reported shareholders' equity as reported on a company's financial statements by adding or deducting the amount by which the value of the net assets exceeds or is less than the value reported for accounting purposes and adjusting for related tax differences.

The adjusted net book value methodology can be applied in both a going-concern and a liquidation value scenario. Under a liquidation approach, value is calculated as the difference between the net realisable value of the business' assets and the amounts needed to satisfy the business' liabilities. In these calculations, the net realisable value of a particular asset is the cash retained by the business from the sale of each asset after paying any sales commissions, moving costs, taxes and other costs incurred to dispose of the asset and effect the winding-up of the business.

Cash flow and earnings-based valuation methodologies

Cash flow-based valuation methodologies are commonly employed when the underlying business interest is determined to be a viable operating enterprise. The two most common cash flow-based valuation methodologies are the capitalised cash flow (or earnings) methodology and the discounted cash flow methodology.

Cash flow or earnings-based valuation methodologies require:

  1. an informed assessment of the prospective future cash flows of the business being valued;
  2. an assessment of the risk of achieving the projected future cash flows both in quantum and on the anticipated timeline. The risk assessment informs the valuator's estimate of the appropriate risk adjusted rate of return (or valuation multiple) to apply when estimating the business' enterprise value;
  3. an analysis and assessment of the fair market value of the business' interest-bearing debt and equivalents at the valuation date. Interest bearing debts and equivalents are deducted from enterprise value to determine the equity value of the business; and
  4. an analysis of the business' net assets. The calculated enterprise value assumes that the business has adequate operating assets (i.e., working capital, fixed assets) to generate the projected cash flows. Where the business does not have adequate assets, an adjustment is required to account for a shortfall. Similarly, when the business holds excess assets that are not required for the ongoing operations of the business, the fair market value of these redundant assets are added to arrive at the equity value of the business.

The capitalised cash flow/earnings methodology

The capitalised cash flow (or earnings) methodology involves dividing an estimate of a business' normalised maintainable after-tax discretionary cash flow by an appropriate capitalisation rate that reflects the risks and rewards of the business. The capitalised cash flow methodology is based on the assumption that a business' future cash flows will be relatively stable from year to year or increase at a stable rate of growth. As a result, this methodology is typically adopted for mature businesses with relatively stable earnings that can be reasonably estimated into perpetuity or when a reasonable forecast of cash flows is not available.

Pursuant to the capitalised cash flow methodology, the valuator first estimates the company's annual maintainable discretionary cash flow. Discretionary cash flow is the quantum of cash flow earned by the business that can be distributed to the shareholders of the business each year without impairing the business' ongoing operations.

Estimating a reasonable maintainable cash flow level requires professional judgement and analysis of the business and its prospects, including the prevailing and prospective economic and industry conditions. Maintainable cash flow is often expressed as earnings before interest, taxes, depreciation and amortisation or EBITDA.

To estimate a company's maintainable cash flow a valuator typically considers:

  1. the historical operating results of the company. Historical operating results provide an objective benchmark upon which future operating levels may be estimated. However, it is important that the historical results are reviewed in the context of prevailing market conditions; and
  2. contemporaneously prepared forecasts, business plans and budgets. A well-formulated budget provides insight into management's expectations and may reveal business trends or factors that should be considered in assessing maintainable earnings. Business plans, budgets and forecasts are often prepared by management as part of their annual planning.

The analysis of a business' historical and prospective cash flows should also consider the need for any adjustments to normalise the business' performance. Normalisation adjustments are required to account for non-recurring, unusual and non-discretionary amounts and may include adjustments to:

  1. eliminate the impact of non-recurring or unusual historical revenue or expense amounts including, for example, start-up costs, one-time litigation costs, moving expenses and restructuring charges;
  2. reflect adjustments to related-party compensation (salaries and bonus) paid to owners and managers to the extent the reported compensation expense does not reflect a fair market value for the services rendered;
  3. adjust other non-arm's-length transactions to reflect a fair market rate. For example, it may be necessary to adjust rent payments if such payments are paid to a related party and are below market rates; and
  4. eliminate income or expenses related to redundant assets as it is assumed that these assets are not required for the ongoing operation of the business. The fair market value of redundant assets is separately added to value.

Based on the foregoing, the valuator estimates a range of maintainable cash flow. From this maintainable cash flow, the valuator deducts corporate income taxes, sustaining capital expenditure requirements4 and incremental working capital requirements to arrive at an estimate of the company's after-tax maintainable discretionary cash flow.

Components of discretionary cash flow
Earnings as reported on the financial statements
+/- Non-cash adjustments (depreciation, amortisation, etc.)
+/- Normalisation adjustments (non-recurring and related party)
Maintainable earnings
Less: Corporate income taxes
Less: Working capital requirements
Less: Capital expenditure requirements
After-tax discretionary cash flows

The second step of the capitalised cash flow methodology is to estimate the present value of the future cash flow by dividing the estimated maintainable cash flow by an appropriate risk adjusted capitalisation rate. The capitalisation rate reflects the valuator's assessment of the risk of the business realising the maintainable cash flow.

The selection of a capitalisation rate is subjective and is based on the professional judgement, experience and the knowledge of the valuation professional. The valuator may consider:

  1. prevailing market rates of return, including the prevailing risk-free rate (often measured with reference to government bond rates) and equity risk premiums (measure with reference to public equity market returns);
  2. industry risk factors and prevailing market rates of return for industry participants;
  3. company specific risk factors, including an analysis of the principal strengths and weaknesses and the opportunities and threats facing the company at the valuation date. The valuator will consider the company's customer relationships, client concentration, stability and predictability of earnings etc.;
  4. an appropriate capital structure of the subject company having consideration for the debt capacity of the subject company, its existing lending arrangements and the capital structure of comparable companies; and
  5. the prevailing and prospective corporate income tax rate.

The capitalised cash flow of the subject company is calculated by dividing the estimated maintainable discretionary cash flow by the selected capitalisation rate. To the capitalised cash flow, the present value of the existing tax pools is added to arrive at enterprise value. To determine equity value, the fair market value of redundant assets, if any, is added and interest-bearing debt and debt equivalents outstanding at the valuation date are deducted.

The following table illustrates the capitalised cash flow methodology.

Capitalised cash flow illustration  
Selected maintainable EBITDAUS$90,000US$100,000
Less: corporate income taxes(23,850)(26,500)
After-tax cash flowsUS$66,150US$73,500
Less: incremental working capital requirements(5,000)(5,000)
Less: sustaining capital expenditure (net of the tax shield)(10,000)(10,000)
Maintainable after-tax cash flowsUS$51,150US$58,500
Divide by: capitalisation rate (per cent)11.012.0
Capitalised cash flowUS$465,000US$487,500
Add: present value of UCC tax shield10,00010,000
Enterprise valueUS$475,000US$497,500
Add: redundant assets500500
Less: interest bearing debts and equivalents5,5005,500
Equity value/fair market valueUS$470,000US$492,500

Discounted cash flow methodology

Whereas the capitalised cash flow approach is based on a single annual estimate of maintainable cash flows, the discounted cash flow (DCF) valuation methodology involves forecasting the year-by-year cash flows of the subject company for a specified number of years. The present value of each of these future amounts is then calculated based on the valuator's estimate of the appropriate risk-adjusted required rate of return (discussed previously).

In addition to the forecast period cash flows, most businesses will continue to earn cash flows after the forecast period. The value of these post-forecast period cash flows is referred to as the terminal value. The valuator estimates terminal value based on an estimate of the business' annual maintainable cash flow in the post-forecast period capitalised at an appropriate rate of return. The calculation of the residual value is in essence a capitalised cash flow approach bolted on to the DCF analysis.

The net present value of the cash flows during the forecast period and the terminal period are added to determine the enterprise value of the business. To determine the equity value, interest-bearing debts are deducted and redundant or deficient assets are added or subtracted.

A DCF methodology is typically appropriate where the business has relatively sophisticated business-planning protocols, where the business is expected to experience variable production over several years and for assets with limited economic lives (e.g., mines).

The following chart illustrates the DCF methodology.

Discounted cash flow illustration
 Forecast periodTerminal period
 Year 1Year 2Year 3
Less: corporate income taxes(1,250)(2,500)(5,000)(5,100)
Less: working capital requirements(500)(500)(1,000)(40)
Less: sustaining capital reinvestment(1,000)(1,000)(1,000)(1,000)
After-tax discretionary cash flowUS$2,250US$6,000US$13,000US$14,260
Capitalisation rate (per cent)8.0
Terminal value$178,250
Discount rate (per cent)
Discount period (number of years)
Discount factor0.9530.8670.7880.788
Net present value of cash flowsUS$2,145US$5,201US$10,244US$150,308
Sum of the present value of the cash flows during the forecast periodUS$17,590
Present value of the terminal period cash flows150,308
Enterprise valueUS$167,898
Less: interest bearing debt and equivalents(10,000)
Add: redundant assets5,000
Equity value/fair market valueUS$162,898

Market-based valuation methodologies

The market-based valuation approach relies on public equity market data and precedent transaction data of companies determined to be somewhat comparable to the subject company being valued. This valuation methodology involves analysing the valuation multiples, financial ratios and operating results of these comparable companies and transactions and applying those multiples to the subject company. The underlying premise of the market-based approach is that companies in similar industries face similar risks and as a result should have similar return profiles.

The two principal market-based valuation approaches are (1) the comparable public company approach, and (2) the precedent transaction approach.

Comparable company approach

A comparable company approach involves researching and calculating the valuation metrics and financial ratios of publicly traded companies that are deemed to be somewhat comparable to the subject company. In these cases, the valuator may consider 'value benchmarks' in his or her analysis.

Examples of valuation benchmarks include:

  1. enterprise value to EBITDA multiple – calculated as enterprise value divided by EBITDA;
  2. enterprise value to revenue multiple – calculated as enterprise value divided by revenue;
  3. price-to-book-value ratio – calculated as the public market capitalisation of the company divided by the reported net book value of the company; and
  4. price-to-earnings ratio – calculated as the public market share price divided by the earnings per share.

There are many other valuation ratios that are commonly calculated. Some ratios are more relevant to one industry than another. Given the inherent difficulties in identifying reasonably comparable companies, the comparable company approach is most often used as a secondary valuation approach, to assess the reasonableness of the notional valuation conclusion based on a cash flow or asset-based methodology.

Precedent transactions approach

Precedent transaction analysis involves researching and reviewing actual transactions involving companies that are comparable to the subject company. Utilising publicly disclosed information about actual transactions including the selling price, historical performance and terms and conditions of sale, it is possible to determine comparable valuation metrics that can then be applied to the subject company to determine a value conclusion. Similar multiples as those illustrated above can be determined for these precedent transactions.

Rules of thumb

In certain industries, market rules of thumb may exist that can be used to determine business value. Rules of thumb are generally applied as a secondary test of the reasonableness of a value conclusion arrived at through a cash flow or other valuation methodology. Rules of thumb have their foundations in market transactions involving companies in a specific industry and are based on industry-specific activity ratios or formulas that have been derived over time. When using a rule-of-thumb approach, it is important that the valuator considers what exactly the rule of thumb is calculating and whether the rule of thumb is applicable to the business interest being valued.

VII Conclusion

Business valuation is an inherently subjective exercise. In preparing a business valuation, valuation professionals apply their professional judgement, experience and knowledge of business valuation fundamentals to the specific facts to arrive at an informed and reasoned value conclusion. Whether for the purpose of calculating damages from a capital loss or otherwise, it is generally advised that a business valuation professional be consulted when a business valuation is required.


1 A Scott Davidson, Sid Jaishankar and Ashley Houlden are managing directors at Kroll.

2 For example, in Canada, 'fair value' is generally adopted as the definition of value to be used in cases involving shareholder oppression, shareholder dissent and in family law. Fair value is commonly defined as fair market value without the consideration of a minority discount.

3 United States v. Cartwright.

4 Sustaining capital expenditure requirements are the annual capital cost required to sustain the operations of the business. It represents the annual required investment in a company's capital assets.

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