I’ve given my “elevator speech”, or as the case may be these days, my “zoom speech”, about what I do as a Chartered Business Valuator (CBV), many times over the past year. After an introduction about what I do as a CBV, I’m often asked, “But when would I need a business valuator, and how does that apply to me?”. I usually follow up by saying that the best way to explain how I can help, is to give a real life example.
The other day I received a call from a client, Mark. Mark has been married for 30 years, has two children, 28 and 25 years old. He wanted to have a quick chat about the future of his business, given the impacts of the COVID-19 pandemic. He operates his own business as a fully integrated computer service provider, which was having a good year. Given the ages of his children, he was thinking about succession planning. He also acknowledged that he did not have a will in place, but was thinking about putting one together.
Specifically, Mark was interested in transferring his business to his children over time, and was told that an estate freeze made the most sense. He was thinking that now would be a good time to look into this as an option, because in spite of (or because of) the pandemic, his business was actually doing quite well. He wanted to know whether an estate freeze made sense, and if this was something that we dealt with.
I eased his mind that this is a common scenario that I deal with as a Chartered Business Valuator. Often, clients will come to me requiring a third-party valuation to help plan for their future and develop a strategy to execute their plans. In these cases, my role is to be objective and to provide a realistic view of the company’s value at a certain date.
Simply put, an estate freeze is a mechanism to allow Mark, as the business owner, to “freeze” his unrealized gain in the business at a specified time and amount; whereas, the future growth would be in the hands of his children. This can have many benefits, including being able to plan for the ultimate tax liability. In order to accomplish the freeze, the value of Mark’s business would need to be calculated.
Upon relaying this information to Mark, he was adamant that he would be able to “ball-park” the value of his business since he had been running it for over 25 years. I discussed with him that he would be well advised to hire a CBV in order to obtain a value of his business from an independent and objective third-party. Mark re-iterated that he knew the value of his business and was sure that it was worth $2,000,000. Although he seemed reluctant to hire a CBV, I still advised him that obtaining an accurate value of his business may be critical, as it could have a material effect on his estate and the ability to optimize the tax treatment, and potentially help avoid potential conflicts down the road.
We discussed that the Canada Revenue Agency (“CRA”) requires that the fair market value of the shares (in this case common shares) of his business be established, and that the value must be determined in a “reasonable” manner. The CRA can challenge the transaction if the value is not set at fair market value.
Mark might be able to take advantage of a price adjustment clause (“PAC”) if the CRA disagreed with the value of the business used in the estate freeze. The PAC could be retroactively used to revise the fair market value of the business, to avoid issues and disputes with the CRA. However, the PAC may not be used if it’s found that a fair and reasonable attempt at valuing his business was not initially undertaken by Mark. The CRA may not see Mark’s “ball-park” figure of $2,000,000 as a fair attempt at valuing his business; whereas, an independent valuation completed by a qualified CBV would be more likely to meet the CRA’s criteria. Implications of not being able to use a PAC (where an inadequate value was used), can include additional taxes, interest and penalties, and litigation with the CRA and potentially other advisors.
For example, if his business was worth more than Mark had “ball-parked”, then there could be immediate tax and penalty consequences to Mark, as well as future tax consequences to his son, who was to obtain the common shares in the business. However, if Mark was allowed to use the PAC, then no taxes or penalties would stem for that adjustment to the value of the business. In this case, obtaining a valuation by a CBV would be essential.
Mark understood the merits of having an independent valuation obtained, but he still was not sure if all this work and money spent would be worth his time. We continued to talk about his children, and his older son’s desire to stay in the family business, while his other child wanted to pursue a different path.
Mark was convinced that his children would just figure it out amongst themselves. I advised him that an independent business valuation may help with ensuring that his estate would be distributed as he intended it, and to settle any conflicts ahead of time. If Mark were to leave the business to his older son, it would be helpful to know the value of the business, so he could make arrangements to leave assets of a similar or equal value to his other child, if this is what he wanted to accomplish. If Mark’s assessment of the business is incorrect, he may unintentionally leave one child with a bigger part of his estate than he intended.
I mentioned to Mark that if he wanted the estate to be fairly and equally split between his children, that having a CBV value of his business would be imperative to ensuring that his children were compensated fairly, either during his lifetime or upon his death.
Another idea I presented to Mark was explaining the importance of life insurance coverage, as it provides tax-free funds to his estate upon his death. This would ensure that his estate would have sufficient cashflow to pay the taxes that would arise upon his death if he chose to leave his assets to his children instead of his spouse. In order to know at a minimum how much life insurance he should obtain to cover the estate’s tax liability, the value of his business would be necessary to obtain.
Mark also brought up a situation where his older son was planning to be married in a year’s time. He did not have a marriage contract himself, and did not think that his son needed one either. However, he was advised that he should look into it, and if he transferred any of the business to his son, that it should be done in a manner to protect the business assets. Mark asked what I thought about this and I mentioned to him that if his son would be obtaining shares in the company prior to marriage, that it would be beneficial to have a valuation completed by a CBV prior to entering into any marriage contract. I also advised him that his son’s business interests would be considered family property and subject to an equalization payment if they were to separate and his son did not have a marriage contract dealing with this issue in place.
If the “ball-park” figure of $2,000,000 were used for the estate freeze, it may be considered the value of the business as at the date of marriage. However, if the business was actually worth more than this amount, it would impact the amount of any equalization payment his son may need to pay in the future. Whether he entered into a marriage contract or not, it would be beneficial for his son to obtain a value of any business interests he holds at the date of marriage.
Mark thanked me for my time. He stated that he had a lot to think about; the current pandemic had forced him to re-review his future outlook, and made him understand that an estate plan or succession plan was an important next step. However, Mark understood the necessity of hiring a CBV to value his business before finalizing any strategy regarding the estate/succession planning process.
About the Author
Julie Zylberlicht, CPA, CA, CBV, CFF is a Senior Manager in the Valuations | Forensics | Litigation Support Group at Crowe Soberman LLP. Julie provides a wide range of services to clients including business valuations, forensic accounting and loss quantifications in, for example, matrimonial matters, shareholder and partnership disputes, corporate and commercial damage claims, corporate reorganizations, and litigation support matters. She is an active member of her Canadian Hadassah Wizo chapter, and sits on committees and on the Board of Directors of Bialik Hebrew Day School.