The 7 basic principles of business valuation : Principle 5Jean-Claude Desnoyers
Principe 5 : When the value is considered to be equal to the present value of all future benefits that the owner should accumulate, this value can have two distinct components: commercial (transferable) or non-commercial (or value to owner) value.
The definition of fair market value refers, among other things, to the highest price that a buyer and a seller would be willing to transact. Without making any direct reference to it, it is clear that what interests a buyer is the transferable portion of the business, that is, tangible net assets and intangible assets (such as goodwill) that he will benefit from after the transaction.
The fifth principle of business valuation refers to the concept of transferability. It indicates that the value of a business can have two components: commercial (or transferable) value and non-commercial (or non-transferable) value.
The commercial value is the value of tangible net assets and intangible assets that can be transferred to a purchaser in a transaction. It should be noted, however, that an adequate transition of the business between the seller and the buyer must be considered to the extent that the seller has the ability to do so. In practice, it often
happens that the seller must continue to work for the business for a certain period after the sale, to transfer the maximum intangible assets as possible to the buyer. For example, it could be the seller’s contacts or the introduction of the buyer to the customers of the business or, the transfer of the successful business model.
If, on the other hand, we have the case of evaluating a business where the owner has passed away, there will be no reasonable transition and we must look at what is transferable at the time of the evaluation without the owner. A non-competition and non-solicitation agreement is also signed in a transaction to preserve some of the commercial intangible assets that might otherwise be lost.
Non-commercial value is basically skills, contacts or knowledge that can not be transferred to a buyer, even with an adequate transition period, assuming that the seller has the ability to transfer the business over an adequate period.
To illustrate a non-commercial intangible asset, let’s take the example of a renowned surgeon. Let us say that he is incorporated and that his company realizes a very important profit. Of course, he will tell himself that if he retires, changes profession or dies, he would not be able to sell his practice to a potential buyer. Why? Because he is his own product. He makes significant profits from his knowledge, personal skills and reputation. His practice would not be transferable.
In a transaction, the buyer may wish to retain the seller’s services after the sale to maintain the non-commercial value of the business. It should be noted that the buyer will not pay during the transaction for this additional value but will be willing to pay the seller accordingly for his future involvement in the business.
If you need the services of a chartered business valuator to determine the fair market value of a business, or to plan the transfer of value to a buyer, you can contact me. It will be my pleasure to help you.