What is a multiple?

Have you ever wondered what stock traders mean in the movies when they say “what’s it trading at?”  Are you a tad confused when you hear “it’s worth about 4-times EBITDA”?  If you are, you are not alone, and the truth is that the answer is not as complicated as one may think.

Overview of Intergenerational Transfers

When transferring a business to the next generation, the most commonly used tax strategy is to implement an estate freeze. An estate freeze will allow the business owner to transfer the business without triggering income taxes. Alternatively, business owners may choose to sell their business to their children or other family members to utilize their lifetime capital gains exemption (“LCGE”) – approximately $892K in tax-free capital gains. Care must be taken in selling a business to family members as the Income Tax Act contains “surplus stripping” rules which prevents the selling parties from extracting cash on such sales.

Twenty years ago today, Tom Strezos — currently a Senior Business Advisor in the Valuations Group at Grewal Guyatt LLP — wrote an article published in The Lawyers Weekly on valuing a Dot.com. In this article he valued the then struggling internet start up company, Amazon. Tom thought his assumptions, in 2001, were “crazy”  and valued it at 3x the then market value of  $5B. With the passage of time, those “crazy”  assumptions weren’t nearly enough as it’s value today is in excess of $1 trillion…… but with hindsight, who would have known. We hope you enjoy the read on how to value a start up company and the valuation of Amazon 20 years ago.

For deceased individuals who owned shares of a private corporation, the so-called “pipeline” transaction is a commonly used post-mortem tax planning strategy designed to minimize taxes on death. While the Canada Revenue Agency (the “CRA”) has, historically, consented to the use of pipeline transactions, it has usually imposed strict timing requirements that restrict the ability of the estate to access corporate funds in the years following death.  In a recent tax ruling, the CRA relaxed its position when corporate funds were used to pay taxes of the deceased.

Although there are many factors to consider when valuing a business, there are particular nuances to contemplate with respect to private, owner-managed or family-managed companies. These can include, but are not limited to the following:

1. Whether compensation is paid to family members, including those who do not actively participate in the business (i.e., income splitting);
2. If there are transactions with related parties;
3. The existence of non-operational assets or liabilities;
4. Internal controls and governance policies; and
5. Transferability of goodwill (i.e., personal goodwill vs. commercial goodwill).

Starting 2021, new trust income tax return filing and information reporting requirements will come into effect for most Canadian trusts.  Non-resident trusts that are required to file a T3 trust tax return are also subject to the new rules.  The changes were announced in the 2018 federal budget and will be applicable for trust taxation year ending on or after December 31, 2021.

In 2016, the Department of Finance introduced significant changes to the principal residence exemption rules under the Income Tax Act (Canada). The mandate of these changes was specifically to “improve tax fairness by closing loopholes surrounding the capital gains exemption on the sale of a principal residence”. The proposed changes to the principal residence exemption rules effectively limit the ability of certain taxpayers to reduce or eliminate the capital gain on the sale of their home.

The valuation concept of “double-dipping” refers to the double counting of marital assets; once in the property division and again in the support award. This theory is premised upon the fact that the same cash flows capitalized to determine the value of a spouse’s business (an asset subject to equitable distribution) are also considered a component of that spouse’s total income for support calculation purposes.

Recent legislative changes to foreign reporting requirements for Canadian taxpayers requires the reporting of all specified foreign property owned during the year if the cost base of all specified foreign property exceeds $100,000 at any point during the year.