Components of Business Value

When the premises from which a business operates are expropriated and the business is unable to relocate, there will often be a loss of business value. This blog post explores the different components of business value, and the different ways in which they can be affected by an expropriation. Note that our discussion here will be purely financial; we express no views on legal liability or the extent to which losses are compensable under the Expropriations Act.

Components of Value

Businesses generate profits from a combination of tangible and intangible elements. 

• Tangible Assets: These sources of value are physical or financial; examples would include working capital (e.g. accounts receivable, inventory, net of accounts payable), leasehold improvements, and equipment.
• Intangible Assets: Other sources of value are intangible. These can include intangible assets that are identifiable (e.g. brands, patents, favourable contracts). They can also include other assets, such as goodwill, which is not identifiable. Goodwill is simply a residual value, or a “plug”. It is equal to the difference between a business’s value as a whole and the sum of its identifiable parts. 

A Conceptual Example

Consider a manufacturing company that generates $1M per year in EBITDA. Assume that the relevant EBITDA multiple to value the operating assets of this business is 8x; therefore, the Enterprise Value of the business (i.e. the combined value of its tangible and intangible assets) is $8M.

Suppose the company’s balance sheet shows the following:

It is certainly a very consistent business!

We would say that the business has net working capital of $1.5M (based on $1M of AR, $2.5M of inventory, less $2M of AP) and capital assets of $3.5M, for a total book value of tangible assets of $5M. 

We would compare the Enterprise Value of the business (i.e. $8M) with the book value of operating assets (i.e. $5M) to arrive at the intangible value of $3M. Supposing the business has no specifically identifiable intangible assets, we would conclude that the goodwill is $3M.

Now, assuming the business is unable to relocate, it will have lost the $3M in goodwill when going-concern ceases. But is that the extent of its losses?

The business may be able to sell some of its equipment; but it may be sold at liquidation value far less than the book value of $2.5M. And the leasehold improvements will likely have zero salvage value, as they cannot be removed from the premises. 

What about the working capital? It may be that the business is able to draw down its inventory levels and achieve some net cash flows from the inventory; it may not suffer a complete loss on the $2.5M in inventory that it normally carries. But it may struggle to collect some of its AR if its customers know that it is going out of business. And its suppliers will need to be paid in full.

Conclusions

The manner in which an expropriated business is wound up will depend on the unique circumstances of the expropriation, as well as the nature of the business and its constituent assets. However, the net losses to an expropriated business will often far exceed the value of its goodwill.