Show download pdf controls
  • Valuation of a business

    On this page

    Meaning of 'business'

    We use the term 'business' in a way consistent with usual valuation industry descriptions and definitions, applied within the context of Australian federal tax law.

    Business is defined in the International glossary of business valuation terms as meaning 'business enterprise' and is defined as: 'a commercial, industrial, service, or investment entity (or a combination thereof) pursuing an economic activity.'

    Section 995-1 of the ITAA 1997 defines 'business' as including 'any profession, trade, employment, vocation or calling, but does not include an occupation as an employee'.

    See also

    • Taxation ruling TR 1999/16 Income tax: Capital gains: goodwill of a business

    Valuation methods

    The valuation of a business is usually based on a number of established valuation methods built around the market-based, income-based and asset-based approaches.

    These methods include:

    • comparable transactions
    • comparable trading
    • capitalisation of earnings
    • discounted cash flow
    • calculation of net assets on a going-concern basis.

    The mechanics of these methods are not covered in this information other than to note their application within the context of existing legislation, our publications and established industry approaches.

    In valuing a business, we would like you to consider a number of factors that may affect the market value and produce a reasonable and defensible view of the market value.

    These factors may include:

    • valuation methods – you would need to explain your choices and demonstrate why they are appropriate
    • valuation metrics – you would need to explain your choices and demonstrate that you have applied them appropriately – for instance, you would need to show how you derived a company weighted average cost of capital
    • valuation date
    • purpose of the valuation
    • basis or premise of your valuation – for example, valuation of the business on a going-concern basis
    • description of the business
    • a summary of the corporate structure and management of the business – including such details as the operating history, management and board, capital structure, company constitution, board minutes, shareholder agreements, business and strategic plans, marketing plans and operating plans
    • market information – including key customers and spread, customer lists, sales pipeline, barriers to entry, competitors, alternative products, market size and growth
    • operations – including information such as manufacturing and production, service delivery, research and development capability/plans, fixed asset details, key suppliers, intellectual property protection and utilisation, resourcing, risk identification and management and regulatory issues
    • products or services – including information such as product description, product pipeline, pricing and the basis of pricing (for example, market or cost-plus)
    • financial requirements and financial structure - including information such as current and historical financial statements, budgets, forecasts, key operating metrics, funding details and terms (equity, hybrid and debt funding – existing and planned), off-balance-sheet structures, capital expenditure requirements and operating cash flows
    • strategic and corporate development initiatives – including information such as previous and planned acquisitions, previous and planned divestments, corporate restructures, corporate actions, strategic alliances and joint ventures
    • sales and marketing strategies – including information such as target markets (existing and planned), direct or channel strategies, reseller or supplier agreements, compensation strategies and product and brand awareness strategies
    • adjustments for items such as non-operating assets (for example, investments) and excess cash
    • adjustments for factors such as control and liquidity or marketability (at the company or business level).

    See also

    Valuation of securities

    On this page  

    Meaning of 'security'

    This information covers a number of securities (but not all) that fall within the definition of 'security' in subsection 159GP(1) of the ITAA 1936, namely:

    • stocks, bonds, debentures, certificates of entitlement, bills of exchange promissory notes or other securities
    • deposits with banks or other financial institutions
    • secured or unsecured loans
    • any other contracts, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

    The Financial Services Reform Act 2001 defines the term 'security' (section 761A and Part 7.11) to mean one of the following:

    • a share
    • a debenture
    • a legal or equitable right or interest in a share or debenture
    • an option to acquire, by way of issue, any of the above securities
    • a managed investment product.

    Securities may be listed or unlisted and may be categorised generally into three types:

    • equity
    • debt
    • hybrids.

    Examples of equity securities include:

    • ordinary shares
    • preference shares (depending on structure).

    Examples of hybrid securities include:

    • some preference shares (depending on structure)
    • convertible notes (not covered in this guide).

    Examples of debt securities include:

    • discount securities
    • bonds
    • floating rate notes.

    For the purpose of this information, we refer to ordinary shares, preference shares, floating rate notes and bonds in accordance with commonly accepted industry understanding, but applied within the context of Australian federal tax law.

    Valuation methods

    The valuation methods that may be used to determine a market value for securities are based on established approaches that are market-based, income-based, cost-based or probabilistic.

    These methods include:

    • business valuations adjusted for the relevant security or ownership interest
    • trading benchmarks, for example, volume weighted average price or closing price
    • security-based discounted cash flow.

    Equity securities – ordinary shares

    An ordinary share may be either:

    • listed – registered on a recognised exchange such as the Australian Securities Exchange (ASX)
    • unlisted – held privately by an individual or group of shareholders.

    Registration of an ordinary share on a recognised exchange provides for a daily market in the ordinary share, whereas an unlisted share is sold either in a limited market or in a transaction between two or more parties.

    Preference shares, convertible notes, bonds and floating rate notes may also be registered and traded on a recognised exchange.

    Valuing listed shares

    As listed ordinary shares are commonly traded on a daily basis, you may be able to rely on the appropriate share market as the source for valuing a listed ordinary share.

    When you value a listed share, we would expect you to take into account a number of factors in addition to the listed price. These include:

    • liquidity
    • volatility
    • valuation changes resulting from company capital structural events or changes in retained earnings (for example, as a result of dividend payments)
    • the period to which the valuation applied.

    If a stock is relatively liquid and does not exhibit significant price volatility, you may, in certain circumstances, refer to a point-in-time valuation (such as the closing price of a share). However, there are a number of tax contexts where this may not be applicable.

    A common method of smoothing the effects of illiquidity (that is, thin trading) and volatility of a stock is to take the volume weighted average price of the stock over a certain period. You may also adopt this method if the stock is liquid but does not exhibit excessive volatility. Within a tax context, this method is commonly applied to corporate events and actions.

    In addition to the valuation of an individual listed share, the value of a block of listed shares in the hands of one owner will often be derived using the value of a listed share as a base. As an example, depending on the size of the shareholding (in absolute and percentage terms), a discount may need to be applied to take into account the difficulty of selling this block of shares into the market. This is known as the blockage discount.

    The application of the blockage discount needs to be based on the particular facts relating to a case. For example, a significant holding of listed shares could, in some circumstances, require the application of a premium rather than a discount.

    The value of a company's equity (or significant portion, where an individual legal or beneficial owner could exert significant influence) will often also be derived using the value of a listed share as a base. In such situations, a premium for control would often be added to the value of the company's shares. This would be necessary to account for factors such as the influence a particular shareholder may exert on the running of the company and synergies that may be gained through the acquisition of a controlling holding.

    Valuing unlisted shares

    Where an ordinary share is held privately by an individual or group of shareholders, applying the appropriate valuation method (or methods) may be more complex.

    When you value an unlisted share, we would expect you to take into account a number of factors that may affect its market value, including:

    • many of the factors described in Valuation of a business (accounting for the specific interest)
    • adjustments – you need to adjust for factors such as liquidity (at the holdings level) and degree of control (actual or effective) and show that these adjustments are appropriate – for instance, you could benchmark a minority interest in an unlisted investment company against a listed investment company operating in a similar environment
    • the rights of other equity and debt holders (which may influence the market value of an ordinary share).

    If an ordinary share is held privately by an individual or group of shareholders, applying the appropriate valuation method (or methods) may be more complex.

    Hybrid securities – preference shares

    Preference shares may be unlisted or listed, and may be classified as either equity (depending on the preference structure) or debt.

    From the equity perspective, the preference share may be represented as an additional class of equity (despite the hybrid tag) differentiating itself from an ordinary share in its basic rights (for example, voting rights and liquidation preferences).

    From the hybrid perspective, the preference share may be more akin to a debt instrument where a number of debt-like features comprise the elementary features of the preference share – for example, in the form of a reset preference share that may include a conversion option, fixed dividend, step-up rights and redemption.

    Valuing a preference share

    In valuing a preference share, we would expect you to take into account factors that may affect the characterisation (that is, equity or debt classification) and valuation of the preference share.

    While a preference share may trade on a recognised exchange, you will need to consider certain factors concerning the preference share's structure (including attached rights) when assessing its market value, including:

    • issue date
    • issue rating
    • issue price
    • term/maturity
    • reset dates (if applicable)
    • dividend rate
    • dividend payment period
    • whether it is cumulative or non-cumulative
    • whether it is redeemable or non-redeemable
    • conversion details (if applicable)
    • conversion discount (if applicable)
    • voting rights
    • ranking
    • liquidation preferences.

    Some of these factors may also apply to a number of hybrid structures more widely.

    Where you use a traded preference share (such as a reset preference share) as a benchmark in assessing the market value of a debt instrument, we would expect you to exclude the equity factors embedded in the pricing of the preference share.

    In deriving the value of an ordinary share by reference to preference shares issued by a company, we would expect to see the rights attached to the preference shares incorporated fully into any valuation.

    We do not expect to see preference shares valued at their paid-up value unless warranted by industry standards. We would expect to see the rights of the preference shareholders fully incorporated and priced in the market value of the ordinary shares for the valuation of a start-up firm where a senior class of shares was subsequently issued.

    Debt securities

    This information focuses on the valuation of debt securities that are not listed on a recognised exchange or traded in 'over-the-counter' markets. Such debt securities should be priced using industry accepted practices.

    In basic terms, any interest-bearing instrument is generally referred to as debt (such as discount securities, bonds and floating rate notes). This definition extends to cover zero-coupon notes and bonds, but excludes hybrid and derivative structures.

    In most circumstances, we would expect the yield or price adopted in a transaction to be appropriately benchmarked to the market (accounting for the arm's-length principle). When you value a debt security or derive a market yield we would expect you to take into account factors such as:

    • issue date
    • issue price
    • term/maturity
    • early redemption options
    • face value
    • coupon rate or interest rate
    • coupon payment period
    • coupon payment date
    • accrued interest
    • par yield curve (for instance, government)
    • zero yield curve
    • forward curve
    • credit rating (actual or estimated, issuer or issue)
    • credit curve
    • liquidity.

    Price may vary depending on the circumstances and structure of the debt. Where inter-group debt has been issued, we would expect to see the debt priced at market value. Our general expectations about certain debt structures and price are as follows:

    • coupon that is equal to the yield to maturity – we would expect to see the bond priced around par
    • coupon greater than the yield to maturity – we would expect to see the bond priced at a premium to par (the amount of principal owing on the bond at maturity; this value may include accrued interest, as in the case of a zero-coupon bond)
    • coupon that is lower than the yield to maturity – we would expect to see the bond priced at a discount to par
    • zero-coupon or discount structure – we would expect to see the issue price lower than the face value.

    Where an Australian subsidiary issues debt to an offshore parent, we would expect you to price the issue with reference to factors such as those mentioned above.

    See also

      Last modified: 18 Aug 2017QC 21245