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Business |
| Any undertaking for the purpose of
profit, including any interest in any such
undertaking. |
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Factors
Affecting Business Valuation |
| Business valuation can be complex given
the range of potential factors and the
variety of operating businesses. Prudent
buyers and commercial practitioners must
delve into situations beyond a thorough
analysis of financial records and supporting
documentation. |
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| Eight important factors are detailed as
a guide for practitioners in the valuation
of businesses. |
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| Location |
| As with all real estate, location plays
a vital role in determining value. Value can
be substantially enhanced by business
location on a primary, arterial thoroughfare
(as opposed to a secondary street), location
on the arterial road, and availability of
parking. Traffic and pedestrian counts are
also important elements, plus proximity to
other retailers with high customer appeal. |
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| Appearance |
| Attractive, inviting appearance, high
level of cleanliness and neatness, and
well-stocked premises contribute to business
appeal and can materially increase sales.
Selected types of discount stores can be an
exception as they deliberately use
industrial racking, basic store fixtures,
and heavy window display advertising to
promote the image of minimum operating costs
and consequent consumer bargains. |
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| Span of Operation/Image |
| A long history of satisfied and repeat
customers produces greater value for a
business operation, as compared to a new
venture that lacks a track record or
reputation. An exception is the new
franchise outlet that, while possessing no
local track record, acquires a sense of
longevity through an acquired, known image. |
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| Competition |
| Generally, the less competition facing
any particular business, the greater the
chance of that business having higher sales
and potential profit. This statement
assumes, of course, a demand for the
particular services and/or products being
offered. High sales performance normally
translates into heightened value if
operating costs fall within acceptable
limits. |
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| Demand |
| Certain businesses have high consumer
demand and, sometimes, a perception of
glamour in the eyes of the public. This
preferred type of business will not only
command a high price, but will also be
easier to sell. For example, certain fast
food and automotive franchises fall within
the high demand category, while selected
clothing and home fashion outlets attain
glamour status. |
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| Turnover |
| The number of times that stock is sold
and replaced in a given year. The number of
turns achieved varies by type of business.
For example, four to five turns are normal
for a department store, as compared to 30 to
35 for a supermarket. A major financial
advantage exists concerning start-up costs
for high turnover businesses. Most
merchandise can be sold before payment is
required, thereby freeing up lines of credit
and capital for other purposes, e.g.,
leasehold improvements and advertising. On
the converse, a major disadvantage of the
high turnover enterprise lies in the
commensurately increased levels of employed
staff required to operate the enterprise and
manage stock-related issues. |
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| Service Quality |
| As a general statement regarding the
service industry, the sales volume and
ultimately the value of the enterprise is
directly related to the quality of service
provided to the customer. Further, a direct
relationship has traditionally existed
between the number of well-trained,
adequately-compensated staff and the
achievement of sales goals. Given the
preponderance of low pay-scales for retail
employees, service quality is a continuing
problem for many employers. Successful
entrepreneurs have overcome this through
better compensation packages including the
use of sales bonuses and the introduction of
share participation programs. This
enlightened philosophy normally translates
into increased customer traffic and
ultimately higher returns. |
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| Ownership vs. Lease |
| Security of tenure and continued
operation is of paramount importance to the
typical business. An overriding priority for
businesses in leased premises, is long term
possession. When real estate is owned, this
concern is eliminated or at least
significantly minimized. However, such a
statement requires qualification. Many
commercial practitioners point to the
benefits of leasing, despite uncertainties,
as a rental arrangement permits the use of
available capital more productively in the
expansion of the business enterprise.
Further, short term leasing may be ideal for
a rapidly expanding business not wanting to
be hampered by inadequate facilities during
the growth pattern. |
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| The listed criteria are provided for
general guidance. Any business must be
critically scrutinized including a thorough
examination of financial records. Selected
factors can be improved by a new owner
(e.g., service quality), while other
elements (e.g., location), are usually
fixed. All of the above contribute to the
present and future value of any business
under review, however, their relative impact
will vary by type of business. |
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Business
Taxes |
| Taxes levied and due to the appropriate
municipality for the operation of a business
as defined by, and located within, that
municipality. In commercial tenancies,
business taxes of the tenant are normally
paid by the tenant and include:
license/registration fees and other charges
for the equipment and facilities of the
tenant; the improvements within the leased
space for the tenant; and the business
carried on by the tenant (or subtenants). |
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| Business taxes are addressed differently
within provincial jurisdictions. In Ontario,
for example, business taxes were abolished
during the 1998 taxation year, given a major
overhaul of property taxation within the
province. |
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Business Valuation |
| Three primary methods of valuation
exist, although there are numerous
variations based on the type of business
under consideration. Summary descriptions
are provided, however practitioners must be
prepared to address unique complexities in
the marketplace. |
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| Direct Capitalization |
| Income generated by the business is
capitalized based on market research
involving analysis of comparable sale
prices. |
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| Discounted Cash Flows |
| Projected cash flows derived from both
operations and ultimate sale of the property
are discounted based on an acceptable
discount rate to arrive at value. Appraisers
reference this process as yield
capitalization. |
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| Adjusted Book Value /Asset
Valuation |
| These are normally used when assets are
broken into components, valued, and summed
to arrive at a selling price. Component
valuation typically involves the sale of
assets only without consideration of the
operating business. In instances where the
business is included, financial performance
may have little or no impact on final value
as acquisition risks (e.g., assuming
leasehold interests), can equal or even
exceed any value in retained earnings.
Adjusted book value or asset valuation
techniques vary significantly in the
marketplace. |
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| In practice,
precise theoretical lines to valuation
approaches are frequently blurred as buyers
and sellers negotiate. Negotiating parties
typically wrestle with value from personal
perspectives, giving consideration to
historical income performance and present
circumstances, no matter whether they are
bargaining based on the complete business or
simply its assets. With assets, valuation
can prove particularly complex, e.g.,
inventory for a retail sales operation
(often referred to as a distributive
operation ), is treated much differently
than a manufacturer’s inventory consisting
of raw materials, work-in-progress, and
finished goods inventories. |
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| While direct capitalization can be
relatively straightforward for many
commercial properties, the sale of a
business introduces special considerations.
For example, net operating income is often
affected by the extent of owner
contribution, the seller’s unique skills in
relation to a specific business, and a host
of other judgmental factors. To further
compound matters, unique combinations can
arise in negotiating positions. Buyers and
sellers utilize capitalization for certain
items (e.g., determination of goodwill based
on excess profits derived from average
earnings), while calculating depreciated
cost (book value) on other items such as
equipment and stock, and applying wholesale
values to still others. |
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| Regardless of valuation procedures used,
practitioners are advised to remember
certain basic rules about businesses. |
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- Clearly identify the components of
the business being sold.
- Establish an effective date for the
valuation.
- Determine if market value or other
type of value, e.g., book value, is
required.
- Gather all pertinent documentation
relating to identified components.
- Provide an estimate only after
careful evaluation of all the facts.
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Listing of a
Business |
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A registered real estate broker (agent), if
entitled to list and sell businesses under
the provisions of the applicable real estate
act, typically treats this type of sale
similarly to the sale of real estate. The
regulatory definition of real estate, in
such instances, normally includes real
property, leasehold interests, and the
business whether with or without premises,
fixtures, stock-in-trade, goods, or chattels
in connection with the operation of the
business. |
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With businesses, various documents and
special considerations also arise. The sum
of all documents available to a potential
buyer is normally referred to as the
documentation package. |
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Business
Shares or Assets:
A vital factor in listing a business is
establishing whether the shares of the
business, or its assets, are to be sold. If
shares in a corporation are being sold, the
buyer assumes all assets and liabilities.
He/she will have the use and benefit of such
items as the company name, copyrights,
leases, and real estate, unless otherwise
agreed. If only assets are being sold, the
seller normally assumes responsibility for
any existing debt, e.g., accounts payable,
but retains all accounts receivables. The
buyer acquires the remaining assets, such as
equipment, inventory, and goodwill. Tax
implications arise from either approach and
the tax position of seller and buyer can be
complex. The listing salesperson is strongly
advised to confirm that the buyer and seller
have consulted accountants regarding such
matters. |
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Financial
Statements:
The balance sheet (statement of assets and
liabilities), as of the last day of the
fiscal year of the business should be
obtained for at least three (and preferably
five or more), years of operation. Ideally,
balance sheets are obtained from the
seller’s accountant and will be prepared for
small businesses as unaudited statements
used in the preparation of income tax
returns. |
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The profit or loss statements (statement of
revenue and expenses), should also be
obtained for the same period, or as many
years as available. The extent of historical
financial documentation often translates
directly into more accurate analysis of
business trends and a more saleable listing. |
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Provincial requirements concerning the sale
of a business may vary. In Ontario, for
example, the Real Estate and Business
Brokers Act (REBBA) requires that financial
statements be delivered to the buyer or that
the buyer waive compliance with this
requirement. Standard forms have been
developed for use by brokerages. |
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Fixtures and
Chattels:
Detailed lists of fixtures and chattels are
needed: |
- A list of items included in the
sale; and
- A list of items not included in the
sale.
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Lease:
If the business premise is leased and not
owned by the seller, a copy of the lease is
required. The contents of the lease can
directly affect both the value of the
business and its marketability. Buyers will
be particularly concerned with: |
- Whether the lease can be assigned;
- Under what conditions the assignment
can occur;
- The remaining term of the lease
including any provisions for renewal;
and
- The terms, benefits, and
restrictions contained in the lease
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Where a relatively short possession period
remains, the buyer may require assurances
that a satisfactory extension of the lease
agreement can be arranged and require a
condition to that effect in the agreement. |
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Franchise
Agreements:
If the business operates under a franchise
arrangement, a copy of relevant agreement(s)
must be included in the documentation
package. Conditions can exist within such
documents that affect, or possibly nullify,
the sale. For example, the franchisor
normally charges an ongoing royalty fee for
benefits accruing from the franchise
affiliation. In most retail franchises, an
advertising fee is also levied for regional
and/or national promotional programs. The
franchisor may further require approval of
any new franchisee along with an appropriate
condition inserted in any offer. The
franchisor may also require that a new owner
undertake specific product training. |
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Licenses:
Details of any operating license(s) must be
obtained from the seller and inserted in the
documentation package. Depending on
circumstances, information about how the
buyer should obtain or have the license(s)
transferred is also necessary. A prime
example would involve a licensed restaurant
under the Liquor Licensing Board of Ontario.
The license is awarded to the owner (as an
individual), who operates the restaurant and
not to the premises. Any transfer of
business ownership must be accompanied by
the transfer of that liquor license, subject
to approval, to the new proprietor. |
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Financing
Options:
Buyers rarely pay all cash for a business
and, consequently, seller financing is
commonly encountered as well as additional
outside financing. In either or both
instances, details should be clearly set out
concerning the range of financing options
available, as these can translate directly
into an improved marketing position. For
example, the buyer may have a 30%
downpayment based on the purchase price, but
unable to secure funds elsewhere. The
balance of the purchase price can then be
financed by a seller take back mortgage with
the assets of the business as security. |
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An earn out can be used to
pay off the mortgage. The terms of the earn
out are established to suit the parties. The
buyer is able to pay the balance of the
purchase price from cash flow, while the
seller concludes a sale by offering a
favorable and manageable financing option.
The buyer may also ask the seller to remain
as a consultant for a predetermined salary
or fee. The buyer benefits from the seller’s
experience and knowledge, while the seller
can ensure the continued success of the
business and the payment of the outstanding
balance. |
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Additional
Documents:
The range of documents is dictated by the
type of sale (assets vs. shares), the
specific business involved, and the
creativity of the salesperson in providing a
detailed offering to the marketplace. As
with all commercial offerings, the better
the documentation package, the more
effective the overall marketing program, the
better the prospects of a sale. Additional
documents might include: |
- Details of any equipment leases
along with relevant terms and
conditions;
- Copies of any notes, business
contracts, or unique agreements that
affect the business and will be assigned
to the buyer, e.g., franchise
agreements, employment contracts,
licensing agreements, and client
contracts;
- Demographic, economic, or other
statistical information in support of
the business, e.g., trends in retailing
and traffic counts;
- Photographs of the business (both
exterior and interior), including trade
fixtures;
- Copies of any appraisals completed
on chattels and fixtures included in the
sale; and
- Selected tax return information
relating to the business.
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Sale of
a Business |
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Requires specialized knowledge particularly
concerning provincial legislative
requirements that may impact the sale,
including the use of specific forms. |
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Prospects must be properly qualified
concerning financial matters, particularly
given the challenges of securing business
financing. |
- Establish precisely how much actual
cash or liquid assets can be applied to
the purchase price.
- Ascertain whether the buyer intends
to work on a full-time basis in the
business being acquired, or simply
purchase the enterprise as an investment
as this will have considerable bearing
on selecting the appropriate type of
business.
- Determine if the buyer has any
practical skills in the business under
consideration. Experience is frequently
a determining factor in whether a seller
will accept or reject an offer,
particularly when providing financing.
- Obtain permission to conduct a
credit check.
- A buyer’s net worth statement can be
advantageous in assisting the seller in
making a decision about a particular
offer.
- Since many businesses involve seller
financing, the buyer’s willingness to
enter into a personal guarantee should
be established at the outset.
- Lastly, evaluate the buyer’s
attitudes, temperament, experience, and
aspirations. Often, businesses look
attractive from an investment
perspective but are not suited to a
particular buyer, e.g., amount of manual
labor needed, number of hours required;
range of hours demanded (e.g., early or
late), and necessity of specific skills.
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By narrowing the field, both buyer and
salesperson can work more productively in
finding the right fit. |
