Overview

The purchase of an existing business most often involves the purchase of the operating assets only. Occasionally, a prospective purchaser may consider buying the shares if the business is already incorporated. Also, some buyers will not purchase receivables and others may want to view those as a means of keeping the client attached to the business under their “new” ownership.

Regardless of which applies, you, as the purchasing party, can negotiate a deal that can include or exclude virtually any asset.      

Business Evaluation

The first step a buyer must take in evaluating a business for sale is that of reviewing its history and the way it operates. There are many methods that one may use to determine the value of the business. Asset value methods, earning value methods and combined methods are the most commonly used. Buyers should utilize a number of these to arrive at a range of prices which can be used during the purchasing negotiation.

The business’ financial statements, operating documents, and practices should be reviewed.  A summary of the most common items to be reviewed is as follows:

Balance Sheet

The balance sheet is a document in financial accounting which reflects a company’s financial position, be it a sole proprietor, a partnership or a corporation. The balance sheet acts as a summary or a snapshot of a company’s financial balances for a specific period of time, such as a financial year. A balance sheet is typically divided into 3 sections: assets, liabilities, and owners equity, where:

Assets – liabilities = owners equity.

For an example of what a balance sheet looks like see Appendix I at the end of this document.

Accounts Receivable

• Obtain an accounts receivable aging schedule and determine if there is concentration among a few accounts.
• Determine the reasons for all overdue accounts.
• Find out if any amounts are in dispute.
• Are any of the accounts pledged as collateral?
• Is the reserve for bad debt sufficient and how was it established?
• Review the business’ credit policy

Inventory

• Make sure the inventory is determined by physical count.  Manufacturers should divide inventory into: finished goods, work in progress, and raw materials.
• Assess the method of valuation and why it was used. (LIFO, FIFO, WAC, etc.)
• Determine the age and condition of the inventory.
• How is damaged or obsolete inventory valued?
• Is the amount of inventory sufficient or too large to operate efficiently and for how long?
• Should an appraisal be obtained?

Marketable Securities

• Obtain a list of marketable securities.
• How are the securities valued?
• Determine the fair market value of the securities.
• Are any securities restricted or pledged?
• Should the portfolio be sold or exchanged?

Real Estate

• Obtain a schedule of real estate owned.
• Determine the condition and age of the real estate.
• Establish the fair market value of each of the buildings and land.
• Should appraisals be obtained?
• Are repairs or improvements required?
• Are maintenance costs reasonable?
• Do any of the principals have a financial interest in the company(s) that perform(s) the maintenance?
• Is the real estate, required to operate the business efficiently?  Can a lease agreement be arranged to lessen cash required instead of purchasing?
• How is the real estate financed?
• Are the mortgages assumable?
• Will additional real estate be required in the near future?

Machinery and Equipment

• Obtain a schedule of machinery and equipment owned and leased.
• Determine the condition and age of the machinery and equipment and the frequency of maintenance.
• Identify the equipment and machinery that is state-of-the-art.
• Identify the machinery and equipment that is obsolete.
• Identify that the machinery and equipment is used in compliance with Canadian standards and determine if additional equipment and machinery is needed to comply.
• Will immediate repairs be required and at what cost?

Accounts Payable

• Obtain a schedule of accounts payable and determine if there is concentration among a few accounts.
• Determine the age of amounts due.
• Identify all amounts in dispute and determine the reason.
• Review transactions to determine undisclosed and contingent liabilities.

Accrued Liabilities

• Obtain a schedule of accrued liabilities.
• Determine the accounting treatment of:

1. unpaid wages at the end of period
2. accrued vacation pay
3. accrued sick leave
4. payroll taxes due and payable
5. accrued Federal and Provincial income taxes
6. other accruals like GST

• Search for unrecorded accrued liabilities.  Example - severance pay.

Notes Payable and Mortgages Payable

• Obtain a schedule of notes payable and mortgages payable.
• Identify the reason for indebtedness.
• Determine the terms and payment schedule.
• Will the acquisition accelerate the note or mortgage or is there a prepayment penalty?
• Determine if there are any balloon payments to be made and the amounts and dates due.
• Are the notes or mortgages assumable?
• Have personal guarantees been provided

Income Statement

The income statement is a document which  indicates the amount of money received from sales (revenue), the expenses incurred, and the net income ( the remainder after all expenses and taxes have been subtracted from the gross revenue) over a specific period of time, such as a financial year. Often, the income statement is also referred to as “profit and loss statement” in many accounting software packages, and the purpose of this document is to show the company’s financial position (whether it has made profit or loss) to managers or potential investors.

The potential earning power of the business should be analyzed by reviewing profit and loss statements for the past 3 to 5 years.  It is important to substantiate financial information by reviewing the business’ federal tax returns.  The business’ earning power is a function of more than bottom line profits or losses.  The owner’s salary and fringe benefits, non-cash expenses, and non-recurring expenses should also be calculated.

For an example of what an income statement looks like see Appendix II at the end of this document.

Financial Ratios

While analyzing the balance sheet and the income statement, sales and operating ratios should be calculated in order to point out areas requiring further study.  Key ratios are the current ratio, quick ratio, accounts receivable turnover, inventory turnover and sales/accounts receivable.  The significance of these ratios, the methods for calculating them, and industry averages are available through publications such as Dun & Bradstreet and Robert Morris Associates.  Look for trends in the ratios over the past 3 to 5 years.

Leases

• What is the remaining term of the lease?
• Are there any option periods, and if so, is the option exercised only by the choice of the tenant?
• Is there a percent of sales clause?
• What additional fees (such as a common area maintenance or merchants association dues) are paid over and above the base rent?
• Is the tenant or landlord responsible for maintaining the roof and the heating and air conditioning system?
• Is there a periodic rent increase called for to adjust the rent for changes in the consumer price index or for an increase in real estate tax assessments?
• Is there a demolition clause?
• Under what terms and conditions will the landlord permit an assumption or extension of the existing lease?
• Is a personal guarantee required?

Personnel

• What are the job responsibilities, rates of pay and benefits of each employee?
• What is each employee’s tenure?
• What is the level of each employee’s skill in their position and are they employed under an employment contract?
• Will key employees stay after the business is purchased?
• Are any employees part of a union, or is any union organizing effort likely?
• Have there been layoffs in the past year which could trigger lawsuits?

Patents

A list of trade names, trademarks, logos, copyrights, industrial designs and patents should be obtained, noting the period of time remaining before each expires.

Taxes

• Are CPP, EI, GST, and Income Tax payments current?
• What were the dates and the outcome of the last audit?

Legal Issues

• Are there any suits now or soon to commence?
• What Occupational Health and Safety, W.C.B., environmental and other regulatory requirements must be met and are they currently being met?
• Are all registration requirements and regulations being met?
• Are all local zoning requirements being met?
• Review the articles of incorporation, minute books, by-laws, and/or partnership agreements.
• What are the classes of stock and the restrictions of each, if any?
• Has any stock been cancelled or repurchased?
• Is the business a franchise?  If so, review the franchise agreement.

Insurance

• What coverage has been provided for business assets, general and professional liability, business loan, business interruption, and “Key Person” insurance?
• Was there a past or is there a current claim?

Marketing

• Are any of the products proprietary?
• Describe any new upcoming products and projected sales.
• What is the business’ geographic market area?
• What is the business’ percentage of market share?
• What are the business’ competitive advantages/disadvantages?
• What are the current market trends?
• Is the business name included? Is it registered?
• Is there a customer list or database and is it included?

Competitors

• Who are the business’ competitors?
• What is their market share?
• What are each competitor’s competitive advantages/disadvantages?

Business Web Site

• Is the transfer of the domain ownership part of the agreement?
• If so, the administrator must be changed with domain registration company.
• Who currently hosts and maintains the company website?
• Will you have the technical support to do so after the sale?
• All service agreements regarding the website must be changed to reflect the new ownership.

All the factors identified in this section on evaluating a business have to be carefully scrutinized and weighed. Some factors will have a positive influence on the decision to buy. Others will have a negative influence. Seek out professional assistance if help is needed.

Business Valuations

Chartered Business Valuators (CBVs) assess the value of a business, or its components: enterprise value, equity interests, securities, business operations, copyrights, trademarks, other intellecual property and goodwill.

The business and security valuation field in Canada is essentially unregulated. The Canadian Institute of Chartered Business Valuators (CICBV) (or the Institute) is a self-regulated body which is not regulated by federal nor any provincial statue.

While the CICBV's qualifications and standards are recognized by some Canadian regulatory authorities, the Institute does not claim exclusivity in the field of business and securities valuation. However, the Institute and its Members have achieved significant stature due to the excellent training and certification process and the enforcement of the Institute's Practice Standards and Code of Ethics.

The CBV designation has come to be recognized as the premier credential for professional business valuators in Canada, with Members providing a broad range of business valuation services to Canada's business, legal, investment, banking and government communities.

Additional Resources

• Tips and Traps When Buying a Business / Greg Balanko-Dickson 2005

HD 1393.25 B35 (The Business Link Library)

• The Complete Idiot’s Guide to Buying and Selling a Business for Canadians / Larry Easto and Ed Paulson 1999

HD 1393.4 C3 E27 2000 c.3 (The Business Link Library)

• Buying and Selling a Small Business / Michael M. Coltman 1994

HD 1395.25 C722 1994 (The Business Link Library)

Appendix I: Balance Sheet

Balance sheet
COMPANY XYZ
July 12, 2010
			2003	2004
Assets
Current assets:
Cash
Investments
Inventories
Accounts receivable
Pre-paid expenses
Other
Total current assets			$                       -	$                       -
Fixed assets:
Property and equipment
Leasehold improvements
Equity and other investments
Less accumulated depreciation
Net fixed assets			$                       -	$                       -
Other assets:
Goodwill
Total other assets			$                       -	$                       -
Total assets			$                       -	$                       -
Liabilities and owner's equity
Current liabilities:
Accounts payable
Accrued wages
Accrued compensation
Income taxes payable
Unearned revenue
Other
Total current liabilities			$                       -	$                       -
Long-term liabilities:
Mortgage payable
Total long-term liabilities			$                       -	$                       -
Owner's equity:
Investment capital
Accumulated retained earnings
Total owner's equity			$                       -	$                       -
Total liabilities and owner's equity			$                       -	$                       -
			Balanced	Balanced
		Difference:	$0	$0

 

*Adapted from http://office.microsoft.com/en-ca/templates

Appendix II: Income Statement
Income Statement
	Company XYZ
	For 2006 through 2009
(all numbers in $000)
REVENUE		2006	2007	2008	2009
Gross sales		$500	$650	$720	$850
	Less sales returns and allowances	200	230	280	320
Net Sales		$300	$420	$440	$530
COST OF SALES
Beginning inventory		$350	$360	$420	$435
	Plus goods purchased / manufactured	120	165	185	190
Total Goods Available		$470	$525	$605	$625
	Less ending inventory	360	420	435	440
Total Cost of Goods Sold		$110	$105	$170	$185
Gross Profit (Loss)		$190	$315	$270	$345
OPERATING EXPENSES
Selling
	Salaries and wages	$35	$41	$46	$52
	Commissions	12	14	16	18
	Depreciation	14	15	16	16
	Other	5	6	6	7
Total Selling Expenses		$76	$88	$98	$113
General/Administrative
	Salaries and wages	$12	$14	$16	$18
	Payroll taxes	2	3	3	4
	Insurance	6	6	7	7
	Rent	8	8	9	9
	Utilities	2	2	2	3
	Depreciation & amortization	3	4	4	5
	Office supplies	1	1	1	1
	Travel & entertainment	3	3	3	4
	Interest	0	1	1	2
	Furniture & equipment	3	4	4	5
Total General/Administrative Expenses		$45	$52	$57	$67
Total Operating Expenses		$121	$140	$155	$180
Net Income Before Taxes		$69	$175	$115	$165
	Taxes on income	22	32	26	28
Net Income After Taxes		$47	$143	$89	$137
Extraordinary gain or loss		$0	$0	$43	$0
Income tax on extraordinary gain		0	0	12	0
NET INCOME (LOSS)		$47	$143	$120	$137

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*Adapted from http://office.microsoft.com/en-ca/templates