How do I evaluate a business?

Purchasing a business in Ontario is usually a quicker process compared to starting up one from scratch. However, it is critical to ensure that you have the capacity to manage the new business so that you don’t end up overpaying for it. Before embarking on the journey, there is much that you must learn. You need to understand the purchasing process and decide on the type of business to invest in, locating the opportunity, negotiating the price, closing the deal, and ensuring that all legal requirements are fulfilled. For this reason, this guide gives you the best skills you need to evaluate a business for sale before signing any checks.

Finding a Business: Independent or Franchising

 

When purchasing a business, you have the option of considering either an existing independent business or franchising. Either way, every type of business has its own strengths and weaknesses.

Pros of buying an independent business:

  • Since you will be owning 100% of the business, you won’t have to divide the profits made with anyone.
    • An independent business gives you more control over operating, setting your own operational rules, and making key design decisions.
    • Purchasing an independent enterprise that has the potential to do well can reap you a lot of rewards after hard labor.

Cons of buying an independent business:

  • A major challenge of running an independent business is the overwhelming responsibility.
    • The success of such a business is solely on you.
    • When tasked with establishing a brand or revamping a brand with a poor reputation, an independent business holds the highest risk.

Pros of buying a franchise:

 

  • Franchises already have positive track records. Since the business is proven, there will be less risk involved.
    • Since a franchisee operates under a parent company, the business owners do not need to spend more time in minor details such as advertising or coming up with company policies.
    • Franchise already has an established customer base; you won’t invest in creating brand awareness.

Cons of buying a franchise:

 

  • You will have less freedom in controlling business operations.
    • A part of the profits generated must be shared with the parent organization.The Basic Question: How Much Am I Willing to Spend?

The valuation process will help you address the fundamental question, “How much do I want to spend on this business to be able to get $X every year?” In order to answer this question, you will have to review the historical financial flow, including reviewing the Income and expense statement of the company; arriving at the net profit before interest, tax, depreciation, and amortization; considering the financial impact of potential market changes such as non-recurring expenses or a windfall profit. You may also need to make adjustments to reflect “normal” market rates, such as including the standard wage rates of a business in the Greater Toronto Area used in the market.

After determining your “normalized” estimated earnings using the trends and historical data, choose a multiple that exist in the market. Compare the costs and benefits of the business and the return on investment to other alternative investment options. Using this information, you will be able to determine whether the purchase is worth it.

Why You Need to Evaluate the Performance of a Business:

As you review the performance of a business in Ontario, you need to assess information about past performance to accurately determine the overall value. The economic valuation will tell you whether you are making the right decision in considering a used business. As you review the financial details of the business, you will prepare financial statements. The three types of statements commonly prepare are:

A Notice to Reader Statement:

This is the cheapest and quickest financial statement to prepare. The evaluator will have to record only basic financial details of the company using current bookkeeping records. The information collected is filed in a financial statement, Notice to Reader, which conforms to the accounting standards in Ontario used for valuation.

Review Engagement Report:

This financial statement is more reliable and thorough compared to Notice to Reader. Your financial evaluator in Ontario, will prepare the report by checking the budget and profits of the company as well as market trends. The final report informs the buyer whether there is something unusual about the business.

Audited Financials:

This is the most expensive and comprehensive statement for a business in the Greater Toronto Area used for evaluation. Your accountant will be able to conduct an in-depth analysis of the company, thus providing a complete understanding of the management system and operation processes.

What to Look for When Purchasing a Business in Toronto, Ontario:

Business evaluation ensures that the type of business you plan to invest in is profitable. To determine the profitability, you must review the financial plans and statements. Here are the factors to consider finding the right business on sale.

Profitability—When purchasing a business, you need to look through the financial statements to understand the company’s EBITDA (Earnings before interest, taxes, depreciation, and amortization), the profit for evaluating an enterprise’s financial health. You will need to hire a professional Accountant in Ontario to help you with the financial evaluation. Experienced accountants always have the knowledge and skills to analyze the profitability of a business.

The price— When buying a business, you also need to consider the price. How will you know that the price set for the business is not exaggerated? To avoid being exploited, you need to calculate the market value and then make a comparison with the seller’s price. The value of a business is usually calculated between two to five times EBITDA, considering the following adjustments:

  • Bonuses offered to the business manager
    • Non-recurring revenue sources
    • Non-recurring expenses
    • Personal expenses

Growth— When purchasing a business, you must look at whether there is potential for growth in the net income or revenue. You want to invest in a business that has the potential to grow in sales and net income. It is very difficult and subjective to assess the growth potential of any business. However, some of the factors to consider for potential growth include possible additional revenue sources, recognized brand name, ease of expansion, and existence in a growth industry like technology.

Location— The location of a business to buy is very important during evaluation. When investing in a retail store, for instance, the area should have a lot of traffic and parking spaces. Similarly, when investing in an office building, consider the type of investment you are making. An office space that is ready for an occupation will be worth investing in compared to a business that still requires some work.

3 Steps to Evaluating a Business That is For Sale in Ontario, Canada:

Once you have set your eyes on a particular business to buy, it is necessary that you conduct in-depth research to understand the pricing and content of the business without feeling overpriced. Thus, here are the three steps to follow when performing company valuation.

Step 1: Decide on the valuation level:

You first need to determine the complexity level of the business valuation process and the assurance you need. Depending on these factors, a valuator prepares a valuation report. There are three types of reports that can be prepared, depending on the company’s true value:

Calculation report—This is the most basic valuation report, which provides limited details about the company. For instance, the report may only highlight the sales data, the number of employees, or the current operational costs. Such a report is useful when assessing a preliminary valuation.

Estimate report— This type of report offers mid-level details of a business compared to a calculation report, thus providing the potential buyer with a high assurance level. It consists of a review of the company information and may breakdown sales information into divisions or service lines. In most cases, it is used for acquisitions.

The comprehensive report—This type of report contains high detailed information and assurance. It corroborates information about the business and may include economic and market research as well as an in-depth breakdown of the sales figures.

Step 2: Get information about the business:

After you sign an engagement letter with the company of interest, you may have access to the financial documents of the organization as well as other important data for preparing the valuation report. Typically, the information needed includes:

  • The tax return of the prior year
    • Financial details of the company for the past 3 to 5 years
    • A list of one-time or non-recurring expenses
    • Management compensation data
    • The number of employees
    • Size of the business (square footage), rental statures, and the business location
    • Bylaws, patents, and all the legal agreements and much more.

In the case of a more detailed report, your evaluator may also ask for the product margins, a breakdown of sales by customers or seasons, and supplier concentration data. Furthermore, a thorough business evaluation process may follow up with independent research of business trends and market conditions and an on-site visit.

Step 3: Utilize the proper valuation method

When purchasing a business, you have different valuation options. Your evaluator may choose one method or a combination of two or more depending on the type of information needed and the company. Keep in mind that the valuation process determines the business value without strategic considerations from the buyer.

The seller’s price may differ from the evaluator’s fair market value due to due diligence, the seller’s eagerness to make a profit from the sale, available financing option, and expected interests. Below is a list of the methods in Canada used to calculate the value of a company:

Earning-based methods:

These methods are applied in cases where a business generates reasonable profits and has a greater value than the net assets. In this case, the valuator assesses the value of the business through a thorough review of past performance and forecasted earnings. The evaluator may also review the projections of the company.

There are two common types of income-based approaches used by valuators:

capitalized cash flow and discounted cash flow. The capitalized approach is used when the business promises a stable cash flow in the future. The discounted method is applied to a business that forecasts a fluctuation in cash flow in the coming years.

Market-based methods:

These valuation methods are used to calculate business value through a valuation multiple, based on the revenue, EBITDA, or other financial metrics. The type of ratio and figures of businesses in Toronto used for the valuation process depends on several factors, including:

. Trends in sales
• Market conditions
• The location of the business and industry
• Size of the company and maturity
• Supplier and consumer diversification
• Past and projected earnings
• Employee engagement
• Key employees and owners
• Intellectual property and goodwill

Asset-based methods

 

These approaches are usually applied when the value of the business to buy is related to assets instead of operations, such as the real estate sector. These methods apply to businesses that do not generate sufficient returns or in case there is a plan for liquidation. In some cases, your evaluator may call for an equipment appraiser for more input. The common asset-based methods used in Canada include:

  • Liquidation value—In this case, the business liabilities are subtracted from the estimated value of the company assets during a liquidation minus the expenses of liquidation.
  • Adjusted book value— This approach subtracts liability from the company assets fair market value.

 Conclusion:

Never acquire any business creating losses. If you realize that the value of the business is worth investing, you can proceed to negotiate the offer. This can be done either through a purchase and sale agreement or taking a letter of intent, which is usually non-binding. Your offer should include the total compensation offered, list of assets and liabilities, tax liability limitations, advisory and non-competition clauses, the operating conditions of the business machinery and equipment, purchase price allocation, lease review, zoning and current usage, city approval, inventory, approval by the landlord and franchisor, renovation cost, closing date and much more. It is advisable to secure professionals for the evaluation and purchase process. Business brokers such as I, Sarnail Singh can give you worthwhile assistance to acquire the most valuable business.

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