Valuation and Due Diligence
About the Author: Wilson Wong PC, are Chartered Accountants in Calgary providing tax and accounting services to small and medium sized businesses and high networth individuals.
Probably the most important process in buying a business is the process of valuation and then the due diligence to verify that this value is indeed in this business. Valuation is more of an art than an actual science. Often as the accountant we are asked to provide a value to owners of businesses or prospective buyers. In this article I will discuss various valuation methodologies but please keep in mind none of these strategies are universal. I will then discuss various due diligence techniques, things to look out for, and how it relates ultimately to your valuation. Remember, value is a perceived concept in each person's mind, just because a valuation model suggests a certain value does not mean it will be applicable to your business.
As a small business owner one of the most common basis for which you are selling your business for is the goodwill or other intangible assets of the company When you are selling goodwill or some form of intangible assets (such as customer lists, schematics, etc) then what the buyer is getting is the hopes of a recurring stream of income. A recurring stream of income is one where a past customer is expected to return some time in the near future generating additional sales for the business. It's easy to see that there is a value in such a thing. The valuation of such an asset is usually measured with a multiplier.
A multiple of gross sales or net income is usually a common valuation amount. For example, a business my sell for 2 times the amount of annual sales, or it may sell for 5 times the amount of annual net income. Whether to choose net income or gross sales is usually determined on the appropriateness of the business. If a list of customers does not need additional expenses and can easily integrate into an existing similar business then it may be appropriate to use gross sales. If there are a lot of expenses attached to generating the gross sales then its probaby more appropriate to use net income. Consideration is also made on what the multiplier should be of course. The multiplier is usually dependant on what is a common benchmark of the same industry. You woud compare yourself to your competitors. Review past sales of businesses on what their multiplier is. As you can see this is becoming very much an art. This is where a Chartered Business Valuator comes in who will do the research involved in deciding what is a good multiplier, and whether it should be based on net income or gross sales.
If your business does not have a recurring stream of income then you may be looking at purely the value of individual pieces of assets held by the company. Perhaps you have sellable inventory, a building, or manufacturing equipment.
If you have a medium to large enterprise it's important that you seek the professioal guidance of a chartered business valuator. Often there is goodwill in areas that you don't know about. For example, there is value in your business' assembled workforce. Another example, there is value in having exclusive rights such as distributorships or simply you are the only business with a certain competitive manufacturing process.
-Wilson Wong, Chartered Accountant