Your Business Valuation Cheat Sheet To Buy A Business

Can Anything Replace Good Business Valuation When It Comes To Buying A Business In Canada

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YOUR COMPANY IS LOOKING AT BUYING A BUSINESS!

COMPANY VALUATION METHODS FOR FINANCING A? BUSINESS PURCHASE

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"Behind every successful business acquisition lies a properly executed valuation."

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7 Park Avenue Financial originates business financing solutions for Canadian Businesses – We offer Business Acquisition Funding and working capital solutions ?– Save time and focus on profits business opportunities, and the value of your business target

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7 Park Avenue Financial: “Canadian Business Financing with the intelligent use of experience”

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Business Valuation When Buying a Business in Canada

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Successful business acquisitions and deal-making in Canada, particularly in the SME sector (small to medium enterprises), often start with reasonable business valuation around true fair value.

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It’s a bit of art and science, quite frankly, and if you don’t have an army of investment banking / private equity analysts or board of directors expertise in the valuation of mergers and acquisitions doing the work for you around discounted cash flow, understanding business assets, both tangible and intangible, is crucial in determining a company's overall worth.

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These tips and advice should help in mergers and acquisitions. Let’s dig in.

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HOW TO DETERMINE THE VALUE OF A COMPANY FOR ACQUISITION PURPOSES

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In hindsight, buying a business or merging with one will seem like a good or bad deal.

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Many clients we meet boast they have been able to purchase a business for a great price when it comes to m&a valuation—often the reason being poor sales and profitability that they hope to turn around.

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THE HIDDEN TRAP IN? VALUING A BUSINESS

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If you are inexperienced in valuation when buying a business, it must feel like being blindfolded. We have always thought—make sure you don't miss those critical 'drivers' in determining what the target company is worth. Let the? 7 Park Avenue Financial team help you identify the right price for your business finance acquisition.

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?TWO UNCOMMON TAKES !

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1. Psychological value drivers often outweigh financial metrics in small business valuations.
2. The most valuable businesses often have the messiest books.

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DID YOU KNOW?

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• 75% of business buyers overpay due to inadequate valuation
• Only 20% of businesses sell at their initial asking price
• Professional valuations typically vary by 10-15% from asking prices
• 68% of failed acquisitions are traced back to improper valuation

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THE IMPORTANCE OF ASSESSING CASH FLOW NEEDS

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Knowing the amount of cash you need to acquire and run the business is critical, and understanding the business's cash flow needs is essential for both acquisition and operational purposes.

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If you’re not supplying equity, then it’s all about the right amount and cost… of debt you are willing to pay and take on.

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When acquired, a good business in Canada can often be financed with bank debt. However, our bankers and lenders need to understand the company's nature clearly.

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You will want to cover the seasonality of cash flows, client profiles, revenue recognition and billing issues, and the level of financial control you can demonstrate in running the business.

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BUSINESS VALUATION APPROACHES: DISCOUNTED CASH FLOW ANALYSIS

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Cash flow analysis is critical, if only because your bank and other lenders want to know how and when they will be paid back.

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Here’s where a clean business plan and cash flow forecast matter most. The latter document should clearly show how debt will be covered, how profits will be generated via asset turnover, etc.

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The discounted cash flow analysis is crucial for evaluating a company's value by estimating its future cash flows and discounting them to present value.

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This technique is often considered the gold standard in business valuation. It reflects a company's liquidity while posing challenges due to its reliance on assumptions about future growth and discount rates.

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The discounted cash flow method estimates the present value of a company's future cash flows, adjusted for risk and inflation. It is particularly suitable for newer businesses with high growth potential.

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INCOME APPROACH

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The income approach is a business valuation method that determines a business's value based on its expected future income or cash flow.

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This approach is beneficial for businesses with a stable and predictable income stream. It involves estimating the business’s future cash flows and then discounting them to their present value using a discount rate.

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There are several types of income approaches, including:

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• Discounted Cash Flow (DCF) Analysis: This method estimates the present value of future cash flows by applying a discount rate. It’s a detailed and forward-looking approach that considers the time value of money, making it a popular choice for valuing businesses with predictable cash flows.
• Capitalization of Earnings Method: This method estimates the value of a business by capitalizing its earnings or cash flows. It’s often used for companies with stable earnings, where future earnings are expected to remain consistent.
• Multiple of Earnings Method: This method estimates a business's value by applying a multiple to its earnings or cash flows. It’s a more straightforward approach that provides a quick estimate based on industry standards.
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The income approach is particularly practical for businesses like real estate investment trusts (REITs) or utility companies, where income streams are stable and predictable. By focusing on future cash flows, this method provides a clear picture of the business’s potential profitability and value.

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MARKET APPROACH

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The market approach is a business valuation method that determines a business's value by comparing it to similar companies that have been sold in the market.

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This approach is commonly used for publicly traded businesses or those with large comparable sales, making it a practical choice for many industries.

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There are several types of market approaches, including:

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• Comparable Company Analysis: This method compares the business being valued to similar publicly traded companies. Analyzing these companies' financial metrics and valuation multiples provides a benchmark for the business’s value.

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• Precedent Transaction Analysis: This method compares the valued business to similar businesses sold in the market. It looks at the sale prices of these businesses to determine a fair market value.

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• Guideline Public Company Method: This method also compares the business being valued to similar publicly traded companies, but it focuses on a broader set of guidelines and industry standards to establish value.

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The market approach is particularly useful for publicly traded businesses or those with large comparable sales.

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This method leverages market data to provide a realistic, market-driven valuation that reflects what buyers are willing to pay for similar businesses.

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KEY FACTORS IN BUSINESS VALUATION

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Several key factors are considered in business valuation, each playing a crucial role in determining the overall value of a business. These factors include:

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• Financial Performance: The business’s financial performance, including its revenue, net income, and cash flow, is a primary determinant of its value. Economic solid performance indicates a healthy and profitable business that is attractive to potential buyers.

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• Industry and Market Trends: The business’s industry and market trends, including the level of competition and the industry's growth prospects, significantly impact its value. A company operating in a growing sector with favourable market conditions is likely to be valued higher.

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• Management and Operations: The quality and operational efficiency of the business’s management team are also key factors. Effective management and streamlined operations contribute to the business’s success and sustainability, enhancing its value.

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• Assets and Liabilities: The business’s assets and liabilities, including its tangible and intangible assets, are critical in valuation. Tangible assets like property and equipment and intangible assets like intellectual property and brand value all contribute to the business's overall value.

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Considering these factors, a comprehensive and accurate business valuation can be achieved, providing a clear picture of the business’s worth.

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FINANCIAL METRICS AND BUSINESS VALUATION

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Financial metrics are essential in business valuation, offering insights into the business’s economic health and performance. These metrics are used to estimate the business’s value and include:

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• Revenue: Revenue is a fundamental metric for determining a business's value. It reflects the business’s ability to generate sales and is a key indicator of its market position.
• Net Income: Net income, or profit, is another critical factor. It shows the business’s profitability after all expenses have been deducted from revenue.
• Cash Flow: The business’s cash flow is crucial in valuation, indicating its ability to generate cash. Positive cash flow is a sign of financial stability and operational efficiency.
• Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA): EBITDA is a widely used financial metric in business valuation. It provides a clear picture of the business’s operational performance by excluding non-operational expenses.

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These financial metrics are integral to various business valuation methods, including income, market, and asset-driven approaches.

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By analyzing these metrics, a comprehensive and accurate valuation can be achieved, reflecting the true value of the business.

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THE USE OF MEZZANINE CASH FLOW FINANCING TO FINANCE YOUR PURCHASE

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If your transaction has a proposed high debt-to-equity ratio, a non-bank lender will often be required to complete the deal. This deal can be successfully consummated via a cash flow mezzanine type loan or even a non-bank asset-based line of credit.

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This latter facility monetizes its assets to the maximum your ABL asset-based lender allows.

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THE PERSONAL GUARANTEE ISSUE AND INTANGIBLE ASSETS

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Very few deals in Canada regarding mergers and acquisitions can be accomplished without some level of personal guarantee from the purchasers.?

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Many business owners don’t realize that the ' PG ' is often negotiable in size and can be negotiated to be released based on certain ' pivot points' in the future.

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Although generally rare, it is possible in Canada for one bank to place less emphasis on personal guarantors than another bank.

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One age-old technique is to provide a resolution of your directors confirming that personal guarantees of owners aren't allowed. That forces a bank to consider the transaction on its own merits. As we have hinted, it is possible but not probable.

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4 KEY ISSUES IN BUSINESS ACQUISITION FINANCE

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It comes down really to 4 key issues you face when acquiring a business and financing the transaction:

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1. The amount of internal capital you have and the external capital you need

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2. Types of financing that will accommodate your transaction

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3. Distinguishing between working capital needs and long-term debt

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4. Cash flow? generation

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We have seen that there is no one single valuation formula for a company. Proper business valuation focuses on benchmarking the proposed deal within industry parameters, understanding key operating ratios, and being able to put solid management in place to close a deal and run a business.

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KEY TAKEAWAYS

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• Normalized EBITDA serves as the foundation for most business valuations, reflecting true operational performance.
• Industry-specific multipliers provide quick benchmarks for initial valuations while considering market conditions.
• Working capital requirements dramatically impact purchase price and must be analyzed thoroughly.
• Customer concentration risks can significantly affect valuation multiples and future stability.
• Seller's discretionary earnings calculations reveal the true profit potential for small business acquisitions.

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CONCLUSION

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For solid business valuation financing advice, call? 7 Park Avenue Financial, a trusted, credible, and experienced Canadian business financing advisor who can assist you with your financing needs when buying a business.

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FAQ

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What makes a business valuation accurate?

• Comprehensive financial analysis
• Industry-specific benchmarking
• Proper risk assessment
• Market condition evaluation
• Expert verification

How does proper valuation protect my investment?

• Prevents overpaying
• Identifies hidden liabilities
• Reveals growth opportunities
• Supports negotiation strategy
• Ensures adequate returns

What factors impact business value most significantly?

• Revenue growth trends
• Profit margins
• Market position
• Management strength
• Customer Diversity

How are business valuations calculated?

Business valuation determines value? and typically combines multiple methods, including asset-based valuation, market comparison, and income-based approaches. The process typically involves:

? Analyzing historical financial statements

? Normalizing earnings (EBITDA)

? Applying industry-specific multipliers

? Adjusting for assets and liabilities

? Considering market conditions and trends

What determines company worth?

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Several key factors determine company worth:

? Historical and projected cash flow

? Quality of earnings

? Market position and competitive advantages

? Asset condition and value

? Customer relationships

? Intellectual property

? Management team strength

? Growth potential

Where can I find comparable sales?

Comparable sales data can be accessed through:

? Business broker databases

? Industry associations

? Market research reports

? Professional valuation firms

? Business sale websites

? Public company filings

? Professional networks

Why do multipliers vary by industry?

Industry multipliers vary based on:

? Risk levels within each sector

? Growth potential and market trends

? Capital intensity requirements

? Regulatory environment

? Competition levels

? Profit margins

? Economic cycles

? Technology disruption risks

How is goodwill measured?

Goodwill measurement involves:

? Calculating the difference between purchase price and tangible assets

? Evaluating brand value

? Assessing customer relationships

? Measuring workforce value

? Quantifying intellectual property

? Analyzing market position strength

What affects business value?

Business value is influenced by:

? Financial performance trends

? Market conditions

? Competition level

? Customer concentration

? Employee retention

? Supplier relationships

? Location and facilities

? Technology infrastructure

? Regulatory compliance

Where do I start due diligence?

Due diligence should begin with:

? Reviewing financial statements

? Examining legal documents

? Analyzing customer data

? Assessing operations

? Evaluating employees

? Checking compliance

? Verifying assets

? Investigating market position

? Reviewing contracts and agreements

' Canadian Business Financing With The Intelligent Use Of Experience '

?STAN PROKOP 7 Park Avenue Financial/Copyright/2024

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Stan Prokop is the founder of 7 Park Avenue Financial and a recognized expert on Canadian Business Financing. Since 2004 Stan has helped hundreds of small, medium and large organizations achieve the financing they need to survive and grow. He has decades of credit and lending experience working for firms such as Hewlett Packard / Cable & Wireless / Ashland Oil