Buying and Selling a Business

Buying and Selling a Business

There are several things to consider when buying or selling a business, in particular, due diligence and business valuation.

Due Diligence

Provides sufficient information to:

  • Evaluate the financial prospects of the target company and strategic fit with the purchaser.
  • Provide a reasonable basis for the consideration to be paid.
  • Inform management of the risks and opportunities inherent with the acquisition.

There are two types of due diligence:

  • Preliminary due diligence

This provides the purchaser with a broad understanding of all aspects of the company’s business and operations including:

  • Company information
  • Industry structure and growth
  • Internal control environment
  • Marketing
  • Human resources (management)

 

  • Comprehensive due diligence

This supplements the preliminary due diligence process and examines the following:

  • Financial health – review of financial statements, tax returns, management reports and budgets.
  • Operational efficiency – evaluation of the company’s internal operations, production, sales, marketing, facilities, equipment, staffing and insurance.
  • Legal issues – review for compliance with regulatory and environmental regulations, contracts and labour matters. 

Business Valuation

Now that the due diligence procedures have been performed the value of the company needs to be determined.  There are three types of valuation engagements that can be performed by a valuator:

  • Calculation of Value (lowest level of analysis and assurance)
  • Estimate of Value (mid-level of analysis and assurance)
  • Comprehensive Value (highest level of analysis and assurance)

After this has been decided the valuator need to determine the approach to use.  Depending on the type of business there are several valuation approaches that can be used to determine the value.  For example, if the business has active operations you could use an income or cash flow based approach.  Types of approaches would be:

  • Capitalization of maintainable earnings – A simpler method used when a business has relatively stable earnings that approximate discretionary cash flows.
  • Capitalization of discretionary cash flow – Used when average discretionary cash flows can be estimated through a business cycle and forecasts aren’t available or meaningful.
  • Discounted Cash Flow Approach – Used in situations of varying cash flow from year to year or where finite period exists.

Now what if the value of the business is not in its ability to generate cash flows but instead is in the underlying assets?  Then an adjusted net asset approach would be appropriate.  It is commonly used in valuing holding companies with real estate holdings or marketable securities.

Navigating the sale of a business you have spent your time and energy building can be a complicated process and requires the assistance of qualified professional lawyers and accountants.  If you are looking at buying or selling your business and are unsure of what the value of the business is please contact your CPA or:

chris

Chris Newton CPA, CA 250-492-8444

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Chris Newton CPA, CA

A partner at Omland Heal, Chris works on the audits of non-profit organizations and owner-managed businesses. In addition, Chris prepares business valuations for estate and tax planning.

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