Business Valuation Edmonton, Income Valuation And Appraisal Firm appraisal, business valuation, business evaluation, Edmonton ON Tax issues, divorce or sale. Income Valuation for divorce proceedings.

Eric Jordan business valuator is an accredited CPPA giving you a  business valuation certified by an experienced industry specialist, making this one of the best business valuation firms in Edmonton  with CPPA certification. If you are considering a small business valuation due to an acquisition in Edmonton you may wish to compare CBV designation as compared to CPPA. Chartered Business Valuators are unlikely to have the vast experience possessed by Eric Jordan. CBV program shows you how to become a certified business appraiser in Edmonton . You may pass the Chartered Business Valuators CBV Canada exam but the resulting business valuations can generally be shredded by the experience of someone like Eric Jordan using the “25 Factors Affecting Business Valuation. Watch the YouTube on the page and pay attention to the Experience section. You will surely agree Eric Jordan distinguishes himself as the best qualified valuator to give you an affordable and professional business valuation in Edmonton for 2021.

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25 Factors Affecting Business Valuation

By Eric Jordan (CPPA)

Copyright 2017; 2018 Eric Jordan Publisher by Eric Jordan 209 – 1027 Pandora Avenue

Victoria, B.C. Canada ISBN 978-1-7750074 Printed in China`

 

The author is the proprietor of www.pin.ca website established for over 20 years (January 1998) promoting business opportunities and businesses for sale.

 

Eric Jordan is the host www.BusinessforSaleRadio.com heard on many radio channels across the USA, Canada and around the world.

Please visit the website for local times and stations.

 

25 Factors Affecting Business Valuation

Contents

Acknowledgments.......................................................................... iv

Preface............................................................................................. v

Introduction..................................................................................... 7

Factors Affecting Business Value

Factor 1: History ........................................................................... 14

Factor 2: Purpose .......................................................................... 15

Factor 3: Financials....................................................................... 16

Factor 4: Research & Development (R&D).................................. 19

Factor 5: Shareholder Agreement ................................................. 23

Factor 6: Value of Employees....................................................... 25

Factor 7: Valuing Distribution and Client Base............................ 27

Factor 8: Value of Supply Chain .................................................. 28

Factor 9: Social Network - Internet Footprint............................... 29

Factor 10: Dominance in the Marketplace.................................... 30

Factor 11: Processes and Procedures ............................................ 31

Factor 12: Company Documentation............................................ 32

Factor 13: Industry Averages........................................................ 34

Factor 14: Lease Terms................................................................. 35

Factor 15: Leasehold Improvements............................................. 37

Factor 16: Equipment.................................................................... 38

ii

 

25 Factors Affecting Business Valuation

Factor 17: Inventory...................................................................... 39

Factor 18: Business Risk including Liquidity............................... 40

Factor 19: Currency Fluctuations and Geopolitical

Considerations.......................................................... 41

Factor 20: Opportunity.................................................................. 42

Factor 21: Leverage - Terms and Cost of Money......................... 43

Factor 22: Minority Interest .......................................................... 44

Factor 23: Special Interest Purchaser............................................ 45

Factor 24: Redundancy in Management ....................................... 46

Factor 25: Return on Investment................................................... 47

Operations Manual Template........................................................ 43

Conclusion .................................................................................... 54

iii

 

Acknowledgments

I want to dedicate this book to the teachers and mentors in my

life who made me who I am. I am grateful for my mother and

father, Fred and Edith Jordan who taught by example. I would

like to thank Roy and Earle Hamilton; John Koelle; Reid Nunn;

Debby Schlutter; Bill Massey, my cousin; Ange, my daughter; and

all the family members who helped me along the way. A special

tribute to Charlie Salfries who was my first real mentor and who

made me realize I could be whoever I wanted to be. Thanks

Charlie.

.

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Preface

 

This book offers 3 things:

1. Intangible Assets and Intellectual Property

This book will prove that the average business today consists of 70% to 80% Intangible Assets.

2. 25 Factors Affecting Value

I will show the 25 main factors affecting business valuation that must be measured in order to evaluate a business. Most of these factors are intangibles. I will explain how and why these factors affect the value of a company. The methodology becomes clear and is proven in the current marketplace snapshot.

3. Operations Manual Template - INCLUDED FREE - Processes, procedures, systems, and the

documentation of those factors are generally contained in what is commonly called an

Operations Manual. Having an up to date functional operations manual could add up to 25%

more value to your company. It is imperative that everyone have one of these. I have enclosed a free template. This template will help you build your own company specific operations manual that, when filled out, will be the best insurance you could have for your business, your employees, your clients and your family. It will also add tens of thousands to your value; some larger businesses could gain hundreds of thousands.

 

25 Factors Affecting Business Valuation

Links from real and accredited people and reputable sources, easily verified on the internet, will be provided throughout the book to prove my points with logic and irrefutable evidence. In the electronic versions, you can just click the links.

Your time will be respected. There should be no empty words, just useful information that is actionable.

 

Introduction

Procter and Gamble paid 60 million dollars for “The Art of

Barber” a small chain of 36 barber shops in 2009. Imagine a

barber shop being worth 1.66 million dollars. I did a

valuation within this same industry using the 25 factors affecting

business valuation. My methodology and conclusions were

validated when I came across the Procter and Gamble information.

This made my client feel very confident about my report.

 

http://adage.com/article/news/cpg-marketing-p-g-buys-art-shaving-retail-

stores/137065/

 

Price confirmation for the “Art of Barber” sale:

 

http://wwd.com/beauty-industry-news/beauty-features/gallery/procter-gamble-

acquisition-timeline/

 

Intangible Assets and Intellectual Property are the elephants in the

room when it comes to small business valuation. Few valuators are

willing to come out of the old-fashioned comfort zone provided by

their associations to address the measurement of Intangible Assets.

Our methodology is not new. Venture Capitalists and industry

specialists understand and use this kind of methodology in daily

business. What our proprietary system has done is to bring these

currently used processes down to the small business level. This

way, the value of a business can be measured using 2018

methodology and processes instead of the 1970’s model that is

now most commonly used in business valuation.

Wisdom and experience cannot be taught in an accounting class.

 

Section 1:

 

Intangible Assets and Intellectual Property: Intangible Assets make up the majority of the value in most businesses. My objective in this section is to help you understand and accept that it is true. 70% to 80% of the value of your business is intangibles. If this is not true you should be concerned.

Intangibles rule the way we live:

Google maps get you where you are going. Amazon is the largest store in the world and the

owner is now purported to be one of the world’s richest men. eBay. Who has not used eBay? Facebook and Twitter are two of the most popular and commonly used social networking apps. Airbnb, Uber, and GrabTaxi are all “disruptor” business models that changed how things are done. Netflix has changed the way most people watch television and movies. Smartphones are streaming data to the masses, including business people.

Intangibles in business I want to refer you to an internet site that you may not be familiar with unless like me, you have a reason to follow up such information. Crunchbase.com - Crunchbase reports on funding, mergers and sales on a more global scale than most information sources ON A DAILY BASIS, tracking hundreds of millions of dollars in business. Most of these hundreds of millions of dollars that trade daily are intangible assets. Prove it to yourself and look at the website. The following

is an example of a daily report.

www.Crunchbase.com- Daily Newsletter - July 21, 2017

Klarna raises $225M for payments. Private equity firm Permira will pay $225 million for a stake

of at least 10 percent in Klarna, the Stockholm-based online payments unicorn (Unicorn Pay is an online Payment Gateway Services Provider). Permira will buy shares from existing

shareholders General Atlantic, DST and co- founder Niklas Adalberth.

Insurance is a hot space for Venture Capitalists Funding for insurance-focused startups has shot up dramatically in recent quarters, with a big chunk of investment coming from major insurers, a Crunchbase News analysis finds.

In other news, we look at the massive growth spurt that preceded the latest Series A for loan startup “Self-Lender.”

Shyp curtails service, cuts staff. On-demand shipping service Shyp announced in a blog post that it is withdrawing from all but one market, the San Francisco Bay Area, and cutting staff at headquarters in what it described as an effort to prove its business model for long-term success. Up till now, Shyp had also been operating in Los Angeles, Chicago and New York.

Betterment closes on $70M. Online financial adviser Betterment has raised $70 million in a new Series E-funding led by Kinnevik. The New York-based company has raised a total of $275 million to date.

Recent Activity on Crunchbase 181 Funding Rounds Added 130 Acquisitions Recorded $2.5B

Fundings Captured 12,087 Entities Updated

Make a list of the non-tangible things in your business. It will surprise, if not shock you.

http://www.kmworld.com/Articles/Column/The-Future-of-the-Future/The-world- of-intangible-asset-valuation-

110580.aspx

Another link - same conclusion. https://www.strategy-business.com/article/08302?gko=47f49 60% to 80% back in 2008.

Employees and client lists are not tangible assets - but try to run a business without one or the other. What value does a business with a storefront have without a valid, renewable lease? You might have a partner; without a solid, up-to-date shareholder agreement in place how secure is your investment? Did you know that some franchises are for a specific time period, perhaps twenty years? After that you may have only the salvage value of used equipment and leasehold improvements. Your old location might be given to a new franchisee or the franchisor may tell you that in order to continue, you need to move five blocks away into a new building and completely rebuild the store in order to have a new twenty-year franchise agreement. What do you think this sort of franchise is worth in the last four or five years of the franchise agreement?

10

 

25 Factors Affecting Business Valuation

What is a long-term lease in an airport worth to a high profit food franchise? Add to this some exclusivity and see how that affects things. What about Research and Development (R&D)? The R&D you keep investing in might be written off in the year it was done, but is it gone? Investors in Google and Amazon say NO. Many learned people share the same opinion I do; I hope to prove my points by showing you the profiles of accredited people who have written articles that I believe strongly support and prove my position. If you don’t have a detailed, well written, and up to date operations manual you are probably missing 25 percent of the value of your business. Without a detailed map of what to do, your business cannot run for any length of time without you. Who would want to buy a business without a good operation manual? Who would want to lend money to a company without an operations manual that would allow the company to survive even if the founder was gone? This is one of the reasons why financial institutions prefer

financing franchises over independent business startups.

I believe I have proven the point that seventy to eighty percent of the value of businesses

today is intangible.

 

Section 2

These are the 25 main factors affecting business valuation that must be measured in order to evaluate a business. Most of these factors are intangibles. I will explain how and why these factors affect the value of a company. My focus is companies valued at under 10 million dollars.

Factor 1: History

Factor 2: Purpose

Factor 3: Financials

Factor 4: Research and Development

Factor 5: Shareholder Agreement

Factor 6: Value of Employees

Factor 7: Value of Distribution

and Client Base Factor

8: Value of Supply Chain

Factor 9: Internet Footprint – Social Network

Factor 10: Dominance in the Marketplace

Factor 11: Processes and Procedures

Factor 12: Company Documentation

Factor 13: Industry Averages

Factor 14: Lease Terms

Factor 15:Leasehold Improvements

Factor 16: Equipment

Factor 17: Inventory

Factor 18: Business Risk including Liquidity

Factor 19: Currency Fluctuations and Geopolitical Considerations

Factor 20:Opportunity

Factor 21: Leverage - Terms and Cost of money.

Factor 22: Minority Interest

Factor 23: Special Interest Purchaser

Factor 24: Redundancy in Management

Factor 25: Return on Investment

 

Factor 1:

 

History

 

The value of a business starts with the unwritten knowledge

of the business founders when they started the business. By

digging into their past, we get a glimpse of what unique

knowledge they had and what they were attempting to develop.

What special talents did the founders have? This can be a big help

as we go through the rest of the factors, as we can understand the

“purpose” the founders had in mind when they started. In many

cases, one will find that there was an unfilled need and a plan to

fill the need. History gives us a solid starting point.

Here is a real-world example of history to the rescue:

Kraft Cadbury - History to the rescue.

When Kraft took over Cadbury in 2010 it was not looking pleasant

as many Cadbury people were thinking Kraft would dilute the

quality. Kraft management went back into the founder’s history

and showed how the two founders were very similar. They were

able to pacify the Cadbury people with the similar beginning

information and it was one of the smoothest mergers Kraft ever

undertook. (Read the whole story)

 

Factor 2:

 

Purpose

 

We need to know the purpose of the valuation to

determine what factors are relevant. If the purpose of

the valuation is to determine value for the firm and

establish a share price to facilitate a new partner coming in, it is

different than establishing a price for the purpose of a divorce

proceeding.

The divorce proceeding requires we establish a “fair market value”

on the legally defined “Effective Date of Valuation.” “Terms and

Cost of Money” would not be a relevant factor because no

seller terms would be considered.

A valuation for the purpose of establishing value of shares for a

partner coming in, would certainly look at “Terms and Cost of

Money” as a relevant factor affecting value. If the “buy in” is

100% financed by the existing partner or partners and the “risk”

minimized for the buyer, a higher valuation is likely because of

lack of risk.

If I am hired by a prospective buyer of a restaurant, the purpose of

the valuation changes. I would look at the value of the business to

the current owner, but additionally I would be looking at how the

subject business would fit on the new proposed purchaser. In this

way, the prospective buyer can make an informed decision about

making an offer to purchase. When we look at purpose, this system

requires that we ask the question, “value to whom?”

 

Factor 3: Financials

 

When analyzing financial statements one must adjust the

statements to reflect only purchases and expenses at

prevailing fair market price that are related directly to the business.

We want to find out if the operation of the business is making

money or losing money. We need to know if there are redundant

assets that need to be stripped out of the balance sheet. For the

purpose of a business valuation we want to look at the balance

sheet and income statements. (Income statements are sometimes

called profit and loss statements).

We will need to normalize the information. Any underpayments,

perks or advantages to anyone including owners, friends, and

family must be accounted for at fair market value. Once

everything is adjusted to “fair market” we have what

would be called “Normalized Net Income.”

Depending upon the situation and purpose we may want to look at

2 to 10 years of financial statements. If auditing is required I

suggest an outside accounting firm for that process. The delicate

part for small business valuation is “discretionary income.”

What to count, how to measure, and what is the purpose.

Determining the “Normalized Net Income” is a real skill set and

the first and most important step in determining the value of your

small business, any other term implying the same thing is suspect.

(Small business being less than ten million dollars in sales.)

If you are reading financial information about a small company

and you see the terms, owner's discretionary income, seller's

discretionary income, seller's discretionary earnings, free cash

flow, seller's discretionary cash flow or owner's cash flow. BE

CAUTIOUS! These are terms that people feel they can trust, but

in fact they are often very misleading. You may also see the

term EBITDA (Earnings before Interest, Taxes, Depreciation

and Amortization) this is a legitimate term, but only when

used in the right context.

If these terms are used in relation to the sale of a small business,

someone (usually the buyer) can be easily misled. The managers of

banks and other financial institutions have been misled by these

terms so often that their head offices are often very skeptical about

financing the purchase of any small business.

OWNER'S DISCRETIONARY INCOME: This term will

often be used by those trying to sell a franchise. They will show

you a number like $75,000 per year, or perhaps even $90,000 for

owning and operating something like a plumbing franchise. What

they do not make clear is that the $90,000 per year is

BEFORE the owner/manager/PLUMBER is paid. Depending on

where you live a plumber will probably make $65,000 to

$85,000 a year just by going to work every day.

If the people selling the franchise were being truthful they would

use the term “Normalized Net Income” that would show the profit

after everything, including the owner’s wages, were paid out at fair

market value. If the fair market value of the plumber's/owner's

wages were $70,000 the true profit figure would be $20,000 not

$90,000. The perpetrators are generally white shirt and tie, and go

to great lengths to convince buyers they are professionals, and in a

dark way, that is true.

“Free Cash Flow, Owner’s Cash Flow and Owner’s Discretionary

Income” are all 'weasel' words used in the process of separating

buyers from their hard-earned money.

EBITDA (Earnings before Interest, Taxes, Depreciation and

Amortization)

Some industry groups think it is okay to include one

owner/manager wage in EBITDA, which results in the same

misleading situation. You therefore must be very careful in the

context that EBITDA is used, most especially if dealing with small

business and the numbers are being explained by a deceitful sales

person or owner.

EBITDA is generally used as a measure of a company’s operating

cash flow based on stated earning from financial statements

BEFORE interest, taxes, depreciation and amortization.

https://www.entrepreneur.com/encyclopedia/owners-salary

Here are some searches you may want to do to confirm the

conclusions above.

normalization of financials in a business valuation

net income after normalization

owner’s income included as company earnings.

 

Factor 4: Research & Development (R&D)

 

Your R&D was written off on your taxes. Is the R&D

really gone? Generally, NOT.

Research and Development in most western nations is written off

for tax purposes in the income statement/profit and loss. For tax

purposes this is reasonable and lawful.

For the purpose of valuation this is not so true. The value of the

R&D did not disappear in the year it was written off. Most often it

is added to an existing base of R&D and will be added to again in

the next year. It is my opinion that the useful lifespan of

R&D is somewhere between 5 and 12 years in some

industries; in others, the R&D is accumulative, meaning that it

keeps on growing. For the purpose of valuation R&D

could be accounted for in the balance sheet as an

intangible asset. This means that depending upon the individual

business, the valuator will need to make a judgement regarding

lifespan of the R&D and possibly adjust the balance sheet to

correspond.

I am not the only one to come to this conclusion. Millions of

shareholders of public companies and investors in private

companies believe this is true. This is why companies like Uber

and Airbnb have such high valuations. People are investing, not

because these companies are making a lot of profit, but because the

investors believe in the R&D. For public companies, Amazon

for example; not yet returning a lot of profit but certainly a

company with lots of R&D that people believe in by the

 

billions of dollars. I’m not sure how many billions of dollars of

proof I would be expected to produce, but one could compose a

very large list of both public and private companies where the

share price or valuation is based upon the perceived value of the

R&D.

Unless purchased, Brand is the result of R&D and marketing

within. When R&D is part and parcel of a brand, the R&D often

has an accumulative value. Uber would be worth much more

than the accumulated value of their R&D, as would most

companies who have developed things and are successful.

Stability and growing sales are key to the measure.

Certainly, with any kind of software company, the R&D is of

immense value but it may not be shown in the balance sheet. There

is a reasonably simple way of looking at this. Many small business

owners have both an operating company and a holding company

with identical ownership. The holding company generally holds

the real estate and possibly other hard assets. The operating

company runs the business and pays the holding company fair

market value rent on the real estate or other hard assets. The key is,

it must be done at fair market value.

For purpose of valuation consider that there is a development

company and an operating company. The development company

does the R&D and then sells the R&D to the operating company.

Now you have a measured and identifiable intangible asset with a

receipt that can be placed into the balance sheet as an asset and

depreciated over time, instead of being a direct cost this year in the

income statement.

There are some tax rules in different jurisdictions for all of this

according to the Association of Chartered Certified Accountants in

the UK.

 

http://www.accaglobal.com/gb/en/student/exam-support-

resources/fundamentals-exams-study-resources/f7/technical-articles/rd.html

 

Under International Accounting Standards (ISA) 38, regarding

R&D an intangible asset arising from development can be

capitalized if an entity can demonstrate all of the following criteria:

the technical feasibility of completing the intangible asset

(so that it will be available for use or sale),

intention to complete and use or sell the asset,

ability to use or sell the asset,

existence of a market or, if to be used internally, the

usefulness of the asset,

availability of adequate technical, financial, and other

resources to complete the asset, and

the cost of the asset can be measured reliably.

UK has slightly different interpretations. (See link above)

NOTE THAT WE VALUE R&D FOR VALUATION

PURPOSES NOT TAX PURPOSES. SOME OF THE ABOVE

WOULD BE OF INTEREST TO THOSE WISHING TO

RAISE MONEY AND WANTING TO LEGITIMATELY

SHOW VALUE IN THE COMPANY.

Some very bright people have done a lot of research on this

subject:

Read the background on them first:

http://www.valens-research.com/about/background/

Now, read what they have to say about capitalization on the

balance sheet:

 

https://www.valens-research.com/rd-investment-not-expense-capitalizing-rd-

impacts-understanding-corporate-profitability/

 

https://www.theguardian.com/business/2017/apr/15/tesla-electric-cars-sparks-

fly-wall-street-valuation

 

Factor 5: Shareholder Agreement

 

Shareholder agreements are the legal basis for dealing with

all matters in a business. Without a legally binding

shareholder agreement any dispute can become a seriously

costly matter. Minority shareholders are probably the most at risk

in a situation where there is no legal shareholder agreement. Just

ask any minority shareholder who has been involved in a dispute.

There have been situations where minority shareholders thought

their 10% interest in a million-dollar company would be worth

$100,000 this is not necessarily true.

When, how, and how much you might recover as a minority

shareholder could be half, unless there is a strong legal shareholder

document to support your claims. Inversely, majority shares have

the possibility of being worth more. Potential for protracted legal

wrangling could cause a valuator to come with a lower value than

would otherwise result if a proper legal shareholder agreement was

in place. There are different sorts of “shotgun” clauses that can be

included in these shareholder agreements. Payouts can be over a

number of years, so the company can afford to pay someone

out.

 

A shareholder agreement that was detrimental to the remaining

shareholders could result in a much lower value as well. Have a

lawyer you trust review any shareholder agreement before you

sign. Google “shareholder agreements”to find anything you are in doubt about.

 

Factor 6: Value of Employees

Crunchbase data shows firms working with Artificial

Intelligence (AI) that are being funded and

trading hands at valuation numbers representing ten

million dollars per employee (USD).

Crunchbase.com is not an academic journal but they are the

world’s only relevant source of data on large tech buyouts and

funding is updated on a daily basis. Tens if not hundreds of

millions of dollars in new deals are posted daily.

www.crunchbase.com is free to view.

QHR - Canadian Company, Kelowna, British Columbia,

Canada sold in fall of 2016.

QHR sale ($170,000,000 sale with 200 employees) = $850,000

CDN per employee and rather strongly makes the case that skilled

employees are worth something.

Established Web Design and Digital Ad Agency For Sale

South Florida, Florida UNDER OFFER (recent 2017)

Asking Price: $1,245,000 (USD)

Furniture / Fixtures included

Sales Revenue: $780,000 (USD)

Cash Flow: $303,000 (USD)

Asking: $155,000 per employee

This is not to say that every company is worth millions per

employee, but it is important data to reference. The push for high

wages in the restaurant industry is causing the restaurant industry

to automate. The employees that are valuable are those who are

working on the automation and artificial intelligence robots that

will replace the restaurant employees.

Most businesses will fall somewhere in between. Doing the

research and understanding the proper measurement for each

individual business is a critical exercise in any accurate business

valuation. There is a lot of room between zero and ten million

dollars for employee value. Employees and contract workers are

generally both considered when doing business valuation.

 

Factor 7: Value of Distribution and Client Base

 

Did you ever wonder why products appear on the

supermarket shelf at eye level? There is a whole industry

built around product placement. Planogram defines the

what, where, and how much in retail merchandising.

Manufacturers, wholesalers and distributors invest a lot in getting

proper visibility on the retail level. The end buyer can also be

considered as part of the client base. It can take many years to

build a client base that will go looking for the product you want to

sell. For the purpose of valuation, one must be able to measure the

retail purchaser, the retailer, the wholesaler and distributor. How

much time and money would be spent to replace what has been

achieved? This is why companies buy other companies

instead building from scratch.

We should point out that not every factor affecting value is

relevant in each individual valuation. One must know what factors

are important to measure and what factors are irrelevant for each

subject business.

 

Factor 8: Value of Supply Chain

 

First: Imagine yourself as the owner of a company importing

old Russian military rifles, ammunition, and related items

into Canada. Your company is a supplier to retailers and

also has an online store. Your supply chain is from the Ukraine.

This is about as unstable as it can possibly be with the current

geopolitical situation, and you are unable to get product.

This leaves a very big dent in your business and it is not going

to be hard to measure the value.

Second: Imagine yourself as the exclusive Canadian importer of

several well know Asian food brands. Sales are strong, and

everyone is happy. The ties are strong and go back 35 years. This

will take a lot more work to measure than scenario one.

Most valuations will be somewhere between these two extremes.

 

Factor 9: Internet Footprint – Social Network

 

Look at your website. How well does it place on Google for

relevant searches? How many views does it get? Is it an e-

commerce website? What are the details?

 

Additionally, there are all of the social networking sites. Facebook,

Twitter, LinkedIn, Google+, YouTube, Pinterest, Instagram,

Flickr, Reddit, Snapchat, WhatsApp, Quora, Vine, StumbleUpon,

and Digg are some of the more popular social media sites.

What percentage of your sales are e-commerce on your own

website?

Do you sell e-commerce on other platforms such as Amazon or

AliExpress?

If you are a service company what percentage of your business

comes from the internet? If you run a retail store, how much of a

role does your website and/or social media play in your customer's

decision to come to your store?

Even if this is not a relevant factor it may still be worth

considering because you, or someone else, can change this to make

it better. This is where the measurement comes in.

 

Factor 10: Dominance in the Marketplace

 

Dominance in the Marketplace.

Mention ketchup and most people will think of Heinz.

That is product domination in the marketplace. Mention

search engine and most people will think of Google.

 

That is domination of a service in the marketplace.

Most businesses will not be in such a fortunate situation. Some

companies will have 25% or perhaps 75% of the market within a

certain geographic area. If so, this will certainly increase

the valuation.

A fishing license or a dairy quota would have some dominance

effect.

There have been issues with cities who issue taxi licenses

promising in effect dominance, then the licensees have

been “interrupted” by a technology called Uber. The hotel industry

is similarly concerned with Airbnb and similar services.

A dominance situation that a valuator will commonly come across

is an exclusive lease for a service or retail category in a specific

geographical area, something like an airport, university, or

shopping centre. Profits are almost locked in for such situations so

of course the value is higher as long as the lease is long-term. In

some cases, the long-term lease might be the most valuable part of

the business.

Dominance is not always a relevant factor affecting value.

 

Factor 11: Processes and Procedures Agreements, Licenses and Other Intangible Assets

 

Unless it is a franchise, every company has their own

proprietary processes and procedures or something that is

patented with a long expiry date. A registered brand or

other intangible assets must be measured.

For example, a successful retail bakery in an urban centre with its

own proprietary processes and procedures that result in a product

that retail clients choose to purchase on an ongoing basis. This is a

huge consideration for value. The measurement of some of this is

often a ratio depending upon market share or penetration, and

the means to deliver via employee base. Most franchises today are

not doing something so unique, but have simply put very

tight processes and procedures into what would often be

considered a simple service. Think lawn services, hair salons,

tanning salons, pet grooming, sewer pipe cleaning, fencing,

car cleaning, car maintenance, and computer repair for just a

starter list. Keep in mind some franchises have a defined end

date and the franchisor may have no obligation to renew a

franchise.

Processes and procedures do not stand alone. There must also be

documentation which we refer to next. There is a whole section of

this book where we show you a template that can be used to

document the processes, procedures, and systems of a company.

 

Factor 12: Company Documentation

 

Imagine that you have a fully completed operations manual that

documents all aspects of your business. All the processes,

procedures, and systems are documented. It is done so well

that your business runs as smoothly when you are away as when

you are home.

Imagine that you run the same business that is just as profitable;

but where nothing is documented. As long as everyone is healthy,

all is well. You can’t be gone for weeks, perhaps not even for days

without the need to be in constant communication.

The first option offers security of income not only for the owner,

family and employees but also security of continued service for the

clients. The owner could protect his family from his/her untimely

death by having life insurance that is readily available for most

business owners. Adequate disability insurance for small business

owners is generally too costly and usually not even available.

That leaves the owner, family, employees, and clients all at a lot of

risk. The more of the operations manual you have completed, the

better you have protected the future for yourself and all of those

around you.

Not all of this would be on a computer, but rather printed out

with spaces for computer passwords, banking information.

Where are the spare keys? Important client and supplier

information. The list is comprehensive.

All of the information on each employee's job needs to be

documented and regularly updated. This is especially important for

the founder of a small business to leave a paper trail for the family

to follow. This insures the business will continue if something

happens to key players.

A buyer will pay a lot more for a well-documented company than

one where the owner says; “I will train you.” Sure, and what

happens if the owner has a heart attack the day after the sale?

Documentation is so important; a template for making your own

small business operations manual is included at the end of this

book to give our readers added value.

 

Factor 13: Industry Averages

 

Industry averages are not a relevant factor for all business

valuations. One must make sure the comparable data is truly

comparable. Air conditioning companies in Miami, Florida are

not comparable with air conditioning companies in Seattle

Washington.

Many valuators use comparable sales as a major consideration, but

this can be very inaccurate as the sales figures don’t tell you if

terms were given, how much net profit was recorded for the

preceding years or if owner’s wages were included in the profit.

Costs can vary significantly.

Unless you are talking about franchises, no two businesses are

totally comparable, in fact most are very different. Being careful

to measure data that is truly apples to apples is most important.

Industry averages can provide a guideline. It must be understood

that industry averages include both winners and losers and are too

broad to provide any sort of accurate measurement for a specific

business. In some cases, industry averages will be important but in

cases where the business is more unique, the industry averages will

mean much less.

 

Factor 14: Lease Terms

 

A business with no lease, or a lease ending soon, has

limitations on its value. Costs of relocating could include

leasehold improvements, reopening, transferring utilities

and associated fees, new equipment and fixtures, to name a few. A

strong renewable lease is going to enhance the value of a profitable

business. However, a strong long-term lease can choke an

unprofitable company. If you sign such a long-term lease and if

something else happens (your supply or client base evaporates),

you are in a lot of trouble and the lease obligations might offset a

lot of inventory that is paid for, your company could be rendered

almost worthless due to lease obligations. Also, remember that

your landlord is not obligated to renew your lease or let you out

of a lease you have signed.

Reading the lease carefully is an important factor in business

valuation. When you are considering purchasing a business you

better know the terms and conditions of the lease you will be

taking over. You might want to be renegotiating the lease prior to

purchase to make sure you have enough time to make the purchase

worthwhile. The reputation of the landlord matters a lot.

A long-term lease negotiated in Calgary just prior to an oil price

downturn can have the effect of making the company

worthless to a prospective buyer. In other cases, a long-term

lease at a locked in rate can be more valuable than anything

else in the company. Lease terms need to be measured carefully

in a business valuation.

 

Factor 15: Leasehold Improvements

 

Leasehold improvements have three distinct value

classifications and are often valued along with equipment.

 

Value within an “operating business”

Value as “equipment in place” even if the business is not

in operation, but a reasonable new lease can be negotiated

Leasehold improvements and equipment may only be

worth “liquidation value” if the business is not operating

and you can’t negotiate or renegotiate a lease. Note

that in “liquidation value” it is important to calculate the

cost of liquidation which could run from 20% to 45% of

the total received

If you are opening an upscale spa or upscale restaurant you can

expect leasehold improvements sometimes called your “buildout”

to be between $300,000 to $1,000,000. In a business valuation,

one must consider the time left before renovations are necessary

again. If for some reason the franchise is lost, or the lease does not

renew, your leasehold improvements may be of little value. In

most cases used equipment is worth very little without a lease.

For accurate valuation one must measure by the correct

classification.

 

Factor 16: Equipment Tools, Vehicles and Other Hard Assets.

 

Equipment will generally be listed in the balance sheet along

with original cost and depreciated value. Fair market value

of the equipment is most often neither of these numbers.

Equipment generally has two classifications:

equipment value within an operating business

liquidation value

Equipment, in some cases, would be part of the leasehold

improvements and could have extra value as “equipment in place”

provided a lease could be negotiated.

Equipment may only be worth liquidation value if the business is

not operating. If this is the case it is important to calculate the cost

of liquidation, which could run from 20% to 45% of the total

received. It is important to know what measurement best suits the

purpose of the valuation.

 

Factor 17: Inventory

Inventory will generally be valued at cost, however there are

many mitigating factors. How marketable is the remaining

inventory? What would be the cost of selling the inventory at

retail, wholesale, and liquidation?

Inventory within an operating business is going to have more value

than “inventory that is in place” or value of inventory net of

liquidation. Net liquidation might be 40% less than

the gross liquidation figure, to take into account the costs

associated with the liquidation of the inventory. Inventory value

within an operating business may be very close to

wholesale depending upon marketability factors. One must

understand what they are measuring and for what purpose to

make an accurate estimate of value.

 

Factor 18: Business Risk including Liquidity

 

Asking all of the right questions and measuring each

situation is difficult and challenging.

Are you in an industry that is being disrupted or about to be

disrupted? An example would be the taxi business disrupted by

Uber. Is your business niche heavy into manual labour that will be

replaced by robots and artificial intelligence? Are there new

innovative processes and procedures being developed that could

replace what your company does? Could your industry niche

be outsourced to another country? Competition is of course

always a concern unless you have market domination through

some kind of exclusivity arrangement. If you lost a big contract

could a lender call a loan and put you into a liquidity crisis? If

a large contract could not or would not pay, could your

business find itself in a liquidity crisis? One must also look

at liquid investments as compared to investment in small

business that is not liquid. This is a huge consideration for most

investors. Who wants to wait two years or a lifetime trying to get

back money that was invested? This is why ratios are so

different between “liquid shares” that can be easily sold in

public companies and shares that might be hard to sell in a

private business.

 

Factor 19: Currency Fluctuations and Geopolitical Considerations

 

Currency Fluctuations and Geopolitical Considerations

 

Consider a Canadian company importing construction

materials from China with pricing in US dollars. Worse

yet, you are in Western Canada, perhaps Victoria.

You just signed a long-term lease on a much bigger space. The

next month OPEC decides to try and take out the North

American oil producers and the oil price tanks. The Canadian

dollar tanks along with oil. There is a government in place in

Victoria that is not Alberta or oil company friendly. How do

you think this would affect the value of your construction

material wholesale/retail operation?

When doing business valuation, it is best to be well-read on

business and politics both at home and abroad over a number of

years. Understanding the right questions to ask and knowing what

is important to whatever niche business you are dealing with is

essential.

Experience and wisdom cannot be taught.

 

Factor 20: Opportunity

Now we can go back to research and development,

processes, procedures, systems and employees. How well

is all of this is documented, and how well does it all work

together? Risk may of course temper some of the

opportunity enthusiasm in the final measurement. Do you know

the market trends and where your market niche is going and

where you are positioned within that market? When we

measure the R&D, processes, procedures, systems,

documentation, employees, contractors, and how well all of these

factors work together we get an idea of the potential for the

company.

Let us suggest you are an internet media company helping people

to brand and market their products and services. You have a young

and talented team that has been building for six years and are now

starting to show significant profit after taking the redundancy out

of the system.

The story could of course be exactly the opposite, the profit is in

the past, older workforce, losing market share and no R&D to

support growth.

Asking the relevant questions and finding out what is going on

within the company is the task of the valuator. One does not know

until they start the measuring process.

 

Factor 21: Leverage - Terms and Cost of Money

 

Depending on the situation, this factor may not be

applicable.

 

The cost of money is not uniform. A large company may have cash

on hand that they are receiving almost zero return on. This makes

their cost of capital much different than a small business or

individual who might have to pay market rates which could be 5%

to 25% depending upon each individual situation.

If your father-in-law has excess retirement money and is willing to

support you in your new business venture by loaning you $500,000

to $2,000,000 at 3% you have a huge market advantage going in.

Another thing that can happen is a retiring business owner may

decide you are a good manager and he will finance the business at

a very reasonable interest rate with almost no down payment. The

seller trusts the business is good and that you are a good manager.

The seller might feel more comfortable with some of his retirement

money still left in the successful business he built.

Compare this to the situation where a buyer must find his or her

own money for down payment and borrow the rest at market rates

that may be inflated to reflect perceived risk.

 

Factor 22: Minority Interest

 

Minority Interest

Most people think that if you own 40% of the shares in a

private company valued at a million dollars that the

value of the 40% block is $400,000. Not necessarily.

It depends upon your shareholder agreement and your ability to

finance any litigation necessary to enforce that shareholder’s

agreement. There are judges that might consider your minority

shares as only being worth half.

Having a solid shareholder agreement and understanding who you

are in business with can save you a lot of pain in the future. As a

minority shareholder, how are your dividends going to be paid?

Who governs that process? It is a lot easier to buy in than get paid

out. There are companies that actively seek to purchase minority

shareholder positions at a low price with the intent of negotiating

better terms from the majority shareholders who may not want to

face protracted litigation against an experienced and well financed

minority partner group.

 

Factor 23: Special Interest Purchaser

 

A special interest purchaser is a purchaser who already has

assets in place that with this purchase can take further

advantage of the efficiencies and economies of scale. If

there are significant advantages such as elimination of competition,

technology advantages, purchasing power advantages, and a

reduction in costs by sharing overhead, then the premium paid will

be or could be higher. The price could be much higher if there is

more than one potential purchaser.

A purchaser who has insider knowledge and information that

significantly reduces risk in the marketplace could definitely be

considered a special interest purchaser, in comparison to an arm’s

length, third-party buyer. In this definition, the working partners in

a small business would all be special interest purchasers. The

owner/ partners understand the risks and relationships at stake.

Because nothing really changes, there should be high client

retention and little risk to cash flow and profit.

An arm's length third- party must always be concerned about

relationships with both the supply chain and client list.

 

Factor 24: Redundancy in Management

 

W

 

Factor 24:

 

Redundancy in Management

 

What is the backup plan for management and how well is

it documented? This should all be part of an existing

operations manual and part of the company

documentation. However, because this point is so important it must

be covered again on its own. The higher up the food chain in the

company the more extensive we want the backup plan for each

management person.

What is the plan for everyone in management and how good does

the valuator find it to be? Is the operations manual remotely up

to date with computer related passwords?

The valuator must measure what is available and compare it to

what should be available.

 

Factor 25: Return on Investment

 

Return on investment is the most important factor and must

be considered first and last. From our financial review, we

should have found the “Normalized Net Income” if

everyone and everything was paid at market value.

We have measured the processes, procedures, systems,

documentation, and employees. We have looked at all of the other

factors affecting value and we have weighed them up, balancing

the risk and opportunity factors. Now we make a determination of

what is a reasonable return on investment with all of the relevant

factors measured and taken into consideration. Some very large

companies such as Amazon, have a very high stock price

without earnings to justify. On the other end of the scale would

be service businesses in an industry that is being trashed.

The valuator must understand and measure accordingly.

 

Section 3: Operations: Manual

Template

1.

Company Structure

2.

Products and Services

3.

Direct Employees, Contract Workers and Outside Contractors

4.

Licenses, Permits, Accreditation and Certification

5.

Business Suppliers

6.

Clients

7.

Office Procedures

8.

Business Procedures

9.

Business Equipment

10.

Office Equipment

11.

Emergency Equipment

1. Company Structure What is the legal structure of the company?

Proprietorship Partnership Incorporation Public

Names Percentages Shareholder agreement Where is the legal jurisdiction of the company?

Where are these documents stored?

Is this a franchise? If yes:

Where is the franchise agreement? What does it say about? o Length of time o Selling o Renewal rights

2. Products and Services

Provide an overview of the products and/or services produced by the business

3. Direct Employees, Contract Workers and Outside Contractors

Who does the work? Where is the production of goods and/or services done? What control do you have?

Direct Employees

Name, and other information Date of hire Salary, bonuses, and dividends Any extra perks? What

do they represent in the company? What roles do they play? What are their responsibilities?

Who do they answer to? Which people would be best able to replace them (often more than just

one person) In their own words, what exactly do they do? What confidential information does

this person have? Have they signed a confidentiality non-disclosure agreement - if no - why not?

Computer passwords and other such tech information. This needs to be handwritten on a page

with the persons name at the top and kept in a safe place “locked” with an additional copy at

your accountant’s and/or lawyer’s office. UPDATE REGULARLY.

Contract Workers and Outside Contractors

Name, and other information What is their job description? Include all responsibilities. What are

the terms of their contract? What special knowledge and information about the company do they

have? This includes relationships, proprietary information they maintain, and of course computer

passwords and other access codes

Professional Services Lawyer Accountant and/or Bookkeeper (taxes, payroll, etc.) Financial

Institutions Insurance Investment Advisors Credit Card Processing Collections Human

Resources Media Specialists

Consultants (including Business Valuator) IT Computer Hardware and Software Repair IT for Internet presence including social media, domain registration and hosting

Daily, Monthly and Yearly Tasks

Regarding payments and other financial issues Full details required Details

Never store sensitive information into software programs that could get hacked. Have printed copies that you have control of at your lawyer or accountant’s office. An inexpensive computer and backup drive in your safe might be prudent.

Blue Collar Services

Provide complete details Security Plumber Electrician Janitorial Landscaping Delivery Other

4. Licenses to Operate

City business license Other geographic licenses Association and industry certifications and

licensing

5.Business Suppliers

Full list and documentation 6. Clients

Full list in order of importance and/or most profitable

7. Office Procedures

Opening and closing procedures Alarm system passwords and/or codes (need to be handwritten

and locked somewhere secure)

8. Business Procedures

Staffing Training Order processing and sales procedures Call comes in, document what happens

after that Customer service procedures Shipping and receiving

9. Equipment

List each piece Where are the keys? Who knows how to operate it? Who repairs it? Any quirks?

Insurance? Registration? Permits? Lease information

10. Office Equipment

List each piece Computers Passwords (handwritten and stored in a secure location)

 

Maintenance Where you purchase the consumables Lease information

11. Emergency Procedures

Full details including muster stations In case of fire In case of an earthquake

 

Conclusion

 

This book should have helped you to understand that it is

mostly the intangibles in a business that determine the

value. Depending upon the reason or purpose that caused

you to read this book, you will determine how you utilize the

information. If you are a business owner, this book will have given

you some clarity on what is valuable in your own business. Just by

understanding this you will know where you should invest your

time.

If you put some time into developing an operation manual from the

free template in Section 3, you are likely to be gaining tens

of thousands of dollars (or more) in value from documenting all

these things.

Lawyers, lenders, and accountants will know which clients will

benefit the most from reading this book and point them in the right

direction.

Divorce litigants and others in dispute will better understand their

own situation and be better able to make decisions going forward.

I cannot teach wisdom.

I cannot teach experience.

If, however, you are stable, motivated and feel you have enough

wisdom and experience to qualify, I am open to Selling a License and training associates

anywhere in the world.