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Assessment & Valuation: Digging for Truth

While most sellers will genuinely intend to be honest and fair when they present their business for sale, it would be naïve to assume that everything you are told is the truth, the whole truth, and nothing but the truth. The last thing you want is to find that the seller has overstated or misrepresented a critical valuation factor after the purchase agreement has been signed and you are locked into the deal.

If someone sets out to be dishonest, there are many ways they can twist and turn the facts. It is your job, therefore, to play super-sleuth and thoroughly investigate the business before entering into serious negotiations.

There are several ways you can validate the story a seller is spinning, including talking to customers and suppliers. Interview people in the area, and talk to local politicians to find out what you can about the area and future development plans. Could a planned local bylaw drive down the profitability and sales of the business? Here are a few questions that you will definitely want to ask yourself while you do your sleuthing:

  • Are the sales numbers accurate?
    A business owner with more than one business can use sales from the second company to artificially inflate the sales of the first, which could cause you to buy into a losing proposition if this information only is apparent after the deal is signed.

  • Is the profit margin of the business realistic?
    If the business owner has been working for the company for free, a 40% return on investment could quickly disappear as soon as a realistic salary is factored into the equation.

  • Is the inventory of the business overvalued?
    Some items, especially things like clothing or fashion wear, lose value quickly. If you pay the full wholesale value for these items, you may be paying too much.

  • If location and walk-in traffic are important to you, are the numbers realistically reported?
    You may find after talking to other shop owners in the same plaza, mall or area that things are not as rosy as the seller has painted them.

  • If the value of location is enhanced by a large, name-brand store, do they plan to stick around for the long-term?
    A large brand-name store can pull in a lot of traffic. However, if this store plans to pull out of a plaza or area, it can be a serious detriment to smaller businesses that are stuck in place, locked in by long-term leases that extend well beyond the exit date of the larger player.

  • Is a key component of the business' ecosystem threatened?
    Watch for a seller looking to bail due to undisclosed information, such as a key supplier or distributor facing cutbacks or even bankruptcy.

Part of your lawyer's job will be to ensure that the contract you sign includes solid guarantees that will protect you from a fraudulent seller. For example, the contract may offer a provision that allows you to work in the business up until the final closing date of the sale, with a bail out clause that can be applied if any alarming irregularities are discovered. These issues are discussed further in the third section of this workshop, Legal Considerations.

Analyzing the business will help you decide whether you are interested in moving on to the formal valuation and negotiation stages. If you find that the business owner has been telling the truth, then you have lost nothing by carefully confirming the facts. If, however, you have uncovered some flags that will have a significant impact on the valuation of the business and your overall purchase decision, you will have gained immeasurably.

Assessment & Valuation: Hard & Soft Factors Valuation Formulas: Multiplier or Market Valuation

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