Chapter 16Copyright © 2010 by Nelson Education Ltd. Buyout Opportunities 16 PowerPoint Presentation by Ian Anderson, Algonquin College

Chapter 16Copyright © 2010 by Nelson Education Ltd. Looking Ahead After studying this chapter, you should be able to: 1.List some reasons for buying an existing business. 2.Summarize four basic approaches for determining a fair value for a business. 16-2

Chapter 16Copyright © 2010 by Nelson Education Ltd. Reasons for Buying an Existing Business 1.To reduce some of the uncertainties and unknowns that must be faced in starting a business from the ground up. 2.To acquire a business with ongoing operations and established relationships. 3.To obtain an established business at a price below what it would cost to start a new business. 16-3

Chapter 16Copyright © 2010 by Nelson Education Ltd. Relying on Professionals –Matchmakers –Accountants –Lawyers –Other experienced business owners 16-4 Finding an Existing Business to Buy

Chapter 16Copyright © 2010 by Nelson Education Ltd. Pros and Cons of Buying an Existing Business Pros –High chance of success –Less planning –Existing customers/ suppliers –Necessary equipment –Bargain price –Experienced employees –Existing business records Cons –Existing problems –Poor quality of current employees –Poor business image –Modernization required –Purchase price based on inaccurate data –Poor business location

Chapter 16Copyright © 2010 by Nelson Education Ltd. Finding Out Why the Business Is For Sale Owner’s reasons for selling the business –Old age or illness –Desire to relocate in a different section of the country –Opportunity to start another business –Decision to accept a position with another company –Unprofitability of the business –Discontinuance of an exclusive sales franchise –Maturation of the industry and lack of growth potential 16-6

Chapter 16Copyright © 2010 by Nelson Education Ltd. Examining the Financial Data 1.Review financial statements and tax returns for the past five years. 2.Recognize that financial data can be misleading. –Assets overvalued –Expenses overstated/understated –Income underreported –Unrecorded debts 16-7

Chapter 16Copyright © 2010 by Nelson Education Ltd. Income Statement as Adjusted by Prospective B Income Statement as Adjusted by Prospective Buyer Exhibit

Chapter 16Copyright © 2010 by Nelson Education Ltd. Valuation of the Business Asset-Based Valuation –Estimates the value of the firm’s assets; does not reflect the value of the firm as a going concern. Market-Based Valuation –Considers the sale prices of comparable firms; difficulty is in finding comparable firms. Cash-Flow-Based Valuation –Compares the expected and required rates of return on the amount of capital to be invested in the business. 16-9

Chapter 16Copyright © 2010 by Nelson Education Ltd. Asset-Based Valuation Modified Book Value Technique –Historical value of firm’s assets is adjusted to reflect current market values. Replacement Value Technique –Value of firm’s assets is adjusted to reflect current costs to replace the assets. Liquidation Value Technique –Value of firm’s assets is adjusted to reflect their value if the firm ceased operations and disposed of the assets

Chapter 16Copyright © 2010 by Nelson Education Ltd. Earnings Multiple (Value-to-Earnings) Ratio –Determine normalized earnings, and –Divide this amount by a capitalization rate. –Normalized earnings are earnings that have been adjusted for any usual items such as fire damage. Capitalization Rate Normalized Earnings Firm’s Value = Earnings-Based Valuation

Chapter 16Copyright © 2010 by Nelson Education Ltd. Cash Flow-Based Valuation 1.Estimate the future cash flows that can be expected by the investor. 2.Decide on the investor’s required rate of return

Chapter 16Copyright © 2010 by Nelson Education Ltd. Risk Premium The difference between the required rate of return on a given investment and the risk-free rate of return Required rate of return = –Risk free rate of return + Risk Premium Table 13-1 lists suggested risk premium categories 16-13

Chapter 16Copyright © 2010 by Nelson Education Ltd. Competition Market Future Community Development Legal Commitments Union Contracts Buildings Product Prices Negotiating and Closing the Deal

Chapter 16Copyright © 2010 by Nelson Education Ltd. Negotiating and Closing the Deal Terms of Purchase –Assets purchase or total entity –Indemnification clause –Payment in full or partial payments over time Closing the sale –Best handled by a third party Bill of sale Tax certifications Payment-to-seller agreements and guarantees 16-15