Business Advisor: June 2012

A common misconception is that the fair market value of a bakery will be
an amount similar to the price that would be paid for the business
should it to be listed for sale.

A common misconception is that the fair market value of a bakery will be an amount similar to the price that would be paid for the business should it to be listed for sale. In fact, there can be significant differences between price and value.

Despite the differences between price and value, there are sound business reasons for conducting a valuation, either for income tax purposes (for example, an estate freeze) or for an actual sale of a minority interest or the entire business.

Sellers often ask business valuators to value the business so that they can get a sense of the amount they can expect to receive, or to assess the fairness of offers received from potential purchasers. Similarly, buyers ask business valuators to value the business so that they can offer an appropriate price and avoid the pitfall of overpaying for the business.

It’s often been said that price matters to the seller of a business and value matters to the buyer. It’s important to appreciate that value is determined based on the following assumptions:

1. The sale will be for cash. However, in market transactions, the amount paid for the business may include cash and non-cash consideration (such as a vendor take-back loan, a share exchange, or future consideration if certain conditions are met).

2. Value is the highest price. However, in market transactions, this is often not the case as the price may be higher or lower than the value. The reasons for the difference can result from a variety of factors, including the negotiating skills of the parties, financial strengths of the parties, type of purchaser (strategic versus financial) and the representations and warranties required by the parties.

Often, the valuator will not be able to identify strategic purchasers. These are buyers that are able to realize economies of scale as a result of the acquisition. For example, if Weston wanted to buy XYZ Bakery because XYZ produced a highly popular brand that it could not duplicate, it may be prepared to pay more than XYZ’s value, as it would not only be acquiring a brand to add to its portfolio, but it would realize synergies, for example, elimination of duplicate/redundant expenses incurred by XYZ and elimination of a competitor. On the other hand, a financial buyer would not be able to realize synergies and as a result would likely not pay more than the value of XYZ.

The vendor of a business may be prepared to accept a price that is lower than value. For example, the vendor may be concerned that many of the company’s long-term employees may be terminated after the acquisition. The vendor may decide to accept a lower offer if the purchaser provides a representation and warranty that no employees will be terminated for at least a two-year period after the acquisition.

The purchaser of a business may be prepared to pay a price that is higher than value to secure an agreement from the vendor not to compete.

3. The parties are informed and acting at arm’s length. In a market transaction, often one party has more information than the other, as could be the case where transactions take place between non-arm’s length family members. This may result in major differences between price and value.

4. There are no restrictions on sale, the parties are not under any compulsion to transact and they are acting in a prudent manner. This may not be the case in an open-market transaction as, for example, the vendor may be forced to sell in a short period due to health, financial or other reasons that may result in imprudent decisions. Again, this can lead to a difference between price and value.

In the valuation of a bakery, the valuator will assess the trend/quality of earnings and the risk factors of the business, including:

• number of years in business
• quality of management
• competition
• existence of customer contracts
• degree of automated equipment and state of facility
• location of facility and lease terms
• ease of duplication of products
• contracts with key employees and their tenure and existence of a union 
• brand value
• ability to grow and innovate

Whether you are selling or buying a business, a business valuation can give you a good benchmark for negotiation.

Bruce Roher is a partner in the business valuations practice at the Toronto office of Fuller Landau LLP, Chartered Accountants. He can be reached at broher@fullerlandau.com or at 416-645-6526.