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Commonly Used Business Buying Formulas In Canada

  1. Earnings Multiplier or Price-to-Earnings (P/E) Ratio:

  • Formula: Market Value of Equity / Net Earnings

  • Example: If a company has net earnings of $500,000 and the typical P/E ratio in the industry is 10, the business would be valued at $5,000,000.

  1. Seller’s Discretionary Earnings (SDE):

  • Formula: Net Profit + Owner's Salary + Additional Owner Perks + Non-Recurring Expenses

  • Example: If a business has a net profit of $300,000, the owner's salary is $100,000, with $50,000 in additional perks and $20,000 in non-recurring expenses, the SDE would be $470,000.

  1. Discounted Cash Flow (DCF):

  • Formula: Sum of Future Cash Flows Discounted Back to Present Value

  • Example: Projecting cash flows for the next 5 years and discounting them back to the present value at a chosen discount rate.

  1. Book Value:

  • Formula: Total Assets - Total Liabilities

  • Example: If a company has $1,000,000 in assets and $300,000 in liabilities, the book value is $700,000.

  1. Revenue Multiplier:

  • Formula: Annual Revenue x Industry Multiplier

  • Example: If a company's annual revenue is $2 million and the industry multiplier is 0.5, the business would be valued at $1 million.

Unconventional Business Buying Formulas

  1. Value Based on Strategic Fit:

  • Concept: Valuing a business based on how well it fits strategically with the buyer’s existing business.

  • Example: A tech company might pay a premium for a startup that has a critical technology or patent that complements its product line.

  1. Earn-Outs:

  • Concept: Part of the purchase price is paid out based on the business’s performance post-acquisition.

  • Example: A buyer agrees to pay an additional $200,000 if the business reaches a certain revenue target in the next year.

  1. Leveraged Buyouts (LBO):

  • Concept: Using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.

  • Example: A private equity firm buys a company using 70% debt and 30% equity.

  1. Crowdfunding or Community-Based Valuation:

  • Concept: Raising small amounts of money from a large number of people, typically via the Internet.

  • Example: A local community-based business might be valued and funded by the community through platforms like Kickstarter.

  1. Human Capital Valuation:

  • Concept: Valuing a business based on the talent and skills of its workforce.

  • Example: A tech startup with a small revenue but a team of highly skilled engineers might be valued higher due to its human capital.

Each of these methods has its own merits and can be more or less suitable depending on the type of business, the industry, and the specific circumstances of the sale. It's also common for buyers and sellers to use a combination of these methods to arrive at a fair valuation.

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