Musings on business value, sale preparation, sale negotiations, sale structure.

Archive for July, 2017

Valuation indicators Type of business (part1)

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For many years, the obvious question we would ask all our prospective buyers of businesses, is what business each would like to buy; that is, if they didn’t open the dialogue with a statement like “Hi, I’m looking for a small restaurant / coffee shop / factory / workshop” – the standard greeting from buyers in our industry!

Everyone has his favourite, and equally everyone has his pet hate:

  • Factory owners hate the idea of retail food outlets.
  • Retail food franchisees don’t see why they should have to work as hard as a factory owner. (Their perception, not mine)
  • Retailers tell me how they don’t want to call on their customers – “They must come to me”
  • Agents are happy to rent small offices, employ a few people, and move boxes. Preferably from home.

And it is this difference in favourites, coupled to an ever-changing macro-economic environment which contributes to the differences in values from one sector to another, from one time to another.

The old maxim of “if you have no shop, you have no business” is true for retailers, more so than it is for factories, for instance. Retailers in the small and medium size stratum are notoriously short sighted, in the opinion of almost everybody else. Most retailers are at the mercy of their landlords to start with, and are more often that not, abused by these wily foxes.

The big retailers can swing enough clout to turn the tables and have the landlords at their beck and call, while the small guy must simply take everything that is thrown at him from enforced opening and closing times to arbitrary rule changes, usually at the insistence of a much bigger retailer.

Of course, becoming a small retailer has enough of its own hurdles to overcome, that it’s a wonder that there are any of them in the bigger centres at all. Personal suretyships as well as bank guarantees often accompany the inflated rentals which subsidise the much lower rentals paid by their bigger colleagues in the anchor positions.

In difficult economic times, the small retailers are taken out quickly, and we were inundated with requests to sell “for almost anything” over night. So, retail values plummeted. As times improve though, the buyers of retail operations flood into the market to purchase the very few available businesses still operating after the squeeze. Demand drives prices up in a market being held dear by now cash flush owners.

Demand for retail businesses in good times is high, because most small operations are easy to run, and usually don’t require any specialist training. Entry level buyers from the ranks of the recently retired, retrenched or stressed are the fuel that feeds this machine.

During 2006 we saw a major shift in value from the factory environment to retail because of BBBEE initiatives being brought to bear on factory and wholesale businesses. White people unable to stomach the idea of sharing their businesses sold up and moved to retail where the same pressures did not exist. With the nexy round of codes of practice being released in 2007, this trend reversed with the perceived diminished BEE risk, and retailers suffered as the move to manufacture strengthened.

The fall in retail value was cushioned by the rise in consumer spending with the credit largess of that year and 2008. Big spending led to high profits, which attracted high rentals from more and more shopping centres and strip malls opening.

Came the end of 2008 and the so called “credit crisis”: many, many small and medium size retailers fell off the wagon and placed themselves on the market. A flood of supply of businesses attracting few buyers. None of those sellers had pre-approved credit facilities. The combination led to a general plummet in retail value.

So the first to feel the heat as the global credit crunch took hold were the retailers, with many of the buyers of 2007 and early 2008 now closing shop, unable to sell. That was first true for luxury item stores and fast food centres. One trendy night spot franchise in  particular, had as many as 38 of its franchisee operations for sale in 2009.

With a rise in supply and a fall in demand of any income producing entity, comes an associated fall in any of the multipliers which indicate its value. With a fall in profits, there is a magnified effect on the fall in values.

From all this it is easy to understand the high amplitude and frequency of value change in retail operations from extremely low profit multiples in poor times to frankly stupid multiples in good times. “Stupid”, because it is these new owners who will be taken out in the next downturn.

Prepaired

In all my years of helping people to sell their businesses, the biggest frustration was not in finding buyers. There is never any shortage of people wanting to own good, profitable, well prepared businesses.

The real frustration always came in when the would-be owner had to find funding to enable the deal. The seller was faced with a choice:

  1. Look for alternative buyers while the one in hand seeks funding
  2. Wait for the current buyer to find his funding

I generally recommended the first option, in a low key, non threatening (to the buyer) manner. Problems arose if the buyer found out his deal was threatened, which often resulted in him losing motivation to carry through with the project. Similarly, funders insisted on exclusivity for a period while they conducted their due diligences. If, as often happened, the business passed muster, but the buyer did not, the deal failed. We were left looking for another buyer anyway, as if we had waited on option 2.

Taking the funding on offer from buyer 1’s bank often helped subsequent, more suitable buyers, if the seller stayed the course.

Cars

If you ever go into a car dealership to buy a car, as soon as you have got through all the salesman bluster, and shown your buy signal, and you have chosen your colour, seats, extras and so on, you will be ushered to the financing “department”.

Of course this is not a department of the dealership, necessarily. In reality, the “department” is an individual who is a bank clerk with a desk at a dealership. The bank has previously vetted the product and the dealership. Of principal interest to the dealership and the bank now is the viability of the customer – you.

White goods

Similarly for cars, the customer is shown a seat at the “finance desk” of the department store selling washing machines, TVs, laptops, smartphones, and so on. Things are a bit different for these goods because often the financing of the goods sold contributes significantly to the bottom line of the parent company, for reasons which have become abundantly clear over recent times.

Never the less, the metaphor(ish) holds: Goods and services stay sold if the funding is easy to come by. The funding is product approved in advance by the funder, subject only to a suitable buyer.

So why are business sales not pre-approved for funding?

Well they are, and they can be. It is not as simple as the process of a bank getting into bed with a car dealership group, but it can be done.

Our PrepareYourBusinessForSale™ initiative has been expanded into its obvious next step… being “PREPAIRED”. It is a process which takes time and is not easy to wedge into a fixed algorithm, given the complex differences between different businesses. But a guided and considered approach can achieve remarkably rewarding results.

Speak to possible funders of your exit plan well in advance, and get a feel for what they are going to require in

  • Your business
  • The new owner
  • The deal structure
  • The deal value

Keep in mind that you will have to work with your funder in placing the correct new owner, when the time comes.

“I am just so sick of the uncertainty. My business is really doing well, and it has some good years ahead of it, so it is time to get ‘Prepaired’”.

The coming tsunami

The thing with Tsunami warnings is that they appear over and over again following reports of earth quakes, but they seldom manifest in anything discernible to those on the shore. So with time, people, cities, and governments start to ignore the warnings. Frogs in warming water.

When the big event occurs. The unprepared citizens witness first hand entire towns being washed off the face of the coast, nuclear power stations being shut down, or not. And vending machines being left unlooted. This was once a real thing in a first world country.

My South African clients are giving giving vent to any number of local scenarios, ranging between two extremes:

  • Zuma will be out by Christmas, and in jail by the new year (Unlikely)
  • All is lost, the country has been entirely captured. Democracy is a myth in South Africa. Stock up on canned goods and buy Bitcoin. (Also unlikely, although I do find myself attracted by the notion of a finite issue, decentralised, non fiat, digital asset)

We all have our own expectations of the future, and our actions or inactions will be influenced by the current turmoil in the political, social, and economic malaise; but that malaise is the single biggest reason for so many of our clients retaining us in the last year.

As Stephen Grootes says:
“The next five months in our politics could determine the coming decade”.

As luck would have it for those approaching retirement in the near future; there is a growing number of investors looking to expand their own projects into business owners’ horizontals and, or, verticals. They are getting their own acts together for a strong upturn which is quite possible, once the madness is over.

  1. Horizontals – competitors, industry related, and complementary businesses.
    A franchisee in a successful chain of restaurants buys a store of the same franchise which becomes available on the other side of town, and also makes an offer for the new store being contemplated in the new mall.
    A hairdresser buys a nail salon in the same mall so that it can cross sell to both businesses’ customers.
  2. Verticals – in the same supply chain to an end user.
    A large group owning a logistics company, an abattoir, and a coffee bean importer, purchases a national chain of restaurants to enable spare capacity in the abattoir and the logistics businesses to be utilised, while securing a market for its beans.
    The supplier of beauty products buys both the hairdresser and the nail salon so that it can benefit from gross margins on a longer chain.

The potential investment situation is evidenced by the large amount of money sitting unused in large businesses, corporates, and in pension funds. It is the same money which Bell Pottinger might suggest is being held ransom by white monopoly capital (WMC) – an apparent thing – for defined performance by the ruling elite.

Psst… it is money being held back looking for decent investment. Stop being a box!

As a business owner entering the closing years of an exit plan, you have an unprecedented opportunity to tap into that enormous resource; but only if you play your cards right. PrepareYourBusinessForSale™. Get prepaired. The group or company which buys your business is not going to pay over the top. They will pay the value you are able to confidently demonstrate. It’s up to you to demonstrate that value. If you are not adequately prepared, you will leave money on the table.

Think outside the box for a while. Really; give it some serious thought:

  • Who would be interested in buying your business in the coming years?
  • What would they want to buy?
  • Does your business have the capacity to excite, simplify, or add security to a new owner?
  • How do you get things in the right “place” for them?
  • How do you maximise your own value, while enticing the acquiring person / business / group to see the greater future picture?

Those are the current and ongoing challenges for all business owners. Don’t neglect them.