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

Archive for October, 2017

Does your business need an auditor?

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Does your business need to be audited?

  • Perhaps your memorandum of incorporation or shareholder agreement insists on an audit.
  • Perhaps your business is within certain industries which require one.
  • Perhaps your funders require an auditor’s report annually.
  • Or perhaps you believe still, that all companies need to be audited?

If your PIS falls below 350, you do not need to be audited, and you may be wasting a great deal of money on the annual event.

Oh, but perhaps, just because a firm of auditors send an accountant around to your business every year, you believe you are being audited. Perhaps you are simply being reviewed.

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How KPMG destroys a business’s value

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Background 1

There is a sanctimonious attitude in the auditor profession, generally. It is well earned, and indeed, advertised by SAICA:

  • Years of study.
  • Stringent examination.
  • Long hours of apprenticeship.
  • Big pay cheques – commensurate with experience, dark suits, green pens, and the ever present gravitas.
  • Non auditor CA(SA)s take up the lion’s share of CEO positions in JSE listed companies.

They are apparently beyond reproach.

The trust placed in the auditing profession is borne of its rise to excellence, welded to its strict code of conduct, compliance with regulations, and sheer earning power.

By way of illustration on this “earning power” subject; please remember KPMG was paid R23M to “cut” from Tom Moyane’s list of requirements in his brief to the auditor:

  • the required findings, and
  • the names of who’s careers to destroy,
  • which facts to create, and
  • what recommendations to publish…
  • and post those emissions as their own.

(Tom Moyane was also the guy who signed the release from prison of Shabir Shaik, on medical parole, shortly before his unconsummated death).

Background 2

The KVI approach to business valuations and evaluations (and due diligence studies) is based on a potentially exhausting series of probing questionnaires which are scored on

  • Sliding scales
  • Nine box grids
  • Yes / no binaries
  • Weighted averages
  • Vector resultants
  • Answer clouds and
  • Common sense

The outcome is a series of scores which identify the effect of exposure to inherent business risks, balanced against mitigation by imperatives, and the importance of each indicator in

  • The market
  • The industry
  • The geolocation and
  • Any particular point in time.

Background 3

With the “new” Companies Act being enacted in line with the requirements of similar legislation of our trading partners, and international norms, South African companies are increasingly able to compare themselves in performance and value to their international counterparts.
South Africa has a range of reporting requirements, dependent on public interest scores (PIS), Memorandums of incorporation (MOI), and industries and stakeholder requirements.

  • There are various PIS levels.
  • The MOI of the company may require it to be audited.
  • Some industries insist on audits for their members – the estate agents and lawyers, for instance.
  • Investors and lenders may require an audit as part of their covenants.

Background 4

In the sale of a business I brokered about 15 years ago, the target had been well audited, and the buyer was well versed in audit requirements. As part of the negotiation, the new owner asked the auditors to remain on, post deal. The buyer’s thinking, he explained to me, was that the continuity of audit practice gave him comfort in the veracity of the accounts used as a basis for valuation.

In that deal, the purchaser was happy to pay full value, and even higher. He knew that the auditor was on the line.

Summary, so far

  • Auditors are held in high regard, and trusted
  • Each business has its own DNA, expressed through a variety of key valuation indicators (KVIs)
  • Auditors although trusted to give veracity to the numbers, are not always required
  • Where auditors have their round bits on the line, the numbers can be relied on, as a basis for value.

This rather long post serves as background for the the developing requirements in business valuation standards. We have always looked at the requirements of various compliances. The adherence to those requirements as a single KVI among many, determines the nature of the valuation method, its multipliers, discounts, and sums.

In the days leading up to the sudden resignations of the leaders at KPMG in South Africa, I was quizzed on the valuation of a business for which I had lead a valuation a few months back. The base figures were audited by KPMG. This was the problem. The valuation technique was not being called into question; but rather, the auditors report. “Do you have any idea of what is coming here?” said my critic. I did not.

I do now.

KPMG has taken a small slice of your pension away from you

Which brings me KPMG and the value of your business

The cynic might suggest that by subjecting his business to an audit, the business owner is purchasing value. By subjecting his company to an audit, conducted by a premier league auditor is no cheap affair, but it does give gravitas to the financial statements, and lightens the due diligence expectation in a sale. At an honest level, this is indeed so; the company pays to demonstrate its integrity. But we have to expect that at that honesty level, integrity is also present.

In the cold light of the dawn following the KPMG-SARS cut and thrust paste revelation, there may be several dusty mirrors wedged in the fat, smoky invoice.

{Ed- how the heck does one itemise an invoice over four pages, to the cent in each item, and come to EXACTLY R30,000,000-00? And then you have the friends at SARS to ensure that this amount spent on a family member’s wedding, is written off as a business expense!}

Since the first exposure of KPMG’s nefarious dealings with SARS, I have had two separate and independent parties question the validity of our valuations – not for reason of our methods, which are well regarded, but because the underlying financial information was green penned by KPMG.

Imagine THAT happening before Zuma came to power. Oh wait… there was Arthur Anderson. Remember them? The consulting and audit firm collapsed world wide. The local chapter was bought by… ah yes… KPMG. I really should spend some time penning my views on the merging of cultures in mergers, acquisitions and disposals.

Where once subjecting financial reporting to the rigours of an audit gained KVI points, well, for the time being that is going to be diluted by the criminal actions of KPMG.

#TheMostRobustAuditRegimeInTheWorld – South Africa

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It gets more complex

Zuma, the man who would be king, and president of the country for the time being, having admitted via his legal counsel that he has been stringing us all along for fools, for almost a decade, now wants to make representations to Shaun the shawned wether, as to why he should not be tried for corruption.

We can all be quite sure that the veracity of the corruption report used in Shaik’s trial will on the agenda. That report was authored by … KPMG.

Any more of the current nonsense, and South Africa will be downgraded further. And that WILL destroy further value in your business, ragardless of who the auditor is.

Valuation indicators: Shareholder agreement

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PYBFS017

If there are more than just you as a shareholder in your business, chances are that you have not put in place one of the most fundamental building blocks for the creation of value in your business:

The shareholders’ agreement

Let me explain. (Oh, and even if you are the sole shareholder in your business, you should pay heed.)

The shareholder’s agreement is more than a document governing the number of shares or percentage of shares held by each person (or entity). It helps deal with the other shareholders’ family in a time of crisis. It provides you all with a negotiated plan of action in the event you are incapacitated on a Sunday evening. It is something which can possibly stop your bank accounts being put under stress by the wife, girlfriend or children of your now dead partner.

The shareholders agreement will dictate how shares, or even the whole business will be sold or otherwise dealt with in the case of a fallout of shareholders. When you guys got together you never considered that one day there would be a divorce. The state forces us to contract for this eventuality in our personal lives, or face the whim of the courts. But in our business lives, which usually get started some time after our marriages, we are reluctant to take the same steps.

The shareholder’s agreement will help to protect minority shareholders in the case of a sale of the business. If you own less than a portion of the total equity, you are at risk of arriving at work tomorrow morning to find that in place of your shares, you have a cheque for the proceeds of the sale, which you knew nothing about.

A shareholder’s agreement can insure that all shareholders have a preemptive right of first refusal on the sale of any of the other shareholders’ shares. That can be very valuable in five years time when Big Larry wants to take off with his mistress.

A shareholder’s agreement can regulate the manner in which new shares are issued, and give you some say in the manner in which new issues are taken up, and by whom.

What happens if one of the other shareholders is a company, and that shareholder’s shareholding changes? Concentrate here. The control of your biggest shareholder changes to that of your competitor, or your ex wife’s new boyfriend… You don’t want to find that your electronic key no longer works on the first of next month.

What have you agreed to in the event one of your shareholders is sequestrated or liquidated?

How, or on what basis will you value the shares of the company in the event one of the shareholders wants to sell his shares to the other shareholders?

How will the shareholders’ loan accounts be handled in any of the above circumstances? And how will funding be sourced and repaid?

What is your agreed dividend policy; or do you simply have an argument at the end of each year? Wouldn’t you prefer to have left some of that money in the account after the last financial year end?

Many businesses actually fail because this very important document is not in place to regulate the way shareholders direct the directors, who (let’s face it) in our realm, are usually the same people. Such a failure leads to all the shareholders losing all the value built up in the business from the start to the time of the failure.

But most important, one day when you decide to sell the business, and all has gone well, how will you agree on the method of sale, and the distribution of the proceeds?

If you are a one man shareholder, read the above again, and give it a think. What will you do when someone offers to buy a portion of your business one day. I know what you should do. Visit an attorney with all these questions, and a bunch of others I have not brought up.

But there is more…

The memorandum of incorporation (MOI). The government put this into place for us a few years ago. Of course we were given an opportunity to make it agree with what we intended in the shareholder agreement, but most of us didn’t bother. The problem is that if there is conflict between the MOI and the shareholder agreement, then the MOI will hold.

Really. It may really be time to spend some money with an attorney.