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

Archive for the ‘Business value’ Category

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.

Bus number

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What is your bus number?

“But Honey, if I get hit by a bus, this life insurance policy will make sure that you and the kids are looked after”. We have all asked the question, or contemplated the ramifications of someone being hit by the proverbial bus.

Lourens Coetzer, a very bright computer genius, turned this around in a discussion we were having recently, and coined the measure “bus number”: The number of people in an organisation which, them all being hit by a bus, it would take to destroy a business.

A stand alone, one man self employed operation obviously has a bus number of 1. Any employee, no matter what he does, and how he earns his crust, has a bus number of 1. Standard Bank has a bus number of hundreds, maybe even thousands, we would think. But what if all the tech wizards were wiped out in a bomb blast at the annual prize giving? That bus number might only be 20.

{Ed: that seems a bit extreme. At least some of the techs would be in the hydrangeas smoking weed.}

More than considering how many people any particular enterprise is able to lose to the bus, it appears that the crucial bus number needs to be considered at the weakest point in the enterprise.

  • The business is entirely dependent on its sales staff to keep the machinery running, with a short lead time, and there is a single rainmaker making up that sales team – the bus number is very low.
  • The sales department is diversified and competitive – the bus number is high.
  • The business is a professional practice – the bus number is determined by the number of competent professionals.
  • A single CAD designer distributing work to a group of machine operators…
  • Software developers in a disorganised or poorly documented project…
  • That single black shareholder/director upon whom the enterprise depends for its BEE score, now that the government appears to be abandoning its “once empowered, always empowered principle.

That quick list demonstrates how tenuous is the grip SMMEs have on their futures, and it is worrying in the present, but even more so in the future, where business values depend on the sustainability of the enterprise.

So the challenge is to raise your bus number, to account for the systems and redundancies built into your business. It is unlikely that any reasonably sized, privately owned business would have a bus number above 3.

  • The owner or CEO, the financial manager and the factory manager
  • The owner or CEO, the sales director and the factory manager
  • Just, the top three sales people

As we develop Lourens’ concept label, all sorts of derivatives spring to mind:

  • Bus number as a proportion of all employees
  • Bus number per turnover
  • Bus number as a proportion of training budget
  • Bus number critical point of failure!
  • Bus number replacement lead time

And as we reconsider the example of the empowerment score card bus number, it appears that ministerial interference is once again threatening the future values of our businesses, with random brain emissions. Thank you, Minister Zwane.

Four budget speech hurdles

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Not a very official analysis of what will fall out of the 2016/17 budget speech. There is no investigative authority involved. I have not phoned any treasury officials, and I am not privy to an embargoed copy of the speech. #JustSaying. In many respects, this is an alternative to what the popular commentators having been writing for the last week. More importantly, it gives some idea of how the value of your business may be affected.

Small business owners tend to not care too much about the annual budget speech. Like John Lennon who famously said: “I never vote because the government always gets in”, they know that no matter what they think, the budget has been decided and they will be affected – good, bad, or ugly.

This year’s budget is different because of the ramifications of a cock-up following #4DaysInDecember. Investors are watching us, in an environment where the rest of the world is growing, albeit relatively slowly. South Africa has pretty much ground to a halt.

For small business people who are able to nimbly make allowances for changing economic, legislative and tax requirements, the speech means less about talking heads in the immediate aftermath, and more about where loopholes can be exploited, own policies tweaked, and changes taken advantage of.

I think that it is unlikely that the minister will provide us with any short term good news, and nor is it likely that he will mess around with little fiddly changes all over the place. He needs to be seen to be making sweeping changes to effective rates in easily result providing areas. Look out for these pointers

1. VAT

If the VAT rate goes up, you should know that we are really in trouble. Many commentators suggest that this is too hot a political potato to deal with now. It will affect the poor and the rich, and the EFF will scream blue murder. The Davis Tax Commission has reportedly suggested that this is the most efficient way to increase revenue. The poor can be accommodated with a marginal increase in social grants.

Might I suggest that the manner in which the Cabinet backed down on the Tax Amendment Act was the left hand of a deal with Cosatu, allowing the right hand to lift the VAT rate with minimal noise from the trade union congress.

Effect on your business value

Probably minimal. VAT collections are trust moneys, which you need to account for separately to your income statement and balance sheet. If your product has a close link to the retail user, you may come under some short term pressure, but life will go on. Expect some arbitrage around the date on which the VAT rate changes, from the unscrupulous.

2. Amnesties

We are a country of amnesties, and we all understand them very well, from giving amnesty to murderers under the old regime (also committed by members of the new regime), to the various tax amnesties, and the fact that so many small businesses give a monthly amnesty to their debtors by way of a settlement discount to encourage them to pay their bills.

South Africa needs to collect money in a hurry, and an amnesty for all sorts of tax misdemeanours is quite likely, if it means that outstanding taxes are collected quickly and easily.

Effect on your business value

If you have some of these skeletons hiding away, this may give you a opportunity to come clean before risking the process of a due diligence in a sale of your business in the next few years. The improved sleep patterns may also give you further energy to get up and go, for at least a while.

On the negative side, your customers may find themselves cash constrained as they come to terms with having to actually pay those taxes they have been dodging. That may mean fewer, or smaller sales for your business while the system adjusts. Those sales changes will translate into lower profits for a while.

3. Corporate tax

  • In 1980 corporate tax was 42%.
  • In 1982 it rose to 46.2%
  • In 1984 it rose to 50%
  • With the approach of some democracy, Treasury was able to lower it to 48% in 1991, then 40% in 1993. We thought it was Christmas!
  • It got confusing in 1994 with a once off RDP tax of 5%. Nobody seems entirely sure of where that went, but anyway…
  • By 1995 it had dropped to 35%.
  • 1999 it dropped further to 30%
  • 2005 saw 29%
  • And 2009 saw us drop to the current 28%.

Interest rates are rising, and corporate tax is likely to do the same.

According to the Davis Tax Commission, a 3% rise in VAT to 17% will have the same effect as a rise in corporate tax to 33.2%.

Effect on your business value

This is a tricky one, dependent on how you negotiate the sale of your business. You will need to consider other issues, such as whether you are intent on a sale of assets, or the sale of the equity in your business. Currently, the equity deal makes more sense, but that might change after Tuesday.

Either way, all profitable businesses will be equally affected, and the rising tide thing may save us from wild valuation changes. Expect though, that buyers will lean on you either way. Take their nonsense with a pinch of salt. Sit back. Take some advice. Don’t panic.

4. Once off tax on company reserves

Now there is a bombshell waiting to explode.

For a long time the government has been castigating companies about the piles of cash they are sitting on without investing it. There is a mountain of cash sitting doing nothing in many businesses. Government has appealed for this money to be invested. Business has shrugged and suggested that Government should perhaps make things a bit more business friendly (particularly around labour laws).

A once off tax on this enormous reserve would go very far in driving off the ratings agencies.

Effect on your business value

This is a game changer. It is also fool proof. Say 1% tax on all company reserves, which have already been taxed on corporate tax, but not on dividends tax. Perhaps business should be required to use it for investment or submit to a once off taxation. SARS already knows how much it can depend on because we have been submitting our financial statements to them for years.

There will be a lot of money looking for investment homes in small businesses. That will drive business value up sharply and quickly. It will also stimulate the economy like nothing else. This will have a knock on opportunity effect for other taxes to be collected. It will accelerate the capital gains tax collection from business sellers.

It might just be a golden opportunity for well prepared businesses to get out at above average values.

 

Other

You may notice that I have ignored all that talk about Government slowing down on its spending. That’s because we have heard it all before, and we all know it’s not likely to happen. Before Easter we will have some more scandal around one or other minister, MP or director general wasting money on cars, hotels, trips, houses, alcohol or pantypreneurs. Most of us know it will happen. Frankly it is small cheese in comparison, so let’s just concentrate on getting more money in.

 

*PS I am not privy to any ministerial discussions, and the blog written here is pure conjecture in as far as what may be decreed. There is a strong possibility that I have it all wrong. Wouldn’t it be fun if I have it all correct?

Imagine there’s a way

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One of the examples I give in my seminars, on the phone, in meetings when I start to ramble (as one does) is an exchange I had about twenty years back with the owner of a pizza place.

I had queried her on the asking price of her business, which was frankly, just too high. “Well if could buy just two more scooters we would sell more pizza, then the value would be right. So the new owner just has to believe, and buy the scooters as well as the business”. When I asked her why she had not bought the scooters, it was all about the cost of the scooters. We moved on.

Of course scooters have become a metaphor in my lexicon for “if only we could just {add your own dream here}.

Well, imagine there is a way to add that value to your business without paying out vast amounts of capital money. This is not about borrowing hard cash from a bank or investor. It is not about raising trade finance, leasing vehicles or machinery, or bonding a property.

This more of an ephemeral investment in your business, strictly to make it more valuable. When I say “more valuable”, I don’t want you to be dreaming of adding 50% or even 100% value to your business with your “scooters”. This plan is for those who want to add 500% to their value. Or 1,000%. OK, I don’t want to sound like a politician in an election year, but you get the idea.

So this is not for the guy who desperately needs a new truck in his business.

This is all about getting top dollar time investment in your business of people and resources who can make things happen. So if you need

  1. software to run a particular process which will make your business hugely scalable
  2. an “app” to interact with more customers or make some sort of reporting happen
  3. your production and sales relationship aligned with customer expectations to forever get rid of lost production, late delivery, and broken promises
  4. processes to work between you and your customers allowing them to instantly and automatically let you know about each one of their stock movements
  5. your start up idea to move from “ideation” to production
  6. better ways of managing cashflow, that actually work
  7. a concept to be designed and produced

then you should be asking more.

Nobody is going to be giving you any money. But they will be investing time and effort in your business, and they will want to make a profit if it works out. So you will pay them on the success of the dream, and you will pay a bit of money up front. 90% of something is usually better than 100% of less than something.

This is particularly for those who have been freaking out about an idea, but have no money to make it work. If it is that good an idea, opportunity, constraint, then you should have it committed to some sort of presentable plan by now.

Don’t leave a message in the comments section. Send me an email on mark@suitegum.co.za

Toilet paper was invented in Greenbay Wisconsin in 1902. They struggled. It was only in 1935 that they could guarantee that would be splinter free. If this opportunity was available then, the world may have prevented a cuppla big wars!

 

Interesting

“Scientists have developed a powerful new weapon that destroys people but leaves buildings standing — it’s called the 17% interest rate.”

– Johnny Carson


An interesting concept – interest. It’s great when you’re earning it. It kinda sucks when you’re paying it. But either way, its compounding performance can be impressive when the rate rises to 10% and higher.

As far as the sale of businesses is concerned, a rise in interest rates, at the obvious value level:

  • From the buyer it is:
    • more expensive to borrow money to buy businesses (or to “leverage” the acquisition)
    • harder for buyers to convince banks that the deal is a good one
    • more attractive to earn interest with cash money in the bank than to risk it in a business

The result is that there are fewer buyers of businesses. Demand is lower.

  • For the business owner it is:
    • more difficult to do business as an economy slows down
    • more difficult to meet monthly interest payments which are higher
    • difficult to hear of more customers struggling to pay on time
    • an attractive option to exit the business and put the cash in the bank

The result is that there are more businesses on the market for sale, all chasing a shrinking number of prospective buyers. Supply is higher.

Economics 101:

Lower demand leads to lower prices

Higher supply leads to lower prices

Those two statuses lead to an interesting situation, where far from the basic economics of buying potatoes at the market, the buyers in the case of businesses, are risking a lot of money. The result is that they are more careful in a situation where they do not need to be pressed by the risk of losing any particular opportunity to a competing buyer. They have time to look at many other businesses for sale at the same or similar asking price. This puts pressure on the sellers. This leads to lower prices.

There is another compounding problem. When interest rates rise, expenses go up and profits fall. Lower profits are less attractive to buyers of businesses. Values of businesses fall.

 

 

 

Source of funds

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Businesses rely on two main “organic” sources of funds to build their capital and grow:

  1. Investor funds
  2. accumulating profit

The first is “dollop” in nature. It arrives in a lump sum, or a series of lump sums, and allows the air to clear, plans to be realised, and sleep to be had.

The second is slow. It requires patience, hard work, and discipline. It also requires good management of resources, based on good decision making.

A third source of funds comes from loan capital and short term creditors. It requires negotiating skills, some ducking and diving, and often, an economy of truth!

There is a delicate balance between several factors which will determine when it is wise and indeed preferable to borrow funds, rather than raise further investment.

Unfortunately, most small business owners have no idea about the science, and resort to borrowing money only, and then usually when they have run out of customer sales and the resulting margins. The banks they apply to are generally able to identify the risks, and ask for the safest collateral. It usually does not exist any longer.

Sometimes the converse occurs, when the customer sales grow too quickly, and the required inventory is just too far away. The knee jerk reaction to this dilemma is usually one of “just give me the sales, and I’ll make a plan afterwards”. The liquidator files will attest to the folly of this thinking. Those that have survived have been lucky, and will often use the experience to become evangelists of good balance sheet management.

This is playing out on a much larger scale right now in South Africa, and some dramatic exchanges of ministerial seats have taken place as a result.

SAA is insolvent, but for the guarantees provided by the government, funded by the tax payers. Former Minister Nene, refused to allow the organisation to take on a third party as a go between on some strange deal. As a result he was taken out of the equation, and I suspect we may find that during his 97 hours and 30 minutes as Minister of Finance, Des van Rooyen signed off the deal.

We are left floundering wondering about whether or not the proposed nuclear arms deal was signed off in the same period, against the wishes of Mr Nene; he who harbours very conservative accounting principles. That quiet time of the year for pushing embarrassing stuff through the process may find us reading, in time to come, about these deals having happened when people were more taken by the smoke screen of #ZumaMustFall, on the eve of the annual morale regeneration in the country’s holiday spots.

When we get back, we will be facing an interesting 2016:

  1. South Africa is on the brink of having its credit rating dropped to junk status.
  2. Interest rates are likely to rise, and rise and rise.
  3. Inflation is likely to rise
  4. There will be much in the way of political posturing – some of it will be racially uncomfortable
  5. There will be municipal elections

The minister in charge of the municipalities is the same one (van Rooyen) who lasted only 97 hours and 30 minutes as minister of finance recently. He is also the one who took Merafong into bankruptcy. Merafong is a small town with about 200,000 inhabitants – the same constituency which in anger, burned down his house and chased him away. That is the guy who His Excellency Jacob Gedleyihlekisa Zuma has put in charge of making sure ALL the municipalities toe the line.


But let’s not denigrate our president, and his impressive list of honorary degrees:

  • Honorary Doctorate in Law from the University of Zambia for his obviously strong adherence to the concept
  • Honorary Doctorate of Literature from the University of Fort Hare for his demonstrably brilliant reading skills
  • Honorary Doctorate of Administration from the University of Zululand for his ability to administer punishment to those who stray
  • Honorary Doctorate of Philosophy from Medical University of Southern Africa because of great ability to outmanoeuvre his opponents
  • Honorary Doctorate in Humane Letters from Texas Southern University because how else does a university confer a doctorate on someone who is so woefully inadequately equipped to wear the “doctorate” badge, other than for political reasons?
  • Honorary Doctorate of leadership from Limkokwing University no doubt because of his bold leadership?
  • Honorary Doctorate in philosophy from the American University of Nigeria
  • Honorary Doctorate by the University of Abomey-Calavi, Cotonou, Republic of Benin

South Africa is precipitously close to being graded as junk, as to make no meaningful difference. In the last year we have had more business owners engaging with us on exit preparation than in any single year in the last six. The foreign entrants into the small business sector has never been so thin. So we are unlikely to see a great “thump” of falling graphs when the announcement eventually comes. The sentiment is probably already priced into the JSE, other than on the top 40.

More likely is a slightly steeper fall in the already downward trending curve.

Our saving grace on the inflation front is the falling oil price which is conveniently balancing out the weakening Rand. Make no mistake, though; the oil price cannot fall for much longer, interest rates are increasing, the Rand will fall further, and inflation will rise.

Your challenges in 2016, as small business operators, will be working with higher inflation and higher interest rates. Business valuations do interesting things in that contextual mix. For many, the next few years are going to be difficult if getting out of business was the plan. It promises to be an interesting year.

Enjoy the break if you’re getting one.

{So you think you have cash flow problems?}

Losing suppliers

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There is a growing propensity for new cars to be sold without any spare wheel. There is no recent realisation that modern road surfaces provide no reason for tyres to be punctured. Equally, there is no reason to believe that some sort of contingency plan does not need to be in place.

On the contrary, there is only some redundancy in the run flat tyres that are fitted to these cars. One could therefore assume that the possible failure of the initial plan has been mitigated by a combination of good tyre engineering, better roads, mobile phone technology, availability of mobile mechanics, law enforcement and other idealistic plans.

This is all fine and well in the cities of Europe, where it is relatively safe to be a sissy, and where the motor manufacturers would never dream of pulling the wool over the eyes of their customers with any marketing nonsense. Except maybe VW.

For anyone to drive a small car in South Africa, anywhere except in the leafy green suburbs of the safer cities, with no spare wheel, would be crazy. Vehicle owners in the more robust environments all have a plan B, in a more sturdy vehicle, with an adequate spare, and the tools to replace it.

We have to look to a more reliable outcome where the backup plans are dodgy, and the risk of failure has such dire consequences. This is all about supplier redundancy, again.

The risk of supply failure is playing out in the VW supply chain to Swiss car retailers, where the VW diesel test fraud has caused authorities to ban the sale of the vehicles in that country. That means that a bunch of car retailers will suddenly find themselves without one of their favourite sellers on their shelves, almost without notice.

The ramifications are huge for the entire supply chain, all the way down to the suppliers of platinum (South Africa) where that metal is used in the catalytic converters to make the emissions (supposedly) palatable.

The lesson to be learned for business owners is that of supply chain redundancy. If your supplier is suddenly unable to keep product on your shelves, where do you go?

Key in the business valuation process, is testing a business for this sort weakness.

  1. Are there alternative suppliers?
  2. Does the business have a relationship with alternative suppliers?
  3. Is the business somehow embargoed from buying from the alternative suppliers?
  4. Does the business regularly buy from a cross section of alternative suppliers?
  5. Is the business able to shop around for the best price, and actively keep suppliers on their toes, price wise?
  6. Is the business able to regulate its gross margins through negotiations with alternative suppliers?

How does your business rate in those questions?

While you ponder that, consider putting off the purchase of your new mid range family saloon, as African countries look forward to a surge in supply of cheaper diesel powered VWs in the next year or so, as they are dumped out of the European market.

Customer grade counseling

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In the first three presentations on key value indicators (KVIs) I used the examples of exposures to premises and to customers to show how strengths and weaknesses in each business can contribute to perceptions of, and actual value in a business.

This short video shows how questions are asked and answered to get an indication for each business as to how that particular KVI, in that business, in that industry, and even within the greater environment; should be positioned. In a world subject to scientific measurement at every turn, this methodology manages to streamline some of the “art of valuation” into something more defendable.

The valuation interview interrogates all the KVI areas of a business, and apportions strength or weakness scores to each, which is then applied to a profile for a particular industry, within other global sub categories, such as geographical, societal and economic.

The video is simplified, to give an idea of the process without confusing the overall message.

 

Social valuations continue to frustrate

In response to last week’s valuation video, I received a very pertinent comment highlighting the issue of the break even point of sale (BEPOS), and how this important little calculation can affect the value of a business.

So again, in lieu of digging deep to write the necessary, I have waved my hands about a bit, metaphorically, in a video.

This is not brain surgery, you’ll agree. However, the number of business people who rest on their laurels when making a profit, even in the face of a single large customer being their slave driver, is frightening.

We agree that you cannot ditch that large guy. You really shouldn’t, but you do need to get more business out of the smaller guys, and look for others. That will mitigate your risk to a great extent. “Yar, great advice”, I hear you saying. And you’re right; it is very easy to point out the obvious. The frustration at reading the obvious should not be used as an emotional tool for handling any inaction.

  • Sell up and cross sell to your existing smaller customers. Apparently it’s easier to sell to them than to new customers.
  • Find ways of getting new customers, anyway. It’s not easy, but it IS possible. If it were easy, everyone would be doing it. But you’re better than “everyone”, right?
  • Speak to Peter Carruthers about finding new clients. Again, it’s not easy, and it costs some money, but there are easy bailout options from his program if you’re unable to cope for any reason.

Work hard on diversifying that customer base now. Sell the entire business for much more later. You’ll see that I’m right!

Social (mis)Valuations

I used to refer to this phenomenon as the “braaivleis valuation” in recognition of an event I once witnessed which involved a lot of Rum, Coke and no short supply of Zamalek. In furtherance of our international acclaim, it will now be referred to as the “social valuation”.

In brief, it refers to the habit of people haphazardly staking their future financial well-being on the thumb suck valuation technique involving the simple multiplication of two numbers, “because it worked for Alan”.

This video takes the onus away from the written word in explaining the process, and showing where it goes wrong.

Business values fail in a sort of diluted way in which actual business sales fail. The latter may suffer because of an insurmountable problem discovered in the due diligence, or something surfacing which does not fit in with the plans of the purchaser. The former, because of the probability of these factors causing sales to be compromised.

The business valuation is therefore an early warning system of where things need to be improved before taking the business to market, and a valuation should be conducted for each business on a regular basis – annually, if possible.