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

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Pitch Deck 02 Suppliers

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Risky business The ultimate sale of your business is a risky thing for that business. Sellers either realise this and react accordingly, or they give it no thought at all and blunder into a mass dissemination of previously guarded intellectual property – a course which will damage the business in the future, for whoever owns it.

You need to be wary of how you present the information given to potential buyers, some of whom are not as honest as we would like them to be. Consider two different businesses:

  • The owner of a small supermarket on the one hand, with his very wide range of suppliers, all well known in the market place; and on the other hand
  • A niche manufacturer of specialized components to the mine drilling fraternity who purchases wear components to fit to his patented head.

The sensitivity of the latter is much higher. In a meeting with the former, and the owner of another supermarket who is looking to invest in other ventures, the conversation might sound like this: “Do you buy direct from Liger Brands, or do you go through the DC? When you deal with Liger, you should ask to speak to the new guy Louis – much more helpful than Joe.”

The niche manufacturer will be far more guarded in even telling the prospect that he imports his components from China, let alone the name of the supplier. These details are more likely to come out through a due diligence process after the deal is signed.

Open up and die

An example: We were involved in the sale of a motorcycle parts wholesaler which had run into cash flow problems associated with rapid growth and a depreciating currency. (At one time they were selling older inventory at the same price as the new replacement goods were costing them – how’s that for a business model? But that’s another story.) The business had sole agencies for a number of lines, and  general agencies for others. They had prepared tables of information on gross margins, sales trends and flow through profits. The prospective purchasers were appreciative, and through the process there was a short tussle between two buyers to become the new shareholder of the business. Eventually it was sold to the higher bidder.

But midway through the process a very well established motorcycle wholesaler entered the fray. The so called “ideal purchaser”. This was very exciting for our client. Then I calmed the waters by asking if it would be usual to supply this information to other competitors. Would it be okay for us to tell Biglad Biker Bloke (BBB) what the margins were on a product we supplied to them; but more than that, to tell them what our sales on that product had been for the past three years? Well of course not. Imagine how upset would another prospect be once the sale had gone through, and he discovers that BBB has had access to the same data he had, and is now using it to force prices down.

Would you normally supply market sensitive data to a competitor?

The situation resolved itself when BBB told us that they were only interested in some of the brands (the most profitable, no doubt) and would be retrenching all the staff in the transfer.  That was the end of that negotiation. More on this in a later instalment.

Non disclosure agreement (NDA)

An important question: If the prospective purchaser picks up the telephone and calls your supplier; how much damage will be done when the supplier discovers your business is for sale? This is an issue which needs to be dealt with by the M&A practitioner guiding you in the sale of your business, and should be dealt with in the non disclosure agreement signed by prospective purchasers prior to even the name of your business being supplied.

In the meantime, the advice here is to limit your output of supplier information in your Pitch Deck to fairly innocuous generic information to start with. Wait until you have a better idea of who you are dealing with, and what their intentions are. A lot of this information can be provided in subsequent handouts, and even as a generic “promise” to be proven with the due diligence.

Failing to plan? Planning to fail?

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Brian Tracy said “ Failing to plan means planning to fail”
In the mad rush to increase turnover in the run up to a sale, the very essence of the business is often ignored – its raison d’etre: The bottom line and the sustainability thereof.

The formula seems simple: Raise the sales, cut the expenses any way you can, show a magnificent profit; sell to some greedy purchaser.
Unfortunately it is not this simple for a number of reasons.

  • Good quality business buyers and investors always make their agreements of sale subject to a suspensive condition of sale (or condition precedent) in which they require to be satisfied as to the state of the financials as well as satisfactory answers to a lengthy due diligence questionnaire which they will have formulated over several years. During this process they will look for sustainability.
  • Businesses do not always sell quickly. In fact very often they take a long time to be sold, and during that period they will need to be sustained themselves, for themselves. There is no clause which allows a business to deteriorate during the due diligence and financing phases but which still locks in the purchaser. (Well I suppose there is, but you’ll struggle to get a buyer to sign it.)
  • Businesses need to grow, but at the same time remain sustainable and fundable. Uncontrolled growth sucks up cash flow better than any super sopper mopper you have ever seen. With an impending sale looming, quick last minute growth will sound the death knell for most sellers.

As with so many things of any value in life, businesses need to grow in value in a well structured and planned way which takes time and patience, and they need to have the following elements in place:

  • Sales, margins and profits
  • Infrastructure
  • Intellectual property
  • Sustainability
  • Balance sheet

Sacrificing margin to grow sales helps nobody but the psychologists. Raising sales through good marketing efforts while maintaining margin is great. Great that is, as long as your infrastructure is in place to sustain the delivery to customers. But very often, the infrastructure spend bites into the profit line. Worse than that, spending on more staff and the delegation of responsibilities can also bite into the intellectual property of a business, and where the barrier to entry is very low, even bigger problems can arise.

Strangling a business through ensuring sustainability without pushing the risks a bit will ensure that you have a boring stagnating venture that you wish to sell, if only to stop the boredom.

Planning makes the difference.

Just as planning for the sale of a business will make an enormous difference to your life when the sale happens, so planning the growth of the business beyond just adding sales to the top line will allow the business to grow in a controlled manner rather than in fits and starts of feast followed by cash flow crisis. Your added sales may bolster your cash flow initially, but where will your inventory come from, and who will finance it, pack it and ship it? Who will provide the extra after sales service and explain to the greater number of customers how the widgets work? How will you collect the money, account for it and bank it? And how will you survive in the meantime?

Working through bottle necks in advance will not only save you a lot of grey hair, but will also add value to the business long before you have to, or want to sell it. Of course the added benefit is that you get to enjoy stronger cash flows while you still own the business.

Valuation Myths Value is based on turnover

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“Turnover is vanity, profit is sanity and cash flow is reality.” We’ve all heard it said, but a huge number of people have never taken it in, thought it through or understood it.

From time to time we will do some marketing to get some fresh blood into the network; and as the phone starts to ring, we are quick to recognize the “buyers” who have no real understanding as they ask: “What is the turnover?”

You see it does not matter, as a general rule. Of course there are exceptions like petrol stations and supermarkets, both of which work under a fairly standard set of parameters, understood intimately by their operators.

But when it comes to most businesses which battle from day to day to maximise their sales, while buying in their stock as low as possible, and minimizing their expenses, turnover is limited in relevance to calculating the VAT and commissions, and setting records to be graphed on a wall in the owner’s office, usually behind the door.

When it comes to valuing a business, turnover has no importance at all, except to point us in a direction of the business’s growth, and even this can be misleading. When we value a business, our model draws lots of graphs to identify the places that managers of businesses may be going wrong, and one of the anomalies we often see is a sudden rise in turnover coinciding with a fall in gross profit percentage. The inference to be drawn is that the business owner is “purchasing” sales turnover in order to impress someone, usually a hoped for purchaser of the business.

If things are well planned and fixed expenses are rationalised, this may lead to greater profits, but more often than not, the “sale month” leads to lower profits, and the result is exactly opposite to what was intended: Value falls.

Here is the simple calculation:

Two businesses in different cities, manufacturing the same goods with the same turnover and similar expenses, but one has lower cost of sales because it is closer to its principal suppliers.  It has an immediate advantage with stronger cash flows, and after paying the same expenses as its counter part, ends up with more profit.

Given the opportunity and inclination to buy either business, which one would an investor choose? Well the more profitable one of course. And if there were several investors in the same room, there would be a bidding war, and the price would go up, as the less profitable business is ignored.

Does that make sense? Of course it does. Now stop asking about turnover in valuing your business, and concentrate on the net profit and the benefit you really get out of the business as the owner.

Through their eyes: A different customer

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It is amazing how many sellers approach the sale of their businesses with a dogmatic, arrogant attitude of “take it or leave it.” The basis for the asking price is, too often, the amount required to fund the next stage of the seller’s life; be it retirement, another business or an investment target. Their business valuation is not based on market requirements, but on their own ideal outcomes. They entertain very little discussion and only a single position as a target.

I’m not suggesting that you should change your offering for every prospective purchaser that looks at your business, because this will drive you mad. But you should give some thought to who your likely buyer is, and what they will want to see in the investment.

In Daniel Priesley’s book Key Person of Influence, he writes at the beginning of chapter 2:

“Across all industries, the top opportunities go directly to a small group who present themselves as Key People of Influence in that field. The rest of those in the industry are left to fight over the opportunities that the KPIs turn down. It might sound unfair, but that’s how it is.”

In the book, Priestley’s message is all about being a key person of influence (KPI) in an industry, community, or environment. Something similar may be applied to the disposal of a business, if I might paraphrase Priestley: When a business is “on the shelf ready for sale” the top investment decision goes directly to those businesses which present themselves better than the others”.

If you read Priestley’s book, you will notice that I have borrowed some more from the same chapter:

You need to Productise your business. Beyond your business supplying products and services, it needs to become a product itself. It needs to become an ecosystem for a collection of products or services. You probably have stage 1 in this goal already, which is why you have a business to sell. A successful exit from the business at above average value involves the former suggestion – making the business something more than the rest in terms of PrepareYourBusinnessForSale™: The top opportunities go to those who present themselves best.

It makes sense as an eventual business seller, that you should start thinking about providing a buyer with what he wants. And what the buyer of any business wants is profits and cash flow, presented in a manner which will withstand the rigors of due diligence.

Until you learn to see the business through the eyes of a potential buyer, you will be hard pressed to sell it effectively, and yes, I know that it is not necessarily your intention to sell it right now, but that intention may change suddenly, beyond your control – remember?

Look at this way: If you were buying your business, what would your concerns be, and how can you best deal with these concerns today, knowing what you do about your business, without having your back to the wall in a “must sell” situation?

Why would you sell your business anyway?

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This is the tenth instalment in the series, and I thought it might be an idea to take stock of where we are now, and ask the question: “Why sell your business anyway?”

I think that’s a pertinent question, and one which should be answered by every potential seller of a business. It is certainly a question which is asked by every purchaser. The thing is, you know exactly how your business works; you know about the cash flow of your customers, you know how they pay, and you may even know them personally. Add to that: you know your product or service intimately, and by leaving the industry you will have to venture into the great unknown, to learn about new customers, cash flow in different circumstances, how far you can push new suppliers, and you may even have to learn a new skill.

So why does the typical seller want to sell her business? Does it really matter? Well no, in the final analysis, it doesn’t matter; but at the beginning of the process it matters hugely to the buyer. He needs to be sure he isn’t having the wool pulled over his eyes, and that there isn’t a long and dark tunnel about to open up in front of him. An ice breaker in the initial investigation is “so why are you selling?”

What’s wrong with simply selling for profit? Of course there’s nothing wrong with that, but unfortunately it doesn’t instill great confidence in any buyer, and so sellers find all sorts of “reasons for the sale”.

Consider whether or not your motivation in selling the business is honorable. This is a matter for your conscience at this stage. Bear in mind though; dishonorable and fraudulent reasons for sales have a habit of biting sellers in the backside at a time which least suits them. Yes, they get a clump of money up front, but ultimately they end up scrambling for other sources of funds later in defense of their subterfuge. A sort of short term gains for long term losses scenario.

Part of my motivation in persuading people to embark on this long term program of PrepareYourBusinessForSale is to attract and keep business people with a long term business goal in mind, rather than those who are desperate to transform a personal cash flow crisis into a fire sale of their businesses.

A very telling answer can often be elicited from a seller by asking the question “What will you do after the sale?” Sometimes the answer is weighed up carefully by a buyer in combination with other answers.

Let’s leave the finer nuances of selling strategies to another day for now, and instead consider the question in a straight forward way. If you are selling for any other reason that retirement, ill health or death:

  • Do you have another income producing activity to get yourself into?
  • Will you make so much money out of the sale of your business that you will never have to work again?
  • Have you forgotten the heartache and sleepless nights you went through, learning the ropes of this business in the first place?

On many occasions I have advised prospective sellers to hang on to their little money spinners. Of course I am seldom listened to, which I guess is just as well, as I’m in the business of helping business owners to sell their businesses.

More often than anybody would like, I am asked to sell a business which needs to be sold today, rather than tomorrow because of some personal calamity like serious illness or death. In those circumstances, the sale of the properly prepared business can yield enough to make a sick owner more comfortable, or a widow self sufficient. And it is those instances which prompted me to prepare and present this course.

A properly prepared business on the market sells efficiently and for a good price. A poorly prepared business on the market is on a hiding to nothing. You are here for the efficiency, I know

Please never forget this: Something awful may happen to you, rendering you incapable of either running your business or selling it. Your heirs, survivors or dependents may need to sell the business for you or your estate; and without your input, just how complicated is that going to be? And how much simpler would it be if you prepare your Pitchdeck diligently. (You thought I was going to say “prepare your business for sale”, didn’t you?

So please go back to the last instalment and consider the questions asked around preparing that Pitchdeck, and look back through the earlier instalments, get out your “Prepare Your Business For Sale” file and make sure you have covered the requirements properly. Scan paper documents reducing them to digital equivalents able to be transmitted around the world, and store them in your “PYBFS” folder on your desk top.

Pitch Deck 01

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Background

Sometimes known by other names such as the “executive summary”, the pitch deck as we shall call it, is the first real contact that your prospective purchaser is going to have with your business, apart from the somewhat frivolous “business nets R1000’s per month, asking the bargain basement price of RMillions. Please call Frank…” advertisement that you may place in the local classifieds.

Your pitch deck is a document which will lay out the basics of the business, and show what you are able to offer the purchaser. The aim of the pitch deck is to give your prospect enough information to make a decision as to whether or not she wants to move to second base, and come visit you at your place. At the same time you do not want to give away so much information that you find yourself with an extra competitor, or worse, with an existing competitor with more information than he had before.

So we won’t be giving away any strategic information that will compromise us later, and will leave us regretting our honesty and forthrightness. We want to leave her with the need to know more about something she wants, and if she wants to see ours, she’s going to have to shows us hers first, so to say.

Apart from ultimately using the pitch deck as stage one in eventually selling your business, there are other usefulnesses which should not be ignored.

As we continue through this series, your pitch deck will unfold as I ask you to answer the sorts of questions which buyers will ask. Some of these questions may stretch you a bit, but may open your eyes to various aspects of your business. Obviously that will help you to evaluate your business and its value to both yourself and a prospective purchaser.

Through that exercise, it will also help you to identify areas which can be improved with a little effort, and understand areas that will be targeted by a quality buyer. It will give you an idea of what goes through a buyer’s mind as she evaluates your business. The pitch deck is the one document that will not only capture your purchaser’s interest, but will actually sell your business for you. More than that though, your pitch deck can become the basis for an operations manual, which we will learn more of later. For the time being, I want you to give some thought as to how you would describe your business.

Start by expanding on the type of business you are selling. Remember that this paragraph is the very first interaction which your prospective purchaser will be having with your business, and for some business – prospect combinations this start can kill the deal for you. It is one thing to say “pizza takeaway”; we all understand that. But perhaps you run an engineering shop. Most prospective buyers will not understand “plant automation, simulation, optimisation and information systems”. But then this type of business will be aimed at those that do understand, and are not looking at any type of takeaway, anyway. So consider your opening very carefully, to be aimed at your target market.

  • How long has the business been running?
  • How long has the present owner been in control?
  • What is the owner’s background?
  • Is it important that the new owner has a similar background?

Give a brief idea of how the business is run on a daily basis, by the owner and by the management, and describe the level of interaction between owner and management. This is very important. Many years ago we were selling a bakery which to our thinking was a brilliant deal. Very little response was received when we targeted our database of buyers. That was both surprising and disappointing. However, once we amended the report to show that the owner left the bakery to be run by management until 11am in the morning, we were swamped with interest. Potential buyers had seen “bakery” and assumed “opens at 4am”.

Describe the products and services of the business. In particular, if the business has some type of proprietary machinery, process, service or product; scream about it. Many buyers are looking to be involved in something different to the mundane.

Compliance

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The biggest fear of any purchaser of a business is that she is going to be swindled in the deal. As Peter Carruthers is so fond of saying: “When a man with experience meets a man with money, the man with experience gets the money, and the man who had the money ends up with experience.” Or words to that effect anyway. If you have been in business for any length of time, you will know what that observation means. If you don’t understand, be careful because chances are that you will gain that experience in the future!

So how do we put the prospective purchaser’s mind at rest? The starting point is a single word: Compliance.

As a prospective purchaser of a business once said to me: “If this guy is brave enough to take on SARS by not declaring his business truthfully, and if he steals the VAT paid by his customers and does not pay it across, why would he think twice about defrauding me?” I don’t think that I could have put it any better than that.

There is a myriad of compliance issues that can be examined, and which we will delve into as this series unfolds, but for now I want to deal with four important areas.

Tax returns need to be submitted, we know. And taxes need to be paid, and “strangely” this has become one of the most complied with issues in the last decade and more. SARS wields a big stick, which has made a difference. However, there are still taxes dodgers out there, and without fail these guys battle to sell their businesses at a fair price. The reason for this is that buyers know that the most reliable source of reported figures is those supplied to SARS, simply because they are unlikely to be inflated. By the same token, properly prepared financial statements submitted yield higher values than management accounts, and much higher values than spreadsheet projections.

VAT returns must be on file, and less importantly, VAT receipts. Returns report your turnover, while receipts merely provide the amount that was paid over, and can vary immensely in their relevance from one business to another.

Staff details are usually on file together with the related contracts. Most businesses have little trouble dealing with this, simply because staff members themselves insist on compliance, nagging for their contracts until they are produced and signed! Make sure that you have accurate records of addresses and ID numbers and particularly leave details. When the transfer of your business happens, you will need to know how much leave is outstanding to each of your employees. So take your existing leave schedule, make sure that ID numbers, addresses and wages are included for each employee, and put this into your Prepare Your Business For Sale file and make a pdf copy for your desktop PYBFS folder.

Perhaps the biggest culprit of noncompliance which often becomes a hindrance to transferring a business is the asset register. Even though the maintenance of this register is a legislated requirement, many, many businesses flout this requirement, and thereby commit an offence. But not only do they commit an offence, they also bog down the sale of their businesses unnecessarily. Purchasers of businesses want to know what they are buying, for goodness sake! That’s not unfair, is it?

Something we are going to learn in this series, and hammer it home, time after time is the simple fact that when you sell a business, that business competes with all the other businesses out there that are on sale at the time. So give the purchaser what she wants!

Get your asset register up to date, and put it into your Prepare Your Business For Sale file.

VAT Returns

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Although not absolutely definitive, as will be shown later, sales turnover is amongst the foremost in many potential buyers’ minds when they first look at your business. Proving that turnover is so simple if you are properly prepared.

The next addition to your Prepare Your Business For Sale file is a collection of your VAT returns. Go back as far as possible, and from now on, you should add a copy of your VAT return every time you submit it to SARS. That’s an easy maintenance effort. Simply make an extra copy of the return, punch it and put into the file. At the same time, scan the return and place a copy in the PYBFS folder on your desktop.
If you are on e-filing, this is a simple exercise as you can print the return to “pdf”, and save it in your folder.

Why the VAT return? If your financials are unaudited, looking at the VAT returns is the simplest way of verifying your turnover. After all, you have to be psychotic to inflate your turnover to the VAT man. So the prospective purchaser has a source document that he can trust.

If your business is big enough to require an audit with the associated audited financial statements, this is still a good exercise because it will help a purchaser to understand turnover trends. Perhaps a difficult purchaser has been prepped to always ask for the VAT returns. Now you won’t have to argue – just hand them over. You may also want to take your purchaser along one step at a time, in which case you prove your turnover to him with VAT returns, before releasing your more information-heavy financials to him once you are more comfortable with him.

Why VAT returns and not VAT receipts? Well yes I know receipts are easier to find because they were sent to you, but they don’t have the turnover of the business registered on them. Always make a copy of the return when you complete it, and file it.
Not registered for VAT? Think that one through very carefully. The sale of your business may very well tip your turnover through the threshold. That will cause your selling price to be subject to VAT at 14%, and not the 0% which would otherwise be levied. If this is the case, you will be forced to sell your shares of the company, or your membership interest of the close corporation, instead of selling the business out of the company as an asset, with all the associated risks if you have not prepared things properly. More about this later.

Set up & Maintenance 2

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Previously you put together an empty lever arch file with file dividers, and created a folder on the desk top of your computer called PYBFS. Doing that was laid out in the last issue of Prepare Your Business For Sale.

If you haven’t done so already, don’t worry. You are no worse off than 89% of your fellow small business owners. They also have not done anything about preparing their businesses for sale, and when the time comes, their businesses will also languish with the rest of the unprepared, battling to sell, also ran unsold, alongside yours!

So what are we going to put into this file? Well, let’s start off with the things you already have at hand (or should have).

Get copies of all your financial statements that you have, punch them neatly, and put them into the file behind a file divider labeled “Financial Statements”. So obvious, isn’t it? I think you’ll find that most of this series is “so obvious”, but I am always stunned that so many business owners have to revert to their accountants to get more than the most recent financials. And even those have already gone missing.

Now, I know I said “…all your financial statements that you have”, but you may have to do a bit better than that. So get hold of your accountant, and ask her for all of your financials. Go back as far as possible. Put them into the file in chronological order.

Most accountants now provide their clients with their financials in a “pdf” format. If this is the case, save a copy of each year in your PYBFS folder on your desk top. Rename them “Financials 2014”, “Financials 2013”, etc. Make sure that the “2014” refers to the fact that the end of your financial year was in Feb, Mar, Aug (or whatever) of 2014. Don’t complicate things by getting into the “Financials Mar 2013 to Feb 2014” naming structure. Sometime people will use “Financials 20140228” to be more exact. That’s also okay.

So that was fairly painless wasn’t it? Well, here’s a stunning fact: You are now better off than about 47% of the businesses being brought to market.

Mind blowing, isn’t it? But not untrue. As I write this, during this last week I have spoken to a dozen people wanting to start the process of selling their businesses by having a valuation of their business done. Seven of them will come back to me once they have their financials from their accountants. Three of those probably won’t come back to me at all because they will never get the financials sorted out. Please don’t be one of them.

Set up and maintenance 1

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A long time ago, a very successful factory owner with a wonderful product told me that the secret to his success was not attributable so much to his product as to his record keeping and accounting.

So before we move on to the rest of the Prepare Your Business For Sale series, I want you to find yourself a good quality lever arch type file, a new pack of file dividers, and a safe place to keep it.

Once you have that physically in place, you should create a new folder on your computer’s desk top. Call it “PYBFS”, and password protect it.

Consider your lever arch file and where you intend to keep it. You need a balance between security and safety, and ease of access. Call it something appropriate, so that in the event of you not being available to hand it to a suitable business transfer intermediary, it will be identified!

“Security and safety” because some fairly confidential information is going to go into that file, and depending on your circumstances, you may want to give no hint to staff that you are preparing your business for sale. It is possible that they will take it the wrong way. After all, how are they to know that you are preparing for a possible event, and not an imminent one? At the same time, you want this file in a place where you have ready access to it, are reminded to update it every month, but most importantly where your loved ones will find it in the event of an unfortunate event.

With regard to the folder on the desk top, let your spouse / partner / significant other / someone… know that it is there, and tell them what the password is! You may want to consider making it a shared folder in Dropbox, GoogleDrive, Box, OneDrive or whatever your level 1 backup system is. You don’t have one? We should talk!

In addition, have access details for both your lever arch file and your computer folder placed in your will…. Ouch! That struck a note, didn’t it?

Well contrary to your current mindset, you are not immortal, even the more so for the fact that you feel that an annual medical checkup is not necessary.

Next we’ll look at what we’re going to put into the file and folder.