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

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?

Valuation Myths Value is based on turnover

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PYBFS012

“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.

Your IP

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How is your IP?

No really; how is your intellectual property? Is it safe? Have you secured it?

When a leading figure in a political dynasty running for the office of the most powerful man in the world neglects to look after his IP, we should all consider that we may have our own weaknesses.

Jeb Bush is the older brother of George W Bush, and the son of George H Bush, both former presidents of the USA. As is required and done, he registered an internet domain (www.jebbush.com). These things require periodic renewal payments.

You guessed it: Donald Trump spotted the ommision, bought the domain name, and now www.jebbush.com reroutes to www.donaldjtrump.com.

Not even in the movies…

So really; how is your IP? If that kind of kindergarten tomfoolery can happen in the pursuit of such power, what chance for us mere mortals?

 

Through their eyes: A different customer

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PYBFS011

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?

Friends, enemies and lovers

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One day your business and you will no longer be one.

How often do you talk to your partners in your business and personal life about the eventual exit plan you have?

You don’t have partners? Well I’m sure you do, actually. These can all be considered to be partners, in varying circumstances:

  • Fellow shareholders, directors, members
  • Senior employees, support professionals
  • Funders, suppliers, customers
  • Life partners, parents, children, siblings
  • Extended family members and heirs

So unless you’re a one man blogger living as a recluse in a mountain cabin selling hand carved sex toys online, you probably have partners in your endeavour.

You spend long hours talking about the strategy required to close deals, achieve the best return from your advertising, finding better channels to customers, improving production and delivery, and other necessary discussions. How much time do you dedicate to planning for your exit, or that of one of your partners?

That exit has a direct effect on the lives of the counter parties. Quite apart from the fairness side to the equation, those discussions allow the equity holders to GAIN value. The most successful negotiations I have been involved in over 25 years or so, involve annual involvement of the other partners.

“At some stage in the next 7 to 10 years I intend to retire. Let’s have a chat about what your continued role will be in this business after I have left. How are we going to make sure that you add value to the organisation, and therefore guarantee your position”.

“Look guys; one of you is going to have to buy my shares at some stage in the future”.

“Ladies and gentlemen, we are all involved in building a major asset in the nature of this business. Let’s do more than keep tabs on the performance of the organisation, and do whatever we can to maximise value each and every year for the next five, so that we get to exit with something really meaningful”.

“OK, we all know the country is in a difficult time in history, both politically and economically. What can we do to make sure that we don’t only come out the other side of this time, unscathed, but with a much more valuable company?”

There are hundreds of similar conversations to be had, at levels from the boardroom, down to the mom and pop brushing their teeth at night. Are you party to a similar discussion on a regular basis?

 

Sad realities

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So far this year I have come across three sad stories of exit plans going wrong.

And I am so sorry that the story is yet to be written, and that you have clicked here before it is ready for publication.

My emailer went out a full two days too early. Nobody’s fault except mine.

If you are on my email list you will get notification as soon as it is ready.

 

Through their eyes

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PYBFS011

 

Within the paradigm of always being ready; I as not!

The email link you have probably clicked on to get here was sent out in error. and way too early.

It will be ready in the next few days, and I will notify you again.

Sorry for the inconvenience.

{Note to self…. NEVER allow a newsletter to go out at 6am on a Monday again. What was I thinking?}

Oh wait… I was not thinking.

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!

 

Why would you sell your business anyway?

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PYBFS010

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

PYBFS009

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.