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

Posts Tagged ‘business valuation’

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.

 

 

 

Key value indicators

The value of a business is, to a large extent dependent on its numbers – sales, gross profit, profit, and derivatives of those elements business owners will be aware of.

Most owners know that the real value is related by way of some formulas using those numbers in conjunction with multipliers, discounts and limits. But what are the latter all about? How are they decided?

In the spirit of all things graphic, as one does in the 21st century – apparently:

This short video illustrates very simply why strong businesses and weak businesses have different multipliers.

 
In the near future I will get more specific as to what exactly makes those differences, and the mechanisms behind them.

Allergy to BEE stings?

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Keith Levenstein is about to tell us all about where the new BBBEE situation stands in his brief seminars, following the imposition of the new codes next week. At the time of writing this, Rob Davies was intent on imposing the new codes from 1 May. I have a slightly jaundiced view of BEE as a whole, notwithstanding the fact that something (meaningful) needs to be done to sort out the inequities of the past.

I guess I am just a bit tired of poor and indifferent service from people who have jobs because of their skin colour, and not because of their abilities. Indifference arises from the employees knowing that their numbers add to the employer’s score card first, and second; the employees knowledge that employers find it is a leap too far to dismiss the useless, care of the CCMA.

From front line call centre staff to sportsmen in the best teams. They know it and we know it. “Quota” is a four letter word. No really, it is.

There are unintended consequences to this social engineering. None of this is new, of course. When I left school, I was told I would never get a job unless I first got a degree because jobs were all reserved for Afikaners. Life was a lot worse for our black fellow citizens at the time.

Soon after leaving university, I decided that I was unemployable, anyway. Thank goodness for that self realisation as I struggled to create my own space without the luxury of a monthly pay cheque.

That is the thing about the future of South Africa. When the patronising dust has settled, the unintended consequences will simply perpetuate the inequalities of the past and present.

However, it is worth noting that in South Africa in 2015 there are many jobs which are considered very valuable, but falling into a few broad spectra:

  • Most public sector jobs seem to be regarded as “reward – without – work” jobs. But apart from those:
    • Consultants are becoming the life blood of the nation as cadre deployment relies on them to get the job done.
  • BEE has spawned a whole extra layer between those who are able, and those who can connect. Well if nothing else, it is a way of distributing wealth to the connected. We can only hope that some of it filters down to their respective communities. Personally, I have run out of puff, holding that breath.
  • A whole raft of very capable white people who are unable to find employment the various sectors which now place small print at the end of their job adverts: “Preference will be given to PDIs”. Those people become struggling business owners, sometimes employing those with less initiative, other than “always being able to find a job because I am black”.

That last group is going to perpetuate a problem. White people are unable to find jobs commensurate with their abilities. So they take their skills to the small business sector, where they scrape and starve for years, building up one man operations, perhaps with a few staff members in support. The thing with being made to struggle, is that if the struggle does not kill, it strengthens.

When the dust has finally settled, and the strong are left standing, the employers of the future will be the strong who had to fight for their crusts. The workers will be those who rely only on their melanin to get their daily bread. That is a great sadness for a country with so much talent being wasted while it receives handouts.

These “businesses” or “jobs” if you prefer are, in a normal society, difficult to sell. However, South Africa has been an abnormal society for as long as it has had any sort of society in the last 300 years. The current hogs at the trough have no interest in changing that. Much like the pigs before them, and all the previous artiodactylous rulers before them.

The thing with abnormal societies is that abnormal practices flourish. So when a self employed businessman arrives at the end of his career in this abnormal society, there is a ready stream of one man operators willing and desperate to buy themselves into that job. It is not the way it should be. But is the way it is. And it is a meaningful way for small business owners to exit with some accumulated value.

The thing is, while banks may not be interested in financing these acquisitions, the youngsters in question often have access to family funds by way of cash or security, to help put them into jobs which will one day be the employers of the weak sons and daughters of today’s ruling elite.

It’s very depressing for the country as a whole, but it offers a way out for those who need to move on to a new phase in their respective careers.

 


 


 


 

Statues must fall

Agreements are agreements. “But you agreed”. “Let’s look at the agreement”. “We have it in writing”.

Businesses are sold on a daily basis; here in South Africa and around the world. For the most part those agreements are reduced to writing, with much hither and thither to sort out and negotiate the small print. Eventually the bottom line is reduced to the seller worrying about receiving the money promised, and the purchaser being satisfied that he is not buying a lemon – the fruit of an elaborate scam.

Generally amongst much nervousness, the deal is done.

The early 90s were momentous years for South Africa. (Bear with me here, please) As negotiations progressed, demonstrations and lawlessness continued. Free trade sound bytes were born and done to death: “AK47 wielding gunmen”, “levelling the playing fields”, “nothing is set in stone”.

“Nothing is set in stone” has had special meaning for one of our clients recently. Some background:

  • Kiyosaki wrote about a business only being a business if it could run itself without the intervention of the owner
  • Gerber wrote about having a franchise type operations manual, so the business could be run without the owner
  • Carpenter wrote about the joy of systemising absolutely everything
  • Marrillow finally put them all together in a series of “Ted’s tips”.

The common theme for all these gurus is simply; if the business cannot be run without the owner, then it is at best a self employment vehicle.

With that in mind, and the establishment of another business, our client had made sure that the target business was going to be run by professionals. He had one of the best men in the industry working for him, and everything ran smoothly with little more than a brief weekly meeting to take the blood pressure, pulse and temperature of the operation.

Mindful of the fact that one day he may want to sell the business, he entered into an agreement with the general manager that should this ever occur, the GM would receive 20% of the proceeds of the sale. This was reduced to writing, and confirmed by the trustees of the holding trust. All set in stone, one might think.

Several years later, an opportunity arose to sell the business, and we were retained to help negotiate the deal. I initially met with the owner and the GM. As usual, the issues which we anticipated would materialise during the course of negotiations were aired. Chief amongst them was the question of managerial and specialist continuity, post deal. The GM was fully supportive of an exit for the owner, but was not interested in acquiring the business for himself.

And so on we went. Several interested parties, some investigations, and the expected fading of prospective buyers before the eventual buyer arrived at the negotiating table, with some serious intent.

Through that process the price was edged upwards in a few leaps until an amount was agreed. There followed a due diligence, followed by a clanger. The buyer had discovered a flaw in the accounting involving a single customer paying three years in advance, against which the business would have to deliver under the ownership of the buyer, with obvious profit implications. A straight forward, honest mistake, and a product of Ted’s Tip #5 in Built to Sell.

Quite agreeably, a new price was struck subject to the same requirements about the GM agreeing to stay on for at least a year… Which is where the wheels almost came off. The original price agreed had set in the mind of the GM, a 20% share quantum. It was this amount which he had taken to his family over Christmas. It became a fixation amount. So there was no chance that he was ever going to accept 20% of a lower amount. He dug his heels in.

“Mark, you need to understand that without me that business is worth nothing. Now either I get {fixation amount} or I walk.”

The seller was over a very uncomfortable barrel at that point. He had to either give up on his sale, or pay the difference to the GM. Of course we could have played a game of poker for a while, but generally at this sharp end of the game most sellers have had enough. So it proved to be. He paid significantly more than the originally anticipated 20% amount to the GM.

Interestingly, the new owners of the business were fully apprised of all these developments, and so they know what they are up against in the GM, going forward.

So while the undertaking from the shareholder of the company to the GM had been “set in stone” in the mind of the seller, in the final push the GM had no respect for this, and instead chose to insist on something outside the agreement which he knew he could achieve.

Where did our client go wrong? He had a single proxy for himself in the business, handling absolutely everything in his stead. That is almost as weak as a one man owner operation. One of the questions we ask in 0ur valuation of businesses, has to do with the cover of all key personnel, beyond the owner. It is better to be able to go away on holiday at will, leaving the company in the hands of “others”, rather than in the hands of “an other”.

So back to my early paragraph:

South Africa still has AK47 wielding gunmen. Disappointingly, it still has very much unlevel playing fields. While the Constitution of the Republic of South Africa may have come about as a result of a negotiated settlement, “nothing is cast in stone”. We have a president in Jacob Zuma who regularly espouses opinions and plans in direct contradiction of the constitution and the law. Sometimes he is beaten back by “clever blacks” and others. Not always.

Nothing is cast in stone. All statues can fall.

 

 

Get your taxes paid here

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The growing socio economic imperatives of South Africa in an environment of close to zero growth in the economy, means that without any windfalls such as even lower oil prices (currently at about $32 per barrel, and with less and less space to fall), or a huge rebound in the value of the Rand (unlikely while the ANC persists with Zuma), or some miracle; taxes will have to go up.

Big businesses take the view that taxes must be paid by their customers. It’s that simple. They need to give an expected return to their shareholders. Initially they will embark on much marketing noise about “absorbing the cost for the sake of the man in the street”, but eventually consumer prices will rise to give effect to the profits line. Joseph Stiglitz has a lot to say about this attitude, and it isn’t nice; but that’s another story.

Big businesses can indulge in this practice because their competitors all do the same thing, and because consumers expect inflation to happen, and therefore expect to see higher prices, given all the hot air in the media. There is simply no consumer push back. And how would they do that anyway?

Small businesses with a bit of oomph behind them, are also able to pass their tax costs onto their own customers. Business owners who have been around the block a few times, know that if they try to absorb the extra tax expense for their customers, they will eventually lose those customers when the business folds, anyway. They will cease to be tax payers themselves.

Businesses which have a competitive edge will be able to lead the way, and will have the edge in the profit race. Simply put, they can actually start to benefit from the tax increase ahead of their weaker competitors who are afraid of losing customers.

No prizes for guessing which sort of business is more valuable.

What is your business exposure to tax increases like?

Shedding some load

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I was asked to attend a meeting of creditors with respect to the Ellerines business rescue in early August. There were hundreds of very grim faced people there, although I don’t know who was an employee and who was a general creditor, and so on. Judging by some of the questions from the floor, there are some small business people creditors, for whom this is their major, and possibly only customer.

The meeting highlighted for me the exposure small businesses tend to have in not spreading their wings to a much wider base of customers, as difficult as it is to do so. Prospective buyers of businesses are likely to be limited to industry investors in such circumstances; competitors with similar problems, looking to grow and spread their own risk through acquisition.

Unfortunately, in such circumstances, selling prices are always low. The alternative to selling is to cling on for as long as possible, and hope you don’t lose that one really big customer.

Anyway, back to Ellerines, which is reportedly shedding 500 branches this month, in order to make itself a viable entity. That is 500 fewer branches through which suppliers can expect their goods to reach the consumer.

Just another reason for you to look carefully at how many different customers you have, and which of them may be vulnerable to either becoming insolvent or moving to another supplier of whatever it is you make or supply.