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

Posts Tagged ‘Business value’

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?

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.

 


 


 


 

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.

 

BEE and value

More and more, as we conduct valuations of businesses, we see this line item in the expenses: “Donations”. It has taken on a new meaning in our heavily BBBEE influenced way of doing business; it has become a way of easily buying some points towards becoming socially, politically and economically acceptable.

If a business services or sells to a large corporation, or one which in turn supplies a large corporation, this becomes more and more important. You’ll know if you fit into that group by whether or not someone up the food chain has called to ask about your BBBEE scorecard.

We have effectively changed an entrance fee to heaven, to something which is a charity event with a reward on this planet, now. The reward comes by way of being allowed to do business with “the club”.

So how do we treat this line item in a valuation of a business? In years gone by, a buyer would look at it as a possible addition to his own profitability, and calculate value accordingly. After all, it was almost certain that he was not going to sponsor the same mini league soccer side, or the same church as the seller. It was never anything to do with the furtherance of the business.

Now however, that line item has become more of a cost of doing business, dependant of course on whom one wishes to do business with. It is not a charity item which should be automatically taken as an extra profit item by a buyer. Your eventual buyer is looking for the best deal for himself, and he will test all these items very carefully. He will also want to keep your scorecard in place, and so will not tinker with the way you have made it work for you.

Cynically, the benefits the recipients of BEE hand outs are receiving, are the proceeds of a cruel investment their ancestors contributed to by being subjected to 300 years of brutal treatment. BEE in its various forms has had grotesque benefits for a few, and somewhat more humble benefits for some more. In many respects it has had very little, if any, benefit to the majority, and as suggested by the Institute of Race Relations, may have even damaged the prospects of a better life for us all.

  • One thing which is certain; if it works for you to get more business in, then it is a cost of doing business and adds to the value of your business.
  • Another thing which is probable; if you make donations because you are good guy, and not because you have to, then you will benefit when it comes time to sell your business because a buyer will be prepared to add that back to your bottom line, and therefore to the selling price in some way.

Make it work for you. Make sure you know why.

You will have to prove your numbers, and you cannot expect that a buyer will do you any favours in this respect. Getting things in order now, and getting into the habit of keeping them in order will add a few years’ resources to your retirement fund, at a relatively small investment. Understanding why you contribute those “donations” is part of the process.


Middle management cripples

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Last week I sat with a client helping him to assess the value of his business. His is a very smart retail operation. Successful retail stores go into the valuation process a few yards ahead of their similarly profitable manufacturing and wholesaler cousins because their risk associated with customers is hugely spread. In a popular shopping centre they are pretty much guaranteed a wide variety of clientele. All the better if the retailer is also part of a successful franchise group.

Retail customers are less worried about the socially engineered aspects of our society like skin colour of the owners and management, and more worried about the reality of quality, service and price. Mess with any of those definitives and the business has a problem which is soon seen in the income statement, and ultimately the core business value.

The downside of the retail trade is in the big suppliers; banks, landlords and franchisor masters. The typical new franchisee sees herself as stepping out into the world of entrepreneurship. Nothing can be further from the truth. Frankly, franchisors do not see their new franchisees as entrepreneurs. At best, the owner franchisee can hope to become a variation of the middle management level in a larger organisation similar to that from which she recently exited. The abuse is no less severe, except that there is no simple resignation, no CCMA dispute procedure and no early retirement. Once you’re in, it’s going to be for a while.

Abuse? Yip. “These are the rules, and they will be policed by mystery, faceless shoppers and the more overt local representatives”. Penalties are related in one way or another to the bottom line. And therefore the value of the business.

“The store will be revamped every three to five years, in line with latest marketing concept, and this revamp is for your account.”

The landlord presents quite another problem: He has a shopping centre to run, and expects to turn a profit. He knows that he has the franchisee locked in. So while there was a status quo which sold to the new franchisee and tenant five years ago, it becomes something of a movable feast. When it becomes obvious that charging for parking is a great way of gearing one’s investment in the property; well why the hell not? The South African consumer has proven himself extremely accepting of all sorts of salami takings from his disposable income. so charge for that parking!

With investment made in parking bays, ticket billing and the rest, more money can be made by getting them to work for longer. An empty parking bay at midnight is fairly useless, but a full one at 8pm is great. So let’s force shops to remain open to 9pm. The landlord makes more money from a few more parked cars for a few more hours, at very little extra cost. But not many people want their hair done at dinner time, nor do people generally want to have a dinner with their family at a coffee shop. But these guys have to stay open, pay staff, run up unproductive electricity bills on unwelcomed air conditioners, display lighting, music, televisions and so on.

For the small franchise owner, well she probably got into this mess by putting the family home on the line on day 1. In the five years since, that loan has been serviced and reduced, the interest having been a major expense. With that light of value gain and much reduced loan repayment fast growing at the end of the tunnel, she gets an unwelcome wakeup call:

While all other business types have been careful to sit on their profits over the last five years, cautious in the continued uncertainty of what the economy holds for us, the landlord, the franchisor and the bank need to generate cash.

The franchisor exercises his insistence on having the store refurbished. This will almost certainly be an expensive exercise. Probably in the region of R500,000. That is serious dosh for the franchisee. She knows she can access it with the renewed security of her home, but heck, what does this franchisor ever do for her anyway? The opportunities in defranchising suddenly beckon with a glint in the eye and a crooked smile.

So off to the landlord she gaily trips. The lease is up for renewal anyway, and the franchisor had nothing to do with negotiating the lease apart from finding the space.

“Absolutely no way”, says the landlord. “We want a franchise coffee shop in that space. If you defranchise, we will not renew your lease”.

Without a lease, any retail operation has no business worth anything at all .

So options and the future suddenly look bleak. If she parts company with the franchisor, the landlord cuts her off at the knees, and she loses the lot. To raise the required funds for the refurbishment means tying up her house for another five years. The franchisor is secure, the landlord is secure. The bank will be secure. She will work. Perhaps she can delay bringing in that new manager who would have allowed her some spare time…

Wait… What if she sells? Surely this place is worth something by now. Then she can buy a real business with the proceeds of the sale. But here too, are issues.

The broker who sells the business is going to be charging a commission for the job. Of course it’s possible to sell without an agent, although that often results in a below par price. Further to that, the franchise agreement revolves around two other ambush items: The franchisor has to approve the new sucker, and will charge what is called “key money” to him.

Then there is the continued question of that refurbishment. This still has to happen. So here’s the thing: Any buyer with any advice will have an idea of what the business is worth, and this value includes all costs of entry. So that R500,000 is in the value, and so is the key money. The buyer will look for a return on his entire investment.

While independent businesses are able to keep their powder dry, and decide when they intend to pay for new signs and livery, she has to pay for the flipping refurbishment, no matter which way she slices this cake.

Talk about being trapped in a job!

The reliance on suppliers this franchisee has, as a retail operation generally, and a franchise operation in particular is a crippling one. And this ladies and gentlemen, is a fairly typical story in the retail franchise game. When you line up to buy one, the best and greatest in the group will be wheeled out for you to oggle over – the top ten percent – because that is who you want to be compared against.

Corporate SMEs

One of the biggest hindrances in selling a business is the ill preparation of documents, often coupled with exorbitant asking prices. This is most often the case at the lower end of the market, or in instances where there simply is no data available because the business has not been around long enough to generate any.

This latter instance is most often the case where someone has started a venture and seen within months that it is not going to work. Instead of liquidating, he tries to pass the bad deal on to someone else to recover some of his investment. He also hopes I suppose, to find a sucker to take over the three year lease which he has signed, and given up a personal surety-ship for! But that’s another story.

I was recently approached to give a valuation opinion on a business being targeted by an old client of mine. I suppose it is unfair to say that it was being actively targeted as such, because the target’s owner had really solicited the suggested sale with my client. After the usual non disclosure niceties were complied with from our side, we were sent a spreadsheet showing last year’s performance, and what I thought looked like an optimistic projection for the next five years.

There is nothing different here from lots of attempted sales we see in the example I mentioned in the first paragraph: Simple spreadsheet, optimistic reassurances for the future, and an asking price based on the future projections. The difference I suppose, apart from the asking price being in the tens of millions, was that the seller happens to be a listed company on the JSE!

At first there were no audited financials available. Reading through the email thread when the financials were eventually sent to me, it is clear that there was a concerted effort made by my client to get the financials out of the seller, which was complied with only on the eve of the deadline for the tender of offers from interested parties.

What did the financials show?

  • The business being sold is technically insolvent.
  • The business has only one customer –  the seller!
  • Key expenses have been left out of the spreadsheet.
  • The sales turnover has been slipping year after year.
  • And a whole lot of other nonsense.

In the SME market, all buyers would head for the hills on this one. In the corporate market we expect better behaviour. Do we get it? You decide.