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

Posts Tagged ‘interest rates’

Interesting

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

– Johnny Carson


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

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

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

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

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

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

Economics 101:

Lower demand leads to lower prices

Higher supply leads to lower prices

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

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

 

 

 

Source of funds

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

  1. Investor funds
  2. accumulating profit

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

Enjoy the break if you’re getting one.

{So you think you have cash flow problems?}