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

Posts Tagged ‘value’

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.

 

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.


Recouping values

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About ten years ago a bloke took me to tea. He wanted me to sell his business. He intended to cash in and get out. Get out of the country, that is. He had very definite plans, and had everything booked for six months hence. So this wasn’t going to be a long drawn out affair.

As we sat down, he took out a little scrap of paper – one of those sticky Postit things. On it, he had the most basic information from his balance sheet and income statement. It turned out that he did not want to alarm his book keeper, so he avoided making a copy of the audited financials with her around. Instead he just made some notes and left the document back in her tray, or something like that.

Anyway… Over tea he proceeded to tell me that he would be happy to just get his net asset value. As I remember it, that was about R3M. I looked at his key indicators, and agreed to prepare a mandate based on that price. In the meantime, would he please get me copies of the last few years’ audited financials, and his management accounts.

I went away and prepared the mandate. He waited for his book keeper to go home, then quickly made copies for me to take when he signed the mandate. He is a good friend of mine in another country now, and we laugh about the turn of events. We also do things a little differently today, but that night I went and sat with his financials. There was no way the business would get only its NAV, or if we aimed for that, it would be a very quick sale. It had issues about it, which made it far more valuable. And so I went for it. He was a bit worried at first because he did not want any delays, but after a week or so he saw what I was up to, and why.

At one time during the process he went overseas for a week, while I continued to work on the various buyers we had interested. There were many of them. when he came back, I had prepared term sheets for three offers to be negotiated. We spent the next few weeks negotiating with each one in turn, trying not to act like used car salesmen (sorry Jacques!). I think we made quite a good team putting the deal to bed. We finally sold the business for almost twice the NAV. There were foreign exchange issues at the time, and suddenly he had more money available than what he was allowed to take out of the country. What a nice problem to have.

How would my friend have planned his life, if he had an accurate view of what the business was worth, earlier?

It works the other way as well, unfortunately. People believe that their businesses are worth more than what they are. Then when the retirement bus pulls up, they are left floundering and unable to reconcile their lot to reality. It is very sad. A few tweaks a few years earlier, with an accurate valuation and critique, may have made all the difference.

Then there’s the guy who tells me that his accountant says the business “owes him R3M”. The accountant knows full well that his client will never get the money, but this is the easiest way of getting him out of his office without committing to a value. So the poor guy wastes months of energy trying to sell something which will never sell at that price. We see that quite often. We are referred to many accountants’ clients to give them accurate market related valuations. No nonsense stuff. Sometimes it is very difficult. But there is really no point in not knowing where you are, when you are trying to go somewhere in particular.

Yesterday I sat with a seller and a buyer. The buyer is also aiming to sell his business, but has started the process of looking for a replacement business, He likes what he sees. So the seller tells her story, and then comes to the bit which made me sink lower into my seat. “And then Mark did a valuation, and told me I would never get that for my business. I needed someone to be honest with me, because now I’m making real progress”.

“Oh,” says the buyer. “He’s just started doing a valuation on my business”. They laugh uneasily. I try to look professional, squirming only a little bit.

“Good luck to you”, she says with a twinkle in her eye.

He’ll be all right. He has a nice business, and realistic expectations.