Greed, fear and loss

There’s an interesting thing going around: It’s the promise of great riches for the investment of small riches, and when it does not work out, it’s your own fault. That in the proverbial nutshell, is the game plan.

So it works like this:

Step 1 – A competing INTERNATIONAL (often) MARKET LEADER (usually) and (certainly) LARGE company comes knocking, completely unsolicited with all sorts of flattering comments about your business, and a convincing pitch about acquiring that which pays you your salary.

That happens all the time, and is often a scam on its own. I have written about it many times previously.

Step 2 – Unrelated (I like to think, and really hope) a business broker approaches the business owner, or has approached the owner in the past. Oh, this broker will get you way more than that offered by the suitor company. Really?

Step 3 – Said business broker comes with a pedigree involving backing from Europe, USA or some other financially stable powerhouse of banking probity.

Step 4 – If the business owner should be selected as a client then there are some hurdles to be cleared. Nothing wrong in that; we all need to know that our clients are committed to the project. It is just the nature of the hook and the bait in this instance which is troubling.

Before I go on, let’s look at the numbers involved. You should also know that I have been approached separately from different parts of the country on three occasions in the last eight weeks, with very similar stories. Here is one.

  • The business turns over 70 million South African Rands (ZARs).
  • The owner has been offered 100 million ZARs by a suitor.

Then let’s look at some of the emotion involved

  • He has either approached a particular broker, or has in fact been approached by the same one.
  • The offered price is sniffed at because the broker will certainly introduce half a dozen other suitors, all willing to pay much more.
  • The business owner falls for this emotional bait. Hell, let’s face it; if 100 million ZARs can solve a few problems, where are we going with 200?
  • Then the sting: The broker charges a very small commission on the deal because he charges a sizeable administration fee up front. We are talking about hundreds of thousands of ZARs long before any work is conducted. But in the greater scheme of things, what is 300k as a percentage of 200 ZARMs? And then there are the easy repayment options.

So let’s consider something here:

  • First, I am not about to publish actual figures, mainly because I don’t know them. But I do have ball park figures which have been given to me
  • The net margin of any business is usually in the single digits. There are exceptions, but are usually based on incredible margins and very low overheads. None of those businesses which I have been asked to comment on, are of this variety.
  • So let’s be kind and assume the net margin is 20% (that’s big).
  • 20% of 70 ZARMs is R14,000,000. Look at your own business and decide how realistic this might be. But just for the sake of argument…
  • After tax, we are looking at a shade over 10 ZARMs.
  • The suitor is suggesting a purchase price of 100 ZARMs. That’s a price earning ratio (PE ratio) of 10.

Let’s be clear here. Nobody pays on a PE of 10 for a closely held, small, medium, or even reasonably large business. They don’t do so because there are many businesses which are sold for a helluva lot less.

But then the business owner is convinced that there are pressing fundamentals which make this business worth up to twice that! If he will only pay an enormous up front fee to make it happen.

Perhaps I am wrong, but I am willing to bet that in time to come the business owner will be accused of having provided some false information, and naturally that is why the alternative suitors will have never materialised.

Of course the admin fee will have been absorbed in finding these suitors. Who needs a commission anyway?

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