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BUSINESS VALUATION

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

What’s my business worth?

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Are you asking about business valuation or business pricing?

Price is not always value. Sometimes it will be. They are usually different numbers. The degree of difference will change with circumstances. Sometimes the degree of difference will be small. Often it is very large.

Here’s what I mean:

  • You buy an asset for its ability to improve your life. If buying your daughter a car will improve her life, it will improve yours too. The asset has value.
  • Buying gold improves your security in troubled political times. The transaction has a price to add value to your life. That value is a last resort store of wealth.
  • The price of Bitcoin has started to move again. Bitcoin still provides the same utility as it did last month. It is still a means for universal autonomy. We can still trade it around the world with as much ease as before. As much ease as when it was changing hands at $18,000. As much ease as when it was being sold for $4,000. The value of Bitcoin has not changed wildly in the last two years. Its price has.

The value of a business is an expression of what the owner currently gets out of it, and what he will get out of it in the future. He can sit tight and wait to get out of it what he expects but at later dates. Or he can offer the business to another person at a discount to those future cash flows. The essence of discounted cash flow valuation.

The key to value based on what you will receive in future times is the risk that those cash flows will not happen. But you know the ins and outs of your business.

  • You know how to deal with its creditors.
  • You know how to twist the screws to get its debtors to pay on time.
  • You have a good understanding by now of how the inventory cycle works.
  • You have been down a road with your staff members.
  • You have a deep understanding of what competitors are up to.
  • You know what marketing efforts have worked in the past.
  • You know about the wasted money on marketing failures. You won’t do that again.

To you; the risk in the business is small. So if you were to buy your own business, you would be happy to take it at a small discount to its future cash flows. Because… certainty.

By contrast, someone looking to buy your business has a lot of uncertainty. His learning curve will be steep. And yet you want to limit the hand over period to one month. You see the problem here? An uncertain buyer sees lots of risks. Of course, his value discount is going to be higher.

Now, do you understand the disconnect between a willing buyer and a willing seller? As much as you disclose “all pertinent information”. And as willing as the parties may be. No matter how much funding is available. The risk to the buyer is much higher in the raw and even higher in her own perception. There is no getting away from it.

Your job as a business owner (who will exit someday) is to reduce risk to your buyer. Your efforts will gain you a smaller price to value discount. If that sounds obscure; it means you will sell for more.

 

 

Occam’s Razor

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An investment conference and workshop in the Winelands last week asked a question. “Where are all the deals?”
The deals, we know, are waiting to happen. The problem investors have is in the information they receive.
Investors know that deals are “there”. Their frustration is in the quality of information. Too little information. The wrong information.

Information is often so voluminous. That is as much a problem as a lack of information. It is a lack of the right information. It provides too many variables to consider at a high level.


Occam’s Razor
Simpler solutions are more likely to be correct than complex ones.
The more uncertainties and assumptions, the greater the risk of getting it wrong.


When a potential purchaser first looks at your business, she knows nothing about it. Heck, I know that many purchasers still know very little after their due diligence study! But that’s another story.

So in knowing nothing about the business, she has to make lots of assumptions. This is where your pitch deck comes in. Remove all the uncertainties. Prove your facts. Be succinct. But above all else be informative and accurate as can be.
But more than that… Give her relevant stuff.
It is all in the preparation and presentation.

People are quick to offer income statement summaries with a fast write up and an afternoon Q&A.
The very next step is too great a hurdle for unprepared businesses.

Sometimes the sellers and their brokers hand out mountains of information. Too often, it is the wrong information.

These guys have expensive specialists working for them. They should have the capacity to wade through your audit notes and adjustment accounts. But that is not where their capacity goes. Sure they will need that stuff for later due diligence. But for now, they want some high-level information.

This is what happens behind the scenes. Yours is not the only business the investor is looking at. She can only look at one business at a time. So they all go into a box. The first one to confuse her goes to the bottom of the box. And then the next one. Anything with too much work to get to the meat moves down the pile.

The business with all the information summarised and decipherable in an investment industry format… THAT one will stay open on her desk. Now you just need to make sure it is a compelling investment. But hey! You’re invested in the business, so that should not be a problem.

Recognise your Rs

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Recognise – Regroup – Refocus

  • When you started your business…
  • When you bought your business…
  • When you gravitated into your business…

Your business got to where it is today, for the most part, because you worked at it.

Nazier Ebrahim’s success is a product of planning and hard work. He knew he would sell his business one day. He needed to do so because if he didn’t, then his heirs would. He joked that he would prefer to enjoy the sale proceeds. “Rather I get myself a fast car, than this lot do”. He gestured towards an array of piercings and tattoos on his crotch fruit with their doting faces sitting at the table.

But the sale of a business is seldom as easy or as quick as selling a home. A business is a living thing. It is moody; varying between brooding depression and excitable growth.

Nazier’s business had been through ups and downs through its years. His success was the product of the tenacity with which he had directed the business.

“Direction” is what it says. The director recognises a problem. (You do it all the time.) And then by drawing on his own experience, he regroups and refocuses. Then he moves on to the next opportunity, threat, or just daily grind. Rinse and repeat.

“Rinse and repeat” is automated as standard operating procedures evolve. It takes time to create workable automation.

Successful automation makes up growing value in businesses because they become more stable. But successful automation also makes the business more profitable because stuff just happens. When the stability and profitability come together, value accelerates; driven by the complementary forces. (Which is why we avoid using simple multipliers to set prices for businesses.)

Nazier recognised that there is no point to reinventing existing automation. This is particularly the case where the system can be rented off the shelf.

So Nazier joined CSuite to make sure that his exit from his business would be smooth and cost-effective.

He recognised the problem and the solution. He has left the regrouping and the refocusing to a system which already works.

Business as usual

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Imagine your business is, or becomes, black-owned as defined in the BEE codes. You go for that big tender, but you still don’t win it, despite your favourable empowerment credentials. Your big non-compliant competitor wins it instead.


This post is also available on audio


In the disappointment which follows you assume corruption. It is our default position in so many industries. Rampant corruption is the one segment of our daily lives which knows no colour. It is the one real equal opportunity activity in South Africa.

But not all tenders fall to corruption. There are businesses of all hues, tones, and grey scales which do not win tenders. Are all winning competitors corrupt? Probably not. What if they have other strengths with which to bargain?

This is where vanilla black ownership fails in the BEE race for sales. For instance, many tenders go the way of the supplier who is able to offer very favourable payment terms. “Look you have a very poor scorecard, but we’ll give you the business if you agree to no deposit and 90 days payment. From statement.” It is the pain that some non-compliant businesses take.

Poor BEE level businesses have to win contracts with other strengths. If the business has big reserves. Or if it can back the terms off on its own suppliers. Or if it is in its own exclusive and strong niche. These are all gaps for contract winning strategies.

BEE imperatives aside, financing customers with long payment terms remains risky. And risk reduces value multiples.

The contract is value-defeating if it loads the customer exposure index, or if margins suffer. Value decreases if higher operational costs cannot be reduced after the contract and the inevitable project losses.

If the exposure the business has to a single contract is outside sound parameters, then key valuation indicators suffer. Valuation multiples fall. Discount rates rise. That’s ok if the profits rise in proportion to risk. Then values rise. Which is why winning tenders are often more costly to the end user. But then tender reviews become the risk. These short term gains can be very dangerous if there is no plan for life after the tender.

So the winning bidder may have financial reserves to fund the tender. He may have enough swing with his own suppliers so that they help him fund the transaction. He may be able to gain some margin in the tender.

Turnover is vanity. Profit is sanity. Cashflow is reality.

Ultimately the cash flow from the deal will work through to value. In the meantime, that promise of value will be tempered by an assessment of risks taken to gain the cash flow.

 

 

Your lousy business

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Life is not a matter of holding good cards, but of playing a poor hand well.
Robert Louis Stevenson
(also published on 26 February 2019 by Daily Maverick as its quote of the day)

Your business is as good as you have been able to make it so far. It is a thing of pride to you. It is something worth selling one day.


 


 

But when you sit across a table from a prospective purchaser, she will tell you all about the weaknesses. She will lead with passive-aggressive questions. They will leave you wondering how such a lousy business could be so precious to you.

She has to find a way of suppressing the price of the deal. That is her first step in getting the best return for her investment.

You make your surest profit in the purchase price.
about a million investment advisors on Youtube

Of course, your best deal in selling your business is in maximising your selling price. As they remind us in the many court-room dramas playing out: it is an adversarial process.

So she will tell you how desperately she wants this business. For the lowest price possible. Even if it is quite a kak business. </ironyfont> That pretty much sums up the average business buyer strategy.

Your job is to refute those claims. But if you find yourself offended and angry, things will go wrong. The best way of moving forward is to identify issues and plan responses in advance.

There are some things about your business which could improve. Every business has place for improvement. They are unlikely to improve before the deal. Your purchaser is also unlikely to improve on them post deal. When she sells the same business in a few years, she will be defending the same issues.

The difference in successes will be in preparation, and in playing the cards you have.

Our CSuite subscribers learn about the weaknesses they will face in a sale. Then they learn how to preempt the objections with facts and not emotions.

This little piggy went to market

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A market valuation is an expression of the expected offer price in a business sale. It assumes the current prevailing economic conditions and political sentiment. It also assumes an adequate demand from prospective buyers with access to capital.


This post is available on audio


The market valuation is also a product of strengths and weaknesses in the business. We call them key valuation indicators. Compare the KVIs to the financial statements to justify the valuation. They must align. Information must be accurate, and available in a standard format. The format is very often not standard. That does not diminish the value.

The valuer must draw on experience, exposure to deals, and insight of negotiations. This skill will inform the calculations and their variables.

The market valuation result is what one can expect the Business to sell for, as it is, where it is. It is neither definitive nor prescriptive. It does not take into account the vagaries of negotiation, greed, fear, and force of character. By definition of the balance sheet at the end of a financial period, valuation is also time-dependent.

The market valuation puts a stick in the ground. Use it to plan your next step. It is key to building wealth in your business. Don’t be the pig around the stick which rests above the coals of business transfer.

One day when you sell

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You know how you, as the owner of your business, like to be a bit of a control freak?


This post is available on audio.


Well, one day when you sell your business, you will no longer be in control of some things. As a seller of a business, you will agree that the new owner must obviously be free to take the business where she sees best. For better or for worse. You will lose control.

  • So She will take control of the overdraft – what a relief.
  • She will be losing sleep over labour relations and wage negotiations – lol.
  • She will have to juggle the cash flow at month end – she wanted to be an entrepreneur.
  • She will have access to your email account – say what?!?

Yip. It’s a thing. You cannot just delete your emails. There is stuff there which belongs to the business. It is stuff which may be – how do we put this – sensitive.

  • You know when you told your broker about what you thought of the purchaser mid-negotiation? That.
  • Or when you debated about whether to tell the purchaser about a problem with a customer. Yip.
  • That string of comments about pushing a price which is already fair. Embarrassing!

Let’s be frank. Things are said. Email exchanges are had.

So right up front. We ask all our clients to create a private email address. They should use it for all correspondence between them and brokers, advisors, and whoever else may be told about what is going on. It is just good practice.
And of course, you probably have a private email address already. So no biggie. Right?

First, you want some assurance that in the future your discussions will not be shared.

Second, you want access to the record of discussions after the sale. Because… Well please just trust me on this. A private email address costs you nothing.

Our CSuite clients know what I am talking about. This is put to bed right up front. About the same time as we put our NDA in place. It is all good practice.

There is a webinar waiting for you here. Put your feet up for an hour, and see what I am on about.

 

Tetramerginisation

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Yeah. It’s a real word. I made it up. In the world of covfefe, meandos, and expropriation, perhaps it too, will catch on.

In the merger of two entities, nothing is as simple as just adding two balance sheets together, or assuming that 1 profit plus 3 profits will equal 4 profits.

We feel that the end product of a merger of two entities should look something like this:

2018-09-10_20-40-13s

It may end up being a bit rough around the edges, but the idea is to create value, at least equal to the sum of its parts soon after the close.

But too often, the idea of making an acquisition is a lot more exciting than the eventual outcome. The result of poor planning and consideration is the destruction of value:

2018-09-10_20-45-24s

M&A history is littered with grand announcements of mergers “which will be finalised as soon as proper studies have been conducted”. A year later, the deals are called off. In the meantime, both entities have seen the destruction of value. The value of shares have been all over the place. Staff members have started looking for other jobs, worried about their prospects. Competitors are forwarding all manner of rumours around the very businesses which are trying to grow their value.

If yours is a relatively small business, then you have the advantage of being able to plan and plot carefully with the owners of the other business, well in advance of even telling your staff. If it is not going to work, it is not going to work. If you are going to struggle to make it work, at least you can be aware of the difficulties which are coming your way.

 

Your C Suite

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Remember the days when the guys who ran your business were “the directors”? That later changed to “the executives”.


This article is also available on audio


 

More recently it is the collection of chiefs. The chief executive officer, the chief financial officer, the chief operations officer. Then we all got to grips with the acronyms associated with them: CEO, CFO, COO, and CTO.

So where the directors sat on the board, the chiefs now all sit in the “C-Suite”. And these are the guys who count when you want to sell your business.

Here is why…

If your business has significant value, then you are unlikely to sell it to an individual. That means that the new owner will be an existing industry player.

On the horizontal, it will be a competitor or a complementary business which will acquire your business as “a bolt on”. On the vertical, it will be by way of selling to a supplier or a customer.

The horizontal buyer gains markets and products. The vertical gains margin for the acquirer.

When you play with your nest egg at this level, you are up against people who do this a lot more than you do. So you may have a CEO, CFO, and a COO on your side. The guys on the other side of the table will have the same TLAs (three letter acronyms), but a few others besides.

Special chief

The big suitor often has a dedicated officer to deal with you. This will be a specialist in finding and negotiating deals.


You can have your own specialist preparing you if you join our CSuiteOnline programme.


Their CFO could be given the job. Except that those people are often so engrossed in the day to day numbers. They worry about the way in which an acquisition would affect the ratios. The CFO is often one of the people who is more valuable in adjudicating the recommendation. The CEO is also trying to run a business.

In fact the entire C-Suite has to run the business. They owe that duty to the shareholders. It often appoints a non-executive director or a significant shareholder to negotiate acquisitions. But make no mistake… that person will be a specialist.

You will do this very few times in your life. Your opposite number is already prepared. He (she) is up to date on what is what in the acquisition industry. You are about to change your entire life. That is real. Right there.


Let someone who is up to date get you up to speed by joining our CSuiteOnline programme.


Their acquisition officer’s job is to get something valuable for as little as possible and on the best terms possible (for the buyer). The acquisition officer gets to look at lots of possible acquisitions. He can afford to walk away. Nobody ever got fired for not making an acquisition. (OK, there was that one time.)

Who has the stronger hand here?

When you start to push the pace in these negotiations, you weaken your position.
When you are not prepared before the discussions, you weaken your position.
When your pitch obfuscates or is unclear in standard presentation standards, you weaken your position.
When you wait until the imperative to sell is immediate, your position is very weak.

You will lose when your position is weak. By “lose” I mean you will leave a significant amount of money on the table. It won’t even be your table anymore.

Get yourself prepared. Get your business prepared. This does not mean putting your business on the market. It means getting your house in order. It means identifying weaknesses in your business and mitigating them. It means identifying and presenting the stuff that really matters to buyers of businesses.

It means you should join a programme like CSuiteOnline.

It is a scheduled, easy bits and pieces plan, in bite-size chunks sort of programme. It will add millions to the value of your business.

Data room virtual tickets

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Long, long ago in a previous century, when a company was for sale, it created a data room as a place for all the due diligence documents. Various suitors sent their accountants, bean counters, attorneys, and commercial spies to look. It was a dodgy affair.

It took the form of an actual room where interested buyers could view all the documents relevant to the target business. Nothing was allowed to leave the room. All participants signed a non-disclosure document.

Then along came fax machines. To save time, people asked for financial statements to be faxed to them. The thermal fax paper would fade, and so would the information.

A little while later the internet arrived. Then people sent all sorts of information in an electronic format, to be stored forever on the recipients’ servers. And nobody thought this was strange. There were clauses in the non-disclosure documents (if they were ever signed) which called for the destruction of all information on demand. I remember that happening once. By deal-time, everybody was just so chuffed that they either had a business or a chunk of cash. In some cases, competitors had some interesting information on the business.

More recently people started sharing dropbox links, and similar accessibilities. And then one day people woke up to the fact that trusted people shared those links with gay abandon. Control could be easily lost.

Enter the virtual data room

A virtual data room gives control of the data back to the owner of the data. He can put information into it in layers, requiring more and more permission to progress. The owner can revoke permission whenever he wants, for whoever he wants.

He can control the sort of access the visitors have. From a curtained view window to a full-screen online view, to full downloadable access, and some steps between. If he sets up his room properly, when he revokes permission, even downloaded documents will become unreadable.

21st Century stuff.