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

Archive for Apr, 2013

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.

Your MOI may not be as mooi as you think.

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I sat in a business rescue planning meeting last week. In that meeting was an extremely experienced team made up of an attorney, an accountant and a business turnaround professional. They all nodded wisely as one of them said: “There is a system. Work with it quietly. Don’t rock the boat. Live happily“.

Don’t fight it, people.

There is a system. It is designed for people much more stupid than you or I. The fact that it goes against common sense, interferes with our own plans and will cost a bit of money, is just noise. This goes for many new bits of legislation which are being thrown at us at present.

Go with the system.

Here is something you may not be aware of: Up until recently your shareholder agreement may have a clause in it to the effect that if there is a clash between the shareholder agreement and the memorandum of incorporation (MOI) of the company, then the shareholder agreement will rule. That was not so nice for the public dealing with your company, who have access to the MOI, but not the shareholder agreement, and it might have meant they were dealing with a different animal to the one they believed they were.

Things have changed with the new companies act. Now the MOI rules. It is in the act and it is a law which cannot be contracted out of. If you just fill in the common or garden variety unsliced government issue MOI, you may wish you had taken some professional advice in the not too distant future. That professional advice allows you to choose now, the destiny of your business to a great extent. For instance, the commonly held understanding is that 25% plus 1 share is needed to block certain resolutions. How would your wealth be affected if you woke up on May 2 to discover that this has been changed unilaterally to 15% + 1?

So get some good advice, and if you haven’t already submitted your MOI then get some first class, professional, specialist guidance on establishing your MOI by going to Douglas Shaw’s web site, and then buying some of his time. There are 50 issues to be considered in completing a MOI, and as always, there are repercussions and unintended consequences to look out for. He lays these out in a series of video tutorials, which make sense to us lay people.

Here is his website:

Having your MOI under your control is fundamental to the value of your business. Imagine negotiating a deal with a buyer of your business in years to come, only to discover that the terms of your MOI require that you need the sanction of that one minor recalcitrant shareholder, after all. It could mean the end of months of hard work, soul bearing, dreams and retirement.


Add some quick value

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It is has been said by so many people over the years, and I don’t know if it can be attributed to anyone in particular any more: We are the sum of our choices. Our businesses represent the choices which we as directors, managers, employees make each day, every minute.

  • You purchase a new gizmo for the office which saves everyone a whole lot of hassle, and gets the job done quicker and for less money. You add value to the business.
  • You buy a new gizmo for the office which is overpriced and continually breaks down. The support is very poor, and eventually it is consigned to the status of doorstop. Heads drop, productivity falls, the business has lost value.

We are reaching the closing stages of developing a new tool in collaboration with a software developer to add onto our business valuation methodology which will allow us to guide business owners more effectively in making key decisions which add value to a business, which will then one day be sold for more than it otherwise would have. It will form part of our Splinter program.

So as I sat with the developer, we went through an idea which can best be described as adding up the achievement of small business goals. It looks at the future business valuation effect of:

  • making one more sale
  • moving the GP% up one point
  • a salary increase across the board of 8% or 9%
  • Declaring a dividend of 10% of this year’s profit, or 50%, or not at all
  • buying a new delivery vehicle

It is not terribly difficult to work out those results on a spreadsheet in as far as immediate cash flow and profits are concerned. But what effect will that sales presentation have on my retirement value in five years’ time? That is the real question. A sort of short term losses for long term gains approach in places you don’t even know you have places.

In the middle of this all, I have a chat with an old friend of mine, Tony Seifart. A bit of this, and a bit of that… I am a bit frustrated because a client of mine, in the middle of a sole and exclusive mandate snuck off behind the squash courts, and did a grubby little deal with someone else, continued to allow me to work on other deals, then boldly told me to get lost once his nefarious deal was safe. As I say, I am a bit frustrated because I cannot get any information, and the business does not have a PAIA manual… and he refuses to answer questions with righteous indignation which seems to be the preserve of the righteous and holy.

Anyway, I digress. Tony tells me of a website where businesses can have the entire PAIA manual put together for them for a paltry once off R350. So how does that add value to your business?

Here’s how:

  • When someone asks for your manual, you push “send” on your computer, and move back to running your business.
  • You don’t spend a day running around trying to work out what a PAIA manual is, googling like mad and phoning your accountant who will charge you more than R350 to give you the run down… And losing a day’s productivity in the process… You know this is true.
  • If some sneaky attorney goes sniffing around at the Human Rights Commission for your PAIA manual, hoping to add to your stress… Well that’s one less charge to answer to, because this website will register you online, as part of the same fee.
  • You don’t lose any sleep worrying about the R15,000 fine or whatever the jail term is (and there is one, for heaven’s sake!) for not having a manual.
  • The cumulative time you would have spent fighting this fire can rather be spent selling, or producing, or relaxing, at some stage in the future. You’ll remember this point each time you push “send” in respect of this document in the future. And perhaps it will never be required, but at least you have that base covered.

That’ll add some value to your business, today. Oh the web site is