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

Archive for December, 2013

Long arms and preparation

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So we all know that the true value of something is the price that:

  1. is actually paid for it
  2. to a willing seller
  3. by a willing buyer
  4. in an arms length transaction
  5. with no hidden agendas between the buyer and the seller,
  6. the buyer being aware of what he is buying.

There are so many hidden things in there, it is almost unbearable: The agreed price has to be paid. It’s no good that you get an unbelievable offer on your business, the documents are signed, but you never receive all your money. While in certain industries and in certain leagues businesses do change hands with very little due diligence being conducted, particularly where other agendas are involved, the result does not represent true value, even if the seller and the buyer are in agreement, and the money is paid.

As a friend and client said to me at the end of last year, after the prospective purchaser had left the building: “Talk is cheap”. A buyer, prospective or actual,  will only ever part with his money when he is convinced of everything, if there is any substance to the buyer. As it happened in that exercise, the promised deposit was not paid, and still has not been paid. Had the agreement been amended in accordance with the buyer’s wishes, the seller would be sitting with a huge problem already.

I first saw that particular manoeuvre about twenty years back, when I was caught out. Since then it resurfaces regularly. I call it the Hindlick Manoeuvre: Once the buyer has the seller in the desired position, he says to him: “Lick my bottom*”. And then the nightmare begins.

Due diligence (DD) is a particularly strong tool in the hands of the seller if used correctly, and planned for well in advance of actually selling the business. The idea is that a DD should only be conducted on business sales once a price has been agreed and the purchaser is tied up properly, subject to the performance claims being proven. And that is where good preparation is key.

As a small business owner, you are potentially at great risk to competitors in a DD exercise. If there is a gap for a buyer to walk away having studied all your secrets, your business could lose a great deal of value immediately.

Do it like this:

  1. These are the performance figures of my business.
  2. If you like them, let’s agree a selling price.
  3. You pay a deposit into trust, to be paid out to me when the DD is completed, and I have proven my figures to you.
  4. You may not start the DD before your deposit is cleared.
  5. Ok, now the agreement states that if I have lied to you about the performance of the business, you (Mr Buyer) can walk away, or we reduce the selling price with this formula.
  6. If you do not pay the balance of your purchase price after the DD, then you lose your deposit, and will be sued for the balance. I keep my business.
  7. The DD is only about the figures I have represented to you. You cannot bring in other extraneous market analysis, “gut feel” woowoo information later, as an excuse to not consumate the deal. If you are uncertain about those things right now, go away and sort yourself out before we agree on a selling price, and sign this document.

There is no guarantee here that the seller is perfectly safe, but the odds have been shortened considerably in your favour. This is a game for big boys. Not for desperate folk with little experience.

And things still do go wrong.


*Not actually “bottom”.

Calculating Goodwill

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In the bad old days we South Africans (well the white ones) became very adept at sanctions busting, finding workarounds – a boer maak a plan type of stuff. We became more and more isolated, but very good at making a plan.

One of the things which developed in the small business sector at the time was a variation of the concept of goodwill. Not that goodwill was in any way unique to South Africa, it was just that we seemed to develop our own definition. It was usually calculated at some multiple of some element of the income statement. So for instance 20 times the net profit or three times the sales turnover.

Then in addition, the seller would want the stock added to the goodwill, and then to add more gutzpa to the mix, the value (replacement value no less) of the fixed assets must also be added to the price. Needless to say, it was only the really green buyers who fell for this. Still, many buyers have fallen for it… But not at a level of any significance. Today, businesses which have been around for a while are becoming quite significant in value, and buyers are a lot more clued up than before.

For the sake of clarity, the international definition of goodwill is published in hundreds of places as unequivocally being:

The difference between the selling price of the business and the net asset value:

  1. Guide to Analysing Companies by Bob Vause “Goodwill is defined as the amount paid by one company for another over and above the fair value of the net assets appearing in its balance sheet”.
  2. Corporate Valuation: An easy guide to measuring value by David Frykman and Jakob Tolleryd “The investment in goodwill represents the cost of acquiring assets or other companies in excess of their book value”.
  3. Buying and Selling a Business by Jo Haigh “Goodwill: The difference between the price which is paid for a business and the value of its assets”.
  4. How to Buy, Sell & Evaluate a Business by Samuel Tutle “Goodwill, also know as ‘excess over basis’ is the difference between the market value of a firm and the market value of its net tangible assets”.
  5. How to Buy and/or Sell a Small Business for Maximum Profit “Goodwill is the difference between the asking price and the actual asset-value price”. [I have an issue here because that definition is incomplete in its outcome. Until one has a buyer willing to pay the asking the price the good will is pie in the sky. In such a scenario I have often heard the prospective buyer saying “so you’re looking for goodwill of …” Invariably the seller is left floundering at this point, unable to justify his asking price. In my opinion, stick to real market value.] 

So clearly from the above, goodwill is an intangible item arising from the reputation of the company, its staff members, owners, location, agreements, products, services, ability to deal with crises, freedom from large proportion customers and suppliers, barrier to entry for new competitors, exclusivity, growth, cash flow and so on.

Also from the above; a price is agreed on in a sale of a business, and this price is made up of assets and goodwill. The value of the assets is easily identifiable from the balance sheet, and the difference is goodwill. If you happen to have more than R3M (say) in stale old stock which has not sold in the last ten years, you are going to be hard pressed to dump that on an unsuspecting business purchaser in addition to the selling price.

However, a sale does give an opportunity for both buyer and seller to set the levels of assets and goodwill. These levels are required to be set down in the agreement of sale. So typically, the appropriate clause will read something along the lines of “the Selling Price is made of R1M in Fixed Assets, and the balance to Goodwill”. Only it will say it over about fifteen pages. {kidding… attorneys, calm down}

Why do sellers want to sell goodwill? Simply because it gives more money in the pocket, and the tax implications are better. For the buyer, he will want the entire selling price to reflect assets because he can then depreciate his purchase. If the seller falls into that trap, he finds himself paying recoupment tax.

So, for heavens’ sake; don’t blabber on in your negotiations constantly telling the purchaser what a good deal he is getting because the assets are worth more than the asking price. You may be held to this in the agreement of sale and pay dearly when SARS catches up with you.

You’ll find more about business valuations here.


Selling a portion only

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When one considers that the capital value of a company listed on the stock exchange: the number of shares in issue is multiplied by the share price. Simple. That is the value of the whole company.

So who can fault the logic of the business owner who believes that 10% of his business is worth 10% of the total value of his business?

As a general rule, buying out a minority shareholder based on that formula is extremely generous, or the result of some serious fire on the soles of the majority shareholders’ feet.

People believe the direct proportional relationship to be the case because that’s the way it works on any stock exchange in the world (they think). You buy a miniscule portion of the total shares in issue, and you pay that miniscule portion of the capitalisation value of the entire stock. So why shouldn’t it work the same for small businesses?

These are the three aspects which really matter:

  • The contract which pre exists the dissolution of the partnership
  • The goodwill in the relationship
  • The planning leading up to the event
Pre existing contracts

The contracts which are established at the start of a business relationship between shareholders is absolutely key, in tandem with the company’s memorandum of incorporation (MOI). An agreement which envisaged an eventual dissolution of the ownership relationship will have taken care of this provision, one way or another. That will work today, provided it is in line with the company’s memorandum of incorporation.

If there is no provision for dissolution, then other elements enter into the breakup.

Personal relationships

If “partners” (shareholders in an entity) have a poor and confrontational record of dealing with one another, they should both hope that the pre existing contracts are in good shape. If not, the relationship is likely to plumb new depths. The outcome is more likely to be based on force of personality, personal morality and lawyers’ fees than market value.

The intransigence of one shareholder can make for very bitter memories.

I have seen shareholders refusing to sell at a realistic price because they know that they are in the way, meddlesome, unpleasant, obstructionist, pains in arses.

I have seen departing shareholders being tied to barrels, and forced to accept well below par settlements on the value of their shares because they are old, tired and desperate.

I have seen minority shareholders who were previously given their shares because of a perceived “key person” threat, turning on their benefactors, making life very unpleasant for everybody in the office, and eventually demanding huge out of value settlement demands so that they will go quietly.


Planning for the exit of one shareholder, preferably on an amicable basis will make for a much better realisation of value if the portion is being taken by an external investor, or so conventional wisdom appears to dictate. Of course if the existing partner wants to acquire the remaining share there is still a likely conflict of interests in the value, if pre existing mechanisms are not in place.

So people plan for the famous “right of first refusal” option. On the face of it this sounds very fair: “You find a buyer for your shares, and if I think it is worth it, I will match that offer”. The problem is that it puts a tremendous financial and practical pressure on the selling shareholder, particularly where the remaining shareholder makes it clear to all prospective purchasers that he is not going to be an easy guy to work with. (I’ve seen that, too.)

We have a number of clients who have their businesses valued by us on an annual basis. The presented results are then debated amongst the shareholders, and with us. The process makes for a checks and balances environment which everyone can participate in, openly and honestly. Ways can be found to maximise value, and pay it out in the most beneficial manner to all. In the process, the guy who is buying out his partner inevitably ends up creating even more value for himself, than the alternative of constipating the growth while he plots to get everything for as little as possible.

The important thing to understand is that being prepared for the possible, if not inevitable dissolution of the relationship is the best grown up way of doing things. Talking along the way, working together towards a goal. Fairness all round. Unless you’re a real prick, of course. Then do it another way. I wouldn’t be able to help you there.

Isuzu, E20, EToll and Evaluation

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This eToll saga is so tired now, and is coming to a head. It’s a bit like two hours of foreplay, and then failing to fire. Or so I’ve heard. Here is the question: How will the etolls affect the value of your business, and how will you as chief executive manage the process? Your choices:

  1. Register with an etag, pay in advance by way of trusting SANRAL with a debit order instruction of your account, and enjoy all the discounts
  2. Register, but wait for the invoices (or as it turns out; the final demands without an invoice – hello SARS?)
  3. Don’t register, wait for the invoices, question each one, obfuscate the whole process and eventually wait for something to snap – you or SANRAL.

Oh wait… Nobody seems to know how many have done what. Final demands were sent out within 20 days or less. Very emotive and scary words have been used. If it wasn’t so important it would be boring.

My car recently broke down outside Warden. While discussing the options for towing with the mechanic, I was struck by the repetitive nature of his various quotes; each punctuated with “plus the tolls”. Now that is obviously something that has become 2nd nature to him, being on the N3, in much the same way as “plus VAT” became a refrain about twenty years ago when we changed from general sales tax to VAT.

At the same time Bruce Whitfield seemed to think he’d get a reaction from industry when asking CEOs of large corporations if they intended to register for eTolls on the eve of their implementation. The result was was a “yes” from all those I heard. They cited their corporate responsibility to their shareholders in maximising profits by being able to enjoy the discounts on offer for easy compliance.

We should have no doubt that the cost will be passed down the line to the consumer, as is every other tax of this sort. “The cost is so much, plus the tolls”. I have no doubt that consumers will all quietly accept the added cent or two on sugar, milk, bread, caviar etc.

We small business people are a little different. Many of us stick to a principle, and we can afford to because most of us are the shareholders and the directors of our own companies. So back to the original question: How much will the imposition of eTolls affect your business value? As I see it (and this is a thinking in progress here), there are two considerations:

  1. The day to day overhead of your business which translates into an annual profit, which has a direct bearing on the value.
  2. More of a macro element; how sellable is a business with a large contingent liability hanging over it, and how will business buyers use this to dodge the asking price?

Let’s deal with the latter first. Recently I was asked to sell a business by a long standing friend and client who happens to run a reasonably sized fleet of vehicles, which have no option but to use the N1, N3, R21 system. He has been on the radio several times about the problems he has with etolls, and every time he sees me he bends my ear some more. He WILL NOT pay the tolls until he receives a bill in the proper manner, and is then summonsed, and the rest of the disaster. He just will not. That is in his personal capacity. But he is selling his business, and hopes to close a deal by Easter. So the question is, how does he go about balancing his moral imperatives with his selling requirements?

His solution is to stick to his guns with his personal vehicle which is registered outside the company, but to reluctantly register and tag each of the company vehicles. That way he will have no come backs in the sale, and he feels he is personally not dodging his principles.

On the first point: Value of a business is based mostly on the profit it produces. If you are going to allow the business to make less profit by playing the OUTA game, then you should accept that the value of your business for now, will be less than it would otherwise have been.

We should all expect that for the immediate future, until a solution is negotiated to this impasse, and that for the canny buyer it will be a negotiating blunt instrument to beat the seller over the head with.

For the record

I have not registered with SANRAL, and I make contributions to the OUTA coffers to help fight this thing. But then I have no intention of selling my business.

Mandela passing and the value of your business

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How will the death of Nelson Mandela affect the value of your business? I have just been asked this question by a client.

It will have no effect at all. It will have no effect now at all because of people like Nelson Mandela who made great sacrifices to secure that business value twenty years ago. He led a nation away from any chance of civil war, and helped us all contribute to a much more secure and prosperous future.

The value of your business is more about what you do with it than the death of an icon.

Now get back to work.

Tonight I will go and spend a few hours in Vilakazi Street with my family and fellow South Africans.