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

Archive for January, 2015

You cannot do this

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As a child I always struggled with understanding the concept of “you cannot have your cake and eat it”. It seemed to me that if you ate your cake, you still had it (in your tummy). My father pointed out that then “I had, had it”. My ever practical German mother muttered that I would have only had it for a few hours anyway.

A pivotal point in the valuation of small businesses involves calculating a figure called EBITDA – Earnings before interest, tax, depreciation and amortisation. For lack of a better description, it is what small business okes think of as their net cash flow or free cash. Look at your income statement. Near the bottom you will find something called Net Profit Before Tax. Sometimes it appears before interest is deducted as an expense, and then it is called Operating Profit.

Onto that number, add back any interest, finance costs and depreciation allowances which are listed in the general fixed expenses, and which have already been deducted. That number is referred to as the EBITDA. Sometimes personal expenses in the business which can be proved to be as such are also added on. That we call the EBITDAD. The extra D stands for “drawings”. Both EBITDA and EBITDAD constitute a well used basis against which a range of multipliers can be applied.

But valuations involve more than multiplying two numbers together. The balance sheet also plays its part. So as one depreciates the value of assets by way of taking off this expense in the income statement, so the asset base (property and equipment) is… well, depreciated. In conjunction with EBITDA(D) calculations, the depreciated value of assets has to be used to determine a fair value.

What you cannot do, is add back the depreciation in the EBITDA, and then use new or market values of the equipment in arriving at a business value.

That’s like having your cake and eating it. Except SARS will want a slice as well. If you insist on doing it, it really is a bit like what is left a few hours after having had one’s cake! Except you may be in it.

Get your taxes paid here

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The growing socio economic imperatives of South Africa in an environment of close to zero growth in the economy, means that without any windfalls such as even lower oil prices (currently at about $32 per barrel, and with less and less space to fall), or a huge rebound in the value of the Rand (unlikely while the ANC persists with Zuma), or some miracle; taxes will have to go up.

Big businesses take the view that taxes must be paid by their customers. It’s that simple. They need to give an expected return to their shareholders. Initially they will embark on much marketing noise about “absorbing the cost for the sake of the man in the street”, but eventually consumer prices will rise to give effect to the profits line. Joseph Stiglitz has a lot to say about this attitude, and it isn’t nice; but that’s another story.

Big businesses can indulge in this practice because their competitors all do the same thing, and because consumers expect inflation to happen, and therefore expect to see higher prices, given all the hot air in the media. There is simply no consumer push back. And how would they do that anyway?

Small businesses with a bit of oomph behind them, are also able to pass their tax costs onto their own customers. Business owners who have been around the block a few times, know that if they try to absorb the extra tax expense for their customers, they will eventually lose those customers when the business folds, anyway. They will cease to be tax payers themselves.

Businesses which have a competitive edge will be able to lead the way, and will have the edge in the profit race. Simply put, they can actually start to benefit from the tax increase ahead of their weaker competitors who are afraid of losing customers.

No prizes for guessing which sort of business is more valuable.

What is your business exposure to tax increases like?

Five things to avoid

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Add value to your business in 2015 by avoiding these five mistakes:

  1. Taking too much money out of your business
  2. Giving away margin
  3. Falling for lower fuel prices
  4. Ignoring new technologies
  5. Not learning something new

So by now the first of your 2015 resolutions have probably gone undone, ignored or broken.

Here are five things to NOT DO if you want to add some value to your business in 2015.

Do not pay a dividend

Keep your cash in the business.

Your business may have some difficulties ahead of it in 2015. Load shedding looks like it may become an uncomfortably regular occurrence for the foreseeable future. If you don’t plan for it adequately, lost production may eat into your profits, meaning less money to pay the bills. So keep excess profits from the current year in your business, or at least available in your business.

There is more to this: If you sell your business with a strong balance sheet, 1) you will get a higher price for it, and 2) you won’t have to pay dividend tax to get your money out of the business.

Do not give away margin

One of the biggest stresses in most small businesses is the problem of collecting debtors. So many businesses; big, small and everything in between, offer small discounts on the outstanding to persuade debtors to pay by the date they have previously agreed to actually pay the outstanding amount.

Here is the result. Well, here is the background to the result: We look at hundreds of income statements in the course of doing business valuations. Very, very few of them have net margins over 10% of sales turnover. Most are around 5%. The discount businesses give for early settlement are generally about 2% of the sales turnover. You might be giving away 40% of your net profit, just so that your customer does not abuse your agreement with him. Find another way of doing it, or build the discount into your price increases. Don’t give away margin unnecessarily. Build your business value.

Don’t be seduced by falling fuel prices

Three months ago we had no indication that the current windfall was about to happen. The royal house of Saud can pull that plug at any time, or the  Americans can start importing at silly prices again, and slow down on fracking, or {add your own conspiracy theory here}. Wherever the benefit is headed, there are other things ready to step in and negate its benefits. Like Eskom, again. Or like trouble at SARS resulting it being unable to collect sufficient funds to run the country, resulting in further ratings agency downgrades and increased interest rates. Or we could have some good old fashioned South African unscheduled industrial action. Any of those might result in the Rand going south, and adding to fuel prices.

Similarly unexpected, reversing fuel price drops could take away from your sales or add to your expenses. Lower profits mean lower business values. Be careful of blowing fuel savings on something unnecessary.

Keep your powder dry, keep your margins up, keep your expenses under control. Those strategies will keep your business value up, and even increase it.

Don’t ignore the gathering tsunami of cheaper and cheaper technology

In most of our lifetimes, they will start printing body parts. That is happening already on a basic level with some dentists printing new crowns for their patients while they wait. No longer any need for the patient to live for a week or two with a temporary cast. At the same meantime widgets are being printed from designs emailed to printing “factories” which do not need expensive dyes, time consuming set ups, minimum runs or detailed know how. Take a look at this.

The youth next door can conceptualise a competing product to yours, have three very cheap trial runs, and go into production… before the end of the month! She does not need any seed capital beyond that which can be funded by her mom’s credit card. A web site can become her shop front. If she sells one item, she will be in profit. If she sells nothing, she will move onto the next idea. Heck; if she makes a fortune, she will still move onto the next product anyway. Then she’ll have two businesses, neither of which require a work force to make small profits.

Who needs a garage start up today? This tsunami is coming at us from the bedrooms of geeks with goolies (GWG).

So don’t ignore the opportunity for yourself with all the experience you have in your current industry. You can learn how on the internet, this year. Your next prototype can also cost you next to nothing. The difference between you and the GWG is that you have years of experience in your field. She probably does not have the where with all to move to the mass production necessary for tipping point sales, so you’ll be ok.

So many of my clients have successful businesses today because they did not run scared from Chinese production. Instead lying down in a corner with those who went out of business at the time, they started using Chinese manufacturers to make their stuff, and evolved themselves from manufacture to import – wholesaler, making even bigger margins. Did you miss that opportunity?

Don’t miss this one. We are on the brink of something big. You can run scared or you can take advantage of the surge in technological ability at silly low prices.

Don’t discount the value of learning something new in 2015

If your business collapses, your suretyships are called and your lose everything, “they” can never take away your education. Your degree remains in place, or your matric, or your standard 8. You may have to hitch rides and live in a shack, but what is in your head is there, now with a bit of experience, and ready to get you going again. Hopefully you don’t have to go through that sewer, and learning something new in 2015 will add even more to whatever you have of value in your life.

If you are not a book reader, generally; read just one book this year. Make it something that will solve some issues in your business. Then read it again. Then tell people about what you have learned, and put it into action in your business.

Implementing something new in your business, garnered from something you have read that adds to improved processes, improved profits, less stress, more fun, new ideas, fresh outlooks, relaxation or something to talk about… That all adds value, if not to your business, then to your life.

Queued for printing

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A sub client has a wonderful business. It involves making good money out of supplying a HACCP regulated product to big chains.

One of the requirements is that a batch number, sell by date and best before date is printed on each bottle. Those printers don’t come cheap, so it is looked after and not pushed beyond its capacity. When I say they are not cheap, they cost more than R20,000, which is expensive when one compares to a small office printer at Macro.

So this business has a problem: it struggles to get goods delivered on time, and has been in this situation for months. Soon customers will get with the program and move elsewhere. When we looked for the bottleneck in the production line, we found a particular printer through which every single finished package has to go, before it can be sent to its market.

When we had done our calculations:

  • If the printer were to break, it would take four days to get a spare part and fix the thing. There is no redundancy, because it is a very expensive machine, and really doesn’t add any value to the process. The client is trying to raise finance for a new R500,000 mixer. He needs cash on the business balance sheet to make the ratios work.
  • Sometimes the printer operator goes on lunch, tea, or home. During that time unprinted product backs up further in the queue. Packers on the printed side of production then go off to make tea, have a smoke break or get on their phones; well because there is nothing else to do. They are still paid.
  • If the printer were to go down, the R20,000 of the cost of an additional printer, would be lost in production in 34 minutes.

After some flip chart pictures, management agreed to put an additional operator on that bottleneck, so that each operator could take more frequent breaks, keep the darn station running, and take on two hours of overtime each day to clear the line before the start of the next day.

Within a week, there was no more queue, ever. The bottleneck had not been moved down the line either, because those packers were simply kept busy, and delivery trucks were on the road delivering instead of waiting to be loaded.

Customers are getting their orders before the end of the month, along with invoices, closely followed by statements. By next month, the cash flow will have jumped forward by a whole month. And… those tough discussions with customer buyers have been put on hold.

More complicated is that the normal month’s production was completed with a week to spare in the month. the bottleneck has been moved to the front of the whole process. “Where are the sales, fellas? You keep complaining that you struggle to sell because we deliver late.” That problem is solved. “YOU are now the problem. We need to keep our workers busy.”

Oh, and they have ordered another printer, just so that they have some redundancy for when old faithful cocks its toes, or for when the promised sales materialise. The new mixer? Finance for that will be very easy, given our soon to be improved cash reserve.

Apparently the value of the business as a whole has gone up significantly, but we’ll have a better idea of that at the end of the financial year.