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

Archive for May, 2020

Why do they buy businesses?

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“If it looks like you’re overreacting, you’re probably doing the right thing”. – Dr Anthony Fauci

There are always buyers for businesses. Always.

If it weren’t so, there would be no cause for prices to drop. Prices drop because sellers become more desperate and willing to accept lower prices. At those lower asking prices there happen to be buyers for whom the buy-in opportunity is too tantalising to let pass. And so the business changes hands. Willing buyer from a willing seller, etc.

None of that has anything to do with value. The value of the business has little to do with the price at which it changes hands. The seller will not accept less than his perception of value in his circumstances at the time.

Similarly for the buyer. In a time of crisis (like now) everyone wants to hold on to the cash they have. The same applies to buyers. But in crisis times strong buyers have resources to cash and an eye on the future.

Definition: Business value is the sum of all future net cash flows earned from the business, expressed as a present value, adjusted for risk.

A business owner with more cash burn than resources and good prospects:

  • does not know when sales will improve
  • has creditors knocking at the door
  • has frightened staff worried (rightly so) about their next paycheque
  • unable to access funding
  • facing the very real possibility of his company being liquidated in the next 6 months.

When this person applies the the definition of business value to his circumstances, I think we can all agree that the answer is unpalatable – not just to him, but to anyone in that situation.

But current circumstances aside, does the business have no value? Six months back it had great value to the owner. Now the value is limited to what he will salvage in the coming six months? What about

  • the intellectual property in designs and know-how
  • the customer relationships and knowledge
  • machinery installed for purpose
  • the supplier relationships
  • the logistical processes
  • the work in progress
  • trained employees
  • the order book
  • stock on hand
  • loan accounts
  • certification
  • pipeline
  • you?

Is that all to be reduced to the fire-sale value of the machinery and inventory in a market awash with auction stock?

Who buys these businesses?

From time to time periods of consolidation are necessary in economies. This is one of those times. It may turn out to be one of the great defining moments in all our lives. I dare say for the rest of your life, you will remember “Covid19”. Getting beyond the rabbit in the headlights panic will define the rest of your life.

It is what it is. What next?

Let’s look at business value from the perspective of the buyers out there. How can you benefit from their requirements? They have a variety of merger and/or acquisition strategies emanating from those requirements.

Scaling

When two businesses merge, their sales increase. That means more cash receipts. At a slightly more subtle end of the transaction, the sum of operating expenses decreases. So when times are tough and profits are tight or absent, companies get into the same bed to consolidate their shared interests.

You may look here to competitors. Even if the competitor is also in trouble, the economies of scale in overhead and downsizing on less profitable items may well save both companies.

Scope

The vast majority of business valuations I have done over decades show businesses with some sort of seasonal fluctuation. So they all have to make hay while the sun shines, and save for the quiet period every year.

Companies buy or merge others with a view to “smoothing the curve” with products or services which have a reciprocal seasonality. But the products, services, or skills should also be complementary.

Investor companies

These guys buy up individual businesses, perhaps recapitalise and keep everything else working. Their view is to build a “storybook” of individual businesses which can feed off one another for customers, suppliers, knowledge, and skills.

They are already making themselves felt in the current crisis, and they will become rampant soon. They are well funded and motivated to work quickly towards making acquisitions.

They are almost never interested in taking 100% of shares. Instead they prefer to keep the current management on board and help it scale to much greater value.

In recent discussions with a variety of them, I have realised that these are the targets towards which business owners should be aiming for partial and eventual exits from their companies in these times. They offer a vehicle for preserving value for business owners, at the very least.

Beyond that though, choosing the right guys to be shareholders is key.

  • You will want to get a healthy mix of guidance rather than interference.
  • You want their money, but within the ideal financial ratios of your business and the industry.
  • You want to be able to leverage off other businesses in the group.
Enterprise and supplier development

When President Ramaphosa announced the State of Disaster, he made a point which was lost on the greater group of compatriots faced with a deadly threat: the social construct of the country has to change. Clearly we have to move towards a more equitable future. (We will soon see that wealthy people cannot be healthy in a sea of poverty and sickness)

One of the underlying constructs for a more equitable future is the funding targeting at enterprise and supplier development. Big multinational companies and the like are not geared to efficiently doing this. Instead they have tasked specialists with investing in their suppliers to strengthen them.

So it may very well be that struggling business owners preserve value, and are saved by the very necessary drive for transformation which will save the country.

Conclusion

The key to all these strategies is for the sellers to be compensated fairly for their shares. That fair price will guarantee the future of the business relationship with new shareholders, and the future profits of the company.

And therein lies the value to the buyer. The current value of future cash flows discounted for risk. How suite is that?