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

Archive for the ‘Covid19’ Category

Why size matters (part 1)

Does your business fit into the definition of “Small Business”? Or for that matter, “Medium” or “Large” business? The definition varies from one industry group to another. And even within “Trade” it varies from one sub-group to another.

This table shows business sizes as grouped by StatsSA for South African industry sectors.

“Turnover” is the number at the head of your income statement. It does not include “other income” like grants, interest, rent, VAT and the like.

It is the sales turnover of your principal business, excluding VAT.

Those turnover groups have been varied from one industry to the next. My “hot air industries” notation is my slightly quirky reference to a whole bunch of consulting type activities.

The graph below will give you a more aerial view of the way in which sizes relate to one another and across different industries. There is no maximum for “large business”.

‘The one thing this country has taught me, Vaughn,’ said Griessel, ‘things never get as bad as you think they will. And things are never as good as you want them to be.’

Benny Griesel. The Last Hunt by Deon Meyer

So why are small businesses punching above their weight?

In the early stages of a business, the entrepreneur faces the envy of his friends who just don’t have the courage to chuck in the corporate environment and “go on their own”. Or they have to explain their risky behaviour to family members who feel insecure about the lack of “stable income”. But above all, they face their own fears, challenges, impostor syndromes, and bank managers.

Unless they make it big; and quickly, they are to be pitied. And that is also how they are treated when they ask for funding. But then along with the pity comes the distrust.

So to make my small business owner friends happy, here are a few metrics calculated directly from data supplied by StatsSA for 2018.

Just note that these numbers and conclusions drawn exclude banks, insurers, state owned enterprises, and the like.

Better negotiators

Small businesses managed to close off an average of 44% gross profit. The average GP% across all industries in 2018 was 41.5%. Not too shabby for my mates, eh? Gross profit is at the sharp end of running businesses, where the negotiating happens.

The small guys hold out for higher selling prices and convince their suppliers to give them better deals.

Look down the list: small businesses top most industries’ GP% where they have any chance. (There is not much space for negotiation in energy & water supply, mining & quarrying, and transport & communication.)

But for the other industries they do alright!

More working capital

NWC = current assets – current liabilities.

You will recognise that as the liquid assets available to first run the business, and second to build for the future. This you know because all business owners run that calculation last thing at night, first thing in the morning, and several times during the day. I’ve been told!

NWC is the single most useful day-to-day report metric for on-the-go management. If it is positive – you’re good. Negative, and it gets worse with the price of tranquilisers.

But when it comes to using it to compare with other companies it is fairly meaningless. Unless… A small tweak makes it extremely meaningful.

Net working capital ratio (NWCR) = current assets divided by current liabilities.

If the answer is above 1, then immediate liabilities are exceeded by what is available to pay them, now or reasonably soon. If the ratio is below 1, there is a problem now, or just around the corner.

Expressing net working capital as a ratio, we can compare the NWCR of a small business to a medium or large business. And within homogenous industries, these comparisons are very apt.

Any guesses?

For all industries combined in South Africa in 2018, NWCR = 1.15. It is positive. So there is that. But of course, I wouldn’t be writing this if the smaller businesses weren’t in the best shape of all the sizes. Here is the breakdown:

  • Small 1.47
  • Medium 1.36
  • Large 1.07

None of these are great numbers. Analysts like to see the ratio between 1.5 and 2. We’re all a bit tight here, as you may have heard.

But we do know that 1.47 is a lot better than 1.07. That’s small business for you – cashflush!

How does your business match up in each of these metrics? Remember the numbers quoted here are for 2018.

Step by step

  1. You know in which industry your business operates
  2. Place yourself in the appropriate size
  3. Gross profit ratio = gross profit / turnover
  4. Net working capital ratio = current assets / current liabilities

You can be quite sure that for 2020, those results will be very different. But we can only work with what we have, and I’m writing this with a view to showing up how unfair the system can be, and how the so-called “small business rescue packages” are actual, real, common or garden variety BS. And not the balance sheet type of BS.

To be continued…

Assets and equities

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A long long time ago and in a different galaxy, there was only one way to sell a small business. We called it the “asset deal”.

In essence, the company stayed intact. The assets required to run “the business” moved to a new company, replaced in the old with cash.

Assets to run the business:

  • Machinery

  • Vehicles

  • Debtors, creditors, cash (or not)

  • Stock

  • Recipes, procedures,

  • Customer and supplier lists

  • Employees

  • Brands, domains, communications, etc

  • Basically everything needed to carry on what the business does.

Of course, some of it becomes the subject of negotiation. Things like buying cash, excess stock, the owner’s car, bad debts, and so on.

In return, the company, not the owner of the company, receives the cash. For the owner to get it, the company must first pay capital gains tax and then deduct dividends tax. That all gets very expensive.

But the deal was safe for the seller if he had personal sureties in place. The new company with the business in place would have to open all its own accounts with suppliers and banks. There was no risk of the account holders ever coming for their securities.

And safety was important to the purchaser too. What if the company had provided security for the shareholder’s daughter to buy her car? It happened.

Anyway… So here we sit with a shutdown doing a bit more than just threatening every business in the country. CIPC promises to be lenient on directors of insolvent companies. Big hairy deal! The company will still be insolvent.

And that brings us back to the whole asset deal thing. You see, the business is part of the company. And in the current state of disaster with Covid19 and the lock-down fall-down, things are going to get messy for the companies.

A lot of companies are going to get themselves liquidated. That means the company has no value. It does not mean the business has no value. As any small business owner knows; things get done to survive.

Your business can survive without the company

Your business can resurrect itself before, during, or after Easter. And as times improve (and they will) your business will be ready to rock and roll. Yeah, your registration number will change. And you’ll have to open new accounts (so be careful here).

And you must not prefer any creditors over others, so be careful here too. Except perhaps your staff. Look after those guys. You’re gonna need them on the other side.

But you know what? My readers, clients, and friends have been on this journey for too damned long to have their valuable assets taken away because of a bug in the system.

You guys are resourceful. That’s how you got this far. Make it work. The country relies on you, as ungrateful as it may seem most days. 

Too soon for business rescue

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Business Rescue is not covered in the practice note issued by CIPC. Here some things of which you should be aware.

The Companies Act, Section 129 (7):

If the board of a company has reasonable grounds to believe that the company is Financially Distressed, but the board has not adopted a resolution placing the company in business rescue, the board must deliver a written notice to each Affected Person, setting out the criteria referred to in section 128 (1) (f) that are applicable to the company, and its reason for not adopting a resolution contemplated in this section.

Section 128 (1) (a) “Affected Person” means

  • A shareholder of the company
  • A creditor of the company
  • Any registered trade union representing employees of the company
  • Any employees not represented by a registered trade union.

Section 128 (1) (f) “Financially Distressed” means

(i) it appears to be reasonably unlikely that the company will be able to pay all its debts as they become due and payable within the immediately ensuing six months; or

(ii) it appears to be reasonably likely that the company will become insolvent within the immediately ensuing six months.

So what now?

We expect banks to behave in a manner inconsistent with the spirit of the State of Disaster. I have already heard stories, first hand.
Banks and other creditors will use all the leverage they have at the end of this period. And yes, you can always resort to “Covid19 being the reason” for non-payments and so forth.
I am not an attorney. You should give your own friendly legal bloke a call to check on where you stand with force majeure. You may want to talk that through for both debtors and creditors.

And then ask your attorney:

  • Would they use every angle at their disposal to win a case for you?
  • Does that include collecting from your debtors?
  • If the insolvent debtors have not complied with the requirements laid out in the first part of this blog… Will they go after the directors, personally?

Of course, the answers are yes, yes, and yes.

So here we are.

Small businesses all over the world are facing cash flow problems and worse. Goodwill amongst their owners is reasonably healthy right now.
But that isn’t going to last. And if your attorney is going to go after your debtors for you, why won’t your creditors do the same to you? Through their attorneys, of course.
Perhaps while you are on that call with the legal bloke, ask him about completing a CoR123.3.

There are two questions to be answered in the form.

  • The first involves a declaration that the company is reasonably likely to be unable to meet its obligations as they fall due in the next 6 months; and
  • The second involves an explanation which can be loosely summarised as: “The reason is that the world as we know it is busy changing, and the ability to make our usual sales is going down the toilet. But we are confident that once sanity returns we will be able to make profits again.” You may want to rephrase that.

I think your lawyers will tell you that this document will mean that the directors will not be sequestrated on the alter of a company liquidation.
Unless of course, those directors have signed sureties for credit lines. That’s another issue.
But at least the directors will not be declared delinquent through the process.
Just make sure you have it delivered to every single Affected Person as described above. Oh, and make sure you have a meeting of directors and that this decision is properly minuted.
There is also some confusion between the CIPC website which says the document must be filed with it, and the Companies Act and the Companies Regulations which do not say so.

Again, if you’re going to protect yourself properly… Your legal guy… but you know that.

State of business disaster

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On 24 March CIPC issued a “practice note“. It deals with the ramifications of the State of Disaster declared the previous week.
The bits that are important are the following:

  1. In light of the COVID-19 pandemic and the declaration of a national state of disaster [CIPC] will not invoke its powers under section 22 of the Companies Act, in the case of a company which is temporarily insolvent and still carrying on business or trading. This is only applicable where the Commission has reason to believe that the insolvency is due to business conditions, which were caused by the COVID-19 pandemic.
  2. This practice note shall lapse within 60 (sixty) days after the declaration of a national disaster has been lifted.

Section 22 of the Companies Act prohibits a company from trading under insolvent circumstances.

The State of Disaster was declared on 15 March 2020. It is valid for 3 months. The minister can extend it by 1 month at a time. She can also end it at any time.

As of today, 8 April, that means that the “practice note” could be in place until 14 August. That is if there are no extensions to or shortening of the initial state of disaster.
So for the next five months. Or maybe 6 months, or 7…
And then, of course, there will be inevitable delays as things catch up.

Reach your own conclusions. But 6 months seems to be important to me.