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

Archive for the ‘Negotiation’ Category

Occam’s Razor

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An investment conference and workshop in the Winelands last week asked a question. “Where are all the deals?”
The deals, we know, are waiting to happen. The problem investors have is in the information they receive.
Investors know that deals are “there”. Their frustration is in the quality of information. Too little information. The wrong information.

Information is often so voluminous. That is as much a problem as a lack of information. It is a lack of the right information. It provides too many variables to consider at a high level.


Occam’s Razor
Simpler solutions are more likely to be correct than complex ones.
The more uncertainties and assumptions, the greater the risk of getting it wrong.


When a potential purchaser first looks at your business, she knows nothing about it. Heck, I know that many purchasers still know very little after their due diligence study! But that’s another story.

So in knowing nothing about the business, she has to make lots of assumptions. This is where your pitch deck comes in. Remove all the uncertainties. Prove your facts. Be succinct. But above all else be informative and accurate as can be.
But more than that… Give her relevant stuff.
It is all in the preparation and presentation.

People are quick to offer income statement summaries with a fast write up and an afternoon Q&A.
The very next step is too great a hurdle for unprepared businesses.

Sometimes the sellers and their brokers hand out mountains of information. Too often, it is the wrong information.

These guys have expensive specialists working for them. They should have the capacity to wade through your audit notes and adjustment accounts. But that is not where their capacity goes. Sure they will need that stuff for later due diligence. But for now, they want some high-level information.

This is what happens behind the scenes. Yours is not the only business the investor is looking at. She can only look at one business at a time. So they all go into a box. The first one to confuse her goes to the bottom of the box. And then the next one. Anything with too much work to get to the meat moves down the pile.

The business with all the information summarised and decipherable in an investment industry format… THAT one will stay open on her desk. Now you just need to make sure it is a compelling investment. But hey! You’re invested in the business, so that should not be a problem.

Your lousy business

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Life is not a matter of holding good cards, but of playing a poor hand well.
Robert Louis Stevenson
(also published on 26 February 2019 by Daily Maverick as its quote of the day)

Your business is as good as you have been able to make it so far. It is a thing of pride to you. It is something worth selling one day.


 


 

But when you sit across a table from a prospective purchaser, she will tell you all about the weaknesses. She will lead with passive-aggressive questions. They will leave you wondering how such a lousy business could be so precious to you.

She has to find a way of suppressing the price of the deal. That is her first step in getting the best return for her investment.

You make your surest profit in the purchase price.
about a million investment advisors on Youtube

Of course, your best deal in selling your business is in maximising your selling price. As they remind us in the many court-room dramas playing out: it is an adversarial process.

So she will tell you how desperately she wants this business. For the lowest price possible. Even if it is quite a kak business. </ironyfont> That pretty much sums up the average business buyer strategy.

Your job is to refute those claims. But if you find yourself offended and angry, things will go wrong. The best way of moving forward is to identify issues and plan responses in advance.

There are some things about your business which could improve. Every business has place for improvement. They are unlikely to improve before the deal. Your purchaser is also unlikely to improve on them post deal. When she sells the same business in a few years, she will be defending the same issues.

The difference in successes will be in preparation, and in playing the cards you have.

Our CSuite subscribers learn about the weaknesses they will face in a sale. Then they learn how to preempt the objections with facts and not emotions.

The lies of agents

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“You have wasted so much of our time”.

It was not true. Worse it was such an obvious untruth, meant to gas light our client. Worse than that even, it was a lie meant to empower and aggrandise the liar. It was meant to cover up the failures of the agent and give him a bit more space with his client.

Some background

We have helped our client build up a significant body of evidence in his business. It has growing sales, even faster-growing profits, and significant cash reserves. The staff complement is small, and the inventory holdings are well under control. The business happens to own the intellectual property of its biggest customers. It is a fantastic business.

An agent for an obvious acquirer has been looking at the business. He has conducted, what we were first told was a due diligence. In reality, it was little more than a stalling shuffle for an asset grab.

When my client refused the first suggestion on a takeover, the suitor asked for another chance. We prepared a bunch of supporting documentation to help him understand the value of what they were looking at. All that information went into the data room.

The second proposal was marginally better than the first. But it was also rejected. My client countered with something which reflected the requirements of the shareholders.

He put his proposal to the suitor who responded with a statement to the effect that he had wasted the time of the agent and his client. That was an interesting thing to say.

Virtual data room

Our client built his value proposition into one of our data rooms over an extended period. All the information necessary to make a decision about whether to acquire the business in one place. It is layered in its accessibility to different grades of interested parties. So a “prospect” has access to less sensitive data than an “investor”, who has less access than an eventual “new owner”.

Permissions can be granted and revoked easily. And when the deal is finally consummated, all the unsuccessful bidders and tyre kickers have no more access to the information. Ever.

So back to the suitor’s agent and the hissy fit. Had my client wasted his time? Actually no. You see, the virtual data room also has a very detailed history of which documents were viewed, at what time, and for how long. All the way down to page level. It also gives information about the level of interaction with the documents. Neither the agent nor his client had accessed the valuation arguments, for a single minute after they asked for a second chance.

The agent had based his bluster about the waste of time on a frustration. His client was unable to grab an asset. He did not want to pay fair value. There’s a lot of that going around. The jibe aimed at making our client feel bad was rubbish. We could prove that to him as he took a much better option.

Divorce or partnership valuations

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When partners split up, there are problems with money and value. Almost always. Oh yes; there was that one time…

This post refers to a dissolving marriage as a model. But the points made, hold for most partnership dissolutions. They are not pleasant, but applying some rules keeps things fair.

Complications arise when married people split their joint estate. If one of the assets includes a business, the recipe is more than “take the white from the egg”.

  1. What is the value of the business?
  2. Where are business proceeds entering each spouse’s pocket?
  3. Open and fair negotiation

1. What is the business value?

The dissolution of any partnership is a transaction itself. It should be accounted for, with a market-related valuation. Business valuation methods start with the company’s financial statements. But the concurrent interrogation of key valuation indicators in the business is critical.

Competent and confident valuers are bold in declaring shortfalls in the discovery. Do not ignore their messages. The valuer will have taken heed of the shortfalls, in arriving at a number. Those noted shortfalls can provide valuable information for later use.

2. Where is each partner currently benefiting?

Every valuation accounts for an element of “normalising” the income statement. This involves removing or adding items which are “out of the ordinary”.
That exercise should also examine what each partner receives before the dissolution, and adjust for what each will receive after the dissolution. Consider adjustments for replacing the partner in day to day work. Understated assets and income, or exaggerated liabilities and expenses mean lower business valuations.

3. Negotiation

A fair negotiation recognises pre partnership equity. The change since then is what you are after.
A fair settlement considers an ex-partner receiving double recovery for a single asset. That would be inequitable.

The most significant asset in a marital estate is often the family business. A fair resolution hinges on an accurate valuation of it. Work with an experienced valuation expert who understands sound valuation concepts. Don’t play the “tarms 20” game.

Buy-sell agreements

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The scenario in many businesses which have two or more shareholders, is that if one of the shareholders is to die, the shares he owns are, through the process of liquidating his estate, handed on to someone else – his heir or heirs.

This might not be to the liking of the other shareholders, so to forestall any unforeseen effects, they agree (while everyone is alive and kicking) that in the event of the death of any of them, the others will buy the shares of the deceased. It is usually a non negotiable item; after all, who really wants “that woman” kicking around in AGMs asking awkward questions, and grinding away at that axe?

The event is insured by way of life policies owned by the other shareholders on the lives of one another. The arrangement is all good and well.

But what amount is insured for? Some training documents for the brokers actually call for using “an arbitrary value” as the business value. Then there are some other arrangements involving lose multiples of various outcomes.

If that seems like a recipe for dispute; well that’s because it often is. Why should Mrs Axe Grinder be paid for her late husband’s shares at a 30% discount to real value? In particular, why should she settle for that when her brother in law is a hotshot attorney who knows the Companies Act, even more particularly, has an intimate understanding of sections 163 and 165? You have probably guessed by now that those sections hold some magic; and they do: They provide all sorts of natural South African remedies for minority and other shareholders who feel they have been treated unfairly.

Conversely, what if the business is not worth quite as much as the life insurance person thinks it is, and the shareholders spend some years betting on a book at too high a price? Sure the money will be paid out, and it may be a very good deal for the deceased’s spouse, but perhaps the surviving shareholders think that it was all a bit rich, particularly when they are all young and fit, and he is fat, flourishing, and somewhat less than fit. They will have had to pay over the top on two accounts – the dead partner’s insurance was more expensive than theirs, and the business is not worth nearly what they have been paying for.

Just a thought…

We have many clients who have their business value reviewed on an annual basis, and in a way which allows for the value of the business to be decided fairly in the event of the mid term death or disability of a shareholder. So there is a defensible way of dealing with annual sales cycles, quiet times and peaks.

If you have partners, shareholders or investors for whom this would make a difference, and want to explore some easy way of making it happen for you, please drop me an email on mark@suitegum.co.za.

 

Best in the west

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There is a lot to be said for the west.

OK, so there is at least something to be said for the west. I grew up on the West Rand, and I still play games there. As stupendous as the discovery of Homo Naledi is concerned, the truth has been exposed: Ultimately we all originated from the West Rand of Gauteng. Yes, even Donald Trump and Jacob Zuma! But not Zwelinzima Vavi. Of course we’ll know for sure in about fifty years when the scientists have stopped arguing with one another about different theories.

“The best in the west” has a nice ring to it – a marketing call from the last century. Beyond the metaphor, it is what we are after. Consumers look for it in their monthly grocery shopping. We argue about the best cell phone signal. We haggle about value in the housing market. It is what business buyers are after.

Given the choice between two businesses, any investor will take the one which offers the best value for his investment Buck. In making that consideration he takes a lot of his own intention into consideration, but (more metaphors) “first impressions count”.

The initial presentation is absolutely key to the consideration he continues to give the prospect.

So it is with some trepidation that any investor will continue to look at businesses which struggle to produce a set of financial statements for the last few years, who take weeks to provide the latest management accounts, and which cannot easily provide details of the owners’ drawings, loan accounts, and other elements of value to the decision making process.

While these unnecessary delays are happening, there are other better prepared businesses out there competing for the same investment Buck. It is a hardy and dedicated investigative investor who will stick around with his decision making until the seller’s accountant comes back from leave, and starts putting the numbers together.

There are easy and well practiced methods of getting acts together, painlessly and in good time.

 

Options yield results

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The first decent size business I sold in this century was at the dawn of the century. It was a wonderful operation; it was priced right, easy to run, a money spinner, recession proof, Rand hedge… all the good things. But the seller really needed to move on in his life. He was living to an emigration timeline.

We’d had several interested buyers traipse through the factory, drink coffee, ask lots of questions, and move on. In our very respectful way, we had been careful to space the potential buyers far apart so that they never ran into one another, and we gave them lots of time to ask questions… Always the same questions. Always the same answers.

Then my seller had to go overseas for ten days. During his time away I arranged to see at my office, as many new potential buyers as possible. For three days I saw one buyer per hour. It would have been murderous if the documentation wasn’t so well prepared. On the fourth day I arranged a factory visit at 4pm, as everyone was knocking off for the weekend. There were close to twenty different potential buyers present.

I addressed them all to the effect that this was a site visit only. I would answer questions to do with processes, markets and opportunities. All financial questions had already been dealt with, and there would certainly be no discussions about price and terms of the sale in such an open forum. These rules were mostly adhered to by all present. We walked through the factory together. They sniffed the air, they ran their toes through the dust, they kicked some tyres.

At the end of the visit, everybody was quite clear that they were not operating in a vacuum as a single buyer. In other words, they all knew that we had options.

The following week I was able to present four offers to my seller. He took a clean deal which gave him about 50% more than he had originally wanted.

If you have options you are likely to have control of situations. If options exist, you as a negotiator can get up from the table and walk away. Options yield results.

Those options begin early in the cycle and continue through it, with options for:

  • Knowing what the value of one’s business is. This knowledge gives options as to what to do to increase value if necessary, put selling plans on the backburner for a while, or in fact selling the business now.
  • Knowing that it is safe to sell a business either as an asset deal or an equity deal, because the legal framework is in place to do either deal.
  • Taking a business to many different potential buyers, willing and able to do a deal. Having only one buyer places unnecessary pressure on a seller to do any deal that offers itself. Buyers know this. Turn the tables.

Getting hoofed in the eggs

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“You are to terminate all discussions with other bidders and engage exclusively with us and our funders to enable us to assess the business in more detail”.

So reads a sentence within a paragraph, within a letter of intent, all dressed up to look like an agreement of sale.

To be fair, the business owner does not sell businesses every day, and the unsolicited approach had come at a time when he had once again started to toy with the idea of a retirement away from the traffic, the staff issues, the currency volatility and the elections.

The clear requirement of the purchaser is to have the beach to himself for a while so that he can install his own fishing nets. If the fish don’t bite, he is happy to let everyone else in to cast their lines. In the meantime the biggest fish may have been driven to the adjacent beach where his cousin has sole fishing rights.

Even if your intention is to sell to this single buyer, you owe it to yourself, your spouse and your kids to be a little more circumspect in giving away sole fishing rights to people who are vague about their intentions.

Nothing keeps a business buyer more honest and focused than the possibility of some competition skipping down the sandy dunes with bait, tackle and a cooler box.

Nothing is more at risk than a basket with all your eggs.

Sometimes having too many metaphors in a single blog entry is beyond the pale.

Trust your professionals

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Peter Carruthers wrote about it many years ago in his book Crashproof Your Business: Apart from much of the information he gave about frustrating creditors, he was particular about the wealth of experience a banker has versus that of a business owner when it comes to negotiating a loan. The banker does this every day, the business owner does it from time to time when he is under severe cash flow stress and will agree to a lot of silly things.

Similarly with selling a business. You will only do this a few times in your life.

  • It is probably not wise to ignore your tax professional who knows what tax laws changed yesterday. Some probably did change because they seem to change almost every day. Tax professionals do this work every day.
  • Using a lawyer is probably a good idea if there are any contracts to be signed. There are contracts. It is probably not a good idea to ask a friend who has been exposed to a few M&A deals for a listed giant to look at it for you. He would have had a team of lawyers covering his back. Lawyers deal with contracts.
  • Listening to your accountant and talking to him about stuff is also probably quite high up there. Accountants work with numbers all the time.
  • Using some sort of intermediary to negotiate the deal for you works well if you choose the right guy. They negotiate deals every day.
  • You continuing to run your business is probably the best thing you can do. None of the professionals mentioned above would dare to tell you how to best manufacture your widget. That’s something you do every day. That’s why you have a decent business for sale.

Why do I write this?

  • I am busy dealing with a divorce attorney who believes he can just as easily peruse and redraft (read: “cock up”) a commercial contract. The rules around conditions precedent are beyond him.
  • I am dealing with a book keeper who believes that he knows how to value businesses. He does not have the first clue. His 30 year old text book from varsity is not a lot of help, and nor is Google. Neither of those sources know a lot about what is happening in South Africa this year as regards buying trends, prices being paid, interest rate movements, developing alternatives and much more.
  • Another book keeper believes she is a tax expert. Something about a course she did five years ago. It may mean the difference between her client paying 13% tax and 34%. That difference alone, in this instance will be enough to pay all the best professionals, and still have a lot of money left over for some fun and games.
  • I am dealing with a jaded senior executive who sometimes gets to have another look at an agreement for his friends, when he gets home at night, and certainly after he has had his quota of Scotch for the night. He has negotiated multi hundred million Rand deals before. This little R5M deal is a walk over. Unfortunately for his friends, it is the only R5M they have. They deserve better treatment. The erratic and conflicting changes he keeps making late at night to their agreement means someone else will buy the business before they do. At least his ego is getting a good rub down.

So I suppose that further than listening to your professionals; choose the right professionals.

 

 

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”.