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

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Yeah. It’s a real word. I made it up. In the world of covfefe, meandos, and expropriation, perhaps it too, will catch on.

In the merger of two entities, nothing is as simple as just adding two balance sheets together, or assuming that 1 profit plus 3 profits will equal 4 profits.

We feel that the end product of a merger of two entities should look something like this:


It may end up being a bit rough around the edges, but the idea is to create value, at least equal to the sum of its parts soon after the close.

But too often, the idea of making an acquisition is a lot more exciting than the eventual outcome. The result of poor planning and consideration is the destruction of value:


M&A history is littered with grand announcements of mergers “which will be finalised as soon as proper studies have been conducted”. A year later, the deals are called off. In the meantime, both entities have seen the destruction of value. The value of shares have been all over the place. Staff members have started looking for other jobs, worried about their prospects. Competitors are forwarding all manner of rumours around the very businesses which are trying to grow their value.

If yours is a relatively small business, then you have the advantage of being able to plan and plot carefully with the owners of the other business, well in advance of even telling your staff. If it is not going to work, it is not going to work. If you are going to struggle to make it work, at least you can be aware of the difficulties which are coming your way.


Black ownership

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The rush to correct the inequities of the past stalled when the connected got stuck in the trough of excess. The shift in the codes left the little guys lagging, in the interest of ownership. The little guys were slow to start.

But no longer. Now the queues of black investor companies are forming. Longer than a voting queue, and even longer than the line outside a SASSA office. It is time for small business to take advantage of black-owned investment. It is time to keep control.

My client pays R3M every year towards skills development. One would think this would give him the points he needs to do business with the big guys. (He is a biggish guy). This is a big deal. People benefit from this money he invests. He is training people.

But it does not give him enough points. Remarkable.

If he wants to do business with the big guys (who do not have as many points as he does) then he has to become black-owned.

We have worked out a way to do this, on his terms. All legal. Neither smoke nor mirrors.

And here is the thing: he will no longer have to spend R3M every year on training people. But his customers will be happier. They will fall even shorter of his boost in the arm BEE score, with no clear vision of how they will ever match him. But they will have a box ticked.

Vive laBEE!

Of course you have heard of similar stories of madness. First, we kicked the trades into touch by closing the apprenticeship programme. Then we shifted the scope of training to the private sector. Then we encouraged people to become owners of businesses without any training or experience.

The balance of power is shifting in the BEE ownership game. Next up: business owners are able to choose their own partners, in deals to their liking. And as that pendulum swings, the flood of takers for that particular bus is swelling. Soon there will be an oversupply of desirable partners. That will enable current business owners the luxury and strength to choose the best, for one thing; but on their terms as well.

What a time to be alive!

Shareholder register

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Who owns your business?

Who are the owners of your business? I ask this because a surprising number of business owners do not know. Many have forgotten the history of the enterprise. It was once a very convenient relationship. Now it is a muddle. It is easier to get confused about this, and many people do. Here is a scenario:

Some of our clients started out in difficult circumstances. Today’s successful business was not always so calm. He may have founded the business from a position of desperation. A retrenched former employee needed to put food on his table, and clothe his kids.
Having been an employee for years, he ventured out into the small-business world. To call him naive would be accurate. (Yip; it wasn’t only you. And if you weren’t naive, I’m sure you know somebody) The business ran into trouble. Creditors liquidated it. Then his bank sequestrated him. He was not a disciple of Peter Carruthers.

Wiser, and desperate to survive, he started out again. Only this time, he did so from home, without the expense of a landlord. But the second time around there was a small complication in that he had several judgments to his name. We can be so unforgiving of those brave souls who step to the fore. They give effect to the politicians’ platitudes. You know; about small businesses being the cornerstone of our economies.

Our less naive, and now more resourceful entrepreneur, had to make a plan. He approached a friend to stand as a silent partner. That friend would also be the legal frontman of the business.
People do this.

White people fronted for entrepreneurial black people under the old corrupt mob. You know, before the current corrupt mob. Brave or greedy, these white people saw an opportunity. It was an economic reality. Race-based fronting is not new. It was illegal then too.

Some businesses which thrive today, still have the original owners on paper. The friends of the actual businessmen. Owners who never go near the businesses. Owners who have no idea that they own businesses.
This can get tricky at the time of selling the business. And you know, all businesses get sold if they can keep their heads above water long enough. Have I mentioned before that businesses are very valuable retirement assets? Your business might be gold.


  • There are many reasons for, and examples of, legacy shareholders still owning businesses.
  • Husband and wife start out in business together and then get divorced.
  • Siblings take over the business from their parents, without defining duties and expectations.
  • Seed capital partners who themselves have diluted or merged.

This is not an issue for most readers. But you do not know until you look at your share register. Your eventual new owner of the business will want to see it.

Go get it out. And give it some thought.

Consider this

It once was preferable to sell your business out of the company or cc. The asset deal was the safest option for the seller and the buyer. For a developing set of circumstances, it is now better to sell your shares. The equity deal could save about 60% of the tax bill on the transaction in the entrepreneur’s hands. Tax calculations have changed to benefit the shareholder as an individual.

Shareholder agreements may have participation and preemptive requirements. The memorandum of incorporation of your business will define these requirements. If your fellow shareholders are not who you assume them to be, then this could get interesting.

It is better to deal with this stuff now than when you are staring down the boardroom table of a due diligence. Do so before you are dead, dismembered, or comatose. Your heirs will thank you for taking action on this advice. They will write songs about you.

Does your business need an auditor?

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Does your business need to be audited?

  • Perhaps your memorandum of incorporation or shareholder agreement insists on an audit.
  • Perhaps your business is within certain industries which require one.
  • Perhaps your funders require an auditor’s report annually.
  • Or perhaps you believe still, that all companies need to be audited?

If your PIS falls below 350, you do not need to be audited, and you may be wasting a great deal of money on the annual event.

Oh, but perhaps, just because a firm of auditors send an accountant around to your business every year, you believe you are being audited. Perhaps you are simply being reviewed.


Business owners under the bus

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The 2016/17 budget came and went without too much concern from tax payers, given they were all expecting a much harsher tax collection regime. The media in their quest to sell their advertising have concentrated on the effects to their readership because, let’s face it, they need to attract as many interested eyes as possible. I have looked, and seen nothing about how business owners, big or small have been affected. There is nothing I can find, written about how as of now, business owners have become a lot poorer, at the stroke of a pen.

First some history

When capital gains tax (CGT) was introduced in October 2001, there was a lot of panic in the business community about what was perceived to be a crippling tax on the sale of a business. Those fears were reduced to a certain extent by a few apparent concessions from SARS:

  • Businesses could have their businesses valued by a competent authority as at October 2001, which valuation could be used as a base from which the gain would be calculated.
  • Businesses could use their actual acquisition or establishment costs as the base.
  • There was a prorata base for calculating the gain as  well

When the selling event occurred, the business or the owner, could work all three calculations, and use the most beneficial one for his payment of CGT. Crucially, only a portion of the gain was then taxed – 20% for individuals at their marginal rate and 50% for companies at the corporate rate.

That was all good and well. Business owners looked at their valuations, thought about what they could get for their businesses, and realised that the tax payable would be negligible. So they moved on. CGT was relegated from a panic to a mere irritation.

A few years later, business sellers were receiving a bit more on the sale than they had expected, but the CGT tax although payable, was also very bearable.

Something like this: A business selling for R1.2M, with a base rate of R1M, had a gain of R200k. For companies selling the business in an asset deal, the applicable CGT was 50% of R200k = 100k, taxed at 30% (as the corporate rate was then), meant a total CGT of R30K was payable. But for the company owner to get the money into his own pocket, he would have to pay secondary tax on companies of 12.5%. That works out to another R146,250 going to the tax man. The owner walked away with R1,023,750, having paid almost 15% of his selling price to SARS. The CGT implication was dwarfed by, and therefore lost against, the much larger STC.

If the business owner chose rather to sell his shares in the company in the same deal, the tax would have worked out like this: The gain of R200k would have 20% subjected to the CGT, so R40k, and assuming he was at the top tax bracket of 40%, the tax payable would have been R16k or 1.3% of the selling price of the shares.

If the seller was over 55, the first R900k of the gain was not subject to any CGT, and for this example, no tax would be payable.

So why then did business owners not go for the equity deal, rather than the asset deal?

Some essential practical background

In years gone by, business owners were more (how should I put this?) “interested in making profits than doing their paperwork properly”. This left a potential problem of risk in the company (or usually, the close corporation) housing the business. If the owner sold the company as a whole (ie, the shares or equity in the company) the new owner could find himself having to deal with a bunch of skeletons, which often came with crippling price tags. He would then be faced with the prospect of suing an untraceable seller.

So the buyer would prefer to move the assets, the goodwill, the customers, the supplier contracts, the staff, and whatever else as required, into a new company (Newco).

The seller found favour in this arrangement as well, because he knew that almost every bit of paper he had signed on behalf of the company in the past, included a clause tying himself up to the deal in his personal capacity, jointly and severally with the company.

The deal was protected by a clause in the insolvency act – section 34, and some advertising that was done in the press, which nobody ever read.

For many years, that was the way of dong things. I would tell buyers and sellers: “Consider the pros and cons of whether to do the deal as an asset deal or as an equity deal. Then just do the asset deal”. It was the accepted wisdom amongst all professionals in the industry… Despite the extra tax payable. Only in exceptional cases was the equity sale route taken.

Buyers forced sellers to go with the asset deal. Sellers were comfortable with the 15% tax, and took comfort in the protection the structure gave them.

It gave us at Suitegum the idea to launch PrepareYourBusinessForSale™, allowing business owners to take the risk out of the sale of their businesses, gain more value, and save tax. At the same time controlling the inevitable due diligence process, to give greater comfort to the buyer of the business.

Time marches on

Let’s move on by 11 years. You all know about the magic of compound interest –  the greatest force known to man, and all that? Well it turns out that it is not only relevant to interest on interest compounded on your savings bank account.


The same principle holds for other growth indices, most notably felt through the effects of inflation. But even more pertinently to this conversation, the concept holds for the value of businesses. It holds to such an extent that those valuation exercises done in 2001 on businesses which are being sold today, are of almost no consequence at all in reducing the CGT payable.

If your business is older than 15 years, chances are that shareholders have changed in that time, making calculations awkward, the original base value number is useless in mitigating the effect, and your business value has grown enormously.

So I am going to do what most people do, and base the rest of this on the single selling price. Your accountants and tax professionals can tidy up the bits and bobs for you.

Along came a bus

Our small (and not so small) business owners – you know the cornerstone of employment opportunities in South Africa – merrily went about their business of keeping their heads above water, and helping the economy on the way.

But then a bus appeared out of nowhere.

In 2012 a change was made to two taxes; you guessed it, CGT was one, but the other one was dividends tax.

  • The gain subject to CGT was moved from 20% to 33.3% for individuals
  • More importantly, for companies, the rate moved from 50% to 66%
  • The old secondary tax on companies was replaced with dividends tax, and the rate was pegged at 15%
  • Let’s not ignore the effects of geometrical growth in business values

Back to our business which was valued at R1M in 2001. By 2012, this business was quite likely worth R10M.

An individual selling his shares for R10M would have his gain of R9M having 33% or R3M taxed at 40%, so would have to pay CGT of R1.20M, or 12% of the selling price. That is quite a difference from the previous 1.3%!

Pity the guy who sold his business in an asset deal: R9M gain having 66% or R5.9M taxed at 28% or R1.7M. His company would be left with 8.3M. To get that into his own hands, he would have to declare a dividend, and pay that tax. So he would have a little south of R7.1M to take home to his long suffering life partner. That is total tax of 29%, which is significantly higher than the guy selling his shares.

At that point we had the attention of those who thought about spending a small amount each month to get their businesses prepared properly for their eventual exits! And PrepareYourBusinessForSale™ started to make a difference.

The bus is reversing

That bus which did such a good job of wiping out a chunk of the small business owner’s well earned wealth?

Well it has now been put into reverse. Not, you understand, to undo the damage previously done, but rather, to finish off the job!

Look at what has happened in the 2016/17 budget.

  • Dividends tax has remained the same, thankfully.
  • CGT on companies has been increased to affect 80% of the gain.
  • CGT on individuals has been increased to 40% of the gain.
  • Business values have grown significantly, only because of the hard work of their owners (mostly).

Our old friend, the business which was valued at R1M way back in 2001, is now worth R15M. Well, because that’s the way the compounding geometrical growth curve rolls.

For the asset deal… A gain of R14M… 80% of this is R11.2M. Taxed at 28% is R3.1M, leaves R11.9M. After dividends tax, the owner can walk off with R10.1M. So a total of R4.9M is paid in tax. That is 33%. Thank you for playing!

For the “more risky” equity deal… The owner of the company sells his shares for R15M, with a gain of R14M, 40% of which is subject to CGT (R5.6M) at 40%, making R2.2M payable to the treasury (15% of the selling price).

What could you do with an extra R2.7M in your pocket?


There is another benefit to the equity deal for a shareholder older than 55: The first R1.8M is now not subject to CGT. That relief is not available for the asset deal.

The point is

The point is that CGT was introduced to us in a fundamentally innocuous manner, with a cynical eye on where it would take us in the future. The future has arrived. Please don’t suggest that there is no wealth tax in South Africa. It is right there.

For companies selling businesses, the rate has moved from something which was hardly worth talking about, to something which is quite astounding, given that for the business to have reached this sort of valuation, it had to spend years paying lots of taxes already. Thank you for that. Those retiring shareholders who get all their money out… I hope you spend it before you die, because if you don’t you’ll be posthumously handing a lot more over to SARS.

For individuals selling their shares, things look a lot less generous to Mr Gordhan, or whoever happens to be minister of finance by the time you read this. But that approach has its risks for both buyer and seller. The good news is that the PrepareYourBusinessForSale™ program mitigates that risk for both sides, and for a fraction of the extra tax you would pay otherwise.

The imperative, ladies and gentlemen, is to sell your business by way of an equity deal. That means you sell your shares with the balance sheet intact. There are some other interesting tax advantages to this approach which you may want to investigate with us, once you have signed up for the PrepareYourBusinessForSale™ preparation.

Some salt for those wounds, Sir?

To add insult to injury… If you want to keep up your BEE score card at its current level, the new codes dictate that there’s a small requirement in that you may have to sell a bunch of shares, and pay CGT on the gain, following the sale of those shares. Oh how they like milking this particular cow!

Heads up everybody: I am not a tax professional. Every single business is different. In our PrepareYourBusinessForSale™ program, participants’ accountants and tax practitioners are engaged with closely, in determining an appropriate strategy for each participant, because there is no “one size fits all” solution. The examples used here are for illustrative purposes only.

Sad realities

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So far this year I have come across three sad stories of exit plans going wrong.

And I am so sorry that the story is yet to be written, and that you have clicked here before it is ready for publication.

My emailer went out a full two days too early. Nobody’s fault except mine.

If you are on my email list you will get notification as soon as it is ready.


Through their eyes

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Within the paradigm of always being ready; I as not!

The email link you have probably clicked on to get here was sent out in error. and way too early.

It will be ready in the next few days, and I will notify you again.

Sorry for the inconvenience.

{Note to self…. NEVER allow a newsletter to go out at 6am on a Monday again. What was I thinking?}

Oh wait… I was not thinking.

Redundancy Standard – Bank on this

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One thing that is certain to give you grey hairs at some stage in your business owning life, is the concept of redundancy. If, when things hit fans, you are able to move easily to an alternative supplier or resource, you will have an edge over your competitors, and still be able to deliver to your customers. With minor glitches perhaps, you will be able to maintain your profitability, and hence your business’ value.

I maintain several prepaid SIM cards from different carriers in order to be able to buy some data quickly, in need. In the last year that policy has helped me several times as my primary operator has thrown a fit, or I have found myself at a meeting or conference with poor coverage for my principal carrier.

If your business has only one supplier of a primary service or product, your bank will take a dim view of the business value and risk profile. Particularly if that single supplier can screw up the first day of spring for you. As I originally wrote this, a Standard Bank executive was claiming that everything was back to normal. It was not. “If I can be honest with you….” (like they aren’t always). “We truly apologise… ” (because it’s not always truthful).

Why do we insist on having all our funds and facilities in one bank?

The problem stems from the banks themselves who insist on certain “covenants” if your business has any sort of credit facility with them. Some of those covenants created potential value problems for Standard Bank customers when their electronic banking facilities collapsed for the first few days of September 2014.

So the week 36 little debacle serves to highlight in an inconvenient way how we can fall foul of the very covenants which our various banks insist on, in order to safeguard them.

Try negotiate yourself into a space where you are able to have more than one supplier, including your banking supplier. Just so that if something desperately needs to be paid on the first day of spring, you are able to pay it or (better) receive it.

I have bounced this idea off several clients, friends and banks over the last two weeks. Here are the problems:

  • Your banking covenants forbid you doing so, particularly if you run any sort of credit facilities with the bank
  • There is only so much money to go round
  • You’ve already burned all your bridges at other banks
  • You just couldn’t be bothered

I don’t think any of those are insurmountable. Just do it. We are South Africans. We make plans.

Twitchy buyers

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Professional sellers of various products and services use a number of passive and active hard sell tactics to persuade buyers to part with their money, and even put up the price after the fact:

  • “That offer is only available until close of business today”
  • “This is the last one we have in stock, and we don’t know when the next orders arrive”
  • “Calling Mr Otis”*
  • “We have three other buyers”
  • “While stocks last”
  • And many more

So a few weeks ago I wrote here about the high prices for which tech companies tend to be sold. A précis: Twitch is a company which provides live views of gamers’ screens to people that are interested in such things. Google was a talking a $1B deal. I asked about the price of a company that was making no money, and provided some suggestions as to why it would be sold so high.

Suddenly, enter stage left: Amazon, paying $970M cash for the business. It appears that Google may have walked away to avoid anti trust investigations. Perhaps Google was only prepared to pay with their own sky high stock in overcooked shareprice markets.

Whichever way, Amazon blinked because it really needs more revenue (and is ditching Google adverts from its own site in favour of Amazon’s own brand of click through advertising.)

In the new paradigm which Google, Apple, Microsoft and Amazon have created, there will be many more similar deals in the future, as they all seek to either position themselves in line or ahead of the others, or try to take potential competitors out of the mix.

With respect Dear Reader, I suggest that your business is probably not worth this sort of money. But the underlying principles are similar when it comes to selling it one day:

  1. You need to have options
  2. You need to create competition between prospective buyers
  3. You need to know what the realistic value of your business is
  4. You need to understand your buyers’ motivation
  5. You need to be able to negotiate without blinking (or twitching)

Understand the thinking of the business buyers, and your eventual buyer may start the process on the backfoot, without even knowing it. Preparing your business well in advance for the eventual deal will nail the deal down.


* “Mr Otis” was a technique used by motor car salesmen in the USA. A now relaxed buyer would settle back in his chair after signing the papers to trade in his old car. He would mention that the next best trade in offer was substantially lower (by $2,000, say). The salesman would wait a minute or so, shuffle the papers, look for his stapler, then say: “We just need to get this signed off by Mr Otis”. He would call his manager on the phone, and say: “Mr Otis, won’t you please come down and meet Mr Buyer?” Being called “Mr Otis” was the manager’s cue for objecting to the offer on the trade in. Of course by that time the buyer was so emotionally invested in the deal, that he could never back out, and he would quickly agree to the lower trade in value. – Lesson 25 in Harvey Mackay’s Swim With The Sharks Without Being Eaten Alive.

Margins and mark-ups

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Some confusion is doing the rounds again. Mark-ups and gross margins are mathematically tied to one another, but they are not the same thing. Business owners are generally entrepreneurs, not accountants or mathematicians.

When I ask a business owner what his GP is, it means “what is your gross profit percentage?” The question in its original and colloquial form is deficient in that it leaves out the crucial “percentage” word, but it is never the less a common form of enquiry.

When the business owner responds brashly with “Oh it’s 300%”, he stoops to my level of sloppiness in his understanding because you simply cannot have something which is three times itself. But I understand what he means, which is really: “My mark-up is 300%”.

I know what he means, so we move on. Here is why:

  1. When you pay 100 ZARs for something and sell it for 200, your mark-up is 100%. If you sell the same article for 300 ZARs, your mark-up is 200%. In the initial exchange with our business owner, what he clearly meant was that if his raws cost him 100 to acquire and increase in value and he sells them for 400.
  2. 300% is not his margin; it is his mark-up. His margin is 75%. 25% is his cost of sale (or cost of production). Slowly:
    • He sells for 400 ZARs (100%)
    • To get it ready for market costs 100 ZARs (25% of 400)
    • The gross profit he makes on the sale is 300 ZARs (75% of 400)
    • His selling price will always total 100% (25% plus 75%)
    • If he manages to lower his production cost by say 5 ZARs to 20, but keep his selling price at 400, his cost of production is 20%, and his gross margin is now 80% (20% +80% = 100%) His new mark-up is 400%.

This is why it is important to understand the relationship between the two. Where we talk about large mark-ups of 100% or more, the mistake can be glossed over without any risk to buyer, seller or broker, because it can only ever mean mark-up. But when the mark-up is less than 100%, we have the potential for damage.

Let’s say that a mark-up percentage is 75%. This means that for 100 ZARs of product cost, the business would add 75% of the production cost onto its cost, and sell for 175. The cost of production is therefore 100 divided by 175 as a percentage, which is 57.14%. The margin is now 100% minus 57.14% which is 42.86%.

Getting 75% and 42% mixed up is a potential drama.

Imagine a purchaser asks about gross margin % (gross profit %, GP%, or just plain “GP”). The seller tells him that it is 75% when it is really 42%, causing the purchaser to get excited, put his funds on standby, mobilise his auditors for a due diligence, and consult his attorneys about drafting an offer to purchase.

OK, so generally the damage is a lot less dire, and a good intermediary should sort out the confusion ahead of time. But what about this:

Your mate has just sold his almost identical business to yours, except that he tells you that his margin is 75% when it is really 42%. First you kick yourself for either charging your customers so little, or paying too much for your production, and then with great frustration, you start to make changes to match your friend’s metrics.
Understanding the difference, and understanding that others may perhaps be honestly mistaken is simple, but prudent.