A market valuation is an expression of the expected offer price in a business sale. It assumes the current prevailing economic conditions and political sentiment. It also assumes an adequate demand from prospective buyers with access to capital.
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The market valuation is also a product of strengths and weaknesses in the business. We call them key valuation indicators. Compare the KVIs to the financial statements to justify the valuation. They must align. Information must be accurate, and available in a standard format. The format is very often not standard. That does not diminish the value.
The valuer must draw on experience, exposure to deals, and insight of negotiations. This skill will inform the calculations and their variables.
The market valuation result is what one can expect the Business to sell for, as it is, where it is. It is neither definitive nor prescriptive. It does not take into account the vagaries of negotiation, greed, fear, and force of character. By definition of the balance sheet at the end of a financial period, valuation is also time-dependent.
The market valuation puts a stick in the ground. Use it to plan your next step. It is key to building wealth in your business. Don’t be the pig around the stick which rests above the coals of business transfer.
You know how you, as the owner of your business, like to be a bit of a control freak?
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Well, one day when you sell your business, you will no longer be in control of some things. As a seller of a business, you will agree that the new owner must obviously be free to take the business where she sees best. For better or for worse. You will lose control.
So She will take control of the overdraft – what a relief.
She will be losing sleep over labour relations and wage negotiations – lol.
She will have to juggle the cash flow at month end – she wanted to be an entrepreneur.
She will have access to your email account – say what?!?
Yip. It’s a thing. You cannot just delete your emails. There is stuff there which belongs to the business. It is stuff which may be – how do we put this – sensitive.
You know when you told your broker about what you thought of the purchaser mid-negotiation? That.
Or when you debated about whether to tell the purchaser about a problem with a customer. Yip.
That string of comments about pushing a price which is already fair. Embarrassing!
Let’s be frank. Things are said. Email exchanges are had.
So right up front. We ask all our clients to create a private email address. They should use it for all correspondence between them and brokers, advisors, and whoever else may be told about what is going on. It is just good practice.
And of course, you probably have a private email address already. So no biggie. Right?
First, you want some assurance that in the future your discussions will not be shared.
Second, you want access to the record of discussions after the sale. Because… Well please just trust me on this. A private email address costs you nothing.
Our CSuite clients know what I am talking about. This is put to bed right up front. About the same time as we put our NDA in place. It is all good practice.
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.
Remember the days when the guys who ran your business were “the directors”? That later changed to “the executives”.
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More recently it is the collection of chiefs. The chief executive officer, the chief financial officer, the chief operations officer. Then we all got to grips with the acronyms associated with them: CEO, CFO, COO, and CTO.
So where the directors sat on the board, the chiefs now all sit in the “C-Suite”. And these are the guys who count when you want to sell your business.
Here is why…
If your business has significant value, then you are unlikely to sell it to an individual. That means that the new owner will be an existing industry player.
On the horizontal, it will be a competitor or a complementary business which will acquire your business as “a bolt on”. On the vertical, it will be by way of selling to a supplier or a customer.
The horizontal buyer gains markets and products. The vertical gains margin for the acquirer.
When you play with your nest egg at this level, you are up against people who do this a lot more than you do. So you may have a CEO, CFO, and a COO on your side. The guys on the other side of the table will have the same TLAs (three letter acronyms), but a few others besides.
The big suitor often has a dedicated officer to deal with you. This will be a specialist in finding and negotiating deals.
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Their CFO could be given the job. Except that those people are often so engrossed in the day to day numbers. They worry about the way in which an acquisition would affect the ratios. The CFO is often one of the people who is more valuable in adjudicating the recommendation. The CEO is also trying to run a business.
In fact the entire C-Suite has to run the business. They owe that duty to the shareholders. It often appoints a non-executive director or a significant shareholder to negotiate acquisitions. But make no mistake… that person will be a specialist.
You will do this very few times in your life. Your opposite number is already prepared. He (she) is up to date on what is what in the acquisition industry. You are about to change your entire life. That is real. Right there.
Let someone who is up to date get you up to speed by joining our CSuiteOnline programme.
Their acquisition officer’s job is to get something valuable for as little as possible and on the best terms possible (for the buyer). The acquisition officer gets to look at lots of possible acquisitions. He can afford to walk away. Nobody ever got fired for not making an acquisition. (OK, there was that one time.)
Who has the stronger hand here?
When you start to push the pace in these negotiations, you weaken your position.
When you are not prepared before the discussions, you weaken your position.
When your pitch obfuscates or is unclear in standard presentation standards, you weaken your position.
When you wait until the imperative to sell is immediate, your position is very weak.
You will lose when your position is weak. By “lose” I mean you will leave a significant amount of money on the table. It won’t even be your table anymore.
Get yourself prepared. Get your business prepared. This does not mean putting your business on the market. It means getting your house in order. It means identifying weaknesses in your business and mitigating them. It means identifying and presenting the stuff that really matters to buyers of businesses.
Long, long ago in a previous century, when a company was for sale, it created a data room as a place for all the due diligence documents. Various suitors sent their accountants, bean counters, attorneys, and commercial spies to look. It was a dodgy affair.
It took the form of an actual room where interested buyers could view all the documents relevant to the target business. Nothing was allowed to leave the room. All participants signed a non-disclosure document.
Then along came fax machines. To save time, people asked for financial statements to be faxed to them. The thermal fax paper would fade, and so would the information.
A little while later the internet arrived. Then people sent all sorts of information in an electronic format, to be stored forever on the recipients’ servers. And nobody thought this was strange. There were clauses in the non-disclosure documents (if they were ever signed) which called for the destruction of all information on demand. I remember that happening once. By deal-time, everybody was just so chuffed that they either had a business or a chunk of cash. In some cases, competitors had some interesting information on the business.
More recently people started sharing dropbox links, and similar accessibilities. And then one day people woke up to the fact that trusted people shared those links with gay abandon. Control could be easily lost.
Enter the virtual data room
A virtual data room gives control of the data back to the owner of the data. He can put information into it in layers, requiring more and more permission to progress. The owner can revoke permission whenever he wants, for whoever he wants.
He can control the sort of access the visitors have. From a curtained view window to a full-screen online view, to full downloadable access, and some steps between. If he sets up his room properly, when he revokes permission, even downloaded documents will become unreadable.
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.
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.
A while back I suggested that business owners should spend less time worrying about their sales turnover, and consider the importance of net profit when apportioning value to their businesses. While that certainly puts us on the right track, it may also lead down a trail of misrepresentation.
The basis for the earlier assertion is that buyers of businesses are looking for a return on investment, and similar businesses with similar sales figures will be differentiated in their value by the bottom line. Nothing wrong with that assertion until we introduce some other variables.
You may recall that both businesses we previously spoke of were in different cities, manufacturing the same goods with the same turnover and similar expenses, but one had a lower cost of sales because it is closer to its principal suppliers. It had an immediate advantage with stronger cash flows, and after paying the same expenses as its counterpart, ended up with more profit. We concluded therefore that the more profitable business would be more valuable, and we are probably correct.
So for the purposes of this discussion, let’s assume that all those variables are equal; the two businesses are very close together and now have the same suppliers at the same prices, and therefore the bottom line is the same for each.
Fixed Asset Value
The variable we will introduce now is in the fixed asset value of the business. One business invested heavily in equipment twenty years ago. At the time the owner was lucky enough to be granted a loan to get up and running, and he bought his equipment very wisely. He concentrated on good German technology, perhaps spending a bit more than he could really afford at the time. But heck, it has been worth it. He has hardly had a breakdown.
Every year he takes his wife to Europe for two weeks where they spend two days justifying the trip by “visiting the factory parts division” where they purchase the dies for the next year, even if last year’s dies were only installed six months ago previously. Having placed the order (which may as well have been done online) they continue on for their annual ski holiday.
A business like this will typically have written off in their books all the machinery except the new delivery vehicle for which they paid cash. So the equipment has very little carrying value and would probably not fetch a very high price on the open market given the new computer controlled wizardry that is available today – the same electronics that makes the replacement value sky high.
On the other hand, Darrel
This business’s neighbour with the similar profit has done things differently: He was never able to get a loan because the government had introduced some social engineering into the mix at the time he got into business, and money was less easy to get hold of for him. So he relied on supplier rental finance to start with, scraping and battling along until things started to happen. With growth he invested wisely in new equipment, replacing and modernizing, and then as the whole factory hit its sales and production straps, he was able to really go to town on the latest and greatest.
He does not have the old workhorse machinery that will never break, but he does not really need to worry about that because he has a good replacement and modernising policy. The machinery is taken apart every year at the annual shut down when agent trained technicians move in, replace, lubricate and provide a new warranty for the next twelve months.
So which business is more valuable? Answers on the back of a R200 note and send to….
This situation immediately takes the “multiplar-bar-twenty” crowd out of the equation as far as providing a reliable valuation is concerned. The first owner would perhaps be grateful, but the second one would be leaving cash on the table, without a doubt.
This is a very simple example, and of course, there are other variables which come into play as well which we will deal with later. When they are all taken together, some interesting dynamics mean that valuing a business is best left to professionals who know what businesses really sell for at the current time, in the current circumstances.
My father – a teacher – would get very upset when anyone suggested: “there are those who can, and then those who teach”.
Business owners should get upset when anyone says: “there are no such things as mergers – only takeovers”
Considered and well-planned mergers can bring advantage to the smaller of the two, as much as to the apparent “acquirer”.
The textbooks refer to “mergers and acquisitions” or “M&A”. In this twitter-fed and instant gratification world, we truncate that to “merger”. We ignore the “acquisition” part of the phrase. For every acquisition, there has to be a “disposal”. Unless it really is a merger. Then all sorts of stuff happen.
When two businesses are merged, it is almost impossible to get to a position where each contributes exactly 50% to the finished deal. So there has to be a trade-off somewhere, for someone. Finding that split is one of the cores to what we do. It is so rewarding to work with motivated business owners looking for a way to make 1 and 2 equal to 4 at the end of the deal, and equal to 5 soon after. The process involves an initial discovery of each business. Working with the executives as they find their way into each others’ beds holds its own excitement.
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.
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.
The sale of a business requires a rental agreement. The sooner you ensure that you have yours in your PYBFS file, the better. Why do I say this? Many business owners do not have this very important document because they have never received a copy.
Think back to the time you signed your first lease. There was a mad rush as you prepared to get the whole show on the road. Then there was a rush into the rental agent or landlord, some last minute reading, and queries. Then you rushed out the door to get the next step in place. You know you signed the document. Somehow the landlord always signs last. They called you later, or more likely you had to make several calls yourself. They told you the agreement had been countersigned. In the excitement of moving in, you never received a copy of the agreement. This holds true for a great many business owners I see. Whatever the circumstances, make sure you have a copy of the lease agreement, and place it in your file. Make a scanned copy and save it to your PYBFS desktop folder.
Lease reductions = higher value
While we’re on the subject of lease agreements: You should take any opportunity to lower your rental. You would be well advised to do so in the tough economic conditions we’re currently wading through. You can renegotiate at the end of a lease term. If you’re a very persuasive character, you may be able to negotiate a lower rental cost midterm.
Every Rand lower your rental, your profit will rise by the same amount. This much is obvious. The value of your business will rise by some multiple of each Rand saved. That extra value will go to your pension fund for its own growth, and so on.
So, how can you persuade your landlord to drop your rent to last year’s amount? Or can you persuade him to forego the annual increase this year? Keep in mind the effect on valuations, and you may find yourself negotiating with a bit more vigour!
Depending on your industry, you may think about negotiating a new lease in advance of selling the business. For instance, a retail store without a lease is no longer a business worth selling. Retail landlords know the value of the lease to their tenants. The landlord must commit to the new owner with a lease on the same terms and conditions as those currently enjoyed by the owner.
Most factories can be moved, albeit with some difficulty, and the move shouldn’t trouble the customers too much. Of course in boom times, suitable factory space can be difficult to find. But then again; are we in boom times?