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

Posts Tagged ‘sell a business’

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?

Statues must fall

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Agreements are agreements. “But you agreed”. “Let’s look at the agreement”. “We have it in writing”.

Businesses are sold on a daily basis; here in South Africa and around the world. For the most part those agreements are reduced to writing, with much hither and thither to sort out and negotiate the small print. Eventually the bottom line is reduced to the seller worrying about receiving the money promised, and the purchaser being satisfied that he is not buying a lemon – the fruit of an elaborate scam.

Generally amongst much nervousness, the deal is done.

The early 90s were momentous years for South Africa. (Bear with me here, please) As negotiations progressed, demonstrations and lawlessness continued. Free trade sound bytes were born and done to death: “AK47 wielding gunmen”, “levelling the playing fields”, “nothing is set in stone”.

“Nothing is set in stone” has had special meaning for one of our clients recently. Some background:

  • Kiyosaki wrote about a business only being a business if it could run itself without the intervention of the owner
  • Gerber wrote about having a franchise type operations manual, so the business could be run without the owner
  • Carpenter wrote about the joy of systemising absolutely everything
  • Marrillow finally put them all together in a series of “Ted’s tips”.

The common theme for all these gurus is simply; if the business cannot be run without the owner, then it is at best a self employment vehicle.

With that in mind, and the establishment of another business, our client had made sure that the target business was going to be run by professionals. He had one of the best men in the industry working for him, and everything ran smoothly with little more than a brief weekly meeting to take the blood pressure, pulse and temperature of the operation.

Mindful of the fact that one day he may want to sell the business, he entered into an agreement with the general manager that should this ever occur, the GM would receive 20% of the proceeds of the sale. This was reduced to writing, and confirmed by the trustees of the holding trust. All set in stone, one might think.

Several years later, an opportunity arose to sell the business, and we were retained to help negotiate the deal. I initially met with the owner and the GM. As usual, the issues which we anticipated would materialise during the course of negotiations were aired. Chief amongst them was the question of managerial and specialist continuity, post deal. The GM was fully supportive of an exit for the owner, but was not interested in acquiring the business for himself.

And so on we went. Several interested parties, some investigations, and the expected fading of prospective buyers before the eventual buyer arrived at the negotiating table, with some serious intent.

Through that process the price was edged upwards in a few leaps until an amount was agreed. There followed a due diligence, followed by a clanger. The buyer had discovered a flaw in the accounting involving a single customer paying three years in advance, against which the business would have to deliver under the ownership of the buyer, with obvious profit implications. A straight forward, honest mistake, and a product of Ted’s Tip #5 in Built to Sell.

Quite agreeably, a new price was struck subject to the same requirements about the GM agreeing to stay on for at least a year… Which is where the wheels almost came off. The original price agreed had set in the mind of the GM, a 20% share quantum. It was this amount which he had taken to his family over Christmas. It became a fixation amount. So there was no chance that he was ever going to accept 20% of a lower amount. He dug his heels in.

“Mark, you need to understand that without me that business is worth nothing. Now either I get {fixation amount} or I walk.”

The seller was over a very uncomfortable barrel at that point. He had to either give up on his sale, or pay the difference to the GM. Of course we could have played a game of poker for a while, but generally at this sharp end of the game most sellers have had enough. So it proved to be. He paid significantly more than the originally anticipated 20% amount to the GM.

Interestingly, the new owners of the business were fully apprised of all these developments, and so they know what they are up against in the GM, going forward.

So while the undertaking from the shareholder of the company to the GM had been “set in stone” in the mind of the seller, in the final push the GM had no respect for this, and instead chose to insist on something outside the agreement which he knew he could achieve.

Where did our client go wrong? He had a single proxy for himself in the business, handling absolutely everything in his stead. That is almost as weak as a one man owner operation. One of the questions we ask in 0ur valuation of businesses, has to do with the cover of all key personnel, beyond the owner. It is better to be able to go away on holiday at will, leaving the company in the hands of “others”, rather than in the hands of “an other”.

So back to my early paragraph:

South Africa still has AK47 wielding gunmen. Disappointingly, it still has very much unlevel playing fields. While the Constitution of the Republic of South Africa may have come about as a result of a negotiated settlement, “nothing is cast in stone”. We have a president in Jacob Zuma who regularly espouses opinions and plans in direct contradiction of the constitution and the law. Sometimes he is beaten back by “clever blacks” and others. Not always.

Nothing is cast in stone. All statues can fall.