The Train Trip

On a recent train trip I got talking with a fellow passenger.

After the usual introduction, her name was Conchita, she asked me: “I would like to sell my current business and then buy a new one, that is better suited to my interests.  But how do I value my business?

“ Well” I responded,” good question indeed. The answer torments business sellers and buyers for some time. There isn’t one precise method that establishes a valuation beyond argument.”

Company Value

“Conchita, “ I said “the value of a company can vary greatly. Depending on the respective viewpoint of the parties involved.”

Conchita kept persisting: “ok, understood, but how easy (or complicated) is it to estimate the true value of a business?”

Company Valuation Reasons

A company valuation can have different purposes. The most common one are:

  • purchase and sale of a company due to retirement or health reasons
  • attracting new investors, eg for expansion
  • takeover or merger
  • adding or changing shareholders
  • compulsory part calculations in inheritance division

Value not equal Selling Priceprice value diagram

The company valuation serves as a basis for decision-making for both:

  • the Seller (which maximum amount can I demand?)
  • the Purchaser  (which minimum amount should I offer?)

In my experience, Seller and Purchaser are generally colliding with their respective views between the value of a company and its (selling) price.

  • As with every commodity, the price is determined supply and demand.
  • A starting point for negotiating the sale or the takeover price.
  • Both parties should (ideally target) a company value that is as realistic as possible.

Many Valuation Methods

There are many valuation methods. Most can lead to different results. There is no binding method. 

I said to Conchita: “Choose the method that best suits the size of the company. Your capital and asset structure as well as your specific industry.  Then test the result with at least two methods.”

Typically, Seller and Purchaser regard the financial side from different angles.

Seller is…

  • often emotionally connected to their company and
  • most of the time their evaluation is based on the past.

Purchaser…

  • approach the valuation more rationally and
  • are interested in the growth potential
  • ultimately, they want to pay as little as possible.

Overvaluation

It is not uncommon for the seller, and also their consultant or accountant, not to know how to determine a realistic price for the company.

In the case of an overvaluation, there is a risk that the seller party will ‘overplay its hand’. The search for potential purchasers interest or indeed the subsequent negotiations could be at risk or fail completely.

Non-operating factors influence pricing

Although the company value is ideally determined according to objective criteria, other factors are often decisive for price determination. These can be:

  • Personal influence of the current owner in his/her company
  • Anticipated (but not realized) sales and profit development
  • Degree of innovation of products or services (niche)
  • Size of the company and competence of the internal organization
  • Strength or presence of Competition
  • Number of takeover offers and purchasing candidates
  • Age of successor
  • Financial and family situation of both parties

More than just A Selling Price (just like the song ‘It’s more than a feeling?’)

I said to Conchita: “Involve your banking partner in the valuation. 
The value of your company is also a reflection of the company’s creditworthiness.
Which in turn leads to favorable credit rating and favorable credit conditions such as interest rates.”

Several methods are available for determining the company value. For simplification  I am just listing the following:

The Asset Value Method
net asset diagram

 

 

 

 

 

 

 

 

 

 

 

Is the most commonly used valuation method. It determines the Net Assets= Owners Equity.

Pro:

  • Relative easy to carry out
  • Based on current data that can be accessed easily

Contra:

  • Purely based on current information
  • Disregards external factors, eg economic environment
  • Does not take into account future growth (potential)

Discounted Cash Flow Analysis (DCF)

The DCF analysis is one the most thorough method to value a company.
This method is used to calculate the value of a company from the discounting of future cash flows.

Pro:

  • High degree of recognition internationally
  • Used by most financial practitioners
  • Based on future data

Contra:

  • Involves some guesswork of future cash flows
  • Requires Excel and Financial Analysis skills

Pimping your Business

I don’t know what you, the reader, would recommend to Conchita.

My final comments, before I disembarked at the Hauptbahnhof: “Conchita, keep in mind that getting a company ready for sale or indeed its valuation is not a straight forward thing. 

The price which an investor would be willing to pay for your company’s equity depends on supply and demand. And also a number of Emotional Factors.”

The Author

Markus is a Financial Professional, specialising in Process Improvement and Financial Reporting.

 

 

 

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 “The higher a monkey climbs the more you see of its backside.”
 Attributed to US General J Stilwell
monkey-butt

I am sick and tired of seeing the vanishing monkey’s backside. Not that a monkey’s hindside bears a particular appeal.

It’s a good metaphor – companies continue to watch their growth potential disappearing.

It’s tough out there in the market. Business owners fighting on multiple fronts: cash flow, demanding customers, social media marketing, innovation. Any military commander will tell us fighting multiple fronts is not a good option if one wants to succeed.

 

Yet business growth remains the measure of for most companies. Apple Inc just announced the first drop in revenue since 2003. It appears, not even the mightiest are prone against a drop in growth.

I want to highlight 3 points that are fundamental to business growth – in fact they are very obvious:

1 Growth for self-preservation
Companies exist to make a profit. A profit ensures existence tomorrow. This means to compete better than their competitors. Be better, faster, smarter.

Like any living being, companies have a self-preservation instinct – it must grow and adapt to survive.

2 Growth driving increased profitability
In principle, jumping on the growth wagon means applying economies of scale.

Again, Apple Inc designed this to perfection. Higher iPhone revenue meant lower manufacturing costs on a massive scale and thus delivered increased net profit.  Now iPhone revenue has dropped by 10 million units (compared to last year). Reverberations on the stock market are afoot.

3 Growth – a tough ask for many
Whilst we most of the time hear and read the success stories in the business world, there are a lot businesses out there that are doing it tough, real tough.

However, there is light on the horizon:

Changing the source of Growth

Growth 2009 to 2015

Companies seem to invest more (% to revenue) into R&D (including buying technical knowledge or information abroad) nowadays and focus less on broad-brush marketing.

Six years ago, companies R&D share was 37%, last year it was 52% – it appears that more work is being done to produce high quality products.

In sum: Most businesses have to fight ‘tooth and nail’ to keep growing. I generally advise my clients to grow slowly, use the learning curve to get better at what they already doing. Consolidate the core value proposition, and then expand. Doing the homework via R&D.

Need help with growing your business
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Yes, Bad Cash Flow is killing businesses worldwide – merciless and taking no prisoners.

Business failures chartBusiness studies identified poor cash flow as the main reason for businesses to fail.

80-90% of small businesses fall victim to bad cash flow.  It wrings the lifeblood out of most businesses. Start-up or established business. Many fall victim to this (avoidable) malaise.

Some say it an Art to balance your cash going out with the amount of cash coming in.  Well, it is not.

 

 

Why is this business killer so prolific?
It happens for TWO REASONS:

First. Businesses run out of money because they struggle to find a viable business model.
Simply, the business does not make enough money. Not generating sufficient revenue.

Second. Businesses run out of money because they don’t plan their cash flows.

Cash-flow-forecasting
Cash flow forecasting is the elixir to business survival. Essential like breathing for humans.
I am a strong believer in a rolling 12 months cash flow forecast. Perhaps even 18-24 months. And I still have a preference using the old Excel spreadsheet method.
Why?
Because it forces one to think and manually enter every possible future transaction: revenue, expense, tax.

Simple is Best
Don’t get fancy. Keep it simple and meaningful to You. Itemise revenue, expenses and tax. Be conservative and start thinking how revenue, expenses and tax will fall in future. Do use history as a base but don’t rely too much on it.

Review, review, review
Because cash flow forecasting is so vital go over it again, and again. Test assumptions and review with someone you trust: Mentor, another business manager, your accountant or bank manger. 

Don’t be upset if someone points out flaws in your forecast.

Surplus or Deficit diagrammeDecision points
Cash flow forecasting assists the business in which months you can expect to see a cash deficit, and which months you can expect a surplus.

More importantly, you’ll also get an idea of how much cash your business is going to require over the next year or so to survive.

Cash flow forecasting is also useful for decision regarding the next capital project. Growing usually requires investment.

Benefit of cash flow forecasting
I always expel a sigh of relief if a client of mine show me their cash flow. Then I know they have a basis for getting stuck in and improve their business to another level.

(Good) cash flow planning ensures survival of the business. It also puts the business in good stead with attracting investment or joint venture partners.

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Trickle down effect

Māori in Business
Māori (indigenous) economic development for me is an overall indicator how well we are doing in New Zealand.  
I am not Māori nor an expert on Māori Businesses.
However, I have worked with Māori and Pacific Islanders on developing basic business skills at the ‘coal face’.
I can only offer simple observations, having lived and worked in New Zealand for the last 30 years.

 

Trickle-Down-Effect
Trickle down economics is a term used to describe the belief that if high income earners gain an increase in salary, then everyone in the economy will benefit as their increased income and wealth filter through to all sections in society.
Well, looking around, particularly in Northland, New Zealand, I have not seen a lot of evidence of the trickle-down impact.

Māori authorities – Indicative for Business Success?
Within the New Zealand economy Māori businesses include Māori authorities, small- and medium enterprises, and Māori-in-business (self-employed).

Total income for Māori authorities increased $430m in 2012 to $2.9bn in 2013.*
This is a massive increase.

The following graphs look at the growth of Māori Authorities
and how many jobs were created:

Māori Authorities (units) – Indicator for Success?

Maori Authorities growth
Maori Authorities growth (units)

 

 

 

 

 

Total business growth in New Zealand
Total business growth in New Zealand (units)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3 Reasons for Failure
The below reasons are based on my personal observation:

1. Lack of basic Business Skills
Basic business skills are quite often not present – either not been taught or people are reluctant to embrace.
2. Insufficient ongoing Support
Some polytechnics churn out graduates in business but its lacking a proper support network to sustain enthusiasm.
3. Failure to Understand Market and Customers
This is tricky at the best of times – requires the ability to do in-depth research which is quite often beyond people’s capability.

3 Ways to Ensure Success – and to fly like an eagle

1. Essential Business Skills
* Equip people with the basic business skills such as budgeting, cost control and marketing tools.

* I have seen huge development in people once the basic concepts were understood. Sure, some people will embrace it more than others, but once the confidence is built, people move into the ‘business zone’ with more ease than I ever expected.
* The training needs to be ‘hands-on’ right from the start – some could be linked to NZQA unit standards but it’s not vital.

2. Ongoing Support
This is a critical part in the development of business skills because there will be set-backs – some will be painful.
* Therefore a good support network of people with different business skills sets is critical to sustain the effort.
* Ideally an on-going mentoring programme that may include other core skills such communication, how-to research and social media profiling.
* Have a checks & balance system in place that helps people new to business and their mentors objectively check on progress.
* With providing on-going support the commitment (and confidence) will grow – and in turn create a positive outlook.

3. Embed in Local Community
Any Māori (indigenous) or non- Māori business venture needs to be embedded into the local community infrastructure including the local Chamber of Commerce, existing community groups and local business mentors.
*  Develop hand-in-hand partnerships at local level
*  Apply Best Practice methods – use what works
*  Generate local led employment, particularly for Youth

Running a business in isolation is not a good thing.

Do the 3 key areas really ensure success?
Yes, they certainly will go a long way to achieve more favourable results – whilst we hold on for the long-awaited Trickle-Down-Effect:
* Essential Business Skills
* Ongoing Support
* Embed in Local Community
I have seen it seen it first-hand: people looking after budgets, doing research how to reduce costs and teaching others – passing on essential skills.

Contact me for help in your business

 

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money 1Most Small Medium Enterprises (SME’s) face tough choices on how-to-grow:

Keep ticking over and consolidate the current business.
But be limited by own funding access.

2 Seek investors to grow into new markets, develop new products and services.

Seeking and accepting investors, means ‘giving up’ control.

This may be hard to accept for business owners.

On the other hand a pro-active investor may bring highly sought after expertise into the business.
This decision point is a tricky one for business owners.

I’d recommend the following 5-steps before embarking on finding investors:

1 Set goals
What is your ambition? Are you prepared to relinquish some control?
I have worked with businesses that sought investors but were not quite clear why they were considering getting investors on board.

To fix negative cash-flows or reducing debt may not be the best motivation to engage investors.

Set 2-3 main goals on why you want to get investors on board, e.g. do you want to set up business in a different location because you believe (and can show) that you can create value with your unique business proposition?

2 Clear strategy
Position your business clearly by naming your 3 key strategies going forward based on your performance to date.

The investor of today does not profit from yesterday’s growth  W. Buffet

State what was achieved so far and what the future holds:

  • point out the growth potential
  • support this with research
  • and a suggested marketing strategy

This ensures that potential investor can verify that you have thought about the future. It is vital to convey confidence in your value position. This in turn provides potential investors with a real level of comfort.

3 Getting ready
‘Getting ready’ is often underestimated. Meaning to get your internal processes in order:

  • fully understand your internal activity chain
  • streamline your financial reporting
  • fine tune your business dashboard (if you use one)
  • and your personnel management

Once a potential investor is showing interest in your proposition, you want to put your ‘best foot forward’. Demonstrate that the to date performance is no fluke. Your business processes are sound.
Sure they can be improved but they are good enough for now.

The better prepared you are the more confident the investor will be about you and the business opportunity.

4 Value
Price is what you pay. Value is what you get W. Buffet

Be realistic when you value your business – There are many approaches in establishing an accurate valuation for your business. Finding the best method for your business will provide you with the best measure of value.

5 Passion
Add passion to your investment proposal. You have done the foundation work. Now you’re into marketing mode.
Stay away from clichés such as ‘unique opportunity’ and ‘once in a life time…” etc., bring your own flavour or secret sauce into it.

Convey the energy that made you set up the business in the first place.

Include the sacrifice, the struggle, the joy and the commitment. And of course the future opportunities.


Tip: Have an exit door
Always leave the exit door ajar. An investor will jump on the wagon (or jump off).
Consider you own future in the business. Perhaps you wish to reap the benefits of your
hard work and increase your personal liquidity. Or you would like to retain a minority interest as a shareholder and hand over the management.

Contact me for a FREE Consultation

 

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ffjyjgie6zvttpqGrowth is the measure of all things for most, if not all companies – I hardly know a company that wants to pursue a shrinking strategy.

More market share, more sales, increased profit are the common targets.

But why is it like that? Why is that not enough that has been achieved? Why must it always be bigger?

1 Growth as self-preservation

Companies exist to make a profit, so they can continue to exist tomorrow. They can only do that if they compete better than their competitors – this implies: be better, faster, bigger, more profitable than the competitors. Like any living being a company has a self-preservation instinct – it must grow and adapt to survive.

“In this country you have to run as fast as you can to stay in the same place. And if you want to go somewhere else, then you must run at least twice as fast.”
(Lewis Carroll, Alice in Wonderland)

2 Growth driving increased profitability

In principle growth leads to economies of scale and smoothens the learning curve thus delivering more profitability. If a company sells 1,000 steel widgets per year, the company needs  to buy the steel, have a factory with a machine and a operator.

The profit from the sale of 1,000 steel widgets must cover the cost for the purchase of the steel, the factory, the machine, the operator and some margin for the owner.

If the company is able to sell all 2,000 steel widgets, the costs are distributed over 2,000 instead of 1,000 steel widgets – assuming no additional unit costs for the steel for another 1,000 steel widgets and the machine can also produce 2,000 steel widgets.

The same applies to the learning curve – the more the company performs a particular activity, the easier and more efficient it becomes the more routine is embedded and the company can thus work more productively and profitably.

3 The market share of today determines the market position of tomorrow

Especially in a growing market, it is crucial how quickly the company can grow. Growing slower than the competitors, its market share may decline – growing faster than the market, the market share rises.

Once the market growth stagnates or decreases, it may ignite a ‘cut-throat’ competition (like we can observe with the petrol companies such as BP, Shell). The companies that have grown in the past most have the largest market share and thus in the best position to assert themselves in the cut-throat competition.

4 Growth as a threat to small and medium sized companies

For some companies fast, rapid growth may be seen as a threat – a owner-managed small or medium-sized company may choose not to grow as the owner does not want to be a CEO of larger, more international company.

In summary, growth is not a bad thing – almost inevitable if a company wants to survive. However, a company must remain viable and most importantly manageable.

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