The Claridges Blog

[Continued from here] 

One thing to look out for is that stock levels haven’t been tampered with.  That is they haven’t been understated for successive financial years, and the vendor then wants to reinstate the true stocktake figure at the time of sale and claim that the business has come into profitability.  Of course that is nonsense, that accumulation of “reserve stock”, as it is sometimes euphemistically called, is an accumulation over a number of years.  This doesn’t preclude one from buying a business, but it needs to be dealt with in the appropriate manner.

Another issue is that there has been a tendency for parties to pay bonuses or extra payments in a cash form or out of the proceeds of the business.  This is something that’s very hard to detect for the purchaser.  The details of all employees, their gross and wage, need to be clearly spelt out, along with any bonuses or schemes that further reward them.  In some cases businesses pay out things such as school fees, medical and dental.  None of this is necessarily problematic, it just depends on how these expenses are actually described on the Profit and Loss Statement.  One needs to get a warranty from a vendor that what employees are being paid, what is being deducted, and what other bonuses are being provided is clearly set down, and these of course will need to be checked to one’s own satisfaction through the Due Dilligence period.

So then we come to the question of, in assessing a business, do we take into account claims made by a vendor that some of the income has been used for expenses or have simply been removed from the business, or do we rely only on the tax returns.  We say rely on the tax returns only, but then take into consideration any discretionary expenses, that is one off expenses, anything that may have been non-recurring or of a capital nature on the Profit and Loss Statement, as there may be some legitimacy for adding some of those expenses back to the bottom line.

One has to go through each and every expense, applying just a common sense approach to make sure that there are no anomalies and that there is nothing in there that is any cause for alarm.  It is wise to keep in mind the likelihood of new expenses once you take over the business.  It is also important to analyse what full input is going into the business by the proprietors.  So we need to look at how many proprietors or the proprietor’s family, what hours are they putting in, what remuneration they are taking.  This has to be carefully analysed.  Sometimes when there are many family members contributing as a favour, especially in the year in which the business is to be sold, then of course it has an artificial influence on the EBIT that we work on.

“Why”, I get asked, “should I use an agent, what are you going to do that is going to benefit me?”  Well one important part of that answer is that a good agent will take the pain and uncertainty out of buying or selling a good business.  This sounds simple enough, but it’s a matter of dealing with an agent who is sufficiently experienced that he anticipates the sorts of impediments that are inherent in certain types of businesses, and quantifies or measures those before he takes on the task of selling a business.

From the vendor’s point of view, many start off expecting that their business is worth X amount of dollars, and that someone will come along and simply write a cheque.  Fairly early on into the selling process you come to realize that it is not an easy transaction.  Seldom do they go very quickly and very smoothly, and it is a matter of paying attention to the many different ingredients that comprise the sale process.

If a business has too many impediments, has too many covered up aspects that are unattractive, then it just won’t sell.  That means the agent would go through the whole gamut of listing, describing, marketing and securing buyers, who in the end will do their own Due Diligence, where most secrets are usually revealed.  In the end the impediments aren’t going to attract a buyer willing to walk the final steps and that means that a lot of time will be wasted with no result.

(Of course, if the business is priced accordingly, that is down price, and is being sold to someone in the knowledge that it needs a lot of work and someone can be adapted to the problems within the business and fix them, then that is a different case).

A good agent can anticipate the sorts of things that need to be discovered and clarified at the beginning.  For example, whether the purchaser intends to be installed there himself, does he have the capacity to run it, what are his expectations of the outgoing owner, what sort of tuition or what sort of a consultancy period does he require, is he going to relocate the business, does he want to take over the premises, often owned by the associates of the vendor, either superannuation fund or privately held for tax purposes, what’s going to be the reaction of the staff to this style of buyer, what likelihood is there a continuance of the suppliers of the business dealing with this type of buyer, etc  These are the sorts of things that need to be considered at the outset head-on, lest they become deal breakers further down the track. 

I say expose those.  The agents can do that in the early discussions with the parties and have those completely ironed out so there’s are no impediments involved in things proceeding smoothly.

So I get asked from time to time, “What is a good style of business to buy?”, or “What industry is a good one to buy into?”.  I’ve never really been able to answer that truthfully, in the sense that if you look at two businesses in the same industry that appear identical in every respect, similar turnover, similar customer base, similar number of employees, etc, you may find that one is making extraordinarily good profits and the other is just struggling along.  It must not be underestimated how much revolves around the application and the capacity of the owner, their attitude of running the enterprise and making it a success.

One problem is that people can be blinded by numbers, and are unrealistic about their capacity to actually provide a service.  Let me explain.

When you are buying a business, ideally it will be one where you will have a spontaneous stimulation from what the business does, and the service or the product that you are dealing with.  Unless you have some sort of affinity or aptitude for those things then it’s best not to be involved.  If it’s something that you feel you can subsequently grow into and really develop an enthusiasm for, then that’s fine too.

But to take a business that statistically looks like it is performing quite well and take it on that criterion alone is a mistake.  You have to feel that you can expand the business, that you’ve got some love of what it does, and that you can summon the enthusiasm to expand it, grow it, work with the people within it, and know and like the product range or the service it is providing.  I think that’s essential.  You’re going to spend half your life there, quite literally, and it means you’ve got to enjoy arriving and find a sense of enthusiasm, a tingle of excitement about how you can grow and implementing those block by block steps to expand the business.

Many people come in expecting they are going to double the turnover of the business within a short time, and it seldom happens.  It’s not generally like that in business.  It’s a matter of proper planning, but also with some flexibility and consistent application.

Being there, implementing, always looking to over-service, deliver on time, treating people with utmost respect, maintaining your professionalism throughout, these are the things that make people want to deal with you.  Because the truth is most businesses don’t deliver on time, don’t answer the phone properly, the employees sometimes just can’t be bothered or are a little bit discourteous, and you know we all have frailties, we’re all human. But those that can sustain a high level of service and show enjoyment in doing so will get away with all sorts of other benefits.  The price is less sensitive for a product or service where they’re getting delivery times on schedule, complete without call backs about misallocations, shortages of stock or whatever. 

If you can provide this kind of service across the board consistently, you will find natural growth to your business, because most businesses do not even offer the most basic services that were once common place.  And this can only really be achieved when an enthusiasm for the work can come naturally to you.

It’s very difficult to find a good business.  They all look good, and are all presented as being profitable and wonderful.  But you have to look behind the presentation and glamour.

There are a number of key factors.  You have to look first at the vendor to see who is offering you the thing.  You have to get a feel of whether this is the sort of guy you can replace, that you can be like, and of course you have to assess if you feel like he is giving you the whole truth and nothing but the truth… which unfortunately is seldom the case.

So investigating a business becomes a very serious task.  You have to approach it as if you are a detective sergeant solving a murder, not allowing any piece of unusual information to just slip by, or put it in the “too hard” basket.  You can drive yourself mad going to the nth degree, but you have to be looking at a number of essential elements.

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