PREPARE YOUR BUSINESS FOR SALE - PE By Mark Corke

PREPARE YOUR BUSINESS FOR SALE

And the PE – by Mark Corke

When pricing a product or service you provide to your customers, the process you follow in arriving at a price probably runs along the lines of: Take the cost of the product, add the transport cost, import duties and any other costs associated with getting the product to your shop. For a factory, you might look at the cost of raw product, the electricity, gas, water, labour, and possibly costs of holding stock, depending on your accountant. Once you have your cost of sales or cost of production, you multiply by a markup percentage to get your selling price. At this point several variables come into play, such as comparing your price to your competitors' prices or judging how desperately you need to make sales this month in order to cover your overheads. In this instance you may offer a special on some lines, hoping to drag customers in who might expand their shopping list while they're there.

Burned Offerings

As we all (should) know, the pricing exercise is fundamental to the success of a business. Priced too high, sales may be difficult to come by, while pricing too low may result in a gross profit margin unable to sustain the fixed expenses in the business. And so, experienced and usually successful business people talk about the complications involved in setting prices. They show me spreadsheets justifying their decisions, and often they have copies of their competitors' price lists or advertising brochures. And yet when they want to sell this cash cow they rely on a drunken boast over a braai, and the improbable results.

At a recent seminar I presented, there was a long discussion on valuation principles in small and medium businesses. At the end of the seminar, on checking back on the feedback forms, I came across a comment from one delegate "No mention of PE ratios". He or she was quite right; there had been no discussion on an element in valuing businesses which is the source of huge losses for seller of businesses and buyers, alike.

The idea that a business can be valued simply by applying a multiple to the net profit (or even turnover) comes about as a result of those braai and beer discussions. Typically, one of the meat tossers has recently sold his business and has decided to take a year off to work on his golf swing. His admiring buddies question him at some length as to what the secret to his success has been.

He talks of his selling price and his turnover or profits, amongst other things. It is the profit or turnover relationship that gets everyone's attention.

You see, all those boys and girls huddled around the fire have a burning desire to make a killing out the sale of their own businesses. Let's face it; there are only two types of profitable businesses - those that have been sold, and those that will be sold. And as long as yours is profitable, you will fall into one or other category.

Anyway, back to the conversation:

The would-be sellers are all quietly doing their own sums, based on the golfer's experience. What they do not take into account is that the golfer's former business is in a young, highly lucrative industry, becoming more and more sought after every year, with enormous barriers to entry.

Consequently the value could be calculated as having high multiples or price to earning (PE) ratios. These are ratios which cannot be used in comparing businesses in other industries or sectors.

However, our braaimeisters get in their cars at the end of day, turn to their spouses, and announce: "You know, we could get at least R5M for our business." And so they take an ill prepared, badly valued business to the market. Priced too high or priced too low? Who knows?

Probably the former, although more and more often the latter. Attempting to sell too high results in unsold, dangerously exposed businesses. While pricing too low means that the seller can only play golf for six months instead of twelve! Frighteningly, pricing too low can also result in buyers being suspicious of the business - avoiding them, with the result that the seller lowers his price even further. Hardly the stuff of a winning strategy.

2009 is almost upon us. In the next two months South Africa will grind to a halt, and we will all start to contemplate the successes or otherwise of the year past. Inevitably, we will consider our businesses and what we intend to do with them in the coming year. Perhaps it is time to take a look at the current value of your business so that at least you know what you are driving, and where you are driving it. It is always a good idea to know well in advance what the value of your business is, so that you don't find yourself drinking soup in your old age when you thought you'd be traveling the world!

Cheers

Mark Corke