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Don't Pay Too Much

Buying a business ranks as one of the most important and sometimes stressful endeavours one can embark on.  It is a pursuit that for many occurs only a handful of times in a working lifetime.  Accordingly, it is imperative to be mindful of various traps during the negotiation process.  Following are a few that I see on a reoccurring basis.

“The Business Runs Itself”

Vendors are incentivised to understate their involvement in a business and will typically not pay themselves a commercial wage for the operational input they provide.  By representing they have little involvement, the potential purchaser may be seduced by the appearance of inflated profits.  My suggestion is that a business acquisition should be evaluated separately from ‘buying a job’.  In reality, a good business should be able to derive sufficient earnings in addition to paying a commercial wage for the personal exertion of the working owner.

The selling price is $xxx plus stock

Despite some theoretical limitations, the concept that stock is included on top of any agreed business value is widely accepted and promoted by business brokers.  I suggest further investigation prior to settlement.  Items contained in stock often include large quantities of items which are obsolete and should be excluded when determining the consideration to be paid.  Further, it is important for a business to derive a reasonable return for the assets employed in the business (inclusive of stock).  I recommend this analysis is always undertaken before pricing negotiations are concluded.

Employee Entitlements Are the Purchaser’s Responsibility

Mature businesses often have a number of long serving key employees which purchasers seek to retain to minimize acquisition disruption.  The risk here is often not present in financial statements presented by a vendor.  I always suggest an analysis of Long Service Leave (“LSL”) obligations is undertaken.  Any significant entitlements should be used as leverage to reduce the asking price of the business.  Where the vendor is to be retained for a period post settlement, care should be given to ensure the purchaser does not inherit LSL obligations in respect of the former owners.

I have been involved in the Due Diligence process for both Buy Side and Sell Side transactions and would be happy to assist you during this critical time.

By Dean Waters

Business Valuation Specialist
WMS Business Broking

DISCLAIMER:  This article is intended to provide a general summary only and should not be relied on as a substitute for professional advice.


Considering a Franchise Business?

Franchising is, in simple terms, a way of doing business.  Typically through a contractual relationship, the Franchisor sells their products or services through a network of Franchisees who are independent owners that have been granted a right to sell those products and services.  Many household names such as McDonalds, Subway, Jim’s, Boost Juice and Nando’s operate under a franchise model.

One perceived benefit of buying a franchise is that the Franchisee receives a lot of support from the Franchisor.  The Franchisor may have a proven business model with a brand that is well-established and recognised within their market segment.  This may provide Franchisees with an opportunity to step into a business with an existing cash flow which may assist in reducing business risk.  It is important to note that an existing brand is not a substitute for reasonable due diligence and buyers of franchises should always exercise care and seek appropriate advice.

As mentioned above, a franchise relationship exists under a contract or franchise agreement between the franchisor and franchisee.  This agreement includes details on the costs paid by the Franchisee to the Franchisor.  These costs often represent remuneration for the Franchisor in proving services to the Franchisee that may include marketing, training, leasing and operational support.  Whilst the franchise agreement will deal with these costs, it is noted they are often calculated on a fixed basis or as a percentage of turnover and sometimes a combination of the two.

Other benefits of operating a franchise include:
  • Financial support from the franchisor such as equipment financing;
  • Purchasing power when buying business inputs such as trading stock.  This can help with improving margins;
  • Some banks lend against the value of the business which can assist buyers with funding the business purchase without offering their home as security.
However, just because your business may be a franchise, ongoing business success is not a guarantee.  Some reasons to consider not buying a franchise may include:
  • Franchise agreements are generally legally binding, even for the Franchisee.  Any breach by the Franchisee could result in the agreement being terminated and the business ceasing;
  • There is limited scope for the Franchisee to operate outside the terms of the franchise agreement.  For example, you can’t change marketing programs, logos, design fit-outs, recipes or menus;
  • All Franchisees may be tarred with the same brush.  Where one or more independently-owed franchises underperform, this may cause brand damage that impacts the entire network of Franchisees;
  • Different mind-sets between Franchisor and Franchisee may impact the future growth and success of the business.  Franchises typically work best where both parties have a shared vision.
A useful reference point for anyone looking to buy a franchise is the Franchising Code of Conduct.  This Code is regulated by the Australian Competition and Consumer Commission and applies to both Franchisors and Franchisees.  The Code details the information required to be provided by franchisors to franchisees together with a timeline for providing same.  Reading the Code is highly advisable as it details the rights and obligations for franchisors and franchisees including documentation and procedural matters.

As always, we recommend you seek appropriate accounting and legal advice.

By David Hayes
WMS Chartered Accountants

DISCLAIMER:  This article is intended to provide a general summary only and should not be relied on as a substitute for professional advice.

Can I Sell My Business Tax Free?

Well, it depends. 

The government has provided a number of generous concessions targeting small business. Some of these are directed at Capital Gains Tax (“CGT”) assets known as the Small Business CGT Concessions. 

The most common situation where these can be applied is on the sale of a business (i.e. goodwill). However, they can also be used when disposing of one or more other active business assets or even when the entity that owns the business is disposed of. 

Once accessed and applied effectively, the concessions may reduce any tax that would be otherwise payable to nil. In a worst case scenario, any tax payable could be substantially reduced and payment thereof deferred for a significant period after the event.

So what are the downsides?
The two main negatives associated with these concessions are that they are quite complex and so most get it wrong. Due to the complexities as well as the generous tax savings on offer, they have become a big audit risk with the Tax Office. It is therefore very important that your professional adviser is able to understand these concessions effectively.

Accessing the Concessions
To access the concessions, the first step is to determine if you satisfy the basic conditions. The basic conditions allow some of the concessions to be utilised whilst the remaining concessions require some additional criteria to be met.

Firstly, these conditions require one of a possible four scenarios to apply. The most common being that the total value of the net CGT assets that you and certain entities own does not exceed $6 million just before the CGT event in question. This is known as the Maximum Net Asset Value Test. Secondly, the CGT asset in question must be an active asset. It is important to note that there is an additional condition for assets that are a share in a company or an interest in a trust; however, this is beyond the scope of this article.

The Maximum Net Asset Value Test
In calculating your net CGT assets, all of your CGT assets (subject to some specific exclusions) are included in the test and not just business assets. The notable exclusions are your home, provided it has not been used for income producing purposes, your superannuation, personal use assets and life insurance policies. Holiday homes being personal use assets would therefore be excluded provided they are not used for income producing purposes.

We often see clients coming to us after their previous advisers were ‘tripped up’ by the following areas: 
  • The family home being held in a Trust;
  • Mortgage offset accounts attached to excluded property assets;
  • Incorrectly determining affiliates and connected entities; 
  • Obtaining ‘faulty’ valuations to support market values, particularly those relating to business goodwill and unique active business assets;
  • Using the wrong ‘time of the event’ to calculate market values;·                
  • Using excluded liabilities in the calculation. Most commonly we see liabilities with no direct connection to an asset being used or liabilities directly related to excluded assets being used;
  • Not having an effective strategy to deal with unpaid present entitlements (“UPEs”) prior to the release of Taxation Determination (“TD”) 2015/D2.

So, your business might well be tax free provided you consult with an experienced adviser. At WMS, we have the experience but we also care enough to understand our clients, and develop an effective wealth management strategy.

WMS Solutions

 

DISCLAIMER:  This article is intended to provide a general summary only and should not be relied on as a substitute for professional advice.

Common Mistakes in Business Valuations

Everyday companies large and small, public or private are the subject of Business Valuation procedures.  Despite major advancements in valuation literature and developed educational pathways which enable practitioners to ‘upskill’, I am still amazed by the number of mistakes made when undertaking engagements of this nature.

Following are three of my favourite tips for avoiding these errors when valuing your business:



1)         Future Maintainable Earnings (“FME”) and the ‘Average of 3’

When applying an Income Approach and more specifically the capitalisation of FME methodology, it is common for the FME to be calculated by averaging the earnings achieved over the past three financial years.  This practice is inherently flawed and at odds with the concept of FME which requires a forward looking, not retrospective approach to assessing earnings. 

Errors in the averaging of historical results are magnified during periods where wages, rent or other material costs are rapidly increasing.  Additionally, recent changes such as relocations to larger (and more expensive) premises or an expanded workforce are not appropriately captured.  Pricing changes and any departure from historical gross margins are also overlooked in the averaging process. 

With so much time spent labouring over the earnings multiple, it is a shame the determination of FME does not warrant the same scrutiny. 

2)         Understand Economic Drivers

Now more than ever, businesses are subject to seemingly constant change.  Technological disruption is sinking some industries while others appear unstoppable.  From a valuation context it is important to be aware of external factors which impact the key drivers of the subject business. 

Research house IBISWorld publishes their views on industries set to ‘fly and fall’.  History is clearly a poor guide when valuing businesses at either end of the spectrum.  In 2015 a suggested underperformer are those involved in the manufacture of mining and construction machinery.  Newsagencies and video stores have been named in previous years.  Outperformers include online groceries and hydroponic crop farming.  A deep understanding of the industry can help avoid unrealistic valuation conclusions.

3)         Failure to Crosscheck

The Valuation practice is a highly subjective discipline and it is rare to get absolute agreement between practitioners.  Despite this, the process of cross checking conclusions is paramount in confirming or rejecting any assertions made.  It may serve to tighten a valuation range, dismiss erroneous conclusions and ensure that outputs have regard to the ‘real world’.

Crosschecks should include alternate methodologies to validate or discredit the primary approach. Further, conclusions based on theoretical inputs such as betas, alphas and bond rates should be measured against economic and industry expectations to ensure conclusions are not too divergent.  If a chicken looks like a duck and sounds like a duck, it may in fact be a duck!  In other words, if the valuation scope requires an assessment of fair market value, does the outcome represent a value that would be acceptable to the market?

Conclusion

The subjective nature of business valuations requires practitioners to move away from ‘autopilot’ and rigorously challenge the methodology, the inputs and especially the outputs prior to going to print.  There are currently only 98 CAANZ accredited Business Valuation Specialists across Australia and New Zealand.  Contact one from our team who can work with you to navigate valuation complexities and provide deliverables that are fit for purpose. 


By Dean Waters

Business Valuation Specialist
WMS Business Broking



DISCLAIMER:  This article is intended to provide a general summary only and should not be relied on as a substitute for professional advice.

What can I do today if I want to sell in the future?


Only one in three of Australia’s many family businesses are exit or succession ready and while handing over the reigns may not be a near term prospect for yourself, there are steps you can take today to maximise the value you receive on exit.  Following are three of our favourite tips for getting your business ready for sale.

1)   Make yourself Redundant

Often a large part of a business success is attributable to the personal goodwill of the working owner. This value attaches to this individual by virtue of long standing personal relationships developed with customers, supplies and staff.  Deals may have been done verbally and agreements may be forged by handshakes.  

The business owner may also have a high level of ‘know how’ and industry expertise that has never been documented or transferred to others.

By initiating knowledge transfers to key employees and formalising agreements, role descriptions, procedures and policies, the owner can de-risk much of the business and become more saleable to a greater number of potential acquirers.  

2)  Tax matters

When businesses exchange, there is often an unhealthy focus on the headline sale price.  What is ultimately of greater importance is the after tax consideration that will flow to the exiting party.  With this in mind, we suggest the owner understands the various entities and structures that are in place.  Receiving high end tax advice early can also enable restructures and reorganisations to be undertaken where appropriate to ensure that various business and retirement concessions can be accessed.  

3)   Deliver on ‘blue sky’ opportunities

All too often we hear throw away lines from vendors suggesting that there are many opportunities that remain unexplored and that significant new revenue can be derived by targeting new markets, regions or product lines.

Potential acquirers won’t pay for any blue sky achieved as a result of their own endeavours and strategic direction.  Our advice to owners is simple.  Deliver on those strategies that add value to the business.  Earnings are more important than revenue.  Buyers will pay for results achieved.

Conclusion

Preparing a business for sale takes time.  Our team of transaction experts can work with you to meet your retirement and succession timeframes.  It is never too early to start.

By Dean Waters
Business Valuation Specialist
WMS Business Broking


DISCLAIMER:  This article is intended to provide a general summary only and should not be relied on as a substitute for professional advice.