THE SMALL BUSINESS BLOG

It can be difficult to accurately place a value on a potential investment. A common mistake is to estimate using historical data such as previous profits or assets owned, when in actuality it is far more useful to try and work out the future potential of the company. This is known as the investment approach to valuation:

• Discounted cash flow (DCF) is an estimate of the amount of money a company will make in the future, taking into account that money earned today is worth more than money potentially earned in the future, resulting in a discounted rate reflecting the uncertainty and risk involved
• Net present value (NPV) is the value derived from discounting future cash flow back to the present by a percentage representing the minimum desired rate of return
• Long-term cost of capital is a popular rate used when discounting. The level of risk is also a large factor in determining discount rate – for example, purchasing a foreign business in a different market sector would result in a much higher discount rate than a local business in the same market
• Terminal value (the amount expected to be received when the business is sold) is often also considered. However, only private equity investors usually expect to sell the business within five years – most purchasers see an acquisition as a long-term investment
• Internal rate of return (IRR) is the flip side of NPV and is used to work out a break-even rate of return. It is possible to find out which level of discount rate will result in a positive or negative NPV. A business attempting to assimilate a supplier may be happy with an IRR of 15%, whereas a venture capitalist financing a startup could want an IRR of 35-50% in order for the risk to be worthwhile
• These techniques are best used as a comparison between different potential investments than as a way of deciding whether to invest at all

Hat-tip to Robert Moore from Business Data International Limited

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The process of taking over another company can be a very exciting time for you and your business, but it can very quickly turn into an unpleasant experience with serious lasting consequences. Here are some of the biggest mistakes made by companies during takeovers:

• Inadequate due diligence – You need to have done extensive research into the finances, existing contracts and liabilities of the company you are buying in order to avoid lawsuits, extra expenditure or loss of sales.
• Ignoring the culture of the target- If you underestimate the importance of culture then you are likely to experience some clashes, as no two companies will ever seamlessly fit together. To avoid misunderstandings and conflict from the beginning it is best if you set down a clear and consistent policy favouring the dominant culture.
• Forgetting to keep customers informed – You will need to reassure customers that the takeover is in their best interests because your competitors will attempt to unsettle them during this period.
• Failing to retain key employees – It is possible that competitors will also try to steal your best employees at this time by playing on insecurities they have about their own future within the company. You must reassure them and also be forthcoming about job cuts because an atmosphere of uncertainty will lead to false rumours spreading.
• Overpaying for target – Do not get carried away and end up paying far above the market value of the target, especially in e-business where it can be easy to over-estimate the value of a company because of the amount of potential you believe to be there.
• Bad leadership – Without a clear and powerful leader to drive the takeover forward it will stagnate. Make sure that if you are creating a combined managerial team from the two companies everybody is sure of their role.
• Not understanding foreign markets – A cross-border merger can easily fail if you simply assume that things are the same in another country. Legislation or consumer attitudes towards products and advertising can be vastly different.
• Poor IT integration – This process is never as simple as just swapping one IT system for another. In order for the transition to go smoothly it will require a lot of planning.
• Failed brand consolidation – It will be important for you to have a clear idea of how you want to manage the new brands you acquire. Maintaining a brand can be expensive in marketing terms so you may wish to drop some entirely.
• Mis-timing the takeover process – You will need to get the timescale just right in order to be successful. Rushing to completion could ultimately result in a poor merger with aspects overlooked, but going too slowly will only extend the period of upheaval further.

The best advice for completing a takeover successfully is to consider all the areas that could potentially go wrong and make sure you have a comprehensive action plan to guide the company through this period.

Hat-tip to Robert Moore from Business Data International Limited

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If you decide to buy an already existing small business it is useful to be aware of some of the VAT issues involved. Overlooking the importance of VAT will at best result in delays closing the deal and at worst could cost you a lot of money. Of course, you should always consult a specialist accountant if you have any detailed queries, but it can be helpful to know about the big issues:

• If you are buying a business in the hotel trade, education, financial services, charity or property industry you will be subject to specific VAT rules – so consult you accountant
• Usually VAT consideration comes down to two options – a transfer of a business as a going concern (TOGC) or an asset sale
• A TOGC is outside the scale of VAT. To qualify, a transfer must meet all these conditions:

1. The new owner must be in possession of a business that can be operated as such
2. The business (or part of it) must be a going concern at the time of transfer
3. The assets transferred must be intended for use in the same kind of business
4. There must not be a series of consecutive transfers of the business
5. If the seller is registered for VAT the buyer must also be registered, either because all the conditions for compulsory registration are met, or accepted for voluntary registration
6. There must be no significant break in trading right before or after the transfer
7. If only a part of the business is being transferred, it must be able to operate separately as a standalone business

• If the business does not meet these conditions it is likely to be classed as an asset sale and VAT will be charged
• Any land or property included in the transfer will need investigation, as although they are exempt by default there are exceptions (such as if the owner has chosen to tax their interest in them). Make sure this is investigated and sorted out before the deal is completed as you will be stuck with a larger tax bill otherwise

Hat-tip to Robert Moore from Business Data International Limited

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As a small business owner it is possible that at some point in the future you will find yourself entering negotiations with another company, perhaps because you have become so successful that you wish to buy a competitor or because you feel it is time to sell up and move on. Negotiations are delicate processes that take a long time to conduct and often fall apart, sometimes even in the final stage. Here are some useful tips that may come in handy if you ever have to participate in negotiations:

• Have clear goals in mind going into the negotiation process and do not lose sight of them. If you remain mindful about these important issues you will not mind conceding the smaller things
• Do your research going into negotiations as it could provide you with the upper hand if the other party has a weakness that you able to find out about
• Use psychology to understand the aspirations of the other party. If you are buying a business the owner may feel loyalty to their staff, so if you demonstrate the measures you are putting in place to safeguard their employment it will reassure them
• Try to have a team of strong negotiators (senior management or good salesmen) who can make a positive impression on the other party. You can role-play the negotiations beforehand with them to get some idea about how it is likely to go
• Do not make your opening offer too early into the negotiation process. After getting to know the other party well, you may come to find that your planned opening gambit is inappropriate and you can adjust it accordingly
• Make sure your opening offer is credible and does not undermine the other party. A well delivered serious offer sends a clear message that you are close to sealing a deal. Try to be the first to place an offer on the table as you will gain a huge advantage in setting the tone for the rest of the negotiation (although you may rarely miss an unexpected great first offer from the other party)
• Avoid indecisive language like ‘we are hoping for / would like’ as this will make you seem lacking in focus or weak
• If you encounter an offer from the other party that is so far removed from your own objectives it offends you, let them know this in order that their next offer is vastly improved. Do not be rude to them but make sure you convey the message through the words you choose and the body language of you and your team
• Plan beforehand the concessions you are willing to make to close the deal. Try to make the other party concede first and try to arrange it so that the concessions you make are actually not a huge loss to you but would be a huge benefit to them
• Do not be reluctant to remove yourself from negotiations (even at a late stage) if you are unable to satisfy the main objectives you had at the start. Although it may feel like you have wasted your time, in the long-run you could seriously regret making an unsatisfactory deal if you settle for less than you wanted

Hat-tip to Robert Moore from Business Data International Limited

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Recent research at LSE into the productivity gap between which leaves the UK trailing behind the US, France and Germany has found the main problem to be family-run firms. This somewhat surprising conclusion suggests that family-run businesses suffer from poor management practices. The report author Nick Bloom was so convinced of his findings that he urged Gordon Brown to drop the 100% inheritance tax relief given to family businesses.

The problem is not passing down ownership of the business to the next generation but passing down control. Selecting a Managing Director from within the family means that the choice of managerial talent is severely limited. This is especially important in large corporations which require a skillful CEO and not someone who is young and inexperienced.

In addition, if the eldest child is groomed from an early age to be the eventual successor it can actually lead to them coasting through their education and the early part of their career due to a lack of motivation. They may feel there is no need for them to try because they are guaranteed top job, therefore they do not develop the skills to be able to do the job well. It can also lead to low morale within a company because there is a ‘glass ceiling’ that employees will never be able to be promoted above as they are not part of the family.

The report recommends that forBritain to close the productivity gap with the US , business owners should consider only passing equity stakes to their children and giving the running of the company to somebody else.

Hat-tip to Robert Moore from Business Data International Limited

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