How attractive is your business?

Over a year ago we started this column with the idea of helping entrepreneurs understand more about what drives value in a business and how to influence this so as to build a more valuable business.

To recap, the value of a business today is based on its expected future returns (free cash flow generation) discounted by the amount of risk to the capital employed in the business.

A business sources capital from equity investors and by borrowing money (debt) from lenders like banks, so in valuation calculations we discount future cash flows by the Weighted Average Cost of Capital (WACC). This is the after tax cost of debt multiplied by its proportion of capital employed, added to the cost of equity multiplied by its proportion of capital employed.

Generally, any debt is secured against an asset and is repaid from profits before tax. Then taxes are paid and only afterwards does any surplus get passed on to the equity investors.

Likewise, if the business runs into trouble and is liquidated, the equity investors are the last to get any money out – they only get paid once everyone else has been paid.

So what this means is that the cost of equity capital is highest because its at the greatest risk. The cost of debt is the amount your commercial bank charges you on loans longer than a year. It’s easy to calculate – just read your bank statement.

So how do you calculate the cost of Equity capital?

It’s not easy. Even for big listed companies, you need to look at how the business tracks the index, the index tracks the market, the market tracks the global economy and then relate this all back to long-term treasury bond interest rates in the USA. There are fancy words we use in Finance like Beta and synthetic Beta, and a whole bunch of mathematical formulas used to calculate them.

What’s hard to get right in big listed companies becomes impractical in the SMB market, so for SMBs the approach taken is one of two: either the equity investor says ‘I need a return of at least 30% in my fund, so let me discount by that amount and see if the number remains positive’, or the private investor says ‘given what I know about the risk of the business I want a return of 20% on my money, so let me discount by that amount and see if the number is positive’. In both cases these are very subjective numbers, whose practical application is limited really to large funds and experienced investors.

So how can you determine the appropriate cost of equity capital for your business?

Well, over the past 16+ months we’ve been working on scoring risks in a business and trying to come up with an appropriate cost of equity that you can use in Valuations. We’ve been looking for a way to do this that offers not only a reliable estimate for any SMB that uses it, but also allows a bigger fund or investor to compare risk and costs of equity across several businesses, even those that operate in different industries around the world.

So what we’ve developed is a survey tool. We call it the ‘Business Attractiveness Survey’ because it’s about the future and strategy as well as being about risk. The survey takes about 15 minutes to complete, is dead easy for a business owner to do, and the results are entirely free. The results include an overall risk score for your business (compared to its industry peers) and a suggested cost of equity capital that you can use in your own valuation calculations/investment decisions.

All you need to do is go to, register, add your business and start answering the questions. Your results are confidential (others you add in your business will see them, outsiders wont). If you invite others from your industry – your customers and suppliers, even your competitors, you’ll get to see how your risk compares to the industry average (and how your suggested cost of equity compares to the industry average).

Over time, we hope to build up a ‘Zeitgeist’ of each industry in each country, including commentary from business owners around specific risks, trends or opportunities. We’ll share interesting information here and in our blog as it becomes available.

How risky is your business? What returns should you be looking for on your equity capital given this risk? Where should you focus efforts to lower risk and increase your valuation? Find out for free on

Things to do before you sell (continued).

Selling your business is when things hopefully come together for you: all the hard work over the years is rewarded – you get a lump of cash and ride off into the sunset. At this, this should happen if you’ve done all the homework and made your business as saleable as possible. In this article we continue to look at some of the things you need to do before you sell.

Reduce risk, especially concentration:


Most SMBs suffer from concentration risk, particularly in the areas of suppliers, customers and product line. A business that has a great relationship with their sole supplier for 5 years might think they’re doing fine, but they quickly learn the opposite when the supplier changes terms, licenses a competitor, is bought, or goes under. Having only a few customers or selling only a few products carries similar risk: things change, relationships change and when they do your ability to price often goes out the window and the value of your business does with it. So a key step in preparing your business for sale is to reduce concentration risk in these three areas. Actively seek out alternate sources of supply. Make sure you have several suppliers who you can buy from. Actively seek out new customers, and diversify your product range. It’s highly unlikely that you’ll be attractive to a buyer unless these risks are already diversified.

Make your revenue predictable:

You want to make your business into a money making machine. You must get to the point where you know that if you invest $100 today it should spit out $150 or more in a few days/weeks time. Then you can make a call as to how much you invest now and how much of return you expect in what timeframe. More importantly, the buyer of your business can see this too and will quickly understand the opportunity. To get this in place you need to invest in marketing systems: identify your target market; understand how they buy and how they make purchase decisions. Make sure you tick off each box. Show what campaigns you’ve tried and what their success rate has been. Track the entire sales process, gather feedback along the way and ensure you know your Net Promoter Score. These systems all take time and patience to set up, but they’ll give you a far better idea of whether you should be selling your business at all, and if you still decide to, it will help a buyer understand the value of what they’re buying.

Remember that the buyer has many choices, but so do you:

If you want to sell your business you need to standout from the others that are also for sale, and there are many. Luckily most of them are really not worth much, so if your business is well run, if the sale is well packaged and presented, and if you’re not in a rush to sell then you’ll immediately be in the top 5%. The buyer will hopefully have looked around and decided that your business is the one, but more likely they’ll be cheeky with asking price and back off unless convinced they’re getting a bargain. If you’ve done your homework, and taking the effort to a proper DCF valuation then you’ll easily understand whether it makes sense to take a particular offer or keep the business because you’ll know what it’s worth to you in cash terms. You’ll also be able to show this to a buyer to justify your price. Preparing early and properly are key steps towards keeping your options open and making the purchase of your business the only really good option for the buyer.

Selling to a strategic buyer v financial buyer:

You’ll almost always make more money and sell your business in less time, by selling to someone in your industry (or one adjacent to it) than a purely financial buyer. The reason has to do with both better understanding of the business by the buyer (i.e. they more accurately price the risks involved because they know them already) and that an industry buyer can probably reduce costs by sharing sales efforts, distribution facilities or some other cost with their existing business. The corollary to this is that an industry buyer will probably already know if your business is a good one or not. They will have been your customer, supplier or competitor for years. This is how ‘walk in sales’ happen: an industry player arrives at your door one day and asks if your business is for sale, entirely out of the blue. What this means is that you should always be ready to sell and have an idea of how much your business is worth.

Document in advance:

Well-run businesses sell more easily than poorly run businesses, for obvious reasons. A well-run business will have systems in place and its documents in order. So, you need to get your records together long before you plan to sell. Show monthly management accounts, board meeting minutes, marketing plans and results. Employment contracts, annual regulatory returns, tax clearances, contracts and insurances. Including your lease and escalation terms. Key employment contracts, disciplinary notices etc. Get everything in order. Put physical copies in a nice big file. Or preferably scan anything physical and store digital copies somewhere – these are far easier to share with prospective buyers and you’re less at risk from someone losing the file. Getting this stuff together in advance will make you better run, and it will also make you better run. You’ll be able to answer any question about the business almost immediately too, which itself makes the business more attractive.

Get a regular, independent valuation of your business:

Research shows that businesses that have been independently valued sell far faster – the reason for this is that the price is more realistic from the start, and also that a skilled, qualified person has cast their eye over the business already. The other main reason to get a regular valuation is that the Discounted Cash Flow value of your firm is an important target against which you can incentivise staff and deploy resources. The result is that they are shooting in the dark, under-perform and achieve lower selling prices as a result.

Consider these things before you sell you business

Selling your business is potentially the most important thing you’ll ever do and hopefully will be the moment when you realise great financial returns from your efforts over the years. It’s the time when you actually make money from all the hard work that’s gone into building the business over the previous years.

The trick is not to mess it up: selling a business is a complex process with many moving parts and it frequently goes sour, mainly due to the unpreparedness or unreasonable expectations of the seller.

This article is part 1 of 2 that aims to briefly cover the most common mistakes sellers make, and show you how best to prepare your business so that it’s attractive to the right buyer when you’re ready to sell.

Shift happens: always be ready to sell:

In the ideal world we build a business over a period of several years and plan to sell it at a certain milestone: normally the age of the owner, a valuation target, or a certain profit target. The hard fact of owning a business is that accidents happen and people (business owners or major shareholders) are disabled or die. The other thing that happens (albeit less frequently) is that someone walks off the street and asks to buy your business. Either way, you need to be prepared to sell your business at any time, and you need to make sure that your business can be sold even if you’re the one who is dead or disabled. Life happens. Death happens. Make sure the assets of your loved ones are secured by preparing your business for sale and also making sure that you carry key-man insurance so that if any major shareholder dies the business can buy them out.

Transactions cost you time and money:

Selling a business, buying a business, or raising capital can be very expensive transactions. They take time away from running the business and also cost money in terms of specialist advisors who are there to make money by guiding you through a process and other transaction fees as money actually changes hands. The advisors will cost more money if you are unprepared simply because there is more work for them to do and you will also not know enough to stop being taken advantage of. The more preparation you can do in advance the lower your transaction costs will be both in terms of distractions and advisory fees paid. From an advisory perspective, the amount of work done to conclude a deal in the $1M range is not very different to that of a $100M deal, so advisors will charge a much higher percentage fee for smaller deals. Research I’ve seen suggests that smaller businesses pay total transaction costs of up to 25% of the deal, for deals under $500K, whereas total costs on a $100M deal are more likely 2%.

An independent valuation serves as a guide, but it’s different to price:

The goal of an independent valuation is to determine the price at which a business would change hands in a free and fair market, where a deal is concluded by a motivated buyer and a motivated seller with all facts about the business known to each party. The calculations that go into an independent valuation are useful, and it’s good to always know the current valuation of your business and use valuation as a long-term management metric. However, the actual price you get will depend on negotiation. The best possible position you as a seller can be in is where you don’t have to sell the business and probably don’t actually want to, yet have several competing parties bidding for your business. Most sales are concluded in less than ideal conditions – the business needs capital investment, the owners want to retire, someone is ill, etc. In most times this lack of preparedness leads to a buyers market, but it doesn’t have to be the case – you just need to treat your business and investment.

Treat your business as an investment from the start:

The value of a business to you is the value of the cash flows you expect it to generate for you (through dividends, expenses that it covers, or excess owners income) discounted back to today by a factor that accounts for the risk to the capital used to generate those returns. The trick to getting a fair price for your business when you come to sell it is in being able to compare how its risk/reward combination compares to other investment choices you have, or your buyer has. If you’ve treated your business as an investment from the start, then hopefully you’ve taken every step to increase returns and reduce risks. This includes employing a suitable manager and paying him/her the market rate (or paying yourself the market rate if you are that manager too). What this means is that when someone offers you X for your business, you’ll be in a immediate position to know if that deal makes sense or not. Alternatively, if a buyer asks you to justify the price you want you’ll be able to show them how your business offers better returns for less risk that other’s they’re looking at, and is thus worth more. Sadly, if you don’t treat your business as an investment then odds are that you’re not managing it like one, and when it comes to sell you wont see investment-grade returns. You’ll be lumped with the majority of naïve foolish entrepreneurs who accept a multiple of 3x PAT when you could make far more by showing the buyer how much cash your business generates and what that’s worth now.

We’ll cover another 5 tips in next weeks article. Don’t sell before then!

Race pace

Start-ups are incredibly hard. Paul Graham, the legendary investor behind Y-Combinator says of start-ups: “Everyone is surprised by how difficult it turns out to be, because it’s not the kind of difficulty people have experienced before…Nobody knows what they’re capable of until they try it. Maybe half a percent of people have the brains and sheer determination to do this kind of thing. Start-ups are hard but doable, in the way that running a five-minute mile is hard but doable.”

I really like this analogy; the “5 minute mile”. It speaks of the pace necessary to achieve top performance.

As a former international rower (think Oxford/Cambridge, not the Dusi), I used to spend many hours analysing video footage of the top international teams racing. The impression I had of the medal winners was always how absolutely smooth and effortless they made things look, even though I knew that their muscles were burning and they were so starved of oxygen that they were close to blacking out. You’d see these top teams racing to the line, absolutely expressionless and perfectly synchronised, yet going through hell inside. The finish-hooter would sound and in that instant all composure would end – they’d collapse, spent, gasping, faces contorted in pain as the expense of the last 6 minutes of sprinting was allowed to show. The lesson was that these athletes won their races because they were able to relax at speed. They were simply better at being fast than the others around them. The many year of training it takes on top of natural talent helps the body become incredibly efficient and the mind to learn to keep critical control when all systems want to stop. It’s a lesson that applies to business just as much as it does to sport.

There is a pace and a flow to business. Many years ago a VC friend of mine said that there was “a time to walk, and a time to run”. Sometimes you had to chase deals aggressively and run like crazy. Other times the pace was slow and you couldn’t force it. My friends’ lesson was that there was no point running in a ‘walking time’ and no point walking when it was time to run. You’ll waste a lot of effort if you get this wrong – and its’ been an important lesson that’s stuck with me over the past decade. I use this in prioritisation – doing chores when its slow and chasing deals when its time to run. Critical bugs get fixed immediately, and then the pace changes to the more methodological work of adding or improving features. Chores get done because they’re important, not urgent.

In my daily life working closely with software development teams, we follow an agile development process: we break work down into 2 weeks units called ‘Sprints’. The rough idea is that we get measurable progress every 2 weeks and can re-prioritise frequently. When we started this way of work a few years ago it would feel like we were running hard for 2 weeks only to run hard for the next 2 and so on. We were always sprinting, but business is a marathon, right? Sure we have to be very careful of burning out?

The answer lies in what it takes to be world class: A world-class marathoner will run the full 42.2Km at a pace that is faster than most of us could sprint. If you look at top marathoners, they run at a pace that is about 5 minutes per mile. If you watch them racing they appear very relaxed. If any emotion shows its only in the last few minutes when they are digging to a deeper space than before and battling to keep the mental control of their form.

The point is that if you want to change the world you’re going to have to work hard, it will be incredibly difficult. It will take time to build up the skills and to work as a cohesive team to get things done. But you have to do it if you want to succeed. You have to learn to be able to relax at speed, to be able to raise your race-pace so that when others around you are gasping for breath and about to drop out, that you can put in a spurt and ease away.

I don’t know if there is a finish line in business, but looking back on the last few years I can see how we now sprint for two weeks only to sprint again. It’s not so hard anymore. I can see how easy it’s gotten for us only when someone new joins our team and takes a while to slot into the pace. I hope you’re seeing this too in your own business: don’t be discouraged because it’s hard. In a way it has to be hard. Your challenge is to find ways to make it easier: sometimes systems and routines can help; sometimes removing obstacles will help. Other times you’re going to have to see whether you can put your hands deeper into the fire, recover over night and do it again tomorrow.

You probably can. If you can’t, you’ll probably fail. Get out there and work on your race pace. Surprise yourself. Change the world. Do it again tomorrow. You probably can.

Moving away from hourly billing – jump off the cliff

With the industrial revolution came the need for metrics regarding how much human effort went into producing an item of value. Indeed, the industrial revolution gave rise to modern management science. When machines can suddenly produce way more than human labour could previously, we start to need to have a benchmark on how much labour (and at what price) goes into a product. When we understand the value of the end product, we can start to price the value of the labour used in its production, and so began a line of thinking that started with industrial revolution and mass production then filtered into service industries. It continues today with software able to measure all sorts of inputs in our daily lives in minute detail.

Doctors charge a set fee for consultations, platitudes and procedures that are loosely based on the hours they charge. Dentists have the ability to remove or inflict pain and similarly get away with charging a lot for a relatively short space of time. Other professionals aren’t so lucky. The American Bar Association picked up on this in the 1950’s and encouraged their members to start charging by the hour, instead of a broad fee for types of work. The accounting profession (who by nature are largely a compliance sale) quickly copied the idea of time-based billing. In so many ways it makes sense – a project takes 5 hours, the person doing the work gets paid $100 in salary costs so to make profit, cover marketing etc. and put some dough into partners pockets the client is charged $400 for the same time. Billing by the hour allows practice managers to calculate utilisation just as a production line manager would calculate throughput. Since clients only pay for hours worked directly on their business, it’s got the appearance of a very fair system.

Perhaps so for the very routine types of work: the types of work that will eventually be replaced by software – commodity hours, the kind of labour the singularity will gobble up and spit out permanently. The problem with hourly-based billing is that it treats human input as any other resource and is dehumanising. It’s also very hard to make a profit when you’re effectively a commodity, and it may not be so good for the clients after all: hourly based billing encourages long boring projects rather than quick specialised ones that generate valuable insight that’s worth far more than the hours it takes to produce.

There are alternatives: a recent article in the New York Times discussed a group of Accountants, loosely led by Jason Blumer, who call themselves the ‘Cliff Jumpers’ because they refuse to bill by the hour. They don’t have dress codes, don’t keep time sheets and don’t have billable hours. For Accountants, this is radical stuff. Instead of hours the Cliff Jumpers focus on problems where the pay is higher than the amount of time taken to solve them. For example, they work for creative artists who struggle to make sense of their finances as they become more established, or entrepreneurs who want to sell their businesses. So far it seems to be working although I’m guessing that only a few of the 100K plus accountants in the USA have jumped off the cliff so far.

Taken up to the national policy level the bigger problem with service industry productivity is not one of pricing, but one of metrics. Thanks to the focus on productive output given to us by the industrial revolution, 90% of the metrics used in GDP evaluation and policy setting became about goods production. The problem is that the metrics that work for goods production don’t help us understand the value of ideas or the knowledge economy. The value of services is very hard to measure and policy decisions suffer as a result.

The approach the policy wonks take is to try to break services, like law or accounting down into their component parts. This sort-of works for the more formalised, commodity style work but falls flat in areas like doctors, visual design, advertising or education. Even in the USA, a society which values data analysis and fact-based decision making, productivity measures exist for only about half of the US industries. The industries covered are typically the most the older, more slowly growing ones. So it’s impossible at an industrial policy level to know if policies are working or not, which means a lot of spend is probably wasted and opportunities lost at a national level.

What does this mean for service industry or knowledge economy entrepreneurs? Well if we want to be helped, we need to be able to provide bigger players like government and big business with the right metrics to measure our productivity and impact so that we can demonstrate when/how help will be effective. A core challenge then to entrepreneurs and their advisors in the service industries is to develop the metrics. There’s a great business in there for someone…

The Tac SHAC story

Very few entrepreneurial success stories are of ‘greying entrepreneurs who enter a highly regulated, politicised industry that has shrunk by 95% in the past 10 years and quickly grow a successful business’. So when you find someone who has managed to do just that, you need to tell the story…even more when the story involves lifelong passion, a husband and wife team, and a business that deals in military-style guns and ammo.

Enter Paul and Lynette Oxley, owners of Tac SHAC – a Johannesburg-based business that has become very successful at selling what are known as ‘tactical’ weapons – typically high-end semi-auto pistols, semi-auto shotguns and semi-auto rifles/carbines that are the civilian versions of military weapons systems.

Guns and the right to bear arms is an issue that divides people; it’s a sharp fence that doesn’t bear sitting on. So while there may be readers who don’t support the legal right of a person to bear arms, I hope to tell you a story of how an entrepreneur enters a really tough industry and succeeds – please take what you can from the Tac SHAC story.

To set the scene, the South African gun industry has changed a lot over the years, with regulation and politics playing a major role. In the apartheid years it was easy to license a gun (for the white population) and all young white males went through intensive firearms training in their 2 years of national service. When apartheid fell and people feared a civil war, the arms industry boomed: guns for self-defence are very much a fear driven purchase and the white-male market had both the training and in many cases, the fear.

Post the countries surprisingly peaceful 1994 elections and the new ANC government gradually got on top of legislation, making drastic moves to regulate the firearms industry through the Firearms control act of 2000. Implementation started in 2004 and not yet been finalised. This new act made it much harder to become a licenses owner of a firearm, requiring all firearms owners to pass a competency test in knowledge of the law and in the application/use of each type of gun they desired (e.g. pistol/shotgun/rifle/self-loading rifle). In addition to this each gun must be individually justified and licensed, your safe physically inspected and background personality checks done. The process takes months even when things run smoothly. The Firearms control act also put far more stringent requirements on gun dealers, firearms instructors, and the industry as a whole. The challenges of implementing the act have been acknowledged by the Police Ministry who admit that no all systems or procedures are yet in place.

Results of the new legislation were disastrous for the industry: around the millennium, it was estimated that there were over 2000 gun dealers in South Africa. By 2004, when all existing gun owners were required to begin re-licensing their weapons, the industry was in tatters and this number was down to ±800. Nearly a decade later, 90% of those are gone too and now only 70-odd gun dealerships survive. For anyone whose industry exists at the whim of government legislation, the speed of this change bears some thinking about.

Estimates suggest that gun owners who simply couldn’t be bothered to go through the new licensing process handed in over 800 Thousand guns to the police for destruction, without financial compensation and to avoid criminal prosecution. The deluge of applications for renewal by existing owners swamped the systems and meant that almost no new licenses were issued for several years. The uncertainty and delays killed the industry. Over 10 Thousand people working in the firearms industry lost their jobs. Local gun manufacturers almost all closed down.

The few gun shops that survived did so by rapidly diversifying away from firearms and into knives, mace, air-rifles, bows and arrows, and into outdoor gear. Speciality shops died – very few businesses have deep enough reserves to survive a few years of almost zero sales, and while hunting has loyal followers it’s already a highly seasonal business with practically zero demand outside of hunting season.

So that’s the scene over the last decade: an industry absolutely destroyed by a change in legislation. Why then, would Paul and Lynette Oxley decide to enter the market, and how have they made such a success?

The Tac SHAC story starts with Paul – whose parents didn’t have guns but he grew fascinated by them, to the degree that he sold his racing bike to buy his first gun while still at high school. Then came military service after which he started studying law and then philosophy at university, and invested some savings into a gun shop. Those savings disappeared when sanctions effectively blocked imports from the USA and the gun-shop closed.

Along the way Paul met Lynette and he sold some guns to pay for her engagement ring. At university Paul started a shooting club and offered training courses to staff and students alike. He got involved in the founding of SAGA (the South African Gun Owners Association) and became active in the administration of sport shooting in SAPSA (The SA Practical Shooting Association). Over the years they both maintained an active interest in sports shooting, but worked in other industries. Skip forward 20 years and Paul and Lynette are still active sports shooters. Paul is now a main mover behind GOSA (the Gun Owners of SA) and following an attempted armed robbery at their home decide to pivot from their African safari tour-operation business into the world of tactical firearms – something that is clearly a lifelong passion for them.

Whilst both Paul and Lynette share an almost evangelical belief that society is best served by a well-armed and trained civilian population, and they live out their belief by drawing ‘non-traditional’ sectors into sport shooting, it is Lynette who is often sought out by would-be gun owners precisely because its so rare to find a lady so immersed in shooting and the gun culture.

Now back to the market: As opposed to the USA market, where there are ±1.5M background checks per month (i.e. roughly 18M new gun licenses being issued each year), the total licensed gun owning population in South Africa is around 2M people, half of whom have 1 gun only and the others on average have 2, giving 3M licensed guns in total. (Recent research suggests another 5-10Million unlicensed guns in SA, which is far more the worry). The type of long guns that Tac SHAC sell are mostly semi-automatic (or self-loading) – each pull of the trigger fires the gun that ejects the spent shell and reloads the weapon by itself. To get a license for these guns is not easy: in addition to the normal competency and license application you must have and maintain what is known as a ‘Dedicated Sports’ or ‘Dedicated Hunter’ status. This means you have to prove regular participation in sports shooting or hunting and be certified as such by an accredited industry body. The process isn’t expensive but it takes many months to get right: if you want a semi-auto rifle or shotgun in South Africa you can get one, but you’ll need to be patient. A rough estimate is that there are less than 5 Thousand dedicated sports shooters in South Africa, most of who will have a pistol, shotgun and rifle. In other words, Tac SHAC entered an industry that had been destroyed by legislation and then, when almost every other gun shop had survived by diversifying into a wide range of outdoor gear, they specifically targeted the smallest, most hard-core section of the industry.

It’s a counter-intuitive strategy that has served them well. Tac SHAC focus on the core, dedicated sport shooting market who can get a licenses for the kind of guns they sell and by the vary nature of their sport and far more frequent buyers of ammunition, which is about half of Tac SHACs business. In other words, each customer is more valuable, by far, than the typical gun owners who will never practice fire his only gun. Sports-shooters will blow through hundreds of rounds in a weekend, (whereas hunters will do less than 10) and will spend R10 Thousand or more on a pistol, and R20 Thousand or more on both a rifle and shotgun. Not as much as a typical cyclist spends, but enough to build a business.

Tac SHACs sniper-like focus on a market segment hasn’t been all they’ve done right. Paul subscribes to the philosophy of being “long-term greedy”. In other words they keep margins down and focus on volume not mark-up, to the degree that other dealers have described them as being the ‘Robin Hoods’ of the industry. They’re able to support the lower margins by operating out of an owned house in a residential suburb, rather than rent expensive retail space. Their active role in promoting the industry means strong industry contacts, good relationships with regulators and suppliers, and this has translated into a strong foundation for Tac SHAC. Marketing is almost entirely word of mouth – Paul and Lynette both spend a lot of time on the shooting range, mixing it up with their customers, drinking coffee with them back at the shop. Their marketing budget is spent by sponsoring shooting competitions and clubs, across different sport-shooting disciplines across the country. Rather than a fancy website they simply have a Facebook page. One with nearly 800 likes…which is probably 15% of their market…which is simply phenomenal.

Tac SHAC also sell to private security companies and anti-poaching units who also need semi-automatic weapons. These B2B sales amount to about half of their firearms business and help them secure the volume that keeps their prices lower in the consumer market, and keep relationships with the importers more exclusive. Lastly, being in a highly regulated industry has some benefits – the requirements to store and sell weapons are tough to comply with and the same legislation that killed the industry for most now acts as a barrier to entry for anyone thinking of rushing in.

So, in summary, the Tac SHAC story is one of a couple who believe in guns and their role in society, who are active in the sport, entering a market that has been destroyed by legislation in the preceding decade and then focusing on a very particular niche. With strong industry relationships to ensure supply and a low cost approach its meant that have the stuff their market wants at an attractive price. On top of this they marketed via direct relationships with a very passionate bunch of dedicated sport-shooters (who are a small but very valuable market segment)…with some fantastic success.

More things to think about when buying a business

Buying a business can be daunting; especially if you’ve heard even a small fraction of the horror stories that those “experienced in the art” will have to share.

Last week we covered 6 important things to think about when buying a business; this week we continue with a look at how to build confidence in your understanding of any business through more detailed financial analysis and due-diligence.

It’s very important to remember that when buying a business we’re investing, and when investing the most important thing we’re trying to do is protect our capital, and the second most important thing is to grow it. This means that we need to identify all risks and price them into the deal. If the risks are too big then there is no deal, and if the risks are manageable (i.e. the probability of them occurring is low and if it does occur then the impact wont be fatal) then we can build them into the deal terms.

Risks are anything that can impact the future cash-flow generation potential of the business. Understanding them means you need to be able to identify all risks and understand their impact. The only way to really understand the impact of anything is to build a good financial model of the business, that allows you to see how a change affects the cash flows, and hence the valuation of the business.

To help you get started, here are some of the biggest risks you’ll find in the SMB ‘businesses for sale’ market.

Variability/Predictability of cash flows, including seasonal businesses:

To begin, I’m assuming the business you’re buying has full, audited financials for at least the last 3 years and monthly management accounts. If you don’t have this type of information you’re really shooting in the dark and I’d suggest looking elsewhere (or making the entire deal price dependent on future performance). If you have this info then you need to do what is called a ‘horizontal analysis’: this means you compare the same categories from year to year. How much has sales grown or contracted by? Did all expenses stay in proportion? You’ll need to work your way through the financial statements in this manner. What you’re looking for is any year when sales grow faster/slower than the ‘normal rate’ for the business, and also each income statement line (as a percentage of sales). E.g. if Salary expenses go from 15% of sales in 1 year to 25% of sales in the next, you know you need to dig deeper into why this happened. When you get to the Balance sheet, a useful tip is to calculate everything as a % of total assets – this will make it far easier to spot changes from year to year.

Be especially aware of seasonal businesses – they have to generate sufficient cash in the peak season to fund the low season, and you will want to model this carefully. Tourism, agriculture, restaurants and anything in small coastal towns are likely to be very seasonal businesses.

Key staff retention:

The productive capacity of any business depends on its staff, and you’ll always find 20% of staff who account for 80% of the knowledge, client relationships, and whose loss would severely damage the business. You’ll need to identify who these people are beforehand, understand their contractual obligations, and make sure they stay on post your acquisition. Be very aware the key staff are likely to be poached by the seller if he chooses to compete with you, so you’ll need to build your own view as to who is key and who isn’t.

Competitive action by the seller, pre or post sale:

One of the reasons to defer a large part of the payment for any business into the future is to keep the seller motivated to grow the business. In many situations, this means that you want to prevent the seller from competing directly or indirectly with you. It’s crucial to understand who has client relationships and why a particular business buys from you, then you can lock the current owners and employees into a contract that prevents them competing with the business they have just sold. You’ll have to use a carrot and stick approach – a bonus for good behaviour and legal action or damages for poor behaviour.

Concentration of suppliers, customers and product:

A business that has only 1 supplier, a few major customers, and a limited product line is immediately at risk through concentration. Broadly, this means that if one supplier or customer changes their terms with you the business could die. Simiarly to product concentration – a business with only one product can be easily wiped out when the competition change prices, launch a new version, or the Chinese start supplying your customers directly.

Management systems:

A business that is well systemised, that operates as a machine where processes are documented, followed, and improved is far less risky that one where everything is ad-hoc or simply not done at all. The simple reason is that well designed and implemented systems reduce the reliance on key people: a good system means that risk of a key person leaving is reduced because someone else can quickly pick up where they left off. It also means that new staff (yourself included) can quickly get up to speed on the business.

Legal action:

Almost every business faces legal actions at some stage of its life. Sometimes these can be crippling. Pending legal action is easy to hide from a buyer, so you need to consider an independent legal review and also making sure the seller indemnifies you from legal action relating to the business before the sell it to you.

There are many more areas of risk, which we’ll cover later. Hopefully these tips will prevent you making some of the bigger mistakes.

Things to think about when buying a business #1

Buying a business is a potentially great way to become an entrepreneur. With a bit of luck the business you want to buy has got through the first couple of years and a lot of the early-stage risk is gone. Hopefully there are customers who love the product, suppliers who want nothing more than for you to succeed, loyal staff that want to work for a new owner, and the premises is locked into a nice long-term lease with very low escalation clauses, and of course we also hope you have a very motivated and honest seller who doesn’t have any unreasonable expectations of value or deal structure.

Have all that? Congratulations! You are one in a million!

For the rest of us, most times buying a business isn’t a smooth process nor is it cheap. In the next 2 articles we’ll cover some tips to help you buy the business of your dreams, without losing sleep in the process:

1. Keep emotion out of it:

Unlike buying a house where emotion often comes into play, you should buy a business because it represents a solid investment opportunity where the returns far outweigh the risks to your capital. A great tip I learned from a friend is to look at any opportunity three times: your initial assessment, then two more. One as if you are wearing an optimistic hat and another, on a separate day where you wear your pessimistic hat – the results are very different. Listen far more to your pessimistic voice – it’s going to be more accurate 90% of the time.

2. Don’t bet the farm:

We all love a rousing war-story by an entrepreneur who risked it all and made millions, but in truth most times when people risk it all they lose it all. You have to appreciate that no matter how much homework you’ve done and how certain you are when signing the purchase agreement, chances are something will go wrong or you’ll screw up in some unimaginable way and you’ll lose most, if not all the capital you’ve invested. Give yourself a fighting chance by not investing all your capital. Even better, put the rest of your capital into a very low risk investment that offers 100% guaranteed returns and lock it in there for a long time.

3. Have choices:

Make sure you consider where else you can put your money. Consider many different businesses before you choose where to invest. Seriously – unless you really know the industry you’re looking at and have also run your own business before, you want to get to see several different businesses in different locations and of different types before you make such a long-term decision. Take the time. Keep options open so you’re not forced into a deal.

4. Don’t buy a job:

There are many people who fall into the trap of paying a few million for a business where they then work 12 hour days only to earn what they could as a salaried employee elsewhere. Make sure the business you want to buy will pay you a market related salary (i.e. that it will pay you the same as what you’d pay someone else to run it for you) and make sure that it is profitable enough to make an investment return above that. If you are really just buying yourself a job then rather take your capital, invest in a financial product and get yourself a job.

5. Live the life & get advice from people in the business:

If you’re going to be hands-on in a business you need to know what the day-to-day demands are like long before you sign anything. People in corporates often complain about boredom or ‘chores’ but the entrepreneurial grass isn’t much greener – we still do boring stuff each day. We still talk to difficult customers, make coffee, clean up and do stuff that isn’t sexy. Don’t expect different. Speak to people in the industry about what life’s really like, and if you can, spend a week working in a friends business during their peak times to know what kind of hell you are about to pay good money to live in.

6. Do a deal that is almost certain to make you money: 

You make money by buying now and paying later, and by buying low and selling high. You also make money by taking steps to reduce risk. For this reason, most of the deals I’ve worked on involve the buyer paying only a small part of the agreed price as cash upfront, with the balance paid based on performance of the business over time. I’ve covered this in previous articles, but in essence the typical upfront amount is around 20-30% of the deal and the repayment term around 5 years. Bear in mind throughout that unless you are earning healthy dividends, the only time you’ll really make money when buying a business is when you’ll sell it to someone else. So you’re really looking for a business that you can grow at around 30-40% per year before you’ll make any kind of return…and only then if you can find a buyer in the market at that time.

We’ll cover the financial analysis side of buying a business in next weeks article.

When love (or other major things) get in the way of your business

I know of a small entrepreneurial team who met at university, discovered they shared a passion for the tourism industry, graduated later and went to work in tourism as employees of the dominant company at the time. After a few years valuable experience they decided they could do better than the incumbent and left, joined forces and set up their company. They kept costs down for many years.

In any industry it takes time to build up trust and part of this trust is simply being around over time, so keeping costs way low meant that conservative international distributors who met them at a travel show one year, would see them still alive a year later, and would start to trust them with some business only a year or two after that. Inbound tourism has fairly low barriers to entry but long sales cycles, where products are often finalised and marketed 1-2 years in advance, so the experienced distributors know to wait it out and see which of their suppliers survive. Only then can they trust them with their business 2 years from now.

What typically happens with new entrants is that they buy expensive new vehicles in which to carry clients around Africa, and equip them well. They put fewer seats in their trucks so that customers have more comfort, but then make the mistake of pricing their trips the same as the lower cost operators in an effort to win business. The result is that each trip is marginal, if not loss making and within a year or two they are out of business and all capital is destroyed. The experienced distributors have seen this all before, so they hold back on giving business to new operators. This means that new operators must have a differentiated offering, a lot of luck, and very low costs to start with. They have to get around the 2-4 year phase of building trust with their distributors.

This is what the team I know did, almost too well. Pretty soon they had the number 1 distributor in a large foreign market signed up and were in all their brochures and getting all their local business. Then the number 2 supplier in that market approached them also wanting to sell their trips. The problem was that they couldn’t supply both. So after some thinking they set up a separate company, which they owned, and gave some equity to their chief lieutenant who was then tasked with driving the new business. Through the two businesses they could now service both distributors and grow things well. Indeed for the first year or two this is what happened.

Then the Lieutenant’s girl (whom he met on one of their trips) became his wife and this led to pressure from her for him to get his ‘fair share’ of the business. So there were lots of negotiations and eventually he was made the majority owner of the business. I asked at the time what would happen if he didn’t meet targets or how he could be replaced and they response I got was that he was fine and knew his stuff and there wasn’t any need to put these kinds of clauses into the deal. You know what is coming next of course: the Lieutenant’s wife moves back to the foreign country where she came from, pregnant, and he goes with her. Suddenly the local business is being ‘run’ from a distant foreign land from a ‘stay at home dad’ and things don’t go well.

Its been nearly a decade since this happened. The original business is now big enough that it employs nearly 100 people. The spin-off business is still only 5 people, some of whom are seasonal. The original shareholders can’t change the shareholding in the spin-off and haven’t been impressed with the returns, so they have simply stopped supplying the business with managerial expertise or further capital. They’ve considered selling it too, but it’s not easy given the low growth rate, foreign owner and other issues. So they’ve rightly focussed their efforts where they can influence returns.

When they setup the spin-off, they never planned around what could go wrong. They didn’t anticipate the people’s lives change and that someone so committed to the early success of the business could meet someone who would effectively force him to move country and neglect things to such a degree. They screwed up the legal side of things and its cost them some money, but mainly its cost them all the growth that could have been.

The lesson here is around legal homework – any shareholding-level agreement needs a lot of thought not just in terms of what each person gets, but also in terms of what happens when things go wrong. How do you revert? How do you claw back? How do you measure performance and strip away any free gifts of shares before it’s too late. Get an attorney on your side before you sign the deal.

Can your industry cluster?

One of the key concepts in strategy is that of the Industry Cluster, and the underlying economics of agglomeration. Broadly, a cluster is a geographic concentration of interconnected businesses, suppliers, and associated institutions in a particular field. In theory a business that is situated next to its suppliers and across the road from its customers benefits from dramatically reduced transport costs, and almost certainly from far more immediate sharing of information and shorter feedback cycles. The same goes for competitive businesses that are closely clustered – they share suppliers – for example several automotive manufacturers would share the same suppliers of steel, tyres, energy, labour and expertise. Clusters are a core part of industrial policy at a national level, and therefore the analysis around which to support and how to support them has made some consultants very wealthy. The success of Silicon Valley is around the clustering of venture capital and the entrepreneurs in which the capital is invested. Las Vegas is a cluster of hotels and casinos. London is a cluster of financial services. Johannesburg began as a cluster of mining related businesses situated right on top of the reef that they mined.

Done properly, clusters provide a long-term economic advantage to their members. An article in the BBC earlier this year illustrated just that: in the small town of Markneukirchen in Germany, the musical instrument making industry is 400 years old and still going strong. The story is one of survival – of how skills are passed down to the next generation who then adapt further to stay alive. The idea of an industry cluster wasn’t formalised when the makers of Violins set up their shop next to the makers of the bows needed to play them in the 1700’s, it was just the way things made sense. By the early 1900’s the town accounted for over 80% of musical instrument production around the globe. Being in the former East Germany, the town survived communism too: in fact the musical instruments were a prized source of foreign exchange for the East German government and the industry was actively supported. Today the town has over 100 different businesses all involved in making traditional musical instruments, yet using all the modern ways to connect to distant global markets.

Most of the businesses are very small, family owned workshops where skills are passed from grandfather to grandson and both tradition and quality matter. Musical instruments are increasingly mass produced or even digital. So how do the Markneukirchen manufacturers compete with low-cost competitors in China? The answer is the quality of the product and the ability to offer something that meets the exact needs of a highly trained musician playing in an orchestra somewhere. Their instruments have a reputation for durability, for consistency and this means that their customers (who are by nature self-referencing markets) are willing to pay for the quality of the European instrument rather than a cheaper Chinese generic. Their long-lasting profits mostly depend on quality – yes they use new manufacturing techniques where possible – and on selling the market that appreciates the difference they bring. They make sure that if a classical musician wants a particular part on his/her instrument, then they provide exactly that and at top quality too.

In our modern, globalised world clusters are no less relevant especially in manufacturing industries. It’s the service businesses where the walls have come down – modern information systems and telecommunications allow customer support to be outsourced to India, programming to the Ukraine, and design to California. The high quality, non-digital stuff is harder to commoditise, and here clustering may well still have major benefits.

Clustering should be something you think about in the strategy of your business, particularly those involved in manufacture or anything where transport or energy costs are significant. These costs are only going to go up in the future, and the more they do so then the more it will make sense to be very close to your suppliers or your customers, and if it makes sense for you then it will probably make sense for your competitors. Where can you cluster? Can this be a source of long-term profit for your business? How will rising energy costs affect these decisions?