What is the enterprise value of my business?
Many entrepreneurs ignorant of the importance of the value of the enterprise. Being aware of it is important while undertaking strategic decisions like sale or investment transaction.
We met with a new client who is into the business of HR services with over Rs 100 crore turnover. The performance has been consistent and not affected by the Covid pandemic. Moreover, the company has reasonably well-established governance and internal control practice.
He is looking for an exit strategy through sale. The reason for the sale of the business is apparent. He wants to exit as he is growing old and children have no inclination to carry forward the legacy—a commonly sighted situation in the MSME segment in India in recent years.
We observed that the process to sell the company is very inappropriate. There is no preparation of any documents, no organised thought process, or professional advice on the sale. They tried to seek potential buyers through their friends and relatives. They got a potential buyer through their network and almost agreed on a price. We felt that it was much below its worth.
MSMEs generally do not give enough attention to improving the enterprise valuation before any action like sale, investment etc., instead, they accept whatever the value arrived during the transaction process.
Having devoted one’s entire life to developing the enterprise, assessing how valuable one’s business is should be paramount. Secondly, the valuation of the enterprise need not be linked to the immediate sale. There are many reasons for undertaking valuation.
Reasons to Value Your Business
· To sell your business
· To attract investors
· Buying out the other owners
· Offering employees equity
· To better understand business’s growth
The list can go on as small business owners’ personal and professional lives revolve around their business and potential. While many of the reasons above involve changes in the company or its ownership, personal events such as marital discord, illness of a critical person, the sudden demise of the enterprise, age factor etc., may also influence the valuation.
How to Prepare for a Business Valuation
If you’re conducting a business valuation for informal purposes, you may want to do it independently. However, hiring a professional valuer like a certified valuer registered with the Insolvency and Bankruptcy Board of India(IBBI), Merchant bankers, Chartered Accountants, or Financial Advisors could be a good idea if you need the analysis for more serious matters.
In either case, there are a few steps you can take to prepare for the valuation:
Get Your Financial Documents in Order
Every valuation is going to be based, at least in part, on your business’s finances. Even the market-based valuation method requires your business’s financial information to find suitable comparable to justify the value you will seek.
At a minimum, you’ll want the previous three years financial statements, including the balance sheet, income statement, and cash flow statement. Then, combine these statements to ensure everything is up to date.
Other finance-related documents, such as sales reports and industry forecasts, can also be important, particularly for DCF and market-based valuations.
Organise Other Essential Documents
Depending on your reason for the business evaluation, you may also want copies of your business licenses, permits, deeds, and certifications available, along with any ongoing contracts with insurers, creditors, vendors, and clients.
If you’re looking for business loans, you’ll likely need to share these along with your financials. You can also pull out your bureau report (Ex CIBIL) and present it to show your credentials.
List Additional Intangible Assets
It would help list the business’s tangible assets (such as cash, property, and equipment) on your balance sheet. Some intangible assets may be listed there, such as copyrights or patents. But think about other intangible assets that may be providing value.
An extensive email list, customers loyalty scheme, good rankings in search engine results, engaged social media profiles, and positive online reviews can all help you attract and retain customers. These types of assets could help improve your business’s valuation even if they don’t have a value on its balance sheet.
Identify sustainable competitive advantages.
If sustained for years and decades, every business must have something playing a crucial role in its success. So be aware of such strengths that support your business to be there.
There are also ways to demonstrate the business’s value to potential buyers that don’t rely on the numbers. For example, if you can show how processes and systems are in place that will keep the business running after you leave, buyers may be more willing to agree to a higher valuation.
Or, perhaps you can highlight how your employees are happy and take ownership of their work. Low turnover can save the business money, and responsible employees can make transitioning to new management easier.
Improving Your Business Valuation
Your business’s valuation will depend on how much money it makes, and increasing revenue and cutting costs are the core essentials to improving your valuation. This apart enterprise value is influenced by aspects such as the business prospectus, internal control, governance, business process, HR practice, etc.
The enterprise valuation can be improved by working on various elements listed above. However, it will happen over a while, not instantly.
You may hire a professional to advise you on improving the valuation. Hiring a professional valuer might be an excellent step, as they can give you the current valuation and help you identify your business’s strengths and weaknesses. They may even be able to offer suggestions for improvement based on what they’ve seen work for other companies.
Do a Practice of Regularly Valuing Your Business
Learning how to estimate the value of a company can be important for MSMEs for many reasons. Even if you’re not planning on selling your business or seeking investment, regularly performing a quick business valuation can help you track your progress over time. In addition, taking a deeper dive into the valuation may help you uncover growth opportunities.
Regular exercise of undertaking valuation is a healthy practice. It is a strategic initiative and can benefit the company in many ways. Giving attention to factors that contribute to higher valuation will put the firms on a pedestal and help the firms secure investment at shorter notice if the need arises.
An ill-conceived strategy to sell the company: Prone to legal and other risks
While many entrepreneurs plan to leave the business for a variety of reasons, the strategic approach is essential to make it a successful sale.
Recently, I received an entrepreneur who had trouble coming out of her failed exit plan. The business had been running successfully for many years. However, the COVID-19 pandemic and the consequent lockdowns had a severe impact on the business of the company. The company experienced supply chain disruptions on the one hand and the delayed restarting of orders from some of the customers on the other hand.
In view of advancing age and lack of successor within the family, she decided to quit the business and started exploring someone who can take charge of the business and run it.
She identified a businessman looking for diversification to take over the company. The terms were negotiated. He did his due diligence and assessed the company’s potential. After mutual discussion, it was agreed to enter into a partnership in which he would own 95% and hers would be 5%. Upon signing of the deed of partnership, the manufacturing facility was immediately transferred to new premises (belonged to new owner).
Bonhomie did not last long. Cracks started to appear in the association as they went into business. There were gaps. For instance, execution of personal guarantee of the new partner to bank loan was deferred rather bank permission was not obtained for new partnership arrangement. Consent of the bank to shift the assets were not obtained. With respect to compensation for the current owner, there was no explicit agreement rather it was left to mutual unwritten understanding. There was no formal business transfer agreement. The partnership deed was more forward-looking as if for a new entity than addressing the transitional challenges and issues. Likewise, few other issues began to bother them and in turn lead to friction.
The entire transaction was organised in a very unprofessional way and without a solid legal basis. Above all, the new partner was new to the industry and did not show much interest in learning the intricacies of the business of the company. This lead to a situation of mistrust and one began to blame the other. The partnership came to an end. The seller lost a great deal to relocate the company to new premises and again bringing it back. On top of that, the company suffered a business loss for six months because of the bickering. In the end, she felt associated with the wrong person.
Selling to the Wrong Person:
Accepting the first offer may not be an appropriate choice. This may not necessarily be your best offer. Selling your company at a high price with little or no money upfront with an extended contract can lead you to lose it all. This is what opened in the case discussed above.
Business sales often go bad after the new owner takes over. The new owner may be inexperienced in business, have a closed mind or be a bad leader. The list goes on and on.
When this occurs, the new owner eventually closes its doors and lets the previous owner hold an empty bag.
The steps one needs to take while putting business for sale.
It is fact that many small businesses do not find successors in their families when the children pursue their own interests. There are other reasons such as poor health, premature death of a key individual, partner differences, etc.
In any event, an orderly sale requires certain essential measures, a methodical approach and respect for existing legal and procedural aspects. Following are few steps we suggest:
1. Timeframe for Sale and preparedness
Keep a time frame of one or two years to conclude the sale. This timeframe must be utilized to update financial records, ensure legal compliance, document the processes, etc., to make the business fit to BUY. This will make the transition friction-free and will not cause disruption.
2. Business Valuation
Next, determine your business’s value, to make sure you don’t set a price too high or too low. Identify key strengths & opportunities. Consult a professional for an assessment with a detailed explanation of the value of the company. The document will provide credibility at the requested price and may serve as a gauge for your offer price.
3. Avail service from an advisor
An experienced advisor can bring expertise to manage the sale and also free up your time. They can add value by leveraging their business network to speed up selling.
4. Preparing Documents
Prepare a detailed Information Memorandum including financial records, legal compliance, detailed list of assets, contact list of customers and suppliers, disclosure of potential disputes, etc.
5. Finding a Buyer
Use the trade networks, online platforms, professional advisors to identify the potential buyers. Sometimes your own associates may assist you in finding the buyer.
Once you have prospective buyers, qualify them before letting to start due diligence in terms of financial standing and more importantly suitability of the person to keep the business running.
The sale of the company must not lead to legal hurdles either to the seller or to the buyer. Because it can destroy the business you have nurtured for many years. It is highly recommended to take the assistance of professionals to create the documentation and deliberate every aspect before signing.
For many MSMEs, the sale is a compelling transition strategy. In addition, selling is the means of realizing the value of the business built assiduously over the years.
Assess your options and choose the best choice in the long term interest of the business you nurtured. Ask yourself, is he the best person to buy and run my company? Or, can they quickly connect with the customer base and learn how to market effectively? When the business sale goes as planned, it creates a tremendous opportunity for new business owners and the success continues.
It is saddening to see a business fail after years of success due to the lack of a professional approach to sell the business.
Poorly structured sale of a business may also incur unnecessary additional costs, including commercial, legal, financial and tax issues.
A financial safety net for MSME workers: simplified
Govt has implemented few products that benefit the workers of MSMEs if implemented comprehensively.
Recently I had an opportunity to survey the financial safety net implementation by the rural population surrounding an Industrial area, near Bangalore. Many of the members of these households are working or associated with industrial units in that cluster or elsewhere.
In our study, we found that a large section of the households have not subscribed or not even aware of the products despite being widely published by the Govt.
The financial safety net for families- a need felt across more than ever
Every family aspires to secure themselves from the shocks and difficulties of through fair distribution of their earning between savings, risk cover and retirement corpus. The flexibility to do so is very limited if the earning barely covers the living expenses. This situation puts the families into a very vulnerable state and that may act as a deterrent to getting them into activities where the perceived risk to themselves is quite high or they remain alert to risk so much that will lead to lesser productivity from them.
Since their income barely covers the living expenses, Govt has taken many initiatives to supplement these needs by introducing an array of products.
These products are very pertinent for workers in MSMEs. The income level of workers, regular or otherwise, is not very high. These products are made very affordable, meeting their needs.
Financial safetynet –composition:
The financial safety net, we are talking about comprises a few assorted products mainly from Govt sources. In recent times, Govt has made access to avail the products and also to secure the benefits under the products much easier than ever.
These comprise savings, life insurance, health cover, accident cover, pension and skill development. Details as below:
Savings products: Having a bank account is commonplace for employees and it is a good sign. However many of them are just limiting their banking transactions to the savings account and it is no surprise to find some accumulating their hard earning savings in SB account when there are opportunities to maximize their earning even from a scarce amount of savings by opting for products like recurring deposit(RD) and fixed deposits. The spinoff from having an RD account is that it prompts them to adopt a planned approach to save and at the same time maximise the earning.
Term Insurance(PMJJY): Govt has been promoting term insurance of Rs 2 lakhs for an annual payment of Rs 330. It is made available for the people of age group 18-70 years. It is very simple and does not require one to go through any procedure to assess the eligibility.
Accident Insurance(PMSBY): An accident insurance amount of 2 lakhs is available for people for annual premium payment of Rs 12 only. This will help the poor labours to secure the family against accident-related deaths.
Health Cover: To empower poor families against health-related issues. Recently Govt enacted Ayushman Bharat scheme. The coverage is as much as Rs 5 lakhs. This scheme requires one to register and take health card from the nearest Govt hospital at no cost.
Pension products: It has been since a long time that all the citizens are given an opportunity for having their pension account under the National Pension Scheme( Eligible up to 54 years). Thereafter Govt has enacted four new products for the benefit of people in the age group of 18 to 40 years for unorganized and skilled labours. It is called PMSYM( Prime Minister Shram-Yogi Mandhan Yojna) Under this scheme the labours who are not eligible from PF and ESIC can have a pension account with a monthly payment of Rs 55 to 200 depending on their age and will be eligible for a pension of Rs 3000 after 60 years. Under this scheme, the Govt will also contribute an equal amount every month.
Also, those employees who have PF benefit may opt for a pension under Atal Pension Yojna non-subsidised.
Skill Development: Skill makes an individual more valuable for society. It helps one to earn more and to enhance his/her self esteem. It motivates the people to become more productive and he/she can become a source of strength to any organisation. Seeing the skill gap and the industry’s clamouring for support, Govt(state/central) have implemented many schemes to support skill development programmes.
Supporting Employees to become Financially secured- The best CSR initiative for MSMEs:
Corporate Social Responsibility (CSR) has emerged as a new yardstick to evaluate the contribution of an enterprise for the welfare of society. Govt has implemented a law compelling large companies to mandatorily spend on their own to the welfare of the society a portion of the income. However, this is not applicable for MSMEs as they do not have enough financial flexibility to engage in such activities.
It is well said that the best CSR activity for MSMEs is to support their employees. If these MSMEs take initiative to educate and encourage the workers working within their company to take the above social security products, it will improve the goodwill and make employees feel secure. Educating and encouraging these workers to secure themselves under these products does not require any investment. It is the word of encouragement, guidance and follows up will take them to avail these benefits. Some may incentivise in different forms to make them avail these products.
There are benefits for the MSMEs. A financially and socially secured employee makes the working environment secured. Standing as a socially responsible organisation will be further reinforced.
There are many new financial products from the Govt to help the weaker section of the society to become empowered. These products are also very important for employees of MSMEs. Many of the eligible beneficiaries are not aware of these products. MSMEs may encourage workers to cover themselves under these products and make their life more secured. This will augur well for the organisation and counted as a socially responsible organisation.