ascendia Rough Guide: Why Your Business Is Not Your Super
valuation of small to medium sized businesses
Operating a successful small business requires significant business management expertise due to the increasingly competitive business environment.
Such expertise is compensated by a large component of the return of the business. This expertise is not necessarily pre-existing in the business that is sold, in fact it is often embodied in the vendor who is leaving. The result is that the ‘value’ of the business is substantially down because the current owner is selling. What are the chances the new owner will be as successful? They are quite low. Australian Bureau of Statistics publications state a 20% chance of surviving the first year, and of those surviving they have a 20% chance of surviving the first 5 years.
The likely economic return of the business that remains without the owner operator is the return on capital and related ‘business value’ such as remaining staff, client lists, integrated business processed and equipment. Due to the competitive business environment in an ever more opening economy, and the resulting increasing risks of being able to maintain competitive advantage and market positioning over time, the return required of a small business owner / investor is very high. The investor naturally wants as much of the original investment paid back in as short a period as possible. To get this to work (a high percentage return) the investor / purchaser needs to pay a price that is relatively low for the level of available profit in a good year. So basically many business operate on a very low pay back period valuation. Some examples include 0.7 x annual turnover; or 3 x annual turnover, or 2 x annual turnover. The best most business advisers see in the privately acquired SME market is 5 x annual turnover.
This means that for many people they can get more for their business by keeping it for an extra 5 years and deferring your retirement, and then winding it up, than by selling it.
reduced barriers to starting a business from scratch
Skills shortages, demographic shifts and relatively easy credit mean that the ability to start a business from scratch is easier at the moment than 10 years ago.
This is buoyed up by the Australian Taxation Office’s statistics showing a massive increase in the number of self managed / Director owned companies in Australia in the last 10 years. A 30% increase. The shortage of good staff and good service for business clients is making it easier to attract a client base from scratch by hanging out your shingle, whether you are a diesel fitter, roof tiler, builder, IT consultant, engineering draftsperson, pharmacist or whatever. So why would younger people buy your business? The shortage of skilled professionals and tradespeople has made it a skills sellers market. It’s perceived by many as a great time to start a business – not buy one.
sophisticated consumers
Technology, reducing trade barriers, rising education and an increasing sophistication of customers and clients and consumer awareness of competitors’ alternatives (whether its import replacement from China or India, or using the web to rate shop) has disrupted traditional firms marketing channels, competitive positions and brand strength in even niche businesses.
Many younger purchasers of businesses believe that the brand is more expensive to maintain and less certain of premium pricing power even if known, and that consumers believe that there are low price high quality alternatives around every corner in many markets. This means that people are reluctant to pay a premium for a business that may face a major competitive threat from an unknown external source just around the corner.
rising standards required of businesses
Franchise marketers have at the same time raised expectations of business purchasers and made them more sophisticated and wary due to the publicity surrounding fraudulent franchisers.
It may be that your business is too idiosyncratic, with insufficient policies and procedures. It may not have a clear marketing process in action, or a sustainable set of business values being brought to bear in the form of staff training and recruitment patterns, a process for regularly updating services or products and so on. If you think it is good on all these fronts – compare it with a competitor.
If your business is in fact good in comparison to that of competitors – how does it compare with the expectation of a generation raised on the idea of being given a “businesses in a box” from franchise marketers? Even if prospective purchasers don’t end up buying one of these mass marketed franchises and instead look for something more independent that you may be offering - the marketing of franchised businesses has impacted profoundly on the expectations of business purchasers generally. As a consequence most purchasers have a expectations that are vevry high compared to those of purchasers even 5 years ago. This is important in relation to the standards your business offers by comparison, that is the standard in your business of:
- Documentation and procedures
- Records management systems
- Client database information
- Systematic business processes documented for the business as a whole.
Is this purchaser market of no concern to you? That is: the younger generation. They are the ones you are probably going to need to sell to if your business is your retirement, not your contemporaries who may expect to build these business systems themselves. After all, the purchaser is not building a start up but buying an established business.