***Ascent Partners: How do you eat an elephant?***
Okay, so you’ve noticed the elephant in the room (your business in not providing an adequate return on investment and is you’re running an unsustainable business model) and need to do something about it; so how do you eat the elephant? The standard answer is “in small pieces”, but in this analogy you also initially need to know how big the elephant is, and if it’s growing, and then work out a strategy to deal with it to provide the best return when it comes time to exit.
The first thing to do is assess where you are now (how big the elephant is). I said last week you need to have the business appraised to see what its value is, but that’s only part of the answer, because after that you need to calculate your real equity position – i.e. you need to put the real values of the equipment and goodwill, which are calculated as part as the business valuation, back into the balance sheet, and then the real values of the other components.
Because for most business proprietors approaching exit, the aim is to build as much equity as possible, and much of this is about timing, and about trying to forecast the future. Also, part of the equation is how much they are likely take from the business in the lead up to exit, and what role they want to take in that transition period. Let’s talk about these concepts:
1. Real Equity – real equity is the equity you have after reworking the balance sheet to reflect real values. A business appraisal will provide the equipment value and goodwill value, but you also need to consider the other components of the balance sheet. This could include staff entitlements, and accurate statements of liabilities. Calculating you real equity position now is vital for the analysis of the exit options.
2. Timing – the preference to exit is to time it so that that you are in the best equity position. This could be when you make the last payments on assets, or when your lease is about to enter an option period. It can make a huge difference, because in many instances now, proprietors have negative equity in equipment.
3. Forecasting the future. Let’s assume you are running at $500,000 real equity now, after sales have fallen 20% over the last three years, and margins have come down 5%. You now need to predict what is likely to happen in the say the next three years, if that’s when you want to exit, and try and forecast what you’re equity will be at that time. You also need to factor in how much you think will be able to draw in that period
As an example, below we provide a Balance Sheet of Real Equity and a P&L statements, the first as at 30.6.11, the second trying to forecast the future as to what they may look like as at the end of June 2014, if the business continues in its current form.
For this exercise we estimate that equipment values will half, and that sales and GP will continue to deteriorate.
| 30.6.2011 | 30.6.2014 | |
| Plat and equipment | $1,000,000 | $500,000 |
| Goodwill | $500,000 | $300,000 |
| Other Assets | $500,000 | $350,000 |
| Liabilities | ($1,500,000) | ($1,000,000) |
| Equity | $500,000 | $150,000 |
Profit and loss statement
| FY 2011 | FY 2014 | |
| Sales | $3,500,000 | $2,800,000 |
| GP | 50% | 45% |
| GP | 1,750,000 | $1,260,000 |
| Expenses excluding owner's drawings | $1,500,000 | $1,260,000 |
| Profit to owner | $250,000 | $0 |
So, in this example we have assumed that the business could have been sold in June 2011 for $1,500,000, which would have provided the owner with $500,000 after he collected the debtors (in “other assets”) and paid out the liabilities (including the creditors and staff). However at the end of 2014, the business has been sold for $800,000, and he only gets a net $150,000. So effectively he has lost $350,000 of equity by trading on in the existing format.
He does however have some profit available for him to draw from in those three years– let’s say in FY 12, FY 13 and FY 14, $200,000, $100,000, and $0, respectively, as sum of $300,000.
So effectively he has lost $50,000, excluding any taxation calculations, and he has had to work for three years for that privilege.
This is not fantasy land. The above scenario may well play out very similarly to a lot of printers. In fact if you recast the periods to the first column being 30.6.2008 and the second being 30.6.2011, you may find the same situation. Countless printers would have been better off changing their business models, or getting out back then. A small elephant was in the room then and it’s grown substantially!
Hindsight, it’s a wonderful thing. But if you can’t learn from what’s happened, and just continue on, expecting a different result, that’s just dumb.
None of this is easy. But it is a pressing issue, and one I think the industry needs to face up to. There are no quick fixes. But at least you need to work on the numbers now, find out what your real equity position is now, and what it may be in the future if you continue working the same business model as you do now. Then consider the options. I gave a few last week:
• Talk to your competitors and discuss how you could work together to build a more sustainable business model. I’m not talking about illegal activities like price fixing, but more about joint ventures, collaborations, sharing of resources, improving machinery utilisation. A quick glance of the trade press will show many are doing just that.
• Sell machinery, work for another printer and sell them your client base – for many the real asset they have is their client list. There is no shortage of buyers who want to engage proprietors, and take over their sales. Some will even let you continue to trade under your own name. What’s wrong with earning $100,000 and getting paid for your client list as well?. Not a bad exit strategy for many. Sure, chances are they won’t want your machinery and all of your staff, but for many this will be far and away the best financial outcome. The issue many proprietors have with this model is that they “can’t work for others”. That’s fine, but understand, for the majority, they make that choice at the detriment of their future financial position
• Change for being a manufacturer to a marketer – you know the prices that are being quoted out there, and you see your margins falling. Why not focus on really servicing the customers – attaining, maintaining and growing them, and outsource some or all of the manufacturing. Maybe you just do design and digital print, and sub out the longer run A3 and all A2 work. Maybe you just keep the part that you know you have a good chance to make a stable return on
• Focus on the niches – “me too” is generally unsustainable if you don’t have a real competitive advantage – “we’re good quality printers” is not a competitive advantage.
• Form alliances to get more share of the customer. Share of customer is often better than market share
• Update technology to be best in class – here your aim is to be the lowest cost manufacturer
• Sell the business now– Yes for many the sell now option will deliver the best financial outcome. Because the fact is a “no change” policy for most of the commercial printers out there is a “watch the equity in my business deteriorate” model.
These are not the only options just some to get you thinking. Work a few scenarios that may be options for you – which will provide you with the best return?
Enlist the help of trusted accountants and advisers, but at least acknowledge there is an elephant in the room, then start working on eating the elephant. That said, eating it in small pieces may not be the right answer, for some the right strategy is to change the game, adopt a more sustainable business model, or move on.
Contact Richard Rasmussen at Ascent Partners for help in appraising your business, working with you to form strategies to change your business model, and business sales on 0402 021 101.