Business #11 – Art of the Appraisal

Posted by on May 31, 2013 in Blog, Featured, Finance | 0 comments

Business #11 came to us in a roundabout way.  We were advertising for drafting employees to meet the needs of our cell tower engineering customers.  A young lady came in to apply for the position.  We asked her why she was leaving her existing job and she said her employer was retiring.  We took that information and called the owner to find out about his business.  Sure enough, he was selling his business.    He was old, tired and ready to move on.

I contacted the business broker and we started in on the negotiations.  The first thing I received was a copy of the appraisal, which the owner paid a lot of money for.  Historic income statements showed declining sales:  2001, $1,119,655; 2002, $716,131; 2003, $439,599.

The appraiser then developed a risk factor model:

Build-Up Model, Risk Factors:

Risk-Free Rate                                     3.97%

Market Equity Risk Premium           6.92%

Small Business Risk Premium         20.00%

Total Discount Rate                       30.89%

The appraiser then capitalized the earnings with a weighted average:

Capitalization of Earnings            Normalized      Weighting        Weighted

                                                            Earnings           Factor                Earnings

Fiscal 2001                                             401,135                  1.0                  401,135

Fiscal 2002                                             239,774                  2.0                  479,548

Fiscal 2003                                             80,132                    3.0                 240,396

Sum of Weighted Earnings                                                                          1,121,079

Divide this by Sum of Weighting Factors                                                              6.0

Weighted Average Earnings                                                                        186,847

Divided by Historic Capitalization Rate                                                              30.89%

Total Equity Value                                                                                           604,877

It is important to note that business appraisals are part art and part science.  There are a lot of assumptions to be made and the combination of those assumptions can change the value wildly.  In this case, the appraiser weighted the last 3 years of earnings, giving more recent years a higher weight.  This is a common method, but past performance does not predict the future.  If you follow the trend line, the sales will hit zero in a matter of a couple years.  Stating that the company will generate free cash flow of $186,847 in perpetuity is wishful thinking at best.  The new owner needs to pull the business out of a nose dive, which could cost even more capital.  For this reason, its important to appraise a business in at least a few different ways to get a good idea of what’s at stake.  We plan to cover some of these ways in future articles.

With an appraisal in hand, the owner opened negotiations with a sales price of $600,000.  We told the broker we were not interested at all at that price.  His expensive appraisal was only looking at past results and did not forecast the most likely scenario going forward, which was a continuation of 2003 results.  We just stayed in touch while the broker tried to find other buyers.  The seller and broker came to the realization if they wanted to sell his business he needed to lower the price to a reasonable number.  We entered serious negotiations and the business sold for 25% of the appraised value.  I negotiated my usual 50% down, 50% financed over 5 years.

We were able to stream-line the operation and this became a very profitable branch office, even at historically low volumes.

Keys To Success

  • Business appraisals are just assumptions, if yours are different, don’t buy
  • Do not be put off by the initial asking price
  • Be observant and look for opportunities everywhere

 

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Mind Readers

Posted by on May 23, 2013 in Blog, Featured, HR | 0 comments

The ability to read another person’s mind has been a fixture in popular movies and books for at least a century.  Characters like mutants, aliens, vampires and mad scientists are usually portrayed using this power for evil.  People are rightly uneasy with the notion of having their most intimate thoughts plucked from their minds and exposed for others to see.  Likewise, you can understand how these inner-most-thoughts could easily be exploited.  I would like to inform you that a mind-reading device was invented over a decade ago and its use has recently exploded in the last 5 years.  Stalkers, news organizations, global corporations and even the government have access to this device and will use it on you if you are not careful.  Strangely, the device of which I speak does not extract thoughts through compulsory means, but rather, individuals reveal their thoughts voluntarily.

Twitter, Facebook, and to a lesser extent LinkedIn, are broadcasting our collective thoughts 24 hours a day.  I find it funny, and at times disturbing, how often I see news of a celebrity apologizing for some Tweet they posted while tired or utterly inebriated.  It’s even more unbelievable when they are perfectly coherent.  Does your iPhone need a breathalyzer? Do we need a driver’s license for social media?  Maybe not, but your company does need a solid policy for social media.

We all have crazy thoughts, but some people just can’t keep them to themselves.  In the past, this would have only caused an awkward moment at a social gathering, but today, thousands of people will know about these unfiltered thoughts in a matter of seconds.  This poses a huge risk for your company.  Your hard-earned reputation could go down the tubes because of an off-color joke or socially insensitive remark carelessly posted by one of your employees to all his followers.

It’s obvious that anything coming from the official company account needs to checked an rechecked before it gets posted.  This type of work should not be pawned off on the volunteer intern.  This is your company’s image and you should take great care in making sure it’s correct.  There are tools available that will delay a social media post for a predetermined amount of time just in case you want to retract your words before its too late.

What your employees post in their personal time is an entirely different beast.  Your policy on such behavior should be clear.  There are many legal and privacy questions around this subject.  Many companies have policies that limit what high profile employees can say on their personal accounts.  Some companies even state that their executives are not to have personal social media accounts at all.  The bottom line is that you need to mitigate this risk to your company by implementing a policy that makes sense for your industry, your business and your customers.  Once something hits the Internet it is impossible to erase it.

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Business # 10 – On The Lookout

Posted by on May 16, 2013 in Blog, Featured | 0 comments

Business #10 was flat out a business of opportunity.  My mentor had seamless gutters put on his home and during the process he asked the installers about the business.  The foreman explained that they pull a trailer from job to job that extrudes rolls of flat aluminum into gutters of custom lengths.  These gutters are then installed on the spot.  One crew can do two jobs a day and bill out up to $2000 a day.  This seamed to be a low overhead, easy-to-operate business.  After that discussion with my mentor, I was on the lookout for a gutter business.

Not long after this, I was given a tip that someone was interested in selling his gutter business.  I was not told the identity of the potential seller so I had to cold-call some businesses in the area using information from the contractor’s licensing board.  I eventually identified the owner that was thinking about selling his business. His response was, “Maybe, but not yet.” He wanted out of the industry to pursue something else, but his new venture was not up and running yet. I stayed in touch with him for many months, calling occasionally to see how his new venture was developing.  I even had him replace gutters on my house and I was impressed with the crew and the quality of the work.

After 8 or 9 months, the owner called and said he was ready to sell his business.  Given that our relationship was now quite strong, the negotiations went smoothly. We did the typical 50% down, 50% over 5 years at 6%.  The matrix was 65/0/15/20.

At the time of the acquisition we did installations directly for home owners and also teamed up with roofers to sell new gutters with the new roof.  I hired my new son-in-law to manage the business and he landed Home Depot as a customer, which increased sales by 30%.  We added another gutter machine and a second crew to keep up with demand.

Things were going well until the housing market crashed.  With falling home prices, people were less motivated to make improvements to their homes.  Home Depot started to put the squeeze on their wholesale contractors, which left us with little or no margins.  Things looked pretty grim for a while, but the market is recovering and things look much brighter for East Bay Gutters.

Interestingly, after my son-in-law moved on to go to law school, the old owner came back to work as a manager.  His venture did not turn out as he planned and he was looking for a job.  He worked for me for a few more years before finding another job.

The business has had its ups and downs, but it really turned out to be a neat little businesses that can be expanded.  We are looking to reinvigorating the business even more with a new marketing campaign.

Keys To Success

  • If you can, take the business for a test drive
  • Patience will save you money
  • Quality relationships always prove to be valuable
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Business #9 – Putting the Pieces Together

Posted by on May 9, 2013 in Blog, Featured | 0 comments

My mentor always kept an inventory of the skill sets and interests of people he knew so he would have certain pieces in mind to put together his next deal.  This networking tool came into play for me on business #9.

I found business #9 on BizBen.com.  In many ways it was a perfect fit.  It was 10 miles from my home, highly profitable and a great niche.  The seller was running the business at 52/0/10/38 and, like so many other of my deals, he was burned out and motivated to sell.  The only problem was that the company was a civil engineering firm, a discipline outside of my expertise.  The owner was the only licensed engineer, so the new buyer (ideally) also needed to be a professional engineer. Upon learning this, I realized how I could use this fact to my advantage.

The business was priced very high, but finding a buyer with the capital, skills and engineering license would be difficult for the seller.  My brother-in-law proved to be the first piece of the puzzle.  He is a licensed engineer and was looking for a new opportunity after being in city government for 20 years.  He was immediately onboard.  I also added an additional investor to spread out the financial risk.  The seller was tough, but he liked our team.  Knowing his business was a hard sell, he started to move on price. However, the terms turned out to be another obstacle because the seller was not willing to follow my usual 50% down 50% seller-financed model.

The second puzzle piece was financing. We went back and forth many times, struggling to find middle ground.  In the end, we got our price and he got his terms, 70% down, 30% seller-financed for 54 months at 6% with a personal guarantee from my brother-in-law.  I had avoided personal guarantees up to this point, convincing the owners that the business is the seller’s security.  For my brother-in-law’s experience and personal guarantee he was named president in charge of daily operations and issued 1/3 of the outstanding shares of stock.

The final piece of the puzzle was a collection of things I try incorporate into all the businesses I buy, strong accounting practices, efficient operating systems and sufficient working capital.  Luckily, business #9 was the cleanest, neatest business I had ever owned.  The engineering business has minimal inventory; we sell designs and drawings.  It is a great business provided you have work.   We took over the business in the middle of the cellular tower construction boom and we did millions of dollars of cell tower designs.  Fortunately, the seller’s niche paid the business off quickly.  Since then, the company has had to adjust to changing market conditions.  The cellular business became super competitive and dried up with the 2008 crash.  We were blessed to segway into solar and wind energy projects, but that market is developing slowly . The business will need to reinvent itself to continue to thrive.

cell_tower

Cell Tower

Shiloh_wind_farm

Shiloh Wind Farm, Solano County, CA

 Keys To Success

  • Business deals are like a puzzle, the pieces need to fit.
  • Look for great businesses, regardless of your skills.
  • Focus on running the business and leave the rest to the right talent
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Junior Achievement: Entrepreneurs In Training

Posted by on May 2, 2013 in Blog, Featured | 0 comments

For the last few months I have been visiting Ms. Lawrence’s 3rd grade class as a representative for the Junior Achievement Organization.  JA teaches kids about workforce readiness, entrepreneurship and financial literacy though a network of volunteer professionals.  The curriculum is tailored for kids K-12 and teaches a message that I am very passionate about.  Too many kids go on to be adults without the necessary skills to be financially independent.  Many kids do not know what majors are available in college or what careers are out there beyond professional athletes and entertainers.  Many also do not fully understand the dangers of consumer debt and spending more than they earn.

The 3rd grade curriculum is based on learning about the local community.  We discuss things like how cities are zoned and the important role of city planners.  We also started our own restaurants and talked about the considerations of starting a new business.  The kids used data of local preferences to choose a cuisine and set prices. I was surprised by the class’s understanding of how pricing affects the demand and profitability of a product.  The children were also very keen about hiring a proper employee from a list of resumes.  Next time I will discuss the vital role of banks in the local economy.

An important component of the JA program is the exposure to people in various careers.  I try to teach the children about working at HP and the careers available in science and engineering. I answered several questions about how I became interested in computers at an early age and it was fun to see the kid’s interest and enthusiasm as they handled the circuit boards I brought in.

Being a role model is a very important part of the program and I plan to visit low-income schools that may lack access to professionals in the tech industry.  I believe this program is a positive force in the effort to break the ongoing cycle of poverty in our country.

JA is available across the US and I implore you see if you can make a difference by volunteering your time.  I have found it be incredibly rewarding.  The children are excited to see me and hear about my experiences.   The thought of just one child being inspired to pursue a career in the tech industry is well worth the small amount of time I devote to the program.

 

 

 

 

 

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