4 Traps To Avoid When Selling Your Company

Republished with permission from Built to Sell Inc.

Business owners have been known to refer to due diligence as “the entrepreneur’s proctology exam.” It’s a crude analogy but a good representation of what it feels like when a stranger pokes, prods, and looks inside every inch of your business.

Most professional acquirers will have a checklist of questions they need answered if they’re considering buying your company. They’ll want answers to questions like:

When does your lease expire and what are the terms?
Do you have consistent, signed, up-to-date contracts with your customers and employees?
Are your ideas, products and processes protected by patent or trademark?
What kind of technology do you use, and are your software licenses up to date?
What are the loan covenants on your credit agreements?
How are your receivables? Do you have any late payers or deadbeat customers?
Does your business require a license to operate, and if so, is your paperwork in order?
Do you have any litigation pending?

Photo by: American Advisors Group licensed under Creative Commons Attribution 2.0 Generic

In addition to these objective questions, they’ll also try to get a subjective sense of your business. In particular, they will try to determine just how integral you are personally to the success of your business.

Subjectively assessing how dependent the business is on you requires the buyer to do some investigative work. It’s more art than science and often requires a potential buyer to use a number of tricks of the trade, such as:

Trick #1: Juggling calendars

By asking to make a last-minute change to your meeting time, an acquirer gets clues as to how involved you are personally in serving customers.

If you can’t accommodate the change request, the acquirer may probe to find out why and try to determine what part of the business is so dependent on you that you have to be there.

Trick #2: Checking to see if your business is vision impaired

An acquirer may ask you to explain your vision for the business, which is a question you should be well prepared to answer. However, he or she may ask the same question of your employees and key managers. If your staff members offer inconsistent answers, the acquirer may take it as a sign that the future of the business is in your head.

Trick #3: Asking your customers why they do business with you

A potential acquirer may ask to talk to some of your customers. He or she will expect you to select your most passionate and loyal customers and, therefore, will expect to hear good things. However, the customers may be asked a question like ‘Why do you do business with these guys?’ The acquirer is trying to figure out where your customers’ loyalties lie. If your customers answer by describing the benefits of your product, service or company in general, that’s good. If they respond by explaining how much they like you personally, that’s bad.

Trick #4: Mystery shopping

Acquirers often conduct their first bit of research behind your back before you even know they are interested in buying your business. They may pose as a customer, visit your website, or come into your company to understand what it feels like to be one of your customers.

Make sure the experience your company offers a stranger is tight and consistent, and try to avoid personally being involved in finding or serving brand-new customers. If any potential acquirers see you personally as the key to wooing new customers, they’ll be concerned business will dry up when you leave.

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

Mike Flux – Market Update and Investment Alternatives Q1-2015

In this video, I speak with Mike Flux, Senior VP of Connor Clark & Lunn Private Capital to chat about their investment outlook from Q1 of 2015. We also discuss how to interpret the current events, and how to properly position portfolios to take advantage of these market events.

In this second video, Mike gives an update on the alternative strategies that they are using in their portfolios to help reduce the effects of the current volatility without sacrificing returns.

IRONSHIELD Financial Planning’s “Fly On The Wall” update call.
These calls are recorded by Scott Plaskett and allow you to get a behind-the-scenes look at one of his professional update calls. Watch and listen as a “fly on the wall” and get some of the most valuable information you will find on the Internet.

New TFSA Limit Reaches Close—But Not Quite—to Proposed $11,000

Last month, the federal budget revealed that the new Tax-Free Savings Account (TFSA) limit had been raised from $5,500 to $10,000 per year. While this is nearly doubled the original limit, it falls short of the expected $11,000. Still, the 82% increase in contribution room will have a significant change in your financial planning. In today’s blog post, I want to take a look at how the new TFSA limit will affect you.

Photo by: GotCredit licensed under Creative Commons Attribution 2.0 Generic

If you are an eligible client who has not contributed since the TFSA was introduced in 2009, you now have a contribution limit of $41,000. Investors who put the full $10,000 will save $3,708 in tax over the course of ten years, and increase their after-tax investment income by 12%, at a 5.5% rate of return. Taking advantage of the new limit produces better results than if you had contributed $5,500 at the original limit and $4,500 to a non-registered account.

Although the budget hasn’t technically been passed yet, the CRA has announced that the change in the TFSA contribution room is effective immediately. So if you had already used up the $5,500 annual limit this year, don’t worry—you can still add an additional $4,500 without being penalized.

It’s safe to say that even with the change, Canadians in the middle tax brackets—those who earn around $50,000 a year—are not likely to contribute more than the original $5,500. This is because that amount represents nearly 20% of their pre-tax earnings, so these numbers make it highly improbable that middle-income clients would make use of the full $10,000 in any case.

The good thing about the new limit is that it greatly benefits both lower-income and wealthy clients. If you are making less than $50,000, the extra contribution room makes TFSAs more preferable to RRSPs because investment income made in a TFSA and withdrawals are both tax-free. With the increased limit, you will find that a TFSA may be ideal for long-term purposes such as retirement. Similarly, clients nearing retirement will find that they can make withdrawals earlier and move their proceeds from a RRSP to a TFSA. Traditionally, the money in a RRSP is left alone for as long as possible before making withdrawals in order to continue the tax deferral. With the money being in a TFSA, they will be now be able to withdraw without incurring taxes.

If you are making more than $50,000 annually, you can now transfer investments in a non-registered account to a TFSA. With more contribution room, clients should look at how much those assets have increased in value and why the money is needed before moving these investments. In addition, you want to put in investments that don’t have much capital gain in order to avoid taxes upon withdrawal. Moving money between a non-registered account and a TFSA allows advisors to manage their clients’ investments more effectively.

A new limit for the TFSA allows advisors more creativity when it comes to helping their clients with financial planning. Be sure to speak with your financial advisor today about what works for you and how to make the most of the new TFSA limit.

Quick Facts

In 2013, 11 million people had opened TFSAs and 1.9 million people had hit their contribution limits.
The new TFSA limit will cost the government about $1.1 billion in reduced taxes by 2020—within 5 years

Related Links
Top TFSAs Myths Debunked
https://www.ironshield.ca/articles/tax-free-savings-accounts-tfsa-myths-and-tips/

TFSA vs RRSP
https://www.ironshield.ca/articles/tfsa-vs-rrsp-wheres-the-best-place-for-your-money/

Subscribers Make Your Company More Valuable

Republished with permission from Built to Sell Inc.

Why are Amazon, Apple and many of the most promising Silicon Valley start-ups leveraging a subscription business model?

Subscribers not only provide steady revenue; they make your company more valuable in the eyes of an acquirer. In a traditional business, customers buy your product or service once and may or may not choose to buy again; but in a subscription business, you have “automatic” customers who have agreed to purchase from you on an ongoing basis.

There are at least nine subscription models that can be leveraged by businesses ranging from service companies to market research firms to manufacturing concerns.

Recurring Revenue

Recurring revenue—the hallmark of a subscription business—is attractive to acquirers and makes your business more valuable when it’s time to sell. How much more valuable? To answer that, one has to first look at how your business will be valued without a subscription offering.

The most common methodology used to value a small to midsize business is discounted cash flow. This methodology forecasts your future stream of profits and then discounts it back to what your future profit is worth to an investor in today’s dollars, given the time value of money. This investment theory may sound like MBA talk, but discounted cash flow valuation is something you have likely applied in your personal life without knowing it. For example, what would you pay today for an investment that you hope will be worth $100 one year from now? You would likely “discount” the $100 by your expectation for a return on investment. If you expect to earn a 7 percent return on your money each year, you’d pay $93.46 ($100 divided by 1.07) today for an investment you expect to be worth $100 in 12 months.

Using the discounted cash flow valuation methodology, the more profit the acquirer expects your company to make in the future—and the more reliable your estimates—the more your company is worth. Therefore, to improve the value of a traditional business, the two most important levers you have are: 1) how much profit you expect to make in the future; and 2) the reliability of those estimates.

At SellabilityScore.com, one can see the effect of this valuation methodology. Since 2012, this methodology has been used to track the offers received by business owners who have completed the Sellability questionnaire. During that time, the average business with at least $3 million in revenue has been offered 4.6 times its pretax profit. Therefore, a traditional business churning out 10 percent of pretax profit on $5 million in revenue can reasonably expect to be worth around $2,300,000 ($5,000,000 x 10 percent x 4.6).

Then compare the value of a traditional company with the value of a subscription business. When an acquirer looks at a healthy subscription company, she sees an annuity stream of revenue throwing off years of profit into the future. This predictable stream of future profit means she is willing to pay a significant premium over what she would pay for a traditional company. How much of a premium depends on the industry, and some of the biggest premiums today go to companies in the software industry.

Subscription-based Software Companies

To understand what is going on in the valuation of subscription-based software companies, look at Dmitry Buterin. Buterin runs a subscription software company called Wild Apricot. He has also formed one of the world’s first mastermind groups of small and midsize subscription company founders, and each month the group meets to discuss strategies for running a subscription business.

Members of the group were constantly raising money or being courted by investors, so the topic of valuation came up a lot in their conversations. Buterin found that the consensus valuation range being offered to member companies was between 24 and 60 times monthly recurring revenue (MRR), which is equivalent to two to five times annual recurring revenue (ARR).

One way to validate Buterin’s numbers is to check with another guru from the world of subscription-based software companies. Zane Tarence is a partner with Birmingham, Alabama-based Founders Investment Banking, a company that specializes in selling software companies that use the subscription business model. Tarence estimates the valuation ranges he sees as belonging in one of three buckets:

24-48 x MRR (2-4 x ARR)
These are typically very small software companies with less than $5 million in recurring annual revenue. Companies in this first bucket are usually growing modestly, with subscription cancellation rates (i.e., “churn”) in the area of 2-4 percent per month.

48-72 x MRR (4-6 x ARR)
These are larger software companies with recurring revenue of at least $5 million annually, which they are growing at the rate of 25-50 percent per year. Their net churn is typically below 1.5 percent per month.

72-96 x MRR (6-8 x ARR)
These are the rare, fast-growth software companies that are growing more than 50 percent per year, with at least $5 million in annual revenue and net churn below 1 percent per month. These companies usually offer a solution (typically an industry-specific one) that their customers need to use to get their jobs done.

The software business is an extreme example of the benefits of subscription revenue, but no matter what industry you’re in, your company will likely command a premium if it enjoys recurring revenue.

From Alarm Systems to Prescriptions to Mosquitoes

For example, security businesses that monitor alarm systems and charge a recurring monthly monitoring fee to do so are worth about twice as much as security businesses that just do system installations. Retail pharmacies with a large pool of prescriptions for drugs that people take every day, like Lipitor and Lozol, command a premium over a traditional retailer because customers re-up their pills on a regular basis, creating a recurring revenue stream for the pharmacist.

Even tiny companies are worth more if they have subscription revenue. When my colleagues over at the Sellability Score analyzed very small businesses with less than $500,000 in sales, they found that the average offer these small businesses attract is 2.6 times pretax profit.

Compare that to the average Mosquito Squad franchise. Mosquito Squad is a Richmond, Virginia-based company that offers to keep bugs off your patio by spraying your backyard regularly with a proprietary chemical recipe approved by the Environmental Protection Agency. Mosquito Squad franchisees target affluent home owners with an average home value north of $500,000 who entertain in their backyard and don’t want to be bothered by mosquitoes. Mosquito Squad operates on a subscription basis. You subscribe to a season of spraying, which includes 8 to 12 sprays, depending on how buggy it is where you live.

Mosquito Squad is a franchise business, and the impact of its recurring revenue model on its valuation is remarkable. According to Scott Zide, the president of Mosquito Squad’s parent company, Outdoor Living Brands, Mosquito Squad franchises that changed hands over the most recent five-year period had revenue of $463,223 and sold for 3.7 times their pretax profit. That’s a 42 percent premium over the traditional value of a company with less than $500,000 in sales, and it’s because Mosquito Squad operates on a recurring subscription model and 73 percent of its annual spraying contracts renew each year.

Whether you plan to build a subscription-based software application or the simplest personal services business, having recurring revenue will boost the value of your most important asset.

Why did Charles Wilton sell Goldman Sachs?

In today’s episode, I chat with Charles Wilton, Portfolio Manager with the Private Investment Management Group at Raymond James. We talk about the recent deposition in his portfolio.

Why did Charles Wilton Buy CB&I (Chicago Bridge)?

A new interview with Charles Wilton, Portfolio Manager with the Private Investment Management Group at Raymond James. In today’s episode, we talk about the recent acquisition in his portfolio.

The Financial Advisor Evaluation (FAE): 10 Questions—Yes or No?

Based on a past HSBC survey, nearly two-thirds of Canadians don’t have a financial plan. It didn’t make sense to me because another report showed that the majority of advisors in Canada do offer financial plans to their customers. Why, then, do so few people have it when there is such a high number of professionals who are qualified to help them prepare one?

I spoke with Alan Goldhar, a professor of Financial Planning at York University, and he informed me that the issue is that the industry offers more jobs to financial salespeople who sell investment and insurance products. As a result, most individuals choose to forgo the challenging process of finishing their Certified Financial Planner (CFP) designation. Financial planning is the number one priority on a CFP’s agenda, so it’s incredibly essential to find an exceptional financial advisor that you can work with.

In today’s blog post, I will discuss what is known as the Financial Advisor Evaluation form, a list of 10 questions that will help you assess your relationship with your financial advisor to ensure that you are receiving the best service possible. If you don’t have a CFP, go to www.fpsc.ca and check the listing, or contact us at IRONSHIELD to find out more.

1. Did you receive a copy of a Letter of Engagement?

A Letter of Engagement is a document that is reviewed and signed by your advisor, and outlines all of the details of the work they will do for you and how they will receive their compensation.

2. Are you charged fees that are not tied to the value of your investments?

Advisors charge fees for their financial planning work and these fees should not be tied to the value of your investments in any way.

3. Did your advisor provide you with a retirement income plan?

The worst thing that can ever happen is when we outlive our money. Your advisor should provide you with a retirement income plan at one of your progress report review meetings during the year to ensure that your money will outlive you.

4. Did your advisor provide you with an updated Estate Plan?

At the time of your death and your spouse’s, there will be an ultimate tax bill, which will state the amount of estate erosion when your assets are transferred to your beneficiaries. One of those beneficiaries is the government, so you must be aware of how much money will go towards them in order to preserve the value of your estate from the estate erosion that will take place.

5. Has your advisor reviewed your Will?

You should look at all your investments and other financial affairs in order to make sure that they are set up properly in line with the execution of your will. Your advisor should check to see that your affairs follow the will’s instructions when they are transferred to the next generation.

6. Are you provided with a written document as a record of your discussion with your CFP?

It is hugely important to have a written outline of everything that you and your advisor have discussed. You may have receipts as proof of any transactions that were done, but you need to have a full record of the strategy employed and what is being implemented for you by your advisor.

7. During a bi-annual insurance review, did your advisor provide you with an overview of your insurance portfolio?

Financial planning constantly changes due to life circumstances. Adjustments may need to be made if there is a change in objectives. Your advisor should review your insurance plan with you every couple of years to ensure that you are still on the right track.

8. Does your advisor offer investment or insurance solutions from third-party providers?

Investment and insurance solutions are always provided from firms other than the one your advisor represents, so you would want to see if your advisor is what’s called a captive agent, someone who only offers solutions from their company. You want to make sure that there is a degree of separation between your advisor and the solutions that are being implemented, to show that there is an unbiasedness.

9. Does your advisor review your tax return annually to ensure you are paying the least amount of taxes possible?

This is extremely important because your advisor should review your tax returns annually to ensure that changes are being factored in. Whenever there are major tax changes, have your financial advisor re-calibrate your plan and make sure that all their work is being recorded properly by your accountant.

10. Does your advisor provide you with clear options relating to your retirement plan?

A retirement plan is mostly based on assumptions; it is never set in stone. However, your advisor should give you a general framework when discussing retirement. Here are four elements that you should discuss with your advisor:

What is my attainable income?
When is the earliest point I could retire?
What is the required rate of return for my portfolio for me to attain my goals?
How much do I need to invest on a regular basis in order to properly fund my retirement goals?

If you answered “yes” to these 10 questions, be sure to thank your financial advisor next time because you have a great relationship with them! If you had a few “no” responses, it may be time to consider a second opinion. Creating a comprehensive financial plan is crucial and you deserve the best help available to assist you with your planning. Check out our guide for more details because finding an excellent financial planner could be a real confidence boost for you to live the life you want.

Related Links
Financial Advisor Evaluation Form
https://www.ironshield.ca/questionnaire/

The KAIZEN Financial Planning Process
https://www.ironshield.ca/our-programs/

Finding a CFP
http://www.fpsc.ca/find-a-planner-certificant

Why did Charles Wilton Buy Gilead?