Would you pay somebody R10 000 to knock R50 000 – R75 000 (call it 20%) off the purchase of a business you’re buying? It’s an interesting debate that I had with one of my network the other day and it came down to a discussion around the value of “advice” and the team that you put together.

In the current market, raising capital for small businesses is tough and the approval processes are not quick. That means that when you are looking to buy a business, you need to tackle the other lever – price.

Why waste a good crisis?
Former FNB CEO Michael Jordaan once told me in an interview in 2008 / 2009 a saying which has always remained with me … “Why waste a good crisis?”

It’s a fair point – the economy in South Africa is on life support and you only have to look at the construction sector where Basil Read is the latest big name to fall on hard times as it enters business rescue. You can buy many high quality businesses on the JSE on a price to earnings multiple of between 4 and 6 times earnings at the moment (more on this shortly).

Why equity is misunderstood
Jim Rickards is one of the foremost market commentators on economic matters and he made a valuable comment recently: “People don’t sell what they want, they sell what they can”.

The quote is perhaps taken a little out of context and stems from his view that equity markets are likely to fall as years of cheap money are pulled out of the system. Having said that, the same rules apply when looking at equity and price in a business you’re buying.

Equity needs a secondary market: IE somebody who will buy or sell from you at any point in time. If there are no buyers or sellers, your price just becomes a “wish”. In South Africa – where the secondary markets are very under-developed – you need to focus on the price you’re paying if you want to extract value.

Let me give 3 real-world examples that I’ve seen in recent weeks:

Example 1:
I am currently involved in a new business (Give us a follow here!) and I need some capital. My biggest investment in my portfolio was shares I had in JSE-listed media group AME which trades on a PE of 8 and has a market capitalisation of R380m when trading at R47/share. The problem with AME is that its very illiquid and tightly held share so your best buyer is at R38/share in the last week. In other words the seller views the business as worth R380m The buyer values the business at R307m or 19% less than what the seller values it at. I now need capital, I would need to get nearer to the buyers price than the sellers price because my need is to access capital.

Understand the motivation why people are selling before tabling your offer.

Example 2:
I used example 1 to show what happens in a transparent market place where you can see the buyer and seller “spread”. Most entrepreneurs will not trade their businesses over the JSE (or a similar market place) so will need to try and make an educated guess around business valuations.

This sounds really intimidating, especially when you have lawyers and accountants thrown at you to justify valuations. This is where my second example comes in – and I have a bit of a bone to pick because I’m a small investor here. I hold some shares in JSE-listed energy group Hulisani, which is young business run by some of the smartest brains in the asset management industry.

The company made a couple of acquisitions last year including stakes in the Kouga Wind Farm (for R136m), GRI Wind Steel (R72m) and Legend Power Solutions. These are all businesses which were professionally valued within the last 12 months. Hulisani has announced that it has written down the valuations of Kouga by R14m and GRI Wind Steel by R46m.

These are massive write-downs attributed to either the regulatory or operating environment. Importantly these are just the prices that the company itself would pay (IE what the accountants value it at), not the price that a potential bidder would offer.

I would argue that the lesson here is that you should never be rushed into doing a deal.

Example 3:
I am currently assisting two businesses with capital raising activities. One is for a franchise and the other is a service business. In both cases we’ve negotiated down the selling price by over 20%.

The franchise one is interesting because it is a relatively new franchise and the franchisor is looking for footprint and reference sites (NB for getting funding) and they would rather have some sites up and running rather than chasing the upfront license fee.

The value of advice
I started this post asking whether you would pay R10 000 to save R50 000 and interestingly the answer is very often “no”. Week after week, I am approached to assist with capital raising and business plans but very few people want support or assistance in identifying whether the problem is if they need capital or not.

Buying a business is often a very passion-driven exercise. “I’m going to be an owner”, “I am going to be rich” etc. tends to cloud your judgement and you want to get the deal done. Voices of caution are often dismissed as nay-sayers.

We’re frightened that “the deal” is going to disappear if we don’t act fast enough. The above highlights why you don’t need to rush into anything.

Rather you should be consulting a number of voices and getting the insights of people in the industry, lawyers and your financial planner plus other advisors to give you every possible competitive advantage.

Warren Buffett is often quoted as saying: “Price is what you pay, Value is what you get.” – food for thought when buying a business or taking on debt to fund a new venture.