11 Apr 2011
By Wright Communications
Recently I asked if business owners had thought seriously about committing to a long-term lease in the business environment. Let's go one step further; would your business be worth more to you Dead or Alive?
It is a valid question in today's market, because recessionary times generally flush out the underperforming, or less-than-unique, businesses from the market. We have had well over a decade of 'good times' and business owners who have established their companies during that golden period would never have seen an economic downturn. In many cases, they're woefully unprepared for it.
We have talked to a number of businesses over the last 18 months or so, when the DOA question has arisen. In the cases where the owners had taken my earlier advice, and not signed up to a long-term lease, they would be free to make the decision on the fate of their business purely on the numbers.
Let me give you some real-market examples:
Business operating in online marketing category: The market this business sells to is one of the hardest hit by current economic downturn and the business has not made a profit for three years. The owner has had to sell his house to prop the business up and his wife has taken on a job to pay their living expenses. The business employs six staff all earning a lot more than the owner. The owner does not want to close down as he believes things will get better over the next two years.
Wholesale and retail business, which imports a range of products and wholesales them throughout the country: The husband and wife team also run their own retail outlet that they work at full-time seven days a week, with two late nights. They earn $45,000 pa and their stock holding is $250k. The business, which is located in a very small town in the South Island, is worth less than $50k including stock. The couple would end up with more in their pockets if they had a closing down sale and sold off all the stock.
A small engineering business operates in premises paying rent to their family trust at 50 per cent of market value. The business makes approximately $100k after a rental adjustment, and has plant with a sale value of $600k. Based on capitalised earnings' methodology, the business is worth around $200k, including the plant at $600k. We advised the owner to close down and sell the plant for $600k, and then lease the building to a tenant who will pay the full market value of $100k pa.
The owner did decide to close the business down as his bottom line had to improve by 200 per cent just for the business to be worth what the plant was valued at. He sold the plant for $600k, collected all his working capital and put the money in the bank. After leasing the building at market rental, he was able to retire earning similar money to when he was in business but with none of the risk!
Please forgive me if I sound like a doomsday prophet, but common sense should hopefully prevail with some business owners. Credit must undoubtedly be given to the tenacity that some of these owners demonstrate. But sometimes reality must be faced. The insanity clause is to continue doing the same thing in the same way and hope for a magically better result!
Business doesn't get better by right. Just because the market improves, doesn't mean business activity improves for everybody.
In the second case above, if the owners of the wholesale company sold their stock down at a 30 per cent margin, they would bank $325k before costs. But to achieve a gross sale cost of $325k, they would have to find a local buyer, or a party who would want to relocate to their community. Then the business would have to improve by about 150 per cent to achieve that result. The average house price in their community is somewhere around $150k, so a local would also need cash because their house would not be worth enough to borrow what would be needed to fund the purchase.
In the first example the couple would still have the family home, if they he had closed the doors two years ago.
Hopefully owners of SME businesses that are struggling mightily can get good impartial advice from their professional advisers. I think Kenny Rogers said it best in his hit The Gambler:
"You gotta know when to hold 'em, know when to fold them, know when to walk away and know when to run."
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