If the business fits

Eyeing up a business? Heard the horror stories, but still keen to give it a go and be your own boss? This special guide walks you through the issues faced when going into business for the first time. By Glenn Baker.

According to the Statistics New Zealand: NZ Business Demography Statistics 2012, the 40,690 new enterprise ‘births’ recorded in New Zealand last year represented the lowest birth rate since comparable data was first gathered in 2000. It was a drop of 11.2 percent on 2011.
Does this mean Kiwis are going off the idea of business ownership? It’s doubtful – the total figure of 460,120 enterprises, was down just 0.8 percent on 2011.
Business ownership is still a key factor in the Kiwi psyche; nobody can see that changing any time soon. But that fact remains that a high percentage of start-ups, and to a lesser degree, businesses that have recently changed hands, fail in their first few years. So how can you avoid being added to the failure statistics and make your business ownership experience a success?
We put that question to some leading business experts. Most responded by saying that the biggest stumbling block usually revolves around a lack of business management skills.
Harry Ferreira, BNZ’s national manager Small Business, says many people go into business because they’re good at what they do – such as a trade – but they lack the ability to manage a business. “They simply get into business and then drift.”
When considering where people fall down when buying a business, Ferreira shares seven observations. The first is that, surprisingly, people simply don’t understand what they’re getting into – there’s no concept of the bigger, broader market picture. The second observation is a lack of financial literacy – understanding exactly what profit and loss means and where the opportunities are to grow the business. Ferreira thinks this is where the financial sector has a responsibility to educate people.
Number three is as failure to seek professional assistance – many new business owners have a limited understanding of things such as tax and cashflow management. A number of support organisations, including banks, run excellent programmes to assist owner managers and it’s important people utilise them, he says.
Lack of planning is another major stumbling block. Your business plan and marketing plan should provide clarity on what your business is about, what your goals are, and provide a roadmap for getting there, says Ferreira. Putting a price on your products can be an issue too – understanding the difference between margin and the market and how margin affects profitability is vital.
Six on Ferreira’s list is capital; insufficient capital for the hard times. “Business owners will push cashflow to the limit and have no backup plan for the rough patches.” He recalls the Fort Street roadworks in Auckland’s CBD that impacted on the turnover of local businesses for several months. “They knew it was coming but many failed to plan for it.”
Ferreira’s final point is around “the need to do a whole lot of little things really well”. Just focusing on the business’s core function won’t grow the business, he says. It’s attention to detail and all the business disciplines that will lead to ongoing growth.

She will not be right
When it comes to company formations, Glenn Smith, CEO of Auckland-based company formation specialists Company Net has seen more than a few. In business since 1997, Company Net has formed more than 13,000 New Zealand companies over the years. Smith agrees that it’s the general management skills that often let new business owners down. “They underestimate the time, energy and skills required to run their business. They can arrange flowers for their clients beautifully or solve an IT issue perhaps – but they run out of cash to buy next week’s supplies, or fail to file a GST return on time or hire poorly performing staff and don’t know how to get rid of them. Things often snowball so they usually end up selling or closing down.
Smith believes the ‘she’ll be right’ attitude is still alive and well in New Zealand, even if the phrase is not often used. “And ‘she’ll be right’ is just about the worst attitude a person in business can have.”
So what should a person look for when eyeing up a business opportunity?
“Clearly the business has to be a good fit for the person who’s seeking to buy it,” says Smith. “It must be sufficiently inside their comfort zone to give them confidence that they’ll be successful.”
Some of his questions for business shoppers to ask include:
• Are the current owners really intimate with the details of their business? Are all your questions answered fully and honestly? Or are they flying by the seat of their pants during your discussions?
• Is the business operationally sound? Are there processes and written procedures in place? Do staff know what the firm is trying to achieve? Do clients understand the value they receive by transacting with the firm?
• Do the business’s financial accounts stack up? Do their GST returns match their stated revenue figures? Are the current owners’ personal financial affairs so intertwined with the business that it’s difficult to separate them out?

Smith says the following issues would immediately stop him from pursuing a particular business purchase:
• The present owner seems unprepared for sale, with documents unavailable and questions not answered immediately. Why are they in such a rush to exit their business?
• Poor feedback from the business’s clients or the business has a poor reputation in the marketplace. Whilst some satisfied clients will recommend a firm to their friends, you can safely assume that all dissatisfied clients will tell everybody they know. Goodwill is costly and time-consuming to recover and it’s often impossible to do so.
• Financial documents aren’t available, are unnecessarily complex or contain inconsistencies. All businesses, large and small, should be able to provide easy-to-understand, accurate and concise financial statements at the time they are being sold.

Smith has recently purchased another business: North Shore-based renovations company HomePro. So what did he personally learn whilst in the market looking for a suitable business?
“I learnt that people either hugely overinflate the value of their business because of their emotional connection over the years and a disconnect with market reality – or they undervalue the business because they’ve not factored in the ease with which they themselves can be replaced. The business owner thinks he or she is the business, and it has no great value outside of that.”

Careful who you ask for advice
Glenn Smith has observed over the years that people don’t just shy away from seeking advice – they’ll often seek advice from the wrong experts. “If you know an industry expert, ask them for advice about their marketplace – not about the financial statements of the business you’re looking to buy. Similarly, if you know a good accountant, ask them to review the accounts but don’t ask them to comment on market competition. Use experts only for the things they are expert in; business advisers are not a one-stop shop,” says Smith.
When businesses fail, the common denominator seems to be that the person, or people, in charge took their eye off the ball, he adds. “They’ve focused on things that aren’t critical and core to the business, and assumed that people lower down the food chain will look after the firm’s interest for them. That assumption is often fatal to a business.”
Attitude is everything when it comes to owning a business says Smith. “While they’d never say it, successful business owners treat their relationship with their business as they would a worthwhile marriage. They love and cherish the business – it excites them and fires their enthusiasm every day. They invest time and money in their business to ensure it survives and prospers – and they constantly examine and review the business to make sure it’s on the right track for a successful future.”
Smith’s Company Net has been forming limited liability companies for 16 years and he says today three distinct trends stand out.
Firstly, Kiwis are forming many more home-based companies – selling their expertise via consultancies, or niche products, from the home office. “It seems that online marketing, in many instances, negates the need for physical premises.” And Smith sounds a warning for home business owners charging a percentage of their outgoings against their tax deductions. “Don’t go overboard – get advice from your accountant on how to work it out.” It’s important to keep your business totally distinct from your personal life for documentation and reporting purposes, he adds. Put a value on everything, especially your time; treat that home-based business as a real asset right from day one and seek sound financial advice.
Secondly, in the small business space, increasingly women form more companies than men. “The ability to run a business online from home has liberated many women entrepreneurs and sparked them into (enthusiastic) action,” says Smith.
The third trend is that many people start businesses that support their lifestyle interests – not so much for the income it might bring but for the sheer joy of pursuing their dreams. “If research is ever conducted, I wouldn’t be surprised to find many of these ‘lifestyle’ businesses are highly successful financially,” says Smith, “simply because of the passion and drive of their owners.”
He has two other pieces of advice for new business owners too. You must buy into the discipline of owning a company is it is to build into a worthwhile asset; and second, your business, indeed any business, should be ready for sale at any moment. So if a potential buyer knocks on the door, you’ll know exactly what you’re selling and you’ll have all the required information ready.

A question of goodwill
Nowadays sellers are getting much less goodwill for their businesses, and determining the amount of goodwill and factoring it into the sale of a business can be problematic.
Greg James, principal-tax consulting at WHK, points out that business vendors believe goodwill, whether recorded or not, is both separable and continuous. “That often stands in clear contrast to the view of the buyer. When buyers are diligent they conduct extensive testing to determine the goodwill’s value for possible impairment, and to assess its nature and location.
“The goodwill may be reflected in accounting records, but in reality the goodwill can be associated with an asset, or a person, which may not easily transfer to the new owner,” says James. And if a business changes hands – will it survive? Are existing clients likely to continue to trade with the new owners?
A goodwill figure is generally arrived at as the difference between the amount paid for the business, usually calculated using a multiple of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), and the value of the net assets in the business, but James says it all depends on the stage a business is at. If it’s making a loss, consider the assets or the future ‘forward looking’ earnings. If it’s growing, forward looking earnings are factored in. The purchase price can also hinge on the reputation of the brand and business – and an option is for the seller to keep funds in the business and earn his or her way out, perhaps hired as a consultant.
“The forecast capital value of future profits from existing clients” – that’s how Glenn Smith sums up goodwill. “It’s basically saying that the business will continue to remain profitable because this group of clients exists and is pretty much locked in.” His advice to buyers is to talk to people running similar businesses in the same industry, and ask the vendor for copies of signed contracts with clients. “If they can’t show you any, then the goodwill’s probably worth zero.”
He suggests buyers or their brokers contact major clients to determine if they can rely on their continued custom. And check the business’s reputation – “if it’s poor then they really shouldn’t be claiming any goodwill at all.
Also, if a vendor is claiming goodwill, they need to inform their major clients that they’re selling the business, says Smith. If they don’t, then they jeopardise that goodwill when the business changes hands.
“If someone was claiming goodwill and they couldn’t give me a client list then I’d cross that goodwill figure out and say start again – because all I’m buying is the assets and plant that I can see.”
WHK’s Greg James says there also needs to be plenty of attention paid to the sale and purchase agreement, as well as any warranties and indemnities. People are not always aware that the sale and purchase agreement can allow for the purchase price to be adjusted for up to two years from coming into effect (although it depends on the specific terms of the agreement). So if there’s a tax audit, for example, and false statements revealed then the purchaser has some comeback.
Sale and purchase agreements can be anything from 20 pages long to 150 pages, says James – and lawyers like to check the wording thoroughly. Know exactly what you’re buying, he says. Don’t buy the debtors (especially not the long-term debtors) or bank account and ensure you have enough working capital to get you started.

Glenn Baker is editor of NZBusiness.

What it takes
BNZ’s Harry Ferreira says his team spends regular time visiting business owners, and not necessarily customers either – so they have a good understanding of what it takes to be in business. Attributes necessary to be successful include resilience, clarity, vision, tenacity, plus the ability to work hard, to sell, to think strategically, be open to ideas, willing to learn and adaptable to change. You’ll also need the ability to delegate, good leadership skills and tons of creativity – so when your business plateaus you can come up with ways to rejuvenate it.
And what does it take to improve your chances of securing funds from the bank?
Demonstrate that you fully understand the market and the industry you’re targeting, says Ferreira, and that you’re willing to seek and use professional advice.
“You’ll also need to show us a short, sharp business plan, how you will fulfil it and how you will scale up your business.”