The HBS Blog offers insight on Delaware corporations and LLCs as well as information about entrepreneurship, start-ups and general business topics.
"It's always a good time to be a small business" says Mike Masnick from the Open Forum by American Express. At Harvard Business Services we strongly agree with this statement. We have always believed that entrepreneurs are the innovators of our society. According to the Small Business Administration the latest figures show that small businesses will create more than 65% of America's new jobs and that small businesses create more than 50% of the American non-farm private gross domestic product. Those are some impressive numbers. Below is an excerpt from the article that reminds us of some of the positives of being a small business no matter what is happening to the economy:
Whether you are a buyer or a seller, it is important to be able to evaluate a business purely as an investment. There are essentially two kinds of buyers: those who expect active involvement in the business and compensation for their labor, and those who expect to be passive owners, who are looking for a return on their investment. Both types need to ensure that what they do not personally bring to the business will be covered by the business itself.
Aside from understanding the operations of a business, one of the most significant issues to evaluate is the return on your investment. To do this, a “capitalization rate” is applied to the cash flow (see this previous blog post for a description of cash flow). This capitalization rate applies an estimate of a rate of return to determine how quickly the investor can expect to recoup the investment.
Determining the right capitalization rate to apply to a business requires some knowledge – either of the dynamics of the industry itself, or access to information related to the industry. Business appraisers have access to data and ways to determine a meaningful capitalization rate for an industry and can provide objective expectations based on historical capitalization rates for the industry adjusted to current market conditions.
Despite theoretical capitalization rates, the real issue to consider is how the investor will look at the opportunity. Part of the thought process for understanding the expected rate of return (capitalization rate) is the idea of the opportunity cost of investing in a particular company versus investing somewhere else. The two considerations are the “return on capital” and the “return of capital.” In short, an investor will want to receive a current return of at least a “risk free” investment. But his only way to mitigate risk is to receive a return of the total investment in an acceptable period of time. This will ultimately determine the acceptable capitalization rate for the buyer. In concept it’s simple. If the buyer wants the equivalent of a risk free 5% return, and wants to recover his investment (pre-tax) in five years (20% per year), then the acceptable capitalization rate will be 5% plus 20%, or 25% total. The normalized adjusted net operating cash flow is normally divided by the capitalization rate to determine the value. A particular buyer’s acceptable capitalization rate may be significantly different than one derived by an appraiser. It is his personal standard. That is why an appraised value is really the most probable value for a sale within a range of possible values.
It is actually easier to use the inverse, or reciprocal, of the capitalization rate, which becomes a multiplier. So if the cap rate is 25%, the inverse is 4.0 (1/.25) and the value would be 4 X the normalized adjusted net operating cash flow.
At a minimum, a company should be expected to produce enough cash flow to provide a reasonable return on the fixed assets. Any cash flow beyond this minimal level is called “Excess Earnings” and is applied to the intangible asset value. This is a way of determining the goodwill value.
Other items to review include inventory and accounts receivable. It is important to understand the inventory situation (if applicable to the company). This includes calculating inventory turns and understanding the amount of obsolete inventory. Companies with low inventory turns tie up their precious cash in non-productive uses for longer than necessary. Similarly, companies with a history of collection issues and/or receivables that are left in aging too long are not maximizing their cash position. Both inventory and receivables can add or subtract value depending on how well they are managed.
To show maximum investment value requires thorough documentation in an Offering Memorandum (or Private Placement Memorandum). This is usually prepared based upon an appraisal, but contains other information relevant to the investment potential.
In summary, a business is basically an intangible asset, though it may contain some tangible assets. The perceived value depends on how well the intangible aspects are shown to have value.
Post by: Gerald W. Barney MS, CSBA, CMEA
American ValueMetrics Corp.
Within the last few weeks, several friends and close acquaintances have had the misfortune of losing their jobs. All these guys happen to be in sales: software and automobiles. They are all really great guys and are all very good at making you comfortable with them; regular 'Joe Six-pack' kinda guys. As salesmen though, they came into my thoughts when I saw Norbert Aubuchon's The Anatomy of Persuasion on the library bookshelf. I know that sales is what these guys do, not who they are, but I wondered if their previous successes in all matters might somehow be related to their sales personalities. The Anatomy of Persuasion convinces me that they are, and here's why: These guys are all great communicators!
The Anatomy of Persuasion is a book based on, and used in conjunction with, Aubuchon's 'Anatomy of Persuasion' seminars. It's not gimmicky, though, and it isn't a pitch to get you into the seminars. It easily stands alone and is very useful on its own. Each chapter is concise and offers clear directions on how to be a persuasive person. From the very beginning, Aubuchon stresses that the problem with most great ideas is that they aren't clearly expressed and therefore never get implemented. Of course, the opposite is also true: some clearly lousy ideas do get implemented because someone had the power of persuasion to get it done. This dichotomy demonstrates that it is not necessarily whether something is a good idea or not, but how well it was presented: The persuasion, not the idea, is what matters.
The Anatomy of Persuasion's steps and methods include learning how to critically analyze your proposal or product to better explain it to your audience, be it a customer, your supervisor, or management team. Aubuchon's message is that proper communication is the basis for persuasion and strong knowledge and understanding of your product or proposal is at the root of that communication. It all seems simple when you think about it, but in daily operations we sometimes make things more complicated rather than more clearly defined and thus make our proposals less attractive. Simple, clear communication is the way forward.
My friends are practitioners of the clear and simple approach to communication, and they were successful in their fields, and I have no doubt that they will be employed again very soon. One has been selling Pontiacs since he bought a GTO Judge back in 1986, another started with Adobe in the late '80s. Both have picked up MBAs along the way. They know their stuff and know how to talk about it. That's how they get things done. The Anatomy of Persuasion is a great tool for anyone looking to improve their communication skills and motivate others to follow their desired course of action.
On May 6th we published A Critique of Apple's PR Response To Steve Jobs' Health Issues. It looks like we aren't the only one talking about Apple's lack of transparency. The New York Times just published a great article on the same topic. Below is an excerpt:
Apple is one of the world’s coolest companies. But there is one cool-company trend it has rejected: chatting with the world through blogs and dropping tidbits of information about its inner workings.
Few companies, indeed, are more secretive than Apple, or as punitive to those who dare violate the company’s rules on keeping tight control over information. Employees have been fired for leaking news tidbits to outsiders, and the company has been known to spread disinformation about product plans to its own workers.
“They make everyone super, super paranoid about security,” said Mark Hamblin, who worked on the touch-screen technology for the iPhone and left Apple last year. “I have never seen anything else like it at another company.”
But even by Apple’s standards, its handling of news about the health of its chief executive and co-founder, Steven P. Jobs, who has battled pancreatic cancer and recently had a liver transplant while on a leave of absence, is unparalleled.
Mr. Jobs received the liver transplant about two months ago, according to people briefed on the matter by current and former board members. Despite intense interest in Mr. Jobs’s condition among the news media and investors, Apple representatives have declined to address the matter, reciting with maddening discipline only that Mr. Jobs is due back at the company by the end of June.
Read the full article here: http://www.nytimes.com/2009/06/23/technology/23apple.html?emc=eta1
There are literally hundreds of different bureaucratic agencies within the Federal Government and most of them have three or four-letter abbreviations. Every entrepreneur knows the IRS and the USPS and most will be able to recite the full names for the FBI, NASA, INS, FDIC, DEA, NLRB and SEC. The question is: How many of you know what the OFAC agency regulates and what the SDN list they publish has to do with YOUR company?
OFAC, today’s featured four-letter word, otherwise known as the “Office of Foreign Assets Control”, is an agency that has been in existence since 1950, but has only hit the front pages since the attack on the twin towers of September 11, 2001. Many entrepreneurs, small and medium sized business executives are not familiar with the organization or the list they publish known as the SDN list, today’s featured three-letter word, which stands for Specially Designated Nationals.
According to the Official OFAC website: “The Office of Foreign Assets Control ("OFAC") of the US Department of the Treasury administers and enforces economic and trade sanctions based on US foreign policy and national security goals against targeted foreign countries and regimes, terrorists, international narcotics traffickers, those engaged in activities related to the proliferation of weapons of mass destruction, and other threats to the national security, foreign policy or economy of the United States.”
Civil penalties for working with restricted countries or individuals include fines that can be as low as $395.25 levied on an individual who allegedly purchased Cuban-origin cigars offered for sale on the internet (Cuba is a restricted country so purchasing anything from Cuba or selling anything to Cuba is an offense). They can be pretty hefty fines also, as Gate Gourmet, Inc. found out when it was hit with a $581,900 settlement for supplying catering services to Air Cubana Airlines over a three year period. In some cases, criminal violations could land top executives of offending companies in jail.
A list of all violators is published every month along with the penalty imposed; click below to view the various penalties levied upon individuals and companies, some of whom self reported, and others who were not aware that they or their company was breaking the law. Many of the top companies in the world made the list and paid the price, and also a lot of unsuspecting, and maybe naïve, entrepreneurs who stepped across the line due to ignorance of the law. Don’t be one of them.
No company, large or small, in global or internet commerce can afford to simply hide their head in the sand and pretend that this does not pertain to them. Every company should have a compliance program in place to make sure that the company is not inadvertently violating Federal laws.
There are several good OFAC compliance companies and software programs that can scan your database for a potential match to keep your company in compliance. You can also do it DIY by going to the OFAC website and downloading the available lists and checking them against your database of clients, customers and accounts. You’ve got to check new customers before fulfilling the order and it’s a good idea to check your whole database once a month. Also, each time you check your database it’s best to download the freshest copy of the Treasury Department’s list, as it constantly changes.
Be proactive and take the necessary steps to protect your business. If you want more information about OFAC compliance issues for your business click on the link below.