Business Interruption 101

If you are reading this blog post from the Left Coast today, you know all too well the front page pictures and stories on the wildfires affecting Northern and Southern California in the past few weeks. The devastation is unimaginable.

As I write this, the Kincade Fire in Sonoma County (just north of our Petaluma office) is 60% contained and 76,825 acres have burned. In local terms, that is about the size of San Francisco plus a little bit of Burlingame near SFO airport. On the East Coast, it’s roughly the size of Washington, DC from Alexandria, VA to north of Chevy Chase, MD.  While the fire has destroyed almost 300 structures so far, we are lucky that no lives have been lost and there have been minimal injuries.

No Power, No Business…Maybe

For local businesses, it has either been boom or bust, not only from the fires but the local utility’s response to fire prevention, specifically shutting off power throughout the Bay Area. As the affected population moves towards the communities with power, people are dealing with a new way of life during a difficult time.

In Petaluma, which is located just outside the mandatory evacuation zone and has had minor power outages, business has been booming. Restaurants have been overflowing with displaced evacuees from the north. Hardware, department and grocery stores have been full of people looking to replace essentials. Meanwhile communities without power have experienced a bust. One local market is experiencing heavy uninsured financial losses from losing power. A local catering company may lose up to $150,000 in revenue if they can’t reopen in time for this weekend’s wine country weddings.

Insurance for a Dark Day

Business interruption insurance is a form of commercial damage coverage that covers the loss on income that a business suffers after a disaster. Business interruption occurs when the event, such as the Kincade fire, affects revenue and/or cost and profit is lost. Other events include natural disasters, movement from temporary sites to a permanent site, and/or Government actions causing it to cease operations.

In each of the events mentioned above, one thing is common. Revenue is being missed and expenses continue. The company bears the initial burden of the expenses but insurance or litigation can help business owners get through this loss and remain profitable after recovery. If the interruption to the business was caused by a third party (in this case, the power utility), litigation would be carried out through subrogation (or the assumption of debt or damages to a third party) to recover the losses. This situation would mean that the insurer pays the claim initially then goes after PG&E or another party that caused the event and therefore the loss.

How to Calculate the Loss

Whether it is insurance, litigation, arbitration or settlement, covering your business interruption expenses can be challenging. We have handled the expert/calculation side of these type of engagements in valuing the losses/lost profits.

Many losses fall into three areas:

  • Service Interruption – This impact could be direct damage, physical loss, destruction to utilities, services, telephone, transmission lines, substations, equipment of suppliers of such services as well as related plants.
  • Business Interruption –Here, the property damage to the receivers or suppliers is typically covered by the insurance policy.
  • Restoration – These are expenses incurred during the length of time that is required to replace, repair, or rebuild the damaged property, starting from the point the damage occurred.

The value impact is effectively the difference between a “with/without” analysis where the “with” relates to the actual financial performance as a result of the interruption and the “without” is related to the operations of the business without the interruption based on historical performance. In addition to the matter of recovering costs, extraordinary events or “acts of God” can affect the valuation for a business, either temporarily or permanently.

Our New Normal

In the case of Northern California, the local utility has already let customers know that the “new normal” will be one of power blackouts and a bag packed with emergency supplies. It may take Pacific Gas & Electric 10 years of blackouts before they can make their infrastructure more immune to weather events. PG&E even has its own marketplace for generator sales. Yes, the irony is not lost on us. With increased migration out of California, these fires may be the tipping point for some families who just can’t afford to accept these risks.

Hopefully reading this blog post doesn’t scare you away from visiting California, in particular the beautiful wine growing regions of Sonoma and Napa counties. Like a good Boy Scout, you just need to be prepared for our new normal and share the beauty of our part of the world with the friendly and increasingly resilient locals who call this place home.

Exit Strategies values businesses and intangible assets for a variety of purposes including divestitures, mergers and acquisitions, purchase price allocations, financial reporting, corporate restructuring and planning. If you’d like help in this regard or have any related questions, you can reach Joe Orlando at 503-925-5510 or Bob Bates, CPA, CVA, CFE at bbates@exitstrategiesgroup.com.

Profit from Intangible Assets in a Business Sale

The sale of a business includes intangible assets. This article explains what intangible assets are and how articulating, supporting and protecting them enhances business sale outcomes. Let’s get started.

What is an Intangible Asset?

Intangible assets are things that are non-physical in nature that you can identify, describe, document (e.g. a contract, list, logo, drawing or schematic) and, most importantly, transfer. Intellectual property is an example of an intangible asset.

The Financial Accounting Standards Board (FASB), in its ASC 805 standard for reporting of Business Combinations, separates intangible assets into these categories:

  1. Marketing-related: such as trade names, trademarks, non-compete agreements and URLs
  2. Customer-related: customer lists, contracts and relationships, order backlog
  3. Artistic-related: works of art, magazines, books and articles
  4. Contract-based: permits and licenses, licensing and royalty agreements, franchise agreements
  5. Technology-based: trade secrets, databases, patented technology

Do all intangible assets have value?

Just because an intangible asset exists, doesn’t automatically give it economic value. To have value it has to produce some form of economic benefit. For example:

  • Generate operating or licensing income
  • Reduce operating expenses or future capital spending
  • Reduce business risk

Of course, an intangible asset must be transferable in a sale to have value to a new owner. (Intangible asset valuation is a topic for another day.)

Goodwill is excluded from the above list because it is considered to be a blended residual asset. Goodwill is influenced by factors such as high profit margins, barriers to market entry, competitive advantages, a regulated protected position or lack of regulation, longevity in the market, a trained work force, etc.  Synergistic value associated with premiums paid by strategic buyers are often considered “blue sky” value above a “justifiable” goodwill value.

Document to Impress

After you take an inventory of your company’s intangible assets, the next step is to be sure that the key ones are documented in a manner that will satisfy buyers. For example, support for customer-based intangibles may include: a well-populated CRM database, master supply agreements, vendor quality audit records, open quote files, important correspondence, sales and contribution margin by customer history, AR aging schedules, purchase orders, etc.

Protect Your Assets

While documenting your company’s primary intangible assets, you are likely to uncover some that need better protecting through public registration (e.g. patents), securing or improving contracts, or better restricting access.

For many of our clients, trade secrets are their most valuable intangible assets. Suppose a significant portion of your company’s profitability is attributable to a proprietary production process. Ask yourself these questions: Is the process perfected and well documented? Are you taking appropriate measures to keep the process secret? Is access sufficiently limited? Do you have appropriate data security? Do you have non-disclosure agreements with third parties?  Do you have confidentiality agreements with your employees? If not, you know what to do.

Capitalizing on Intangible Assets in a Sale Process

Your intangible assets become the focal point of the Confidential Information Memorandum (CIM) prepared by your M&A advisor. The CIM can also articulate those intangibles that are underutilized and have potential to produce economic benefits to a new owner. We use our knowledge of your intangible assets to decide which target strategic acquirers are likely to derive the greatest benefit from them. We tailor our outreach strategy and communications accordingly. In the end, this generates more interest and better offers for the company in an M&A auction process. The M&A advisor can also advise on how and when to disclose sensitive details about key intangible assets during the discovery and due diligence phases of a merger or acquisition process.

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An investment in perfecting, identifying, documenting and protecting intangible assets is usually well rewarded in a sale. Exit Strategies helps clients take full advantage of the intangible assets in their businesses when going to market. If you’d like help in this regard or have any questions, you can reach Al Statz at 707-781-8580 or alstatz@exitstrategiesgroup.com.

Inside the Mind of a CEO

Of course it’s in a CEO’s DNA to think big, challenge the status quo, set stretch goals and inspire teams to perform to their full potential. So, why did this recent CNN Business article on How power changes the CEO brain catch my attention?  Because my wife pointed it out to me

Seriously, according to this article, neuroscience researchers have found that those who feel powerful become:

  1. more goal-oriented and think more abstractly
  2. more optimistic about risky decisions
  3. less likely to see the world from others’ perspective

I would add, from 30+ years of working closely with founder-CEO’s as a business executive and valuation and M&A advisor, that most successful founder-CEO’s are also surprisingly humble and know how and when to throttle back that power. These traits help them assemble extraordinarily dedicated groups of managers, employees, clients and investors.  Helpful when it’s their time to sell!

CLICK HERE for more insight on how power affects the brain of a CEO.

Exit Planning: Meaning and purpose drives sustainable business growth

Several years ago I had the opportunity to work on an acquisition assignment for Mitsubishi Electric, one of the multinational business units of the Mitsubishi group of companies. While doing research to better understand my client’s organization, I found an inspiring article that quoted Tachi Kiuchi, Mitsubishi Electric’s managing director at that time…

“Are the needs of the corporation and the world in conflict? In the long run, they can’t be. Today, 600 million of the Earth’s inhabitants enjoy the material benefits of industrialism. Soon, 2.5 billion more–China, India, the former Soviet republics–will join us. The final 3 billion people will follow. To accommodate all those people in terms of resources today, we would need three planets.

So how can the needs of the world be met in the future? The truth is, we can’t build a sustainable economy. We can only grow one. That’s a lesson I learned from the rain forest. The vitality of nature comes from its capacity to cultivate more advanced forms of life and then support them for billions of years on finite resources and a fixed flow of energy from the sun. That happens through a constant process of feedback and adaptation. In the global economy, the problem is, we are blocking feedback. As companies extend their reach, they become less tied to the communities they serve. Ecological and social costs and benefits never appear on our balance sheets. Feedback only exists in the form of direct financial returns. If there is not adequate feedback, there’s no adaptation. No adaptation, no innovation. It becomes hard to respond effectively to change. We become vulnerable.

People talk about businesses needing to be responsible as if it’s something new we need to do on top of everything else. But the whole essence of business should be responsibility. My philosophy is, we don’t run companies to earn profits. We earn profits to run companies. Our companies need meaning and purpose if they’re to fit into the world, or why should they live at all?”

Tachi Kiuchi went on to serve as CEO and Chairman of Mitsubishi Electric America and is currently Chairman of Future 500. As Managing Director of Mitsubishi Electric, he broke with Japanese corporate norms to champion a “living systems” approach to business that included rapid adaptation, financial transparency, openness, cultural diversity, executive positions for women, and environmental sustainability. Read the January 2004 article in Fast Company.

Every CEO and business owner looking to create a valuable and marketable enterprise would do well to contemplate its fundamental meaning and purpose within the communities it serves, and decide how well positioned the company is to deliver sustainable long-term growth.

Al Statz is an M&A advisor and the founder of California-based Exit Strategies Group, which is celebrating its 15th year in business. Contact Al at 707-781-8580, via Email, or connect with Al on LinkedIn.

Six Reasons NOT to Skim

Pulling unreported cash receipts out of a business is indefensible and unwise under any circumstances, but particularly if the owner expects to exit in the next 3-5 years.

All of us during our childhood were offered the parental edict: “Don’t do it, you are only hurting yourself.” So “why”, you may ask . . . now that you are a grown adult, “should I not skim?”

Many reasons immediately come to mind and I am certain that we could all come up with many more, but in the interests of brevity, I’ll keep it to six reasons.

  1. Skimming is against the law. Tax evasion is a felony.
  2. Management of your business becomes more challenging. Skimming requires you to underreport revenues which means your cost of sales percentage rises. Cost containment and inventory control are more difficult to assess.
  3. Loss of Employee, Partner and Spousal Trust. You set a bad example and create a fertile ground for others to steal. Worse yet, a disgruntled employee or retaliatory ex-spouse or partner could report you.
  4. Bank Loans are difficult to secure, for you and potential buyers.
  5. The value of your business declines.
  6. The marketabilty of your Business is severely compromised. You cannot expect potential buyers to trust you, let alone make a “leap of faith” and pay a premium for your business on the merits of unreported, unverifiable income.

Hopefully this doesn’t apply to you. But, if it does, what’s the solution? I refer you back to your childhood: Don’t Do It.

  1. Stop Skimming
  2. Clean up your books.
  3. Effectively manage your business, using reliable financial records.
  4. Redeem your credibility with your staff, your partners and your bank.
  5. Add value to your business as an ongoing entity or as a potential sale. The amount you no longer skim can easily be worth 2 – 5 times its selling value, or more, depending on the degree of skimming and the size and nature of your business.

In summary, each of us at some point makes a life defining decision … “Do I want to eat better or sleep better?”  You make the call.  As it relates to preparing a business to sell, you can do both.

Don Ross is a seasoned business broker with Exit Strategies Group. He can be reached at 707-778-0210 or donross@exitstrategiesgroup.com. 

Goethe on Exit Planning

Early this morning at my Rotary meeting I heard a quote that struck a chord with me. Our speaker, Stephan Stubbins, recounted the story of how he co-founded a successful theater company that helped save one of our local state parks. Once Stephan and his partners quit their jobs and fully committed themselves to starting a theater company, things started to happen for them.

The quote he shared is by Johann Wolfgang von Goethe ( 1749 – 1832) the prolific German writer, scientist and statesman …

“Until one is committed, there is hesitancy, the chance to draw back, always ineffectiveness. Concerning all acts of initiative and creation, there is one elementary truth the ignorance of which kills countless ideas and splendid plans: that the moment one definitely commits oneself, then providence moves too.

All sorts of things occur to help one that would never otherwise have occurred. A whole stream of events issues from the decision, raising in one’s favour all manner of unforeseen incidents, meetings and material assistance which no man could have dreamed would have come his way.

Whatever you can do or dream you can, begin it. Boldness has genius, power and magic in it. Begin it now.”

We’ve all seen how the act of truly committing one’s self to an idea or goal, sets events into motion, some planned and some fortuitous. Committing to an exit plan works that way too.

Thanks for the reminder Stephan! Click here for information on Transcendence Theater Company

Do Your Business Emails Convey Professionalism?

Normally we blog about M&A or Business Valuation issues, but this week I want to address email effectiveness, a subject important to all business people considering the tsunami of email messages most of us receive each day (an estimated 121).

I recently read an article from the Harvard Business Review that succinctly focused on important do’s and don’ts regarding business emails, including:

  1. Do keep emails brief, clear and to the point to capture attention and interest
  2. Don’t cc the world – consider the true relevance of your message to each recipient
  3. Do be sure your message shines through and is easily understood
  4. If you are asking for a response, say so upfront

Click here for the full article.

And, of course, Email isn’t always the most appropriate form of communication. Before you fire off that next Email, consider whether a phone call or in person conversation might be more effective!

Contact Jim Leonhard, CVA MBA at 916-800-2716 or jhleonhard@exitstrategiesgroup.com.

Buried in the Corporate Archives …

A lot of our valuation work is done for the purpose of internal share transfers of private businesses, or buy-sell transactions. In doing this work, we often see that owners have overlooked or neglected to keep important documents up to date. One such document is the buy-sell agreement, which articulates important legal, tax, valuation and financing issues that are important to ensuring smooth share transfers and business continuity.

I recently evaluated a holding company with a fair market value of approximately $40 million dollars. Two shareholders each owned a 50% interest in the company, a C Corporation, and one wanted to sell their stake to the other. The client said during our initial conversations that there was no buy-sell agreement in place, so we proceeded with developing a Fair Market Value opinion of a 50% interest. Just to be safe I requested a copy of “any agreements governing  or restricting the sale of shares”, as I always do.

Guess what? Just as I was wrapping up the valuation, the client came across a type-written copy of the corporate buy-sell agreement executed in 1982. The owners and officers had been unaware of its existence. Hence, it hadn’t been updated and they certainly weren’t aware of its terms and provisions. As I reviewed the agreement, I found that it prescribed that any transfer of company shares would be at book value. In this case, book value was less than $1 million dollars.

TAKE NOTE: A buy-sell agreement is a legally enforceable contract. In the 2011 New Jersey Appellate Court case of Estate of Cohen v. Booth Computers, the partnership (buy-sell) agreement stated that value would be “net book value, plus $50,000, on the most recent financial statement.” When Cohen passed away this formula generated a value of $178k. Cohen’s heirs had the business appraised for $11.5 million. The Court upheld the $178k value based on the terms of the partnership agreement!

For my client, this was a nightmare waiting to happen. In my case, imagine what would have happened had my clients not had a great relationship — the seller could have received less than $1 million for a $40-million-dollar asset! Fortunately, the owners were committed to a fair deal and they agreed to set aside the buy-sell agreement.

To assure that your company shares will transfer for an appropriate price when your buy-sell agreement is triggered or to put a buy-sell agreement in place, contact a business appraiser who is experienced in valuing company shares for buy-sell transactions. When you bring in a seasoned business valuation expert early on to interpret the pricing mechanism and other terms of your existing buy-sell agreement, they can recommend changes that will ensure that the agreement operates as the shareholders intended. And the sooner the better. It’s an easy discussion while the shareholders interests are still aligned. Later on, when shareholders becomes buyers and sellers, their interests diverge and making any changes to these agreements become far more difficult in most cases.

For further information on buy-sell agreement business valuation or to discuss a current need, please contact Jerry Matecun, CBA, at jerry@exitstrategiesgroup.com, or call (949) 287-8397.

What you don’t know about your business name can hurt you.

In my work as an M&A Broker and Business Valuation Expert, I’ve noticed that many business owners don’t understand how their trade names are protected. San Jose attorney David Burgess recently wrote an article addressing common fallacies in this area, which I felt compelled to pass along  …

5 FALLACIES ABOUT PROTECTING YOUR BUSINESS NAME
by David C. Burgess, Esq.

You have worked hard to choose the perfect name for your business. You want to be sure you are entitled to use the name. You also want to prevent competitors from using the same name.

This is one area where a little knowledge is a dangerous thing. Following are some frequent misconceptions:

Fallacy #1:  Even though my company’s name is similar to another company’s name, I spell mine differently, so I’m in the clear.

Your business name will be in violation if it is confusingly similar to the name of another business. Among the factors considered is whether the sight, sound, or meaning of the two names is similar. Starting a new beverage company and calling it Pep$i or Pepsee will not work.

Fallacy #2:  Since I got the domain name I wanted for my business, the business name is mine.

Not necessarily true. Obtaining a domain name does not defeat the rights of someone who has been previously using the name for their business. In fact, the prior user may be able to force you to give up the domain name.

Fallacy #3:  I successfully filed a fictitious business name statement (DBA), so I own all rights to the name.

There is a rebuttable presumption that the first person to file a DBA has the exclusive right to use the name. But a DBA filing has several limitations:
• DBAs are filed on a county-by-county basis, so any protection only extends to the county in which you file the DBA.
• Even if you are the first one to file a DBA in a county, another business that can prove it has previously used the same (or a confusingly similar) name in that county can stop you from using your business name.
• A county normally will accept any DBA form that is properly completed and will not reject a statement even if a DBA for the same or a similar name has been previously filed in that county. So, before filing a DBA, you should search the county records to see whether a conflicting name is already on file.

Fallacy #4:  The California Secretary of State (SOS) approved my Articles of Incorporation, so no one else can use the name of my corporation.

The SOS will accept a corporate name so long as it is not the same as or deceptively similar to the name of an existing California corporation or a foreign corporation qualified to do business in California, and the name is not misleading to the public. The SOS does not check corporate names against:
• Names of other kinds of entities on file in California, such as limited liability companies (LLCs) or limited partnerships.
• Names of corporations or other entities filed in other states.
• Federal or state trademark or service mark registrations.
• DBA filings.
Having your corporate Articles filed simply means that no other corporation can register with the California SOS using the same or a similar name. It gives you no rights to the name beyond that.

Fallacy #5:  I filed a federal trademark for my business name, so I have absolute rights to the name, at least in the United States.

Registering a trademark creates the presumption that you own the mark. Registration confers a number of other benefits, including the ability to bring an action concerning the mark in federal court and obtain certain kinds of damages. But rights to a business name ultimately belong to the first person to use the name, whether or not that person ever registered it as a trademark. While federal registration is advantageous, it is not definitive.

Conclusion

Choosing and protecting your business name is a complex matter. It is important to consult with a qualified professional up front to avoid inconvenient and expensive disputes later.

For further information David C. Burgess, Esq. can be contacted at dburgess@buslawgroup.com.

5 Strategies to Preserve Core Values during a Business Sale

For many owners selling their business is not a simple financial transaction, it’s personal. Owners have poured blood, sweat and tears into building a business that is not only profitable but represents their values as individuals.  Their businesses become not just their livelihood but their self-worth and connection to some of their most important relationships.  The business values and culture are reflected in the everyday interactions with clients, vendors and employees.  Often owners live in the same communities where they operate their businesses and will continue to see and interact with these people long after they sell.  When it’s time to exit, it is no wonder that sellers are so interested in making sure that the company’s culture and values are maintained after they leave.
The best businesses are more than the sum of their physical assets.  The culture and values instilled in the business can contribute far more to its success in the form of goodwill.  Understandably the new owner may want to implement their own ideas about how to improve the business, however it is in both the buyer and seller’s interest to recognize the business’ core values and work to maintain them throughout an ownership transition.
Here are five strategies to make sure that the values instilled in a business are maintained through an ownership transition:
  1. Train management to embody the business’ values -Identify those managers that are likely to stay on through a transition and work with them to understand and exemplify the business’ core values.
  2. Develop a quality manual -A quality manual describes the procedures used in the business.  It is the playbook that provides continuity to day to day operations.  At times of transition the quality manual provides a valuable reference to new and old employees about how the business should function.
  3. Create a transition plan -With successful transactions, after negotiating the sale, buyers and sellers should sit on the same side of the table and develop a plan that outlines at least when and how the transition will be announced to clients, vendors and employees.  More thorough plans include setting goals, priorities and strategies to create conditions for a smooth transition.
  4. Plan to stay around through the transition- Once sold, sellers are often anxious to leave a business and move on to new projects.  However, the seller can serve as an advisor or consultant for a predetermined period of time. This can create much-needed stability and help to maintain a consistent business culture during the transitional period.
  5. Find the ‘right’ buyer – A qualified buyer has more than just the finances to pay the asking price for the business.  They also have the skills to run the business and the emotional intelligence to understand and carry on the business’ unique culture and values that made the business successful. It can be difficult for a seller to run a business while trying to sell it.  Working with a business broker like Exit Strategies Group can be invaluable when trying to find the qualified buyer that also understands and cares about the values of the business they are buying.