Martinka Consulting

425-576-1814 john@johnmartinka.com

Business Voyeurism

Posted on by JohnM

I was having an exchange with my friend Ted Leverette on the subject of webpage views, clicks, Google Adwords, etc. when I used the term “Business Voyeurism” to describe all the lookiloos who use the Internet to wish, hope and dream.

The Internet is great; it’s a valuable resource, as long as you watch out for all the people walking down busy streets with their faces buried in their phones. It’s also a fantastic place for dreamers. Five or six years ago I wasted a few thousand dollars on Google Adwords and similar from Yahoo and Bing. What I got was one short game of phone tag. I never talked to a live person or exchanged emails with anybody. Business voyeurs.

It’s so easy to click and look without serious intent. It’s super easy to inadvertently click on something (that will require a payment to the host website). In the old days (waaaay back in the 1990’s) people still looked at newspapers and magazines for a lot of their information. We never knew how many people read our ad, our story or had a modicum of interest in what we had.

Now people are fascinated by page views, clicks, newsletters opened, etc. Yet the result is the same – the serious will pick up the phone or write an email. The rest are just part of big data that gets some people excited over nothing. It’s almost as ridiculous as getting excited that a certain number of people, most whom you don’t know, like a picture you posted on facebook.

I realize it does take people looking at websites, blogs, newsletters, etc. to capture interest. My point is that we shouldn’t get excited over the numbers, just because we now have access to those numbers. We still need to get excited over real live people who show an interest in what we have.

“Experience is the name everyone gives to their mistakes.” Oscar Wilde

Do What’s Right

Posted on by JohnM

The Supreme Court recently ruled that Amazon warehouse workers will not get paid for the time they spend standing in line and going through a security check after their shift ends.

I can’t say it surprises me, but it disappoints me. I can relate to these workers as when I was working hourly jobs, in high school and college, every minute counted. I remember one summer job where you couldn’t punch in early (or late). If you arrived early you sat around with others until the magic minute and then punched in. The same on way out, you were expected to clean up, tools put away and ready to punch out at the anointed time.

At that age I also always had things to do and places to go after work. Waiting around for up to half an hour would have been irritating (and not fair).

Having helped scores and scores of businesses and business buyers I can’t imagine (the vast majority of) my clients treating their clients like Amazon is treating their employees. If you put yourself in the shoes of the other person you often see things from a different perspective.

Transaction Documentation Means Dollars

Posted on by JohnM

The following article is from “IN$IGHT” the Zachary Scott Spring 2014 newsletter. I thought it so valuable I asked them if I could send it out in one of my newsletters and post it on my blog. Therefore, the following is being sent with their permission.

Transaction Documentation Means Dollars

The finer points of the deal could add up to significant value for the seller

By Mark D. Working

Fighting hard to come to a conclusion on price and handing off the transaction to lawyers to “paper the deal” risks losing sight of the fact that transaction documentation is an integral part of the economic bargain. Virtually every agreement contains the same components, as illustrated in the adjacent diagram, but the details of the constituent components are unique to each deal. These fine points have important implications to the amount of value a seller receives and keeps.

READING THE AGREEMENT

Purchase agreements are inherently complicated. Defined terms, interconnected references, and schedules and exhibits make understanding the economic issues difficult if read from front to back. Follow the money. There are three critical economic components to each purchase and sale agreement: the transaction description, the promises and disclosures made by the seller (commonly referred to as representations and warranties), and the insurance policy (i.e. indemnification for broken promises)

Once the economic components are understood, the other important, but not economic, components, such as the procedures to get to a closing, conditions that must be met prior to the close, and the rules governing how the business will be managed during the interim period between an agreement and the transferring of funds and ownership, can be addressed.

TRANSACTION DESCRIPTION

This section provides the overall guidance as to what the parties are trying to accomplish. It defines what business assets will be purchased, which liabilities will be assumed, and the price that will be paid, as well as the timing of payments and currency (e.g., cash, securities, notes).

The form of transaction matters. The broad choice among a merger, purchase of stock, or purchase of assets is based on the objectives to be achieved, as structure can impact the need for third-party approvals, segregation of unknown or unwanted liabilities, and taxes.

These issues can complicate the choice because they can affect the economics of the parties differently depending on the specific circumstances of the buyer and seller.

For example, a stock transaction might be highly desirable to more easily transfer important contractual business relationships. The parties can still elect to treat the transaction as an asset sale for tax purposes (commonly referred to as a 338(h)(l0) election). Depending on the specific circumstances, this could either result in significant value that can accrue to the parties, or have devastating implications to the seller.

REPRESENTATIONS AND WARRANTIES

There are two purposes for a seller giving representations about the business, aiding the buyer in its due diligence and establishing a set of promises of condition that is the basis for allocating responsibility should actual conditions prove to be less than promised.

Supported by an integrated set of schedules, the representations provide an “official” disclosure of the state of the business, which assists the buyer to conduct due diligence.

Completeness matters because the clarity and accuracy of the scheduled data provides the buyer with comfort that the business is well managed. A company that has trouble documenting its assets, contracts, or some other aspect of the business, portrays an image of “seat-of-the-pants” leadership and can lead to more concern on the buyer’s part for protection against the unknown.

Representations also establish standards against which future claims by a buyer that it did not receive what was bargained for will be judged. While wanting to be positive about the company, representations can become the basis for a future claim of shortfall against that standard and be the responsibility of the seller.

The biggest fear of most buyers is the unknown. Therefore, when a seller is asked to state without exception that there are no other liabilities that will accrue to the buyer (as an example), the question of seller’s “knowledge” may become a point of contention. Although a seller might agree to a statement that is accurate “to the best of their knowledge,” the buyer might not take comfort in that standard and might require an independent standard such as the knowledge of a “prudent person, assuming appropriate investigations were conducted.”

Materiality poses another potential trap. Used throughout the agreement, its definition and application can be critical. Sellers generally fight for materiality exceptions to blanket statements, but embedded assumptions can be missed. A prominent example is granting the buyer a standard of compliance with GAAP. Whether audited or not, financial statements in their entirety can be GAAP compliant without individual accounts meeting the standard so long as the auditor determines there would be no material difference in interpretation of the statement in their entirety. Should the dispute be over a specific account, the seller can get caught.

INDEMNIFICATION

Buyers want assurance that they get what they bargained for, nothing more, and nothing less. The “bright line” concept is often used to establish where the seller’s responsibility ends and the buyer’s begins. What happened on the seller’s watch (before the transaction) is the seller’s problem, and what happens thereafter is for the buyer’s account. Seller indemnification obligations arise directly as a result of damages incurred by the buyer for infractions of the bright line.

A claim of damages creates the basis for seller liability. The agreement establishes a mini­ mum claim size, a minimum amount of claims that must occur before any seller obligation arises (deductible), total maximum claim liability, a period of time within which claims must be made, and whether, how much, and for how long an escrow might be needed as collateral for potential future claims. Since the buyer and seller often do not have the same perception of the risk of certain items, great pains are made to define various risks (e.g., taxes, environmental, employees, asset condition), and how each will be treated.

An example of where a disaster might arise is the case where an owner represents that the business being sold is an S-corporation and has no tax liability (as a result of its pass-through status). After closing, it is determined that the conversion to an S-corporation was not done properly and the IRS finds it to still be a C-corporation. As a result, all of the past profits of the business actually represent taxable income to the company and the past distributions made to the owner are recharacterized as dividends. The profits are taxable to the corporation and the buyer files an indemnification claim for damages as a result of the company’s obligations to the IRS.

Many possible surprises can occur after the deal closes. Better due diligence by both seller and buyer can reduce the number and nature of surprises.

NEGOTIATE A HOLISTIC DEAL THAT CONTAINS ALL ECONOMIC COMPONENTS.

The “deal” and the documentation should be treated as an integrated whole. Principals should make sure they have a qualified team of advisors to deal in advance with all issues that will arise during the process of negotiating and closing a business transaction. Financial advisors working hand-in-hand with the owner’s attorneys will greatly improve the overall result. We recommend considering all issues at one time, rather than in sequence, so that the ultimate objective, maximizing the after-tax proceeds after indemnification, remain clearly in focus

Zachary Scott , www.zacharyscott.com, 206-224-7380

 Video Podcast

You Must Stay Ahead Of The Pack

Posted on by JohnM

Recently I visited a client in the DC area and on my way home I saw the wall in the picture below (which I cropped so as not to have any people in it).

 

 

It’s a sign of the times; the bank of pay phones is now a bank of charging stations. It was only 20 years ago that one of the largest (scam) business opportunities was selling people private pay phones (not owned by the phone company).

I wonder how much money people looking for supplemental income lost buying pay phones. And remember Internet kiosks in public places and the infomercials for them?

Things move fast these days, especially when technology is involved (and can you name a business that doesn’t use some kind of technology?).

Now my first thought when I saw the charging stations wasn’t about entrepreneurs investing in pay phone opportunities. My first thought was that my clients and I need to keep on top of this fast moving world because the more you think technology and fast-change doesn’t affect you the sooner it will slam you against the wall.

Every time you see what used to pay phones you’ll be wise to think about how you can stay ahead of your industry’s pack.

“Any intelligent fool can make things bigger, more complex. It takes a touch of genius and lot of courage to move in the opposite direction.” (Economist) E.F. Schumacher

Block & Tackle Better And Hit Harder

Posted on by JohnM

Regular readers know that I like to make analogies between sports and business. As it’s football season let’s discuss how football fans can really get into it. They follow their team, the NFL, the draft, play fantasy football, play Madden Football and more. They study it, critique their teams, especially the coaching staffs, and wonder why the coaches do the things they do (as they, the fans, know what would have worked). They also tend to ignore the fact there’s another team trying just as hard and another coaching staff making adjustments during the game.

Every diehard fan knows in the deepest part of their heart that if their team’s coach would only call the schemes (aka the player formations and plays) they (the fan) would have called then the game would have gone better. A huge reason for this attitude is that fans play the Madden Football video game where each player calls a play and if your defensive scheme stops the play, well, you’re a football genius. So, they think, why don’t my coaches call the right schemes?

Fans and reporters have become vocal about this. If you read the sports page (paper and screen) you know this. I hear it’s huge on sports talk radio, which I don’t listen to.

On September 21, 2014 Green Bay Packers coach Mike McCarthy said, “Scheme is not a crutch.” In other words, no scheme will work if you don’t block and tackle better, hit harder, run faster and do all the other things that determine the outcome of the game.

A few days after I heard this I was in a semi-public area, the guy next to me was on a business call and he said, “We need to block and tackle better.” That’s really what it comes down to, isn’t. Last year the Seahawks exceled at the basics. They blocked better, tackled better, hit harder and won the Super Bowl.

When companies do the basics better they will also excel and it doesn’t matter if your company is just you, a handful or hundreds of employees. Do the basics better and thrive. Here are a few examples:

  • Want to raise revenues? You have to get the word out (marketing). You have to have competent sales people who can build relationships, show value, make calls, stay in touch and do everything it takes to make the customer happy. In today’s world one of the things that gets overlooked too often is the personal touch. A business owner told me recently that he asked his sales staff where they were on keeping in touch with customers and potential orders. One person told him they had sent out emails recently, to which he told them to pick up the phone, call the customer and show some interest in doing business with them.
  • Is it necessary to decrease costs? If done right you won’t be doing this more than once, plus some review, but it can be a worthy exercise. I remember sitting at the computer with a client as we went down their chart of expense accounts. I pressed her on what it was, why it was there, etc. We were about 20% of the way through when she told me she knew what to do and would do it. Their expenses were out of control and she figured out quickly that the big reason was her partner was a spendthrift. As the business grew she ignored costs and they had grown exponentially.
  • Is your process inefficient (this could be manufacturing, distribution, service or restaurant)? Maybe it’s time to bring in a process expert to improve efficiencies. Perhaps your equipment is outdated and not productive enough. If you’re not the expert in this area, as I’m not, get help.

Business is like football; block and tackle better and you’ll do better. Hit harder (figuratively in business) and you’ll win. People have written books on improving the above areas and on a lot more aspects of a business (supply chain management, culture, finance, etc.) so this is just a sample of what you can do. Football is a collision sport and business is a contact sport. The more contacts you have the better you’ll do and that’s not just in sales but having people who can guide you in all aspects of the business.

Talk Competance

Posted on by JohnM

One of the more interesting outdoor things one can do is go fishing with a guide. You not only can learn a lot but it’s fun to observe their culture. The best guides are enjoyable to be with, educate you and know the best places to fish.

Whether the guide is quiet and serious or talkative and fun they have their catch phrases. My favorite three are:

  • “Boy have they been biting the last couple of days.”
  • “The fish don’t bite the day after a cold front comes in (substitute warm front, rain or any other weather condition, and this is always said after you’re done fishing and they’re paid).”
  • [After a fish gets off the line] “That’s why they call it fishing not catching.”

I mention this because we all have our stock phrases. I hear a lot of the same things from bankers, as they all have similar criteria for making loans.

I have my lines that I find myself saying without even thinking about them because they’ve become so natural. I’m sure you do too. When we sound relaxed and comfortable it lets others know we’re competent.

As I’ve helped others get into the consulting business one of the top things I stress is to get to the point so you don’t sound like you’re reciting a script. In other words, be yourself and know your stuff.

“Reality is the leading cause of stress among those in touch with it.’ Lily Tomlin  

To Be an “A” Business

Posted on by JohnM

In the September 2014 Mergers & Acquisitions magazine there was mention of how in today’s market sellers and investment bankers are trying to get “A” prices for “B” businesses.

Surprise, surprise! I don’t think it’s just in today’s market. I don’t think there are too many, if any, business owners who think they have anything but an “A” business. It’s just like how every football fan feels that the NFL draft gave their team the missing pieces to win the Super Bowl.

First let me state that to me any business making a profit after paying the owner a fair market salary for the work he or she does is a “B” or better business. To get to the “A” level (as a small business, which is different than if it’s a middle-market business) a business should have the following usual suspects (of a quality business):

  • A management team, which means the owner can take off for a month with no disruption.
  • Consistent and growing profits, again, after paying the owner a fair market salary.
  • Sustainable growth with an understanding of why growth is occurring (quality of earnings).
  • Achieving scale as it’s rare to see a business doing under $5 million in sales be an “A” business.
  • Solid financial systems and accurate financial statements.
  • Be a leader in product quality, service and innovation.
  • Customer and vendor diversity, loyalty and strength.

“A” businesses will make more money, provide the owner more free time and sell for more money. Why not strive to become an “A” business, or remain as one if you are.

“The free thinking of one age is the common sense of the next” Matthew Arnold

[Very] Small Things Keep Employees Happy

Posted on by JohnM

During a meeting with a group of clients last week another client, Tom McKown, the owner of Industrial Automation, presented on his best practices. Tom concentrated on people and culture. The topic was a huge hit and brought out some of the things my clients do to improve morale.

  • Tom Miller, Western Industrial Tooling, shared that right after he bought the company they did a branding exercise and the employees noted that part of the company’s brand was “Bagel Day” every Thursday. One of the most appreciative things he did was get rid of the old coffee machine and replace it with a Keurig. The reaction was incredibly positive.
  • Fred Barkman, Spectra Labs, told me that when he upgraded the cheap, canned coffee to coffee from a specialty roaster it was like he walked on water. Fred’s business is in Fife so he gets four season tickets to the Tacoma Rainiers and lets the employees use them. The positive feedback is worth the few thousand dollars. He also puts out a snack assortment (chips, etc.) from Costco every week and the $11 a week returns itself in multiples.
  • Finally, Rick Locke with Windows, Doors and More, started holding all-employee monthly meetings after he bought his business and told me the response from the warehouse and similar workers was phenomenal. They had never been included in any company updates or given insights on goals. Rick also keeps soda pop, water and snacks available for free in the lunchroom and, as one might expect, it’s a big hit.

Little things matter (a lot). There is little reason to be cheap when sometimes all it takes is a few dollars to return thousands.

“I’ve never understood why people consider youth a time of freedom and joy. It’s probably because they’ve forgotten their own.” Margaret Atwood

Interest Rates Lower; Business Prices Higher

Posted on by JohnM

June 2014Mergers & Acquisitions magazine has an article titled “Loosening Up” that discusses how intense competition has forced lenders to be more aggressive on pricing (lower) and have covenant-lite loans.

Summer 2014, the lead article in Seattle investment banking firm Zachary Scott’s newsletter, Insight, is titled, “”8″ is the New “6” – For Now, Lenient credit has contributed to higher prices for businesses” (the 8 and 6 refer to the multiple of EBITDA Private Equity Groups are paying for businesses).

While both of the above deal with middle market deals, and while middle market deals have different driving forces (think Private Equity Groups with too much money chasing too few deals), the above does carry over to smaller deals. In my world where the 80-20 rule says most of my clients’ deals will be in the $2-10 million range it’s not that there’s too much money. The challenge is, as always, finding a profitable business that fits the buyer’s skill set and has a willing, motivated seller.

I represent a lot of business buyers and often I hear something like the following, “I won’t pay more than X times cash flow” (or profit, or EBITDA – pick your term). For the buyer stuck on a low number, my comment is to “get over it.” That was then, this is now.

Let’s look at a couple scenarios, which are based on two client deals. For this example we’ll use the term “free cash flow” (FCF) and define it as EBITDA less capital expenditures and after owner salary.

  • FCF (1) = $1,000,000
  • FCF (2) = $1,250,000
  • Price = $5,333,000
  • Bank debt = $4,000,000

I’m showing two similarly priced deals with different FCF to point out that different companies, in different industries, and both highly profitable can be priced differently. (For more on this see the chapters on the non-financial factors in my books and the second article in the Zachary Scott Summer 2014 newsletter titled, “What’s in a Multiple; It is necessary to look under the hood to find the factors driving value.”

The above examples have the bank lending either 4X FCF or 3.2X FCF. The buyer who says something like, “I won’t pay more than 3, or 3.5 or 4, times cash flow” won’t get the deal when the bank will lend that amount or more. Another buyer will offer more, given the generous terms, or, the seller’s advisors will inform them on how much banks will lend and the seller will leverage that information to get a higher price.

So, what can change this? The obvious answer is if interest rates go up. If interest rates escalate more of the payment goes to interest, less to principal and there will be downward pressure on price. Another answer is if the anticipated bubble of businesses on the market appears, creating more choices for buyers. (As per SunTrust Bank in 2010, over 40% of owners have delayed their exit by at least two years because of the recession; and as now times are good, I’m guessing a lot of them are enjoying their highly profitable years).

For buyers, you can’t just look at the price and especially the multiple. As one of my Rules of Business Buying states, “Cash and cash flow is King.” If your payments are $500,000 a year it doesn’t matter if your payments are based on the fact that you paid $5,000,000 or 5% more/less or 10% more/less, your payments are your payments.

For sellers, thinking of selling, this may be the best time ever to sell. There are great buyers out there, money is super-cheap and that means prices are high.

Pay Attention!

Posted on by JohnM

There’s a commercial running on TV for Guinness’s new American Lager beer. I’m not here to critique the beer, or even the fact that Guinness is venturing into a new product line.

No, I’m wondering why they didn’t do their homework. They proudly say that they use Willamette hops. They pronounce it Will-a-met, while it’s pronounced Will-lam-it, Willamette being an area in Oregon.

It’s a lesson for everybody to pay attention and get the little things right. Especially when trying to make a good impression on customers, or prospective customers.