Business Evolution - Onwards And Upwards

The principal challenge facing many small and medium sized businesses over the next decade is how to manage the evolution of their business. 83% of Australian businesses are family owned and it is estimated that 70% of those businesses will face a generational change in the next decade.

Irrespective of whether your business is one of the 70%, the likelihood is that the competitive landscape of the industry in which you operate is going to undergo substantial change.

Already in many industries the “evolution” has been characterised by a process of consolidation. The availability of capital for Australian business is at unprecedented levels and the extent of merger and acquisition activity seems limited only by the quality of “deal flow”.

There is a need to look more deeply at the competitive landscape and to consider where in the business life cycle you and your competitors might sit. How likely is a change of ownership? Is it a threat or an opportunity? Should you be proactive or reactive?

Historically the expectation of family business owners has been to pass their business to the next generation, however more and more this is not occurring. Rather, a myriad of other options for realising the value of a life’s work are being considered. MBOs (Management Buy-Outs), MBIs (Management Buy-Ins), IPOs (Initial Public Offerings / Floats), Franchising, Trade sales, Mergers and Roll-ups just to name a few.

For those facing the implications of generational change the question then becomes – How best do I take advantage of this phenomenon? Should I be a seller or a buyer? Irrespective of the answer the aim should be the same – to maximise the value of your business. Recognising that value is a function of risk and return, the approach must focus as much on mitigation of risk as it does on maximisation of return, not only for the short term but also for the long term.

A technique that we have used very successfully is to assist business owners to look at their business from an investor’s viewpoint. By commissioning a “Reverse Due Diligence” clients can get a critical analysis of their business, which assists in identifying its vulnerabilities and risk factors so as to enable them to put in place positive action plans to address those issues.

This methodology, which is similar in approach to a Due Diligence typically undertaken by an investor, identifies not only the issues (the bad news) but also the opportunities (the good news) to both protect and enhance the value of a business.

Matters typically addressed in this process include:

Value Drivers – understanding what drives value in the business and recognising its KPIs;
Key Risk Areas - understanding weaknesses and threats facing the business including dependency on customers, suppliers or key personnel, integrity of supply chains, impact of technology (product or process obsolescence), capacity issues (human, space, and infrastructure), industrial relations, quality of systems, working capital management, balance sheet strength, gearing, gross margin performance, contingencies;
Earnings Sensitivity - to industry, political or economic factors, including interest rates or exchange rates;
Management Structures – ensuring alignment of management and organisational goals;
Intellectual Property - Identification and analysis of intangible assets including brands, patents, rights, processes and know-how;
Competition - reviewing the competitive landscape; understanding barriers the to entry, and
Identifying and evaluating growth opportunities and exit strategies including consideration of business and tax structuring implications, valuation bases and linking with business value drivers.

Increasingly business owners are becoming more sophisticated and forward thinking in planning their exit strategies, recognising that the best way to realise value may well be to grow and expand the business, prior to exit.

With Venture Capital and Private Equity markets continuing to flourish there are increasing stockpiles of cash waiting for a good home and looking for quality businesses in which to invest.

David Knowles, Partner, Pitcher Partners. For further details contact David on Phone: (03) 8610 5146 or visit the Pitcher Partners web site: www.pitcher.com.au
First published: 15 February 2006.
Last updated: 15 March 2006.