Enterprise Value and Equity Value in A Simple Example

Oct14
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3092372861_f14e04df82_oWe developed this blog entry to answer questions some of our clients had about describing the value of the company we were acquiring on their behalf.

Since most people are familiar with the construct of a home purchase and a mortgage the easiest and most general explanation is that the value of a home is the price you paid for it. If you borrow money from a bank to fund the purchase then that debt plus the amount you put towards the purchase equal the home’s value:

Purchase Price = Amount put down + Amount of mortgage

We can translate that to the value of an acquisition in much the same way:

Enterprise Value of a company = Equity + Debt

Headlines will often read that a certain company is the most valuable in the world. Reading more closely that value will be referred to as either market capitalization or enterprise value.

The market capitalization of a publically traded company is the value of its current share price multiplied by the number of shares outstanding.

The enterprise value of a company is the market capitalization of a company plus its outstanding debt. For simplicity, we omit the discussion around cash and excess cash.

Enterprise Value of a company = market capitalization (equity) + Debt

So in practice consider this situation. The enterprise value of a target company is established at $30 million. The company holds $10 million of debt. Therefore:

Enterprise Value = Equity Value + Debt

$30 million = $20 million of equity + $10 million of debt.

At a hypothetical deal closing the acquirer could show up with $20 million in cash and assume the debt of $10 million or the acquirer could show up with $30 million where the seller would use $10 million of the cash payment to extinguish the debt outstanding. In either case the acquirer would own an asset that was at that moment valued at $30 million dollars.

Getting the Growth Strategy Right

Sep30
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buildingA recent article title Getting the Growth Strategy Right from three Kellogg Professors highlights a simple but powerful approach:

1.) Know what you do well

2.) Stay focused on what you do well

3.) Understand positioning in the industry

4.) Invest in core capabilities

For more details on this approach see the article here:

http://insight.kellogg.northwestern.edu/article/getting-the-growth-strategy-right

Three Mistakes in Strategy Development

Sep17
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no_way_signEvery business executive recognizes that strategy is important. However, it is also challenging to make predictions about unpredictable future events. Roger Martin, in a recent Harvard Business Review article (Jan/Feb 2014), offers some advice on the three most common mistakes in creating a business strategy.

First, business plans are not a strategy. Planning involves detailing expected initiatives and operational improvements. Business plans forecast sales and revenues for the next annual cycle. Strategies, on the other hand, may be less certain in nature and should focus on the long term. Instead of describing specific initiatives, a strategic focus will identify market opportunities.

Second, strategies aren’t perfect. Whereas business plans for the next annual budget cycle should be accurate, strategies allow room for new information. A business plan must forecast revenue and costs to help manage capital, investments, and human resource processes. Strategies look further into the future and try to envision a company’s footprint in an emerging marketplace.

Finally, the third mistake companies make is to not have a strategy at all. Logically, these firms ask, if the future is not controllable, why should we try to anticipate it at all? Of course, failing to consider the future is a recipe for disaster. Firms that fail to develop a business strategy are often short-lived.

Business strategies must focus on the long-term viability of the firm. This means framing opportunities and risks in the marketplace. Strategic outlooks will examine customer needs and satisfaction far more than cost-cutting conditions. Decisions are made based on the company’s fit and alignment in the industry rather than a quarterly metric.

Creating an effective strategy is tough work. It’s easy to fall into the trap of substituting a detailed operation plan for a strategy. Yet, focusing on tough decisions and anticipating industry trends and risks will better prepare your business for long-term success. For more information on creating an effective, long-term business strategy, please contact us.

Implementation Is the Next Step in Strategic Planning

Jul31
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46fda804fa21b4a8c242cf63558a688bStrategic planning is just an abstraction without proper implementation. Implementation is where, as the saying goes, “the rubber meets the road.” The rubber would be the strategy, and the road the path to growth.  Implementation, like a professionally crafted storyline involves the who, where, when and how.

So, if your strategic plan is on a solid footing, your management team can get it on the road with all the resources and organizational buy-in it requires for the successful journey. That journey is what implementation is all about. Therefore, implementation is a carefully crafted process that ensures the strategic plan will be more than a plan. It will become part of the organizational culture because:

  • It involves specific ownership and clear statements of responsibility.
  • Implementation plans are communicated to your staff with a clear statement of how they contribute.
  • Implementation is treated as a separate and special program not to be bogged down in daily business operations.
  • Goals and actions are sufficiently focused and realistic in scope so as not to be overwhelming.
  • The plan contains no fluff or meaningless statements of vision, mission or value statements that promote lip service but no buy-in.
  • The planning document is understood not to be an end in itself, but is at the forefront in every aspect of the strategic planning process.
  • There is highly visible accountability and ownership along with measurable progress tracking.
  • The accountability for implementation is coupled with actual empowerment and delegation of authority — the means and tools to implement the plan.

Implementation allows the organization to transform the abstract to action with buy-in and practical implementation techniques.

Alternative Models in Traditional Businesses

May28
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buildingsSometimes the foundation of successful entrepreneurial idea is to take a well-known, effective business practice and tweak one step in the process with an interesting innovation. In the arena of real estate development,RealtyShares is doing just that.

Based in San Francisco, RealtyShares provides crowdfunding for real estate development, fostering residential and commercial real estate innovation in how investment capital is raised. The process aims to benefit both investors and real estate developers.  Other crowd funding examples exist such as Lendingclub.com for consumer loans.

The crowd funding platform for RealtyShares provides ease of access that typically isn’t available to private investors who want to invest smaller pools of capital.  RealtyShares allows a minimum investment of $5,000 and investors can choose between a range of properties in both commercial and residential markets, creating an opportunity for investment diversification. The model creates a new way for the individual investor to participate in the real estate market.

For developers, the crowdfunding model takes the development process out of the traditional realm of banks and institutional investors, creating a broader network for raising capital. Ideally, with RealtyShares managing the financial nuts and bolts of the investment process, the opportunity exists for developers to raise capital more quickly and focus on the core work of property development.

Clearly, this model shows signs of success, as a recent article states that the company has raised more than 1.9 million dollars in venture capital to grow its platform. Having just opened the doors in 2013, RealtyShares has already funded projects estimated at more than 70 million dollars in value and, with this latest rounding of funding, will continue to bring investors and developers together for more projects.

If you are looking for innovative and effective methods to bring high growth to your entrepreneurial venture, please contact us today.

Manage Supply Chain Risk in Acquisitions

May27
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Gear_HeadWhen acquiring other businesses, it’s easy to overlook vulnerabilities within their supply chain. However, if your growth strategy depends on acquisitions, the strength of the supply chains you acquire is as critical to your success as the overall health of the company you are acquiring. Here are a few ways to protect your interests when your growth strategy involves acquisitions that depend on material supply chains.

Investigate Beyond Tier 1 Suppliers

Tech giant Apple has been ridiculed by the press, labor rights groups, environmental groups, and human rights activists several times due to vulnerabilities within their supply chain. Recently, an internal investigation revealed serious human rights violations involving Apple’s lower-tier suppliers in China. Other reports indicate that Apple may not be able to meet market demand for their new smartphone release due to supply chain vulnerabilities.

If a large entity like Apple can’t identify and address supply chain issues before they hit the news, imagine how vulnerable smaller companies are. Make sure you know who the tier 2 and 3 suppliers of your acquisitions are, where they are located, the working conditions in those factories, and the logistical conditions associated with getting critical parts and equipment to production.

Appoint Someone to Stay on Top of Suppliers’ Business Climates

Many of the countries where tier 2 and 3 suppliers operate are in political turmoil, some are in areas vulnerable to natural disasters, and almost any supplier can get hit with fire or other unforeseen problems. This is especially true if the supplier operates in a country with sub-par building codes.

Once you’ve mapped out the supply chains of your acquisitions, have someone internal monitor the news in any parts of the world where lower-tier suppliers operate. This allows you to get ahead of delivery problems that might derail your supplies and find an alternative solution before you are unable to meet production goals.

Develop a Code of Conduct for Foreign Suppliers

In addition to Apple, Wal-Mart and several U.K. retailers have faced public outrage when reports of dangerous and inhumane working conditions in third world countries came to light. The public doesn’t see the difficulties associated with monitoring a complex supply chain — they merely blame the corporate giant who contracted the work.

The smart way to operate in today’s complex global climate is to develop a code of conduct for all suppliers working outside the protection of solid governmental safety codes, and conduct regular inspections of all suppliers. This is especially important to do for a newly acquired supply chain.

Your vigilance before making an acquisition involving a supply chain pays off when operations run smoothly without the hassle, expensive downtime, and media scrutiny caused by an inappropriately managed supply chain you took over from another company.

Contact us for more information on growing your business through acquisitions.

How to Avoid Unsuccessful Mergers and Acquisitions

May09
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no_way_signLarge acquisitions can make or break a company. While some companies have achieved strong growth and success from high-profile mergers, many deals result in poor outcomes.
High Risk

According to Harvard Business Review, mergers have a 70 to 90 percent chance of failing. Just because a company is doing very well doesn’t mean that the acquisition will succeed. An article posted byEntrepreneur.com emphasizes that “popularity doesn’t guarantee long-term success.”

Long-Term Strategy

Many organizations fail to address the long-term strategy of an acquisition. According to Forbes, it’s important to not just focus on the initial acquisition but also develop a longer term strategy. Many mergers fail as a result of not “developing other revenue streams fast enough.”

Common Factors behind Failed Acquisitions

Before entering into an acquisition, an organization should consider all of the factors which may cause the deal to fail. A report on mergers and acquisitions by Airmic and Marsh suggests that companies should manage risk “more aggressively.” The most common factors that lead to failed mergers include:

  • Overpaying for an acquisition.
  • Rough or failed target integration.
  • Disputes relating to purchase price.
  • Post Deal completion issues.
  • Uninsured legacy liabilities.
  • Warranty and indemnity claims.

Worst Deal in American Finance

Perhaps the most infamous failed merger was Bank of America and Countrywide in 2008. The failed deal cost Bank of America more than $40 billion. The Wall Street Journal referred to the acquisition as the “worst deal in the history of American finance.”

For more information please visit our website, read our blog, follow us on Twitter and visit us on Facebook. Please feel free to contact us with any questions.

Three Signs that An Acquisition Doesn’t Fit

May09
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2890382557_a0fecf0404_oDeveloping a growth strategy can be a little like a trip to the farmer’s market. Everything looks good at first, and it’s hard to see the downside to almost any of the potential opportunities. Acquisitions no doubt seem appetizing; however, unless you want to wind up with a fridge full of rotten purchases, you need to choose well.  Although every company’s growth strategy is different, these three signs will usually point to an acquisition you should avoid.

It Doesn’t Clearly Match the Objective

A good growth strategy gets your company from Point A to Point B with as few interruptions as possible. If you’re unsure if a potential acquisition target will help or hinder that strategy, try to describe in a single sentence how the acquisition will help you get to Point B. The longer it takes you to explain the acquisition’s usefulness, the less likely it is that it will be a worthwhile investment for your company.

You’re Not Playing the Same Game

Although there is a time and a place for diversification, most solid growth strategies these days are focused within the growing company’s market. Competitors, suppliers, and distributors within your market are great choices for acquisitions, because controlling their performance means controlling more aspects of your market. If a target’s connection to your market is tenuous or hard to explain, then it’s unlikely to be a good fit for your growth strategy.

It’s Out of Alignment with Your Portfolio

Again, diversity in acquisitions is not always a bad thing, but a portfolio with too much variety will weaken your company’s growth strategy. This is another good place to apply the one sentence test: if you can’t explain in one sentence how your new acquisition will relate to your portfolio of other acquisitions, then it may be time to reconsider whether it’s a good fit for your company’s growth strategy.

“Innovative” should be a descriptor of the core of your growth strategy, not a euphemism for the high-risk nature of your acquisitions.

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