An arm’s length sale of a business is a form of business transition. So too is a generational transition of ownership of a business. Absent unusual circumstances, if a business ceases to be viable as a going concern in either the near- or long-term its transition becomes irrelevant or largely so.
Both near- and long-term business viability analysis are functions of identifying and assessing internal and external factors that impact business free cash flow and value maintenance and growth. This where internal factors are within, or largely within, the control of business owners, and external factors are those outside their control.
Business owners should maintain a documented and regularly updated business plan that addresses:
- near- and long-term business viability.
- contingency plans – including a downsizing strategy – that can be implemented quickly in unexpected circumstances.
- free cash flow and value growth.
- business transition.
Such a plan readies the organization’s owners, directors and management to take affirmative action in the event things do not go as planned or hoped for.
Developing and maintaining such a written plan is becoming increasingly important. This is because of the uncertainty and potential rapid change in the current economic and business environment – irrespective of where geographically a business is physically located. Having such a documented plan positions owners, directors and management to act if needs be from a position of greater strength than if they are forced to scramble for solutions should a different result obtain than they would like.
Business viability defined
Near- and long-term business viability are subjective measures of a business at a particular point in time in the context of whether that business can reasonably be expected to continue to function as a going concern – that is, function without the threat of liquidation – in both the near- and long-term.
Think of long-term business viability analysis as a long-term version of a conventional near-term focused SWOT – strengths, weaknesses, opportunities and threats – analysis. This where any long-term business viability assessment obviously is conditional upon:
- an understanding that the further into the future conditions, relevant events, and outcomes occur the degree of uncertainty attaching to those things increases significantly, and arguably exponentially.
- the nature, size, complexity, external factor influence and current and expected long-term viability of a given business all may impact near- and long-term business transition planning.
- predictions inherently are based on information available at the time they are made. Subsequent conditions, events and outcomes are impacted by post-forecast factors and events. Hence predictions with respect to long-term business viability are relevant only at the point in time they are generated. Accordingly they need to be continually amended as new information comes available.
Internal markers that at any given point in time speak to long-term business viability
Markers that speak to and influence near- and long-term business viability – and hence business transition – for a given business that can be influenced to a greater or lesser degree by business owners include:
- Whether the current owners have commonly held value systems, risk profiles, and liquidity requirements from the business.
- Whether the current owners have documented contractual arrangements in place that preclude or militate against the business disruption as a result of disputes among owners, or changes in owners liquidity requirements.
- Whether the business is diversified and hence may have built-in risk hedges and increased flexibility – financially and otherwise – as a result of participating in more than one industry.
- Financial viability supported by ongoing balance sheet strength measured by:
- working capital balances adequate to support prospective business operations.
- a conservative interest-bearing debt/tangible equity structure that would contribute to sustaining business operations in the event of operating at least two years of free cash flow losses.
- expectations of continuous growth in after-tax free cash flow and business value.
- Good corporate governance practices within the business including a strong and independent Board of Directors, a strong management team, good reporting standards, and a strategy to continually improve governance practices.
- Well-maintained real estate and capital equipment used in the business, particularly where capital equipment has manageable technological obsolescence that is expected to continue into the long-term.
- Sound employment policies and good labor relations that are expected to continue in the long term.
- Whether the business has any contingent environmental or other liabilities.
External markers that at any given point in time speak to long-term business viability
Markers that speak to and influence long-term business viability at any given point in time for a given business that are outside, or largely outside, the influence of the business owners include:
- Expected long-term competitive viability in the contexts of competitive business size, product/service offerings and supply chain, geographic coverage and other competitive advantages, disadvantages, strengths and weaknesses.
- Whether there are potential strategic purchasers who might gain evident competitive advantage or other synergies by acquiring the business.
- Ongoing globalization in the contexts of economic growth, country-specific economic growth and trade relations – including issues around free trade and trade protectionism. All of which in turn will impact developed country inflation rates and consumer spending in a contagious manner.
- Ongoing central bank intervention that has seen an historically low interest rate environment in most developed countries, and quantitative easing packages intended to buoy up individual country and world economies and economic growth. This where in the case of economic growth it is becoming ever more evident that central bank quantitative easing has not had, and isn’t having, the levels of sustainable economic growth that central banks (and everyone else) has hoped for.
- Many governments at all levels – federal, provincial/state, and municipal – have seen their debt burdens rise significantly after 2008, and to continue to rise. This means it is virtually certain the free cash flow of many businesses will be negatively impacted in future years if for no reason other than governments at all levels will have to find incremental funding to eliminate ongoing operating deficits and pay for ever increasing social programs.
- Technology advances seem to be accelerating in speed, and are likely to have significant impacts on capital-intensive and non-capital intensive businesses. This where:
- many believe technology advances – including increased robotics, deep-data analysis, increased clerical functionality, and artificial intelligence – are likely to increase productivity while at the same time resulting in higher unemployment. That is, result in “net negative” job creation. In such a scenario consumer spending and gross domestic product growth in any given country-specific economy is likely to be impacted negatively. See Technological Advances: What Business Owners and Advisors Need to Know.
- others argue that technology advances will create more jobs than they eliminate. These people cite historic events such as the industrial revolution and early computer development and advances as repeatable historic evidence that further technology advances will create more new jobs than those jobs they will replace.
- The current and prospective low interest rate environment, availability of business acquisition funding – private equity “dry powder” being but one source – and economy of scale advantages are resulting in ongoing business combination activity. This is tending to:
- create acquisition demand and push acquisition prices ever higher for “good businesses” based on increasing scarcity if nothing else.
- result in smaller businesses in some instances becoming less competitive than has historically been the case.
- The business combinations that are occurring in many industries, and the resultant competitive disadvantage that many smaller companies that do not participate in that consolidation process may experience going forward.
- Increasing wealth disparity, which may result in enhanced and further societal issues – which in turn may exacerbate economic and business uncertainty.
- Add “lowest hanging fruit” commodity issues and prices, climate change, ongoing environmental debates, continued world population growth – you name it – and both business owners and their advisors ought to readily “get the picture”.
How might the foregoing factors influence business viability?
This is the $64 trillion (with a “t”) question. In the near- (say 1–3 years) and more particularly in the longer term (say 4 years and beyond) the following factors may influence the business viability of any given privately-held company.
- Possible downward pressure resulting from product and service sales price and input costs. One or a combination of these things may negatively impact gross margins. Factors that may contribute to this occurring include at least the following:
- inadequate corporate governance.
- poor balance sheet strength.
- competitive size disadvantage in the face of ongoing competitor, supplier and customer business combinations.
- being uncompetitive in the context of keeping up with and effectively utilizing technology advances – both with respect to big data analysis and capital equipment improvements.
- reduced levels of consumer spending should that occur in the face of economic and societal change.
- In the face of technology advances possible earlier, and greater, expenditures on sustaining capital reinvestment and growth capital than might otherwise be expected.
- Possible greater and earlier than expected capital and expense outlays related to increased climate, environmental and other regulation.
- Possible – and perhaps better said – “likely” increases in taxes at all government levels. This in the face of continuing escalating government debt in an economic environment where in the aftermath of the 2008 financial crisis world and country-specific gross domestic product growth may be less than hoped for. And where the world population and country-specific populations are aging such that the “retirement population pyramid” is less self-sustaining than what it was.
- A financial markets environment that is controlled by comparatively few, yet where the stability and viability of that environment is crucial to business success at all levels.
- A communication environment where news is increasingly instant, where the quality of news is in many cases suspect, and where societal activity is dictated by that news – sometimes in wrong-headed ways.
Think of that portion of a comprehensive business plan that focuses on near- and long-term business viability as an ongoing “business viability audit”. The foregoing factors – and other factors that may be particular to any specific business – increasingly mandate the importance of documenting and regularly updating such analysis – and reaching meaningful point in time conclusions on near-, and in particular in the case of business transition planning, long-term business viability.
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50 Hurdles: Business Transition Simplified
If you are an owner of a family business you might consider purchasing a copy for every member of your business family. If you are an advisor to business owners you might consider purchasing a copy for one or more of your clients. Discounts are available for multiple book purchases.
Ian R. Campbell FCPA FCBV
Ian R. Campbell is a Canadian business valuation and transition expert. He is the author of several Business Valuation texts and of 50 Hurdles: Business Transition Simplified. The Canadian Institute of Chartered Business Valuators recognizes his contribution to the Canadian Business Valuation Profession through the annual The Ian R. Campbell Research Initiative.
He curates economic and business news relevant to business transition and valuation filtered from world media sources. He writes, with other contributors, The Business Transition and Valuation Review newsletter for business owners and their advisors.
You can reach him by email at email@example.com, or by telephone at 905 274 0610.