Entrepreneurs: How Strong Is Your Business Foundation?

A Business Lesson from the Three Little Pigs

One of the most important business moves an entrepreneur can do is make sure that their business is grounded upon a solid foundation. Just like a house, a business cannot survive in an unstable environment or on shaky ground. If for some reason an entrepreneur ignores this concept and moves forward to build their business on uncertainty they are definitely setting themselves up for failure and loss. Trust me when I tell you that successful entrepreneurs know the value of beginning your business venture on the grounds of stability.

Interesting enough, when I think of a business’s foundation I think of the story of the Three Little Pigs. I know this concept may seem a bit odd at first; however, after further analysis it makes perfect sense. As many of you already know each of the pigs built their houses in three distinct ways using three distinct types of materials. In the story, Pig number 1 built his house out of straw. Pig number 2 built his house out of sticks. Pig number 3 built his house out of bricks. In an effort to show the relevance between this story and an entrepreneur’s business foundation I will explain how a foundation built upon straw, sticks and bricks is relevant to entrepreneurial success.

A Business Foundation Built Upon Straw

Straw is the material that is left over after grain is separated from cereal plants. Typically, when you think of straw the thought of animal feed comes to mind versus house building. In the Three Little Pigs story pig number 1 used straw to build his house as a protective measure against the big bad wolf. However, the straw was not a strong enough material and the wolf was able to blow it down making the pig’s house irrelevant.

In the business arena the same fate would occur to an entrepreneur that decided to build their business on a foundation made of straw. Straw, without a strengthening agent is a very weak material. The slightest amount of pressure added to it and it will crumble to the ground. The best analogy to a straw foundation would be a business built upon fabrications. Fabrications could be anything from falsified financial statements, defective products, and other deceitful business practices. An entrepreneur that builds their business based on lies will eventually find themselves at the wrong end of the law; which could not only cost the entrepreneur their overall business but their reputation as well. Bottom line, building a business upon a straw foundation will more than likely have a detrimental outcome.

A Business Foundation Built Upon Sticks

Now, if you are anything like me, you are wondering if a straw house did not work for pig number 1 in the Three Little Pigs Story, then why would pig number 2 build his house of sticks. Well, it’s due to the same reasons entrepreneurs that have had failed businesses in the past repeat the same mistake in their current business. Neither party seemed to have learned their lesson despite the losses. Now unlike straw, sticks have a bit more stability but will still have the same outcome despite this fact. Sticks in the business sector are entities such as non-existent business strategies, irrelevant mission and vision statements, and other overlooked business foundational principles. If an entrepreneur fails to have these key entities in place within their business then the business is bound to fail just as quickly as a business built upon lies and deceit. The result of building a business on a foundation of sticks means that the entrepreneur failed to plan and as a result they subsequently planned to fail.

A Business Foundation Built Upon Bricks

Now pig number 3 understood the value of building his house on a solid foundation. He even accounted for the fact that the other pigs built their house out of mediocre materials and would need a place to stay once it all came tumbling down. As an entrepreneur this is the mindset that is needed to build a business on a foundation of bricks. Bricks can be categorized as investments, information technology, key stakeholders, strong organizational structure, and other business functions that lead to maintaining the competitive advantage. In order to succeed an entrepreneur must build their business on these solid foundational principles. Just like in the story of the Three Little Pigs a house build upon bricks can withstand the harshest of elements and will not fail in the face of uncertainty.

If you found this article intriguing and would like to know more about how building a business on a solid foundation will be beneficial to your success, feel free to click the link below.

Enjoy Your Journey!

Business Fundamentals – Commit to the Process

Commit to the Business Fundamentals

The late great Vince Lombardi said football will always be a game of blocking and tackling. Sure you have these new spread offenses in college and the pistol formation in the pros. You have hybrid linebackers and strong safeties who can cover and play in the box. But the fundamentals are still blocking and tackling.

In basketball it is defense and rebounding. Yes you have the triangle offense and the pick and roll. But what did you see in the finals between the San Antonio Spurs and Miami Heat. Coach Greg Popovich wanted his Spurs to play defense, rebound, and then push the ball up court. Eric Spoelstra told his team to do the same thing. Play defense, rebound, and then push the ball.

In your home based business it’s the same thing. You must work on your business fundamentals. No matter what your business, niche, product, or service you have core principles that must be worked on everyday. Professionals work on their business fundamentals everyday.

During the off-season athletes work with their own trainers and attend mini camps. Every year they work on the fundamentals before the season begins. During the season they never get away from the fundamentals.

Business Fundamentals and Your Home Based Business

If you are an affiliate marketer, network marketer, internet marketer, or own an online business. You probably have a game plan from your company, sponsor, or mentor. We don’t suffer from lack of information and you can find out if they have a proven successful plan.

Business fundamentals deal with marketing and sales. You must drive traffic to your business and website. You must generate leads and convert them into sales. That is the basics. You must work on your income producing activities everyday. This is where people fail. They get the fancy letterhead, beautiful business cards, and shiny websites. Then they forget all about the marketing and sales.

Real estate agents, insurance agents, inspectors, loan officers, and independent contractors have proven methods of operations from their brokers. Proven models of success but yet people don’t commit to the process. People want the wealth without the work. Are you committed to the process? Are you committed to going through the grind until you succeed? Can You persist until something happens?

Nothing happens until a lead is generated and that lead is turned into a sale. This is why we work on the business fundamentals.

4.5 Business Fundamentals to Follow

1. Get a Successful Plan of Action – Find a success business model and follow it. Get clear on your outcome. Surround yourself with successful people. Commit to the process. Proven success models work and you see it everyday in business. Just look at franchises, network marketing companies, and championship teams.

Come up with a daily method of operation and commit to the process. I don’t know how long it will take for you to make money. In real estate my average escrow is 51 days. That’s 51 days before I get a check. For my online business I make sales everyday and the money is available in 48 hours. Find out your sales cycle.

2. Marketing and Sales - This is an income producing activity that needs to happen everyday. Your success plan of action should give you step by step instructions on how to generate leads and build lists. Every business online or offline needs to generate leads and build lists. In both my real estate business and online business I use direct mail, a viral blogging system, and social media to drive traffic. I capture these leads, build my lists, and grow my business.

I create content everyday and market that content. In fact you are reading this content now. Then I re-purpose this content. This is my daily method of operation. What is yours?

3. Personal Development – You need to read for at least 30 minutes per day and listen to audio. You have to outgrow you. Leaders are readers and the must successful people read every day. Also get in some training or education every week. There is education available to grow your business. You should learn and take action on that education every week.

4, Follow Up and Follow Through – Following the business fundamentals will get you leads and you need to follow-up and follow through. Don’t let all of your marketing go to waste. People want to do business with you and you must perform. Tell the truth, don’t promise what you can’t deliver, and do what you say.

4.5 Commit to the Process - This has been the theme of this whole article. Business is a process and short cuts will kill your dreams. Instant gratification is an enemy that will close you down. There is a process to cooking a cake and if you skip steps the cake is ruined. Work on your business fundamentals everyday and commit to the process of success.

How Much to Pay For a Business

The methodology outlined below is a simplified approach and as purchasing a business is a very significant step and every individual’s circumstances are different, I strongly recommend that you speak with a professional advisor familiar with your personal situation and needs before entering into any binding contract.

VALUING A BUSINESS: CRITICAL POINTS

  1. There is no right or wrong amount – There is only what you are prepared to pay and what the seller is prepared to accept – nothing else is relevant.
  2. How much to pay is based on what CASH you can realistically expect to generate from the business in future years – (There are many valuation methods available from complicated mathematical formulas to a simple percentage of sales. These methods make a good cross-check to the method suggested below).

HOW MUCH TO PAY – THE METHODOLOGY

STEP 1: NORMALISED PROFIT

Calculate a “normalised” annual cash profit (before tax) the business is likely to earn next year based on its past history. This is usually done by beginning with Last Year’s annual profit and making adjustments for items

  • incurred last year but won’t be incurred next year
  • to be incurred next year but weren’t incurred last year
  • Non-cash items

Examples of items you could adjust for

INCREASE PROFIT BY

  • Any wages or benefits paid to the business owner (or people related to the business owner) who will not be continuing when you own the business. This is not just wages but superannuation, medical benefits, motor vehicles, non-business (or slightly business) travel etc.
  • Interest Paid and any Other Finance Costs (that you will not be responsible for)
  • Depreciation and any other Non-Cash Items
  • Any Non-recurring expenses that occurred in the prior year (e.g. legal fees on a case which is now resolved)
  • The expected annual profit of any new (major) customers not included in the past year’s sales

DECREASE PROFIT BY

  • The market wage & benefits payable to you and any partner/relation that will work in the business (the amount is what you would be paid if the business was owned by a 3rd party and not necessarily what you will actually be paid)
  • Any expenses that will be incurred in future years, which are not included in last years’ profit (e.g. the business moved premises 3 months ago into a more expensive site – decrease the profit to reflect the new rental for the next 12 months less what was paid last year)
  • Any revenue earned last year that would be considered abnormal or not likely to occur next year (e.g. a large client was lost to a competitor, a “special” job which won’t occur again)
  • If there is likely to be significant capital expenditure (new equipment) over the next 3 to 4 years then an adjustment should be made (usually the cost of the equipment divided by the estimated years it will be used in the business)

At the completion of this stage we will have a value which represents the NORMALISED CASH PROFIT. This is the amount of profit before income tax that the business is expected to earn next year if it continued to run as it has done in the past.

STEP 2: SELECT AN APPROPRIATE MULTIPLE

There have been books written on what multiple to select and why, but here’s a RULE OF THUMB which has served me well through many purchases. There are 2 ranges

  • Smaller Business (Profit less than $100,000) 2 to 3
  • Medium Business (Profit $100,000 to $500,000) 3 to 4

(This methodology is not suitable for larger businesses)

STEP 3: CALCULATE THE VALUATION RANGE

Multiply the NORMALISED PROFIT calculated in Step 1 with the MULTIPLES in Step 2.

E.g. If you had a normalised profit of $150,000, the valuation range would be $450,000 to $600,000

STEP 4: NARROW THE VALUATION RANGE

To narrow the range further compile a list of factors which either improve or detract from the certainty that you will earn the normalised profit amount calculated in Step 1. Each factor that improves the certainty will support paying a higher amount in the range, each factor that detracts from the certainty supports paying a lower amount in the range. Based upon the number and importance of the factors in each category will allow you to tighten the range to either the lower, middle or upper portion of the range calculated above.

Examples of factors include

1. Age of Business

A business that has existed for 20 years is likely to have more certain earnings and be more established in a market than a business that has existed for 2 years

2. Size of Business

Generally the larger the business the more likely the business would survive any negative events

3. Certainty of Revenue Stream

There are many items that might improve or detract from revenue including

  • Does the revenue naturally occur each year (e.g. an accounting firm which would usually see the same clients to do their tax returns each year) V’s carpentry business which receives most of its clients from internet or yellow pages advertising
  • Is the revenue made up of a lot of smaller clients V’s a few larger clients? Whilst larger clients may be more profitable, they have a higher risk to the business should they take their business elsewhere.

4. Working Capital Required

The larger the working capital required (Debtors + Inventory – Creditors), the less you want to pay. Compare 2 identical businesses, the first requires you hold $200,000 worth of inventory, the second has an arrangement with suppliers to ship directly to customers. At the very least, you save interest on $200,000, plus the extra staff required to receive, pack and ship the stock, do stocktakes etc.

5. Economic Factors

What is the outlook for the next 2-3 years – if the economy or industry is likely to worsen then your valuation should be more conservative.

6. Market Position/Competitors

How secure is the business – are there are a lot of competitors in the industry(many competitors drive down profit margins), are there any new competitors and how difficult is it for a new competitor to enter the market, what impact would a new competitor have on the business.

7. Industry

Is the market growing or declining?

E.g. there are 2 businesses earning identical profit, one sells mobile telephone technology, and one sells facsimile machines. The mobile phone business is likely to have the stronger growth in the future and therefore you’re likely to pay more than you would for facsimile machine business which is old technology and declining sales.

These are only a selection of the factors and there may be others which are very relevant, (perhaps specific to your deal) and these should also be taken into account.

FACTORS THAT YOU SHOULD NOT INCLUDE

There are 2 special factors, which you may be tempted to include but shouldn’t

1. How you will improve the Business

Perhaps you have a special skill, contacts, or insight that will generate more profit than what the business is currently earning. Surely that will allow you to pay more for the business – Yes… and No

Yes, it will increase the profit and add to the value of the business…

No, you should not pay more for the business because of it. This is the extra profit that you are generating for the business, why should you pay the current owner for it? – he hasn’t done anything. The value you add to the business, is what you should receive when you SELL the business, do not pay this to the current owner.

2. Future Opportunities for the Business

The owner has explained to you how the business has many wonderful opportunities for additional sales but he hasn’t had the time or money to pursue.

This will increase future profits so you could pay more – WRONG!

  • it hasn’t happened yet and it might not happen for many reasons, even if it does it’s never as easy as the current owner tells you (if it was, he would have found a way, and he wouldn’t be selling the business)
  • if it does happen – you will be the one who makes it happen – why should he receive anything for this

OTHER TIPS

  • Don’t get into a conversation with the seller about how you arrived at the purchase price. This will spiral into you shouldn’t add back this, did you include that, and the multiple should be higher… this is not helpful. You have calculated a price that you will pay and that’s all the seller needs to know. Of course, there is likely to be a negotiation process so leave yourself some room to go up from your first offer).
  • Get an accountant to assist with the due diligence
  • When apportioning the purchase price amongst the assets, in most countries the best tax outcome will be to put the maximum value to assets in the following order
    • Inventory
    • Equipment and other depreciable items
    • Goodwill (as low as possible)
  • For the seller it is usually best in reverse and I have seen deals where the contract is left blank in this area, and each party fills in their own values later – check with your solicitor
  • Deduct any accrued employee entitlements from the purchase price (e.g. annual leave, long service leave)
  • Whilst it always preferable to have the previous owner to stay in the business for a handover period, if you are taking over their role, in practice it is usually best to let them go as soon as you are comfortable with the business

DISCLAIMER: Many of the comments in this publication are general in nature and anyone intending to apply the information to practical circumstances should seek professional advice to independently verify their interpretation and the information’s applicability to their circumstances. The author expressly disclaims all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything done by any such person in reliance, whether wholly or partially upon the whole or any part of the contents of this publication.