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Financing ConsiderationsFinancing Considerations

&&

Business ValuationBusiness Valuation

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Financial Characteristics of SMEsFinancial Characteristics of SMEs Capital Owned by family: Low recourse to BankCapital Owned by family: Low recourse to Bank

Finance: Personal Assets used as security: HighFinance: Personal Assets used as security: Highdegree of secrecy on financial condition of thedegree of secrecy on financial condition of thecompanycompany

Lower ratio of Fixed Assets to Total AssetsLower ratio of Fixed Assets to Total Assets Higher proportion of trade debts in total assets:Higher proportion of trade debts in total assets:

Cash purchases and credit sales: Cash flowCash purchases and credit sales: Cash flowproblemsproblems

Short term bank/personal loans funding shortShort term bank/personal loans funding short

term/long term assetsterm/long term assets Heavy reliance on retained profits to fund growth:Heavy reliance on retained profits to fund growth:

Lack of willingness to dilute equity stake: SlowLack of willingness to dilute equity stake: Slowgrowth and increased competition.growth and increased competition.

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A typical financing model of a SMEA typical financing model of a SME

High Owners Capital + Short term loans (High interestHigh Owners Capital + Short term loans (High interestbearing)bearing)

Low Fixed Assets+ High Debtors +High InventoriesLow Fixed Assets+ High Debtors +High Inventories(many slow & non moving)(many slow & non moving)

Opportunities to leverage on own capitalOpportunities to leverage on own capital

Low fixed assets hamper ability to secure long term lowLow fixed assets hamper ability to secure long term lowcost loanscost loans

Start/Manage business with subStart/Manage business with sub--optimal capital causingoptimal capital causing

cash flow constraintscash flow constraints High cash withdrawals by owners for personal use (bothHigh cash withdrawals by owners for personal use (both

luxury and necessity): Losing opportunities to financeluxury and necessity): Losing opportunities to financegrowth from accrualsgrowth from accruals

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A typical operating model of a SMEA typical operating model of a SME

High cost of input costs due to inability to bargain forHigh cost of input costs due to inability to bargain forbetter price.better price.

Lower than market selling price as large buyers negotiateLower than market selling price as large buyers negotiatelower pricelower price

Profit a function of personal efficiency of the ownersProfit a function of personal efficiency of the owners

High inventory and High Debtors cause losses in futureHigh inventory and High Debtors cause losses in future

High break even points causing greater risks in business.High break even points causing greater risks in business.Fixed costs more.Fixed costs more.

Reliance on one/few supplier and for most times: one/fewReliance on one/few supplier and for most times: one/fewbuyerbuyer

Owner/Manager spending 80% of time on issues thatOwner/Manager spending 80% of time on issues thatgenerate 20% value (80/20 principle): Working capital:generate 20% value (80/20 principle): Working capital:dispute resolution: bureaucratic hasslesdispute resolution: bureaucratic hassles

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Issues for SMEsIssues for SMEs

Financial Planning/ BudgetingFinancial Planning/ Budgeting

Focus on Costs and Prices: WatchFocus on Costs and Prices: Watch

overheadsoverheads Low cost financing possibilities ignored:Low cost financing possibilities ignored:

Debt/Equity Structure to be set rightDebt/Equity Structure to be set right

Balancing Cash Requirements: CashBalancing Cash Requirements: CashBudgetsBudgets

Tax ConsiderationsTax Considerations

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Valuation of CompaniesValuation of Companies

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Why ValueWhy Value

Buying or Selling BusinessBuying or Selling Business

To Raise Additional FinanceTo Raise Additional Finance

Payment of Property TaxPayment of Property Tax Shareholder DisputesShareholder Disputes

JV Partners/Foreign collaborationsJV Partners/Foreign collaborations

Receiving/Giving on Will or as Gift.Receiving/Giving on Will or as Gift. Divorce SettlementsDivorce Settlements

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What is requiredWhat is required

Balance SheetsBalance Sheets

Income StatementIncome Statement

Cashflow StatementsCashflow Statements Earnings ProjectionsEarnings Projections Most LikelyMost Likely

scenarios : validatedscenarios : validated

Comparables with CompetitorsComparables with Competitors --BenchmarksBenchmarks

All Data Required as much as possible

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All data needs to be realistic,All data needs to be realistic,defendable, true and honest.defendable, true and honest.

Remember, in aRemember, in a

Partnership/Collaboration/JV longPartnership/Collaboration/JV long

term relationship depend on theterm relationship depend on the

initial trust builtinitial trust built

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Methods of ValuationMethods of Valuation

Discounted Cash FlowsDiscounted Cash Flows

Adjusted Net AssetsAdjusted Net Assets

Capitalisation of EarningsCapitalisation of Earnings

Dividend Paying CapacityDividend Paying Capacity

Excess Earnings: Return on AssetsExcess Earnings: Return on Assets

Excess Earnings: Return on SalesExcess Earnings: Return on Sales

Discounted Future EarningsDiscounted Future Earnings Valuation of Goodwill + Net AssetsValuation of Goodwill + Net Assets

Combination of all types from above.Combination of all types from above.

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Discounted Cash Flow ModelDiscounted Cash Flow ModelAlso known as free cash flow modelAlso known as free cash flow model

Future cash flows less future investmentsFuture cash flows less future investmentsdiscounted at adiscounted at a mutually fixed ratemutually fixed rate to fixto fix

value of the firmvalue of the firm Use of past data for due diligence/to arrive atUse of past data for due diligence/to arrive at

growth rate for estimating future cash flow.growth rate for estimating future cash flow.

Key problem in estimating future cash flow isKey problem in estimating future cash flow isto forecast business environmentto forecast business environment

Key terms EBIT, Taxes, Depreciation, OtherKey terms EBIT, Taxes, Depreciation, Otherincome, Working capital changes, Debt.income, Working capital changes, Debt.

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Free Cash Flow = PAT Dep

Total

InvestmtInt (1-T) -

+ +

Calculationn of Free Cash flows to be then discounted at a mutully

fixed rate to Arrive at a Value for the firmThis takes into consideration the time value +

Goodwill earned by the firm in the past

Free Cash Flow Calculations

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Partnership DilemmaPartnership Dilemma

LOCAL PARTNERLOCAL PARTNER

(ON THE ABILITY OFFOREIGN PARTNER TO(ON THE ABILITY OFFOREIGN PARTNER TO

CONTRIBUTE MORE EQUITY )CONTRIBUTE MORE EQUITY )

HE CAN AFFORD ITHE CAN AFFORD IT

THE EXCHANGE RATE ISTHE EXCHANGE RATE IS

WRONGWRONG

HE WANTS OUR MARKETHE WANTS OUR MARKET

FOREIGN PARTNERFOREIGN PARTNER

(ON THE REASONS TO OFFER LOWER(ON THE REASONS TO OFFER LOWER

PRICE FOR PARTICIPATION)PRICE FOR PARTICIPATION)

POLITICAL AND ECONOMIC RISKPOLITICAL AND ECONOMIC RISK

LOW PURCHASING POWER IN THELOW PURCHASING POWER IN THEMARKET PLACEMARKET PLACE

UNCERTAIN FUTURE EARNINGSUNCERTAIN FUTURE EARNINGS

WORKERS DEMANDSWORKERS DEMANDS

BOOK VALUE IS IRRELEVANTBOOK VALUE IS IRRELEVANT