Death is one of those inevitable life occurrences that affect everyone yet still catches one off guard. In the event of the passing of a loved one, having a will in place provides certainty, security, and clarity of who should be the beneficiaries of your estate.

It could be so that you already have a will, but when last was it revised? It is critical to update it regularly, especially after a significant life event such as a birth, death, marriage,divorce, or any major asset purchases.

Furthermore, who have you entrusted with the power of fulfilling your last wishes? The administration of an estate can be as challenging as navigating a maze blindfolded. Therefore, it is important to appoint a trusted person, preferably a professional, to lead this process in ensuring that your property is divided according to your wishes and settling any outstanding debts.

If you need assistance with the drafting of a customised will, codicil, or living will, please get in touch with our team here.

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Cape Town, South Africa

Business advisory firm Creative CFO has recently launched Creative Growth Capital, its very own investment vehicle to meet the high demand for flexible funding solutions that are better geared toward SME business models. Creative CFO has coupled its longstanding expertise in working with SMEs with making flexible investment capital available to SMEs to unlock sustainable growth opportunities and consequently create a positive and measurable impact in more communities in South Africa.

Creative Growth Capital will offer growth capital to SMEs by way of tailored deal structures using an array of investment instruments including debt, equity and combinations of these instruments to craft bespoke deal terms for these businesses.

 

“SMEs are largely underserved by capital markets, specifically in emerging market territories. Traditional financiers lack the flexibility and risk appetite to provide the right type of capital to support SMEs. SMEs are the backbone of the economy and their success should be prioritized to ensure a well-functioning local economy.” (Creative Growth Capital)

 

Anchored by an investment from one of the largest institutional investors in Africa, Creative Growth Capital has recently made a debt investment into an artisanal ice cream company based in Cape Town.  The loan will enable the business to grow its production capacity and expand its delivery and distribution channels to a broader network of customers, both important prerequisites for scale.

Recognizing that private investment is essential for small business growth and job creation, the USAID Southern Africa Regional Economic Growth Office has supported Creative CFO with the establishment of Creative Growth Capital. USAID’s support of these vehicles through its INVEST initiative reflects a growing consensus that private investment is critical to inclusive, sustainable development. In support of the shared commitment to invest for impact, all of Creative Growth Capital’s investments will embody targeted social development objectives, including but not limited to scaling women and minority-owned- businesses, expanding local business operations and supporting job creation. Creative Growth Capital, with USAID support, will continue to fund SME growth within the region, bridging the demand gap between small and medium-sized enterprises and affordable, flexible financing.

 

“Creative Growth Capital aims to uplift entrepreneurs and support businesses that make a real contribution to society by creating jobs, up-skilling their employees, and fostering a thriving and inclusive SME ecosystem. We view investing in SMEs as being the most-impactful mechanism with which we can improve the livelihoods of others and inspire the greatest change in our country and eventually abroad.” (Creative Growth Capital)

 

About Creative CFO

Creative Growth Capital is part of  Creative CFO , an international business advisory firm that, over the past nine years, has been advancing its vision to create a world where more SMEs succeed.

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For South African business owners, the economic stability of Europe coupled with business-friendly legislation makes the continent a desirable place for expansion. While these factors are attractive, access to financing and the potential for lucrative upside when exiting a business are the real drawcards.

We recently performed a valuation exercise for a client who intends to swap shares in a successful South African application software company for those of a similar company in the Netherlands. While these companies operate in the same industry, we found the comparative valuations to be vastly different.

The 3 factors that had the greatest impact on the valuation – the ” triple edge sword” –  were the valuation multiples, the cost of debt, and the cost of equity.

Valuation Multiples

When we perform valuations, we use search parameters to screen hundreds of companies within a comparable industry and/or geographic region. Through this process, we derive a range of companies deemed comparable to our subject. Without regard to a specific industry, we found that the median EV/EBITDA multiple (i.e. the value of a company over its earnings) of selected listed companies in the Netherlands was just under 12x, whereas in South Africa, the multiple was just over 6x. Assuming that our South African and Netherlands companies achieve the same currency-adjusted EBITDA, our South African company takes a valuation hit of about 50% before we even consider the cost of capital for the business.

A report compiled by the CAIA Association echoes our findings, stating that EBITDA multiples in Europe during 2020 approached 12.6x, while in Africa, multiples were between 4x and 8x.

Cost of Debt

The CAIA Association also alludes to the second edge of the sword –the cost of debt – suggesting that higher valuations are likely a result of prolonged quantitative easing and low-interest rates in developed countries. Access to debt at low-interest rates benefits a business from a valuation perspective, as the weighted average cost of capital (“ WACC” ) used to discount the company’s cash flows is lower (lower discount = higher value). The OECD reports that SMEs in the Netherlands have access to debt at an interest rate of 3.3% per annum, whereas we know from experience that an SME in South Africa will be lucky to service debt at less than 15% per annum. In our example below, if both companies were financed entirely by debt, a South African company would achieve a valuation of about 30% lower than a Netherlands comparable.

Cost of Equity

The third edge of the sword and the second component of WACC –the cost of equity – is essentially sharpened by the stark contrasts in the economic climate between Europe and South Africa. Using the capital asset pricing model (“ CAPM ”) to derive a cost of equity, our starting point is the “risk-free rate”. As mentioned, developed countries have benefited from a period of quantitative easing which sees the yield on 10-year government bonds (a proxy for the risk-free rate) in the Netherlands at 1.4% at the time of writing, versus a yield of just over 10% in South Africa. This makes South African bonds an attractive investment but greatly elevates the cost of equity which is detrimental to a South African company’s valuation.

The other levers for the CAPM formula are the market risk premium and “beta”. The latter measures how a company reacts to systematic market risk and is generally lower in developed markets vs emerging markets. Put simply, this means companies in developed markets are less exposed to downturns in the market. The measure is highly dependent on industry and would not be considered a main component of the differences in valuations between European and South African companies. Market risk premiums, however, can increase the discount rate considerably. A South African equity risk premium is circa 7%, versus circa 4% in the Netherlands, based on research done by Prof. Damodaran of NYU Stern. Interestingly, the combined difference in risk-free rate and market risk premium results in a South African company achieving a valuation that is again 30% lower than the Netherlands comparable (again, assuming all else equal).

There are, of course, many other factors to consider when performing a valuation; however, based on these 3 simple metrics alone, it is clear to see why South African business owners look outside of the country to unlock greater value for their companies.

References

CAIA Association. (2021). African Private Equity Returns, Risk and Potential in a Global Context – Part I | Portfolio for the Future . [online] Available at: https://caia.org/blog/2021/11/23/african-private-equity-returns-risk-and-potential-global-context-part-i   [Accessed 19 Aug. 2022].

OECDiLibrary. (n.d.). Financing SMEs and Entrepreneurs: An OECD Scoreboard (The Netherlands) . [online] Available at: https://www.oecd-ilibrary.org/sites/d339ecf2-en/index.html?itemId=/content/component/d339ecf2-en   [Accessed 19 Aug. 2022].

Tradingeconomics.com. (2022). South Africa Government Bond 10Y . [online] Available at: https://tradingeconomics.com/south-africa/government-bond-yield [Accessed 19 Aug. 2022].

Tradingeconomics.com. (2022). Netherlands Government Bond 10Y . [online] Available at: https://tradingeconomics.com/netherlands/government-bond-yield [Accessed 19 Aug. 2022].

Damodaran, A. (2021). Country Default Spreads and Risk Premiums . [online] Nyu.edu. Available at: https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html . [Accessed 19 Aug. 2022].

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When the ground starts to shake around Cape Canaveral, it is a matter of seconds before a rocket is launched and begins its journey into space. But leading up to this moment there have been months, if not years, of preparation and planning for every eventuality. Countless inputs are considered and risks mitigated by modelling various potential scenarios. Without these meticulous processes, a mission is destined for failure.

Like launching a rocket into space, a business needs a thought-out and refined plan to have any hope of lifting off. A key step in assessing the viability of a business plan is forecasting what could be achieved, taking into account as many factors as possible. Such factors include expected sales, customer types, product and service pricing, human resources, capital expenditure, and financing requirements.

How do we consider this plethora of factors effectively, you may ask? Enter the Financial Model.  A Financial Model, as the name suggests, seeks to model the potential performance of a business by combining relevant inputs and assumptions into a financial forecast. A Financial Model can be used as a budgeting tool, to stress-test different scenarios, to calculate the financial impact of a new project, to allocate corporate resources, and to determine the value of a company.

The first step in developing an effective Financial Model is to apprehend the environment in which a business operates and to identify inputs that will impact its performance. At Creative CFO, we have prepared Financial Models for companies like Wingu Academy, BancX, and Automata;  all three of which are exciting, high-growth companies, but operate in significantly different business environments.

For Wingu Academy , the inputs we considered include student enrolment numbers, subjects and classes per student, books per student, and the number of classes a teacher can manage. For BancX , we factored in banking certification costs, volumes of accounts and cards, interchange fees, interest rates, and platform fees. For Automata we needed to consider the manufacturing process for robots, including production capacity, supplier terms, shipping policies, customer warranties, and commission structures for their sales team. Because no two businesses are the same, the specific inputs to every Financial Model are unique.

Once the inputs for the Financial Model are determined, the second step is to consider how these inputs may change over time or how they may be influenced by different scenarios. Again, the way this step plays out is dependent on the specific business. For Wingu Academy , the scenarios we considered hinged on the number of enrolled students, for BancX the scenarios were driven by the number and type of customers that were onboarded, and for Automata the scenarios were driven by considering business performance for different levels of demand and stress-testing whether production could keep up with each scenario.

We develop a “low road”, or worst-case, scenario based on the premise that things don’t quite go according to plan (e.g. low student intake, low volume of accounts, or inefficient manufacturing processes). This gives the business owner an indication of the risk involved in embarking on the business journey. On the other end of the scale, we build out a “high road” scenario that portrays to business owners and investors the results that the company has the potential to achieve. Somewhere between these two extremes is the “middle road” scenario where we use more conservative estimates and assumptions for each of the required inputs. An effective Financial Model allows the user to toggle between every scenario with the click of a button.

Finally, we need to arrange the inputs into a format that allows business owners and investors to easily observe and evaluate the financial performance of a company over time. The format is known as the 3-Statement Model. It is a combination of an Income Statement, Balance Sheet, and Statement of Cash Flows. These three statements are presented on one page, allowing the user of the model to observe how income and expenses generate assets and liabilities and translate into cash for the business. The final line of the 3-Statement Model is typically Free Cash Flow to Equity (“FCFE”) – this figure is the cash that can be distributed to the shareholders of the company as dividends after all expenses, reinvestments, and debt repayments are taken care of. FCFE can also be altered into Free Cash Flow to the Firm (“FCFF”) by adjusting for debt. FCFF represents the cash flows available to both shareholders and lenders. Both of these figures are vital metrics that investors use to arrive at a Business Valuation.

A Financial Model is an essential step in making sure your business doesn’t get stuck on the launch pad. Get in touch with our investment team to ensure your business is ready for lift-off.

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In the world today, a cautious sense of relief is beginning to take hold as vaccines are increasingly being rolled out and the scourge of Covid-19 starts to take a back seat in the international news media. The world we are starting to imagine for the future can justifiably be dubbed, ‘post-Covid’.

As anyone in the professional world will be able to attest, the pandemic has fundamentally changed the environment in which we do business. This, in turn, has altered our investment decisions and the necessary checks and audits that need to be performed.

What is Financial Due Diligence

Due diligence is something that companies normally perform in order to avoid committing an offense and to ensure that they are operating within the boundaries of the law.

Similarly, financial due diligence (FDD) is the term used to describe an inquiry or investigation into a potential investment to confirm the facts that could significantly influence investment decision-making. The purpose of this could be for a merger or acquisition, issuing new shares, or any other transaction where risk is relevant and necessary to make a decision using reasonable care.

An FDD is commonly misunderstood as an audit. The key difference between them is that an audit looks back, while an FDD looks both backwards and forwards, to uncover vulnerabilities and opportunities, and to reveal a realistic future for the company.

The primary purpose of an FDD is an assessment of the financial health of a business.

What do we mean by “Financial Health”?

Financial health can be summarised in four main internal areas of a business:

  • Liquidity is the cash on hand that can be used by the business today.
  • Solvency compares the assets of a business to its liabilities to measure whether a company can meet its long-term financial obligations.
  • Profitability measures profit against revenue and costs, to give a broad overview of a business’s current financial position and viability. The gross profit, net profit and EBITDA margins are good indicators for understanding and strengthening profitability.
  • Operating efficiency measures operating costs against sales to show how profitably a business is serving its customers.

These four aspects taken together make up the overall health of the business, and they can be used as a measure of present performance and future success.

Why perform an FDD?

FDD’s are very useful, especially where investment transactions are concerned. For starters, investment transactions that undergo a due diligence process offer higher chances of success.

Due diligence contributes to making informed decisions by enhancing the quality of information available and identifying all material risks. Such risks will need to be managed should the acquirer proceed with the transaction.

The risks may also be used as negotiating power for the acquirer in determining the value at which the transaction takes place. Alternatively, if the risk is outside of the acquirer’s appetite, the process might result in an unsuccessful transaction.

A systematic process helps to ensure that buyers and sellers are on the same page. This helps to prevent any entity from unnecessary harm to either party throughout a transaction.

FDD’s Post-Covid shift

With market stability returning in what we are tentatively calling the ‘post-Covid era’, FDD’s focus has changed and there are new factors to consider in a business environment that is fundamentally different.

An FDD looks both backwards and forwards, and it is therefore useful for envisioning a realistic future for a particular company. FDDs will now need to assess how businesses responded to the pandemic and how they may have carried on differently. Investors may specifically consider new post-pandemic liabilities. Identifying a company’s ‘new normal’ – in other words, the way that it does business now and in the future – may be necessary.

Furthermore, we expect there to be a focus on areas such as supply chain risk, health and safety, financing arrangements and cybersecurity, given the accelerated digitisation in many sectors of the economy. A business’s digital capabilities will be of utmost importance.

Also, going forward, force majeure clauses in fundamental legal agreements will be relevant especially with the possibility of future waves of the pandemic.

In the current environment, we are seeing an increase in ‘quasi-distressed’ deals coming to the market which is where companies are needing to dispose of assets to support their core business post-pandemic.

While Covid-19 hasn’t changed the overall purpose of an FDD, it is important to assess the impact that the virus has had on the FDD process. It would be difficult to find even one company that has not been affected by the pandemic in some way, so it is only natural that financial and professional advice is needed now, more than ever.

If you think you might need professional assistance in assessing the risks of a potential investment transaction, contact Creative CFO for FDD support.

References

Arnoldi, M. (n.d.).   Pandemic has influenced due diligence priorities for M&A activity, says law firm. [online] www.engineeringnews.co.za. Available at: https://www.engineeringnews.co.za/article/pandemic-has-influenced-due-diligence-priorities-for-ma-activity-says-law-firm-2020-09-14/rep_id:4136

International, B. (n.d.).   Post-COVID Due Diligence. [online] blog.benchmarkcorporate.com. Available at: https://blog.benchmarkcorporate.com/post-covid-due-diligence

https://www.nortonrosefulbright.com/en-za/knowledge/publications/2021/q1. (n.d.).   Due diligence in the time of COVID. [online] Available at: https://www.nortonrosefulbright.com/en za/knowledge/publications/ce966575/due-diligence-in-the-time-of-covid

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In an office-based work environment, smart shoes are essential. However, as the recent pandemic has shifted meetings from board rooms to video calls the need for formal attire has become limited to clothing seen from the waist up. This, in turn, has caused the demand for comfortable shoes to climb through the roof, while the need for formal footwear, like stiletto heels, has dropped sharply – pun intended.

The German footwear brand, Birkenstock, was ready for this transition with their famously comfortable sandal. Birkenstocks are adored for their arch support and hipster appeal – hardly the purview of high-finance – but at least two private equity firms expressed an interest in buying the sandal manufacturer, which was valued at between € 4–4.5 billion*. L Catterton, the company behind fashion giant Louis Vuitton, finally won the bid, purchasing Birkenstock in February 2021**.

The purpose of a Business Valuation

While most can only dream of selling their business for that amount of money, it is important to know how one goes about valuing a business, no matter what the size. A valuation may be required for periodic reporting (i.e. feedback to investors), investment analysis, capital budgeting, raising capital, selling shares in the company, or selling the entire business, as is the case with Birkenstock.

Birkenstock is a well-established company (over 200 years old) and the valuation techniques used for this golden oldie are very different from what would have been used if the company was still in its infancy. Aligned with our vision at Creative CFO to create a world where more SMEs succeed, we will focus on explaining the valuation techniques that would be helpful for the “next Birkenstock”.

How do we value a business?

There are various methods of valuation that are acceptable in terms of the International Private Equity and Venture Capital Valuation (IPEV), and using two or more is considered best practice for valuing a company. This allows for the business to be seen from different perspectives, resulting in a more comprehensive and reliable view.

The methods we often use to value companies in the start-up and growth phase include two Discounted Cash Flow (DCF) methods, the Venture Capital (VC) method, and two qualitative methods:  the Scorecard Method and the Checklist Method. The DCF methods, which we will be describing in this article, represent the most well-known approach to company valuation. These methods are recommended by academics and are also used as a daily tool for investment analysts.

The DCF methods: The go-to guys

The two DCF methods are “DCF with LTG” (Long Term Growth) and “DCF with multiple”. Using these methods we attempt to derive the value of the company today based on projections of how much cash a business will generate in the future. From a technical perspective, we derive the present value of the projected cash flows that the company is forecasted to generate each year in the future by discounting these cash flows by a market risk rate. In essence, this takes into account the time value of money and reduces the cash flow each year – acknowledging that R100 in a few years’ time isn’t worth as much as R100 today.

In South Africa more than 70% of SMEs fail within their first 5 years. This means that it is extremely important to weight projected cash flows by the probability of an SME’s survival. In determining an appropriate risk rate, we consider risks related to the specific industry that the company operates in, the company’s size, stage of development, and the company’s perceived profitability.

Long Term Growth or a Multiple?

Once we have modelled the cash flow over a specific period by constructing a financial forecast , we need to assign a Terminal Value (TV) to the business. The TV represents potential future cash flow, beyond the projections we determined through the financial forecast.

To calculate the TV we use one of two DCF methods: DCF with LTG or DCF with multiple. DCF with LTG assumes cash flows will grow at a constant rate beyond our forecast, while DCF with multiple assumes the TV is the exit value (the price the investor receives upon sale) of the company which is computed by incorporating an industry-based multiple of EBITDA. The multiple is derived by taking into account the EBITDA average of recently acquired companies compared to their value (e.g. if Company X was sold for R10 million but has a TV of R800,000, the applied multiple would be 12.5).

Once we have calculated the projected cash flows and the TV of a specific business we apply an illiquidity discount to complete the valuation. Illiquidity (the opposite of liquidity) refers to how difficult it is to convert an asset into cash. The illiquidity discount is therefore built in to acknowledge that selling an SME (liquidating) is not as easy as selling a large, well-established company like Birkenstock.

The illiquidity discount essentially means that a big, Birkenstock-type company will be more expensive than a small anonymous one. Therefore there will be a more substantial discount for the buyer of the small company because it would be harder to exit (sell).

Using more than one method

Aligned with best practice, we use the other three methods mentioned above to derive a weighted average of the valuations. This leads us to our final valuation – how much we think the company is worth. The weights of each method are applied according to the stage of the business (i.e. idea stage, development stage, start-up stage, and growth stage). The DCF methods make up the majority of the weight once the company is in the start-up stage and beyond.

A Business Valuation requires consideration of a plethora of different factors and can be tricky to get right, especially for a company in the early stages of operations. Knowing the value of a concept or a business model is vital to upscaling into a world-class company.

At Creative CFO we love to see the SMEs of this world become the Birkenstocks. Get in touch and let us help you out with the first step.

References

*Birkenstock sold to LVMH-backed group in €4bn deal. The Financial Times. 26 Feb 2021. https://www.ft.com/content/5d511022-46db-403e-9784-eb3807f918f9

**Bain, Marc. The company behind Louis Vuitton is now backing Birkenstock. Quartz. 26 Feb 2021. https://qz.com/1977953/birkenstock-has-been-bought-by-a-lvmh-backed-private-equity-fund/

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Let’s say your business finds itself in a position where an investor has shown an interest in injecting cash into your company. Whether this investment comes in the form of equity or as a loan to be repaid, the investor will usually want to see specific information about your business.

At this point, the investor will start using technical terms and sometimes they might seem to be speaking a different language. Essentially, the investor wants to assess your business’s financial risk profile . This is a combination of business and financial data about your company that helps the investor decide whether or not to invest. In this article, which is part 1 of this series, we are going to help you understand the process of determining your company’s risk profile.

The seven key indicators of financial risk

There are seven key indicators of financial risk that provide insight into management’s ability to lead the business through economic, market, and competitive challenges. They are not the only relevant indicators of risk, but they are what the analyst uses to launch an assessment.

These seven core cash drivers are:

  1. Sales growth,
  2. Gross margin,
  3. Operating expenditure percentage,
  4. Accounts receivable days,
  5. Inventory days,
  6. Accounts payable days, and
  7. Net capital spending.

A complete financial risk assessment consists of a thorough analysis of financial statement data and notes, financial ratios, cash flow and projections. This is key in determining the overall credit risk profile of a business and is more than just whether you can borrow or how much you can borrow. It is a temperature check of the overall health of your business, although the numbers are just one tool in the analytical process.

🔸 What can sales growth tell you?

Sales growth is a measurement of the rate of change in sales from one comparable accounting period to the next. Understandably, it is one of the most important drivers of profit in risk and cash flow assessments. It impacts many income statement and balance sheet accounts. Well-managed sales that are less volatile allow management to chase growth using the cash generated by the company rather than using borrowed (and therefore more expensive) money. This lower debt decreases your financial risk and supports more sustainable growth.

Rapid sales growth, for instance, tells the analyst that a higher level of operating assets and cash will be needed to support this growth, and the question is then whether the company is fully prepared to scale up its operations and sustain this growth trajectory. A large increase in sales is likely to increase trade debtors and inventory, which puts a strain on cash, perhaps even creating the need to initiate or increase debt. The interest now due will offset the increase in revenue. Management should have a clear strategy and detailed cash flow forecasts to proactively monitor and control this growth phase.

The reason for the sales growth is also a key factor to be considered, whether it be, for example, reduced prices to improve sales, a competitor leaving the industry, or a new product or technology that boosts sales. Alternatively, increased competition, the resignation of a key sales representative or a recession could adversely affect sales. The impact on cash and profitability needs to be accurately recorded, and the duration of the deviance is also a factor that impacts the overall financial risk profile.

🔸  Why the emphasis on gross margin?

With the exception of the services industry, production costs are typically the largest costs of doing business, and the gross margin is therefore a major influence on the profitability of a business, and the first indicator of a business’s ability to be profitable. Gross margins vary greatly for different industries and business types. The analytical value derived from this driver includes a comparison to industry benchmarks. The margin is affected by management decisions, industry influences, and global economic conditions. In general, the higher the margin, the lower the financial risk and the stronger the cash flows of the company.

There are a number of potential scenarios that may influence the gross margin of a company. For instance, a material supply shortage in an industry could drive up production costs and lead to lower profits, or the global economy could be beset by inflation or a recession, although the former could be offset by a price increase. Automation of the production process would impact the costs that affect the gross margin. Similarly, a decision by management to cut selling prices could also influence the margin. Overtime incurred to meet an increased demand would have a positive effect on the margin if the increased production is scaled to exceed the increased production costs. These are all examples of scenarios that influence the gross margin which could be used by analysts to determine the financial health of a company and its prospects with respect to profitability and cash flow.

🔸  How important are operating expenses (“opex”) as a percentage of net sales?

Opex as a percentage of net sales gives us a ratio that represents the portion of gross margin consumed by expenses related to selling, general and administrative costs. The ratio is a keen measure of management’s ability to manage expenses consistently throughout various phases of the business cycle. Absolute levels and trends in this ratio are highly informative about the operating efficiency of a business, with an inverse relationship. The lower the costs, the higher the suggested operating efficiency. As with most indicators, the level of opex varies greatly from one industry and business type to another. The most useful comparison is that of a company’s opex to the industry benchmarks. The lower and better controlled a company’s opex is, the better its financial risk profile.

In the scenario of a recession, which would imply a drop in sales, some variable operating costs would decline because they are directly linked to the sales volumes, but fixed costs would be fairly rigid. If the company has a lean opex structure, it will be more resilient to the recessionary effect, and the opex percentage would remain fairly stable. Management would thus be maintaining a stable financial risk profile.

The historic trend of the opex ratio would also be an indication of the stability of the business and of its ability to withstand external pressures, such as competitive forces (higher rental at better premises) or industry changes (such as wages). A consistent ratio that is fairly low if benchmarked to industry norms will be reflective of consistent management policies and strong controls governing expenses.

🔸  What do accounts receivable days, inventory days, and accounts payable days indicate?

Accounts receivable days, inventory days and accounts payable days are activity ratios that help the analyst to gauge the financial risk profile of a company. This is because all three components impact heavily on the cash flow position. As for all other indicators, these measures vary from industry to industry and benchmarks are the most useful comparison to determine the health of the ratios. Factors such as seasonality and the location of the debtor, creditor or business (terms) and source of inventory will play a role in determining the risk profile too. A comparison of historical measures and trends will indicate the stability of the cycle for debtors, creditors and inventory.

Accounts receivable days refers to the average time it takes to collect cash from customers for the sale of products or services. This is an indicator of the efficiency of the collections process and management of the debtors. A more efficient process will result in fewer accounts receivable days. The better the receivables are collected, the better the cash flows and the stronger the financial risk profile of the business. It is important to know what influences the time taken to collect the debt, as this understanding will support the perception of the reliability of cash flows. If a customer has longer terms either to boost their support or to accommodate specific trading circumstances, cash flow may need to be substituted to compensate for this, thus weakening the financial risk profile.

Accounts payable days refers to the average time it takes a business to repay its suppliers, and it is similar to accounts receivable days but in a converse relationship. Taking longer to pay a supplier may slow the outflow of cash but it can penalise the business if a discount is available or the company’s credit rating and/or reputation is adversely affected. The effect of discounts available for payments made should be compared to the equivalent cost of borrowed funding that may be required to pay creditors early. The financial risk profile is determined on the back of a thorough understanding of the components of the ratio.

Inventory days refers to the average time it takes a business to sell its stock. The more efficiently inventory is controlled, the lower the inventory days will be and the stronger the financial risk profile of the company. Peer comparisons are a good benchmark of the effectiveness of the inventory policies and procedures. The faster inventory is turned into sales, the better the cash flow into the company. Trends in this ratio are important as they could indicate slow-moving or obsolete stock, fast-moving stock that is in high demand, and various other scenarios that would require proactive management. Detailed inventory information will assist management in making sure that inventory is relevant and sought after, and that excess cash is not absorbed by the inventory cycle.

🔸  What is the relevance of capital expenditure (“capex”) or net capital spending?

Capital expenditure (“capex”) is often grouped with gearing, liquidity and debt service coverage measures to provide insight into financial risk evaluated by an investor or lender.

Although capex falls outside of the trading framework of a company, it has a direct impact on the cash resources of a company and the impact on the operational ability of the company should also be considered. Net capital spending is the difference between the amount of cash spent on fixed assets and the amount of cash received from the sale of any assets in any one year. An investment in a capital asset is usually funded partly by internal cash resources and partly by external funding, particularly in relation to expansionary capex. This investment in an asset is expected to lead to an increase in the generation of revenue and future cash flows. The lag between the actual expenditure and the ability of the asset to generate revenue should be taken into account when determining the cost of borrowing money and the ability to repay that money.

A lack of spending on capital items is also a focus area for an analyst in a business where revenue is derived from the sweating of fixed assets. For example, a manufacturing firm that has assets that constantly need repairs and that have been written down to a nil net book value in an industry that is exposed to technological advancements will indicate a high risk. In conjunction with this perception, future expected capex must be planned for as it is critical both in terms of cash flow projections and operational efficiencies.

🔸  Are these the only relevant contributors to a financial risk assessment of my business?

These seven factors form the initial phase of a financial risk assessment. They are not the only relevant contributors but they are what the analyst uses as a springboard to launch an assessment. Once you understand these seven basic factors the elements that follow on from this will make sense. After the initial assessment, your business’s risk profile will then be layered with a further analysis of more complex financial elements to determine a holistic picture of the financial, business and blended risk profile of your company.

Reference: Moody’s Analytics

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So you’ve been thinking about growing your business and you’re full of ideas. But then you start to think about financing that growth and the glow of enthusiasm dulls as the questions form in your mind. How much financing do you need? How do you get it? From where?

Financing always seems to come with mountains of paperwork, which doesn’t appeal to many business owners. But there is an easier way, which involves getting Creative CFO to help. We have the team, skills and affordable products to help your business grow, with a straightforward approach that will not overburden you or your company.

A business poised for growth or a strategic shift is faced with the following questions:

  • What to finance?
  • Where to look for funding?
  • What is the company’s optimal debt capacity?

Creative CFO can help you answer these questions.

Adding debt to the balance sheet

Even if a company has cash resources, these are usually needed for the day-to-day running of the business and working capital needs. If cash resources are used to fund a project or to pay for an asset this will place a huge strain on operating cash requirements.

An alternative to depleting your available cash resources is applying for a loan which will introduce new debt to your balance sheet. Adding debt to the balance sheet may be scary, but if it is responsibly taken on, it will not overburden the company. Rather, it will support growth and create a new generation of cash flow. For a completely new project or a new source of revenue, debt funding combined with an equity injection could be the best way to source cash.

What is the invested cash used for?

Not all the cash invested or lent to the business is necessarily used to pay for new assets. It could be to support the initial increase in operating costs, such as new staff members, or to pay rental for increased office space. These are just a few of the daunting decisions that a business owner needs to make. That’s why Creative CFO offers a range of expertise and investment products developed to take a business to the next level. We have the experience and knowledge necessary to shoulder some of the burden as we offer solutions that are tailored to your company’s needs.

Applying for funding

A survey conducted in 2018/19 revealed that access to finance is the biggest barrier to success for an SME. This is because SME’s face several challenges when they apply for new funding. Banks and financial institutions remain cautious of lending to SMEs, largely due to the perception that the risk of recovering the loan will be too high. Historically, the lender has much more negotiating power than the SME. Creative CFO believes in helping SMEs succeed, which is why we strive to make the credit market more accessible and return some of that power to the SME.

We want to partner with our clients to build sustainable businesses with a stable balance sheet, and to maximise the SME’s ability to exploit growth opportunities without exorbitant costs or an onerous borrowing structure. We know that each SME is different and has the potential to tap into unique possibilities. Together we will explore the options available to develop a bespoke balance sheet structure that will maximise your potential and help to build a successful and sustainable business.

Creative CFO’s approach

Creative CFO has a flexible approach to assessing a business and its associated risk profile. Our assessment is not based on the conservative principles applied by first-tier lenders which are better suited to large corporations. We will assess your risk profile on a stand-alone basis, with no preconceptions, coupled with an understanding of the business’s financial and operational structure and performance, the industry that it operates in and the competitive advantages that make it unique.

The Independent Business Review

An example of a product offering that could support effective strategic growth is the Independent Business Review. A business review is an objective assessment of the commercial and financial position of a company to determine its future viability. The review is made available for both internal and external stakeholders. The review includes a stress test of management’s business strategy and plans for real challenges and opportunities. It also evaluates the risk of meeting performance forecasts, and identifies potential upsides that could be exploited.

In performing this review, we focus on market prospects; customer and product profitability; working capital; funding structures; and management processes. After an initial assessment, we would meet with you or the necessary representative team to discuss what you would like to achieve and what your concerns are. Then we do a deep-dive into the business and prepare a succinct report.

How does the business review help?

The report can assist management in addressing the areas of the business that are identified to refine current processes and policies, and introduce cost savings, optimise operating efficiencies and generally streamline and refine the business model to strengthen net cash inflows and the operating performance.

A business review can expose those areas of the business that will benefit from a cash investment, and explicitly indicate how the cash can be applied to introduce new or increased cash flows. One example of this would be to highlight the need for a vacant role to be filled so that vital financial functions are performed that can strengthen the working capital cycle and increase the cash inflows.

An independent business review will also indicate pressure points such as direct costs that impact margins, whether optimal pricing decisions are in place (including whether customers are price sensitive), and what economies of scale would be introduced by certain volumes of product. A trajectory that shows a negative correlation between increased production versus fixed costs will appeal to a funder, and provide reassurance that new cash inflows can support debt repayments. In short, the review will communicate vital data about your business to the lenders.

Applying for funding is a big step for an SME. It can be tricky to convince lenders that your business is the right one to invest in, but this is where a business review and the advice of Creative CFO will stand you in good stead. When you are ready to take the plunge and accelerate the growth of your company, contact your Creative CFO financial manager, or email our Investment Team to find out more.

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Introduction

For many business owners, their business is an accumulation of enormous efforts over a lengthy period of time: a schooling career, tertiary education, mentorship, saying no to many social get-togethers, hard work, mistakes, parting ways with savings, more hard work. The list is endless. Given the sacrifices made in building a business, it is no surprise that deciding to expose it to potential investors, is an emotional rollercoaster.

And while one might assume that seeking investment is predominantly a financial transaction, this isn’t entirely true because a large component of the process has a qualitative dimension to it. It is as much about telling your story, giving the investor confidence in your team,  and positioning your brand right, as it is about proving that your business’s financial performance makes for a sound investment.

In order to have a relatively frictionless experience, all aspects associated with seeking investment for your business need to be identified, unpacked and then packaged in a manner that is the most appropriate for your business. One stone left unturned may make all the difference in whether you achieve the desired outcome or not.

Channels for Investment

The context of the particular case will largely determine what type of investment opportunity is best suited for you and your business. You might be looking for someone to help you grow your business and who is strategically and operationally involved with its day-to-day running. This sort of investor might be best incentivised through an offer of an equity stake in your business. Alternatively, if you would prefer to remain in total control, and can prove that your business is in a strong cash-flow position, debt financing might be the better-suited solution for you.

On the contrary, you may not even have thought about whether or not you are ready to take investment and so you wouldn’t know what investment medium would be appropriate for you.  A good question to ask yourself would be, how you would react if an investor made you an offer that’s too good to pass up.

There is no blanket answer as to what investment channel is the best. One would need to ask the right questions and assess the details of their particular needs in order to determine what channel could work for the business.

With that said, there are four main types of investment that can broadly be defined as follows:

  • Equity – where the investor takes ownership in your business (usually, part ownership, unless you are exiting your business fully).
  • Debt – a debt financier lends you a sum of money for an agreement to pay back the sum with interest at an agreed future date.
  • A combination of both equity and debt – referred to as ‘mezzanine’ financing where the investor has a right to convert his ‘interest’ in the company to equity in the case that the borrower defaults on the loan.
  • Government grants or loans – the government provides funding on the basis that certain criteria are met.

How Best to Prepare

The most important part of raising investment is what comes before the transaction, for this will define the success of the transaction itself. The pre-investment phase also determines what your experience and your team’s experience will be like once the deal has been concluded. This phase includes strategy, planning and ensuring that your financial information is reliable (that you can provide a clean set of financials to the investor).

The post-transaction phase is also important to consider: are you being managed by the new investor and told how to run ‘your’ business? Or,  did you intend on stepping away from the business, but the transaction has created more stress and pressure than you’ve experienced before?

A successful transaction is in the eye of the beholder, but there are a few key items that should be kept at the forefront when seeking investment:

  • All factors considered, are you getting the maximum value for your business?
  • Are the terms of the transaction fair?
  • Is there alignment between your business and the investor from a values and vision point of view?

Smooth Sailing?

It’s always advisable to manage expectations, and in the context of looking for investment, it is only fair to know that it is a ‘testing’ process. This is largely because the business owner does not hold the power, the buyer or lender does. This is not the nature of the relationship in every instance, but certainly in most.

With the investor guiding the process, one may find that it is executed at their pace, which is often slower than the business owner’s preferred timelines. It is also possible that you could be ‘lead on’ by the investor – you may be lead to believe that there is a strong likelihood of a particular transaction being successful, only to find out shortly before finalising the deal, that the investor has changed their mind and that your business is not quite a part of ‘their risk appetite.’

Having recently walked the road with a client in applying for traditional debt financing at various banks the timeline from the date of application to receiving the terms of the deal were in the region of six to eight weeks. During this time period, there are ongoing communications between the funder and the business owner or the financial professional facilitating the transaction. Communications will take the form of requests, for:

  • Supporting documentation
  • Details pertaining to your financial statements
  • Forecasted performance expectations or
  • Information that you have already disclosed but that the funder has overlooked due to the ineffective internal processes within the investing organisation (traditional banks).

The Right Tools for the Job

The end goal is to try and identify the ‘right partner,’ who is prepared to make the ‘right offer.’ Part of this process is conducting what has been termed a ‘reverse due-diligence.’ This involves completing an assessment of your potential partner and allows you to maintain a degree of control along the way.

Before considering the suitability of the investor you need to take a step back and first clearly define what you are looking for and identify the items that you are not prepared to compromise on. The importance of knowing what you are looking for cannot be over-emphasized. In times of pressure and emotional turmoil, you will need a reference point against which to measure whether the offer on the table is the right one or not.

Once your strategy has been formulated, an overview of your business and its financial performance are packaged into one document, referred to as an Information Memorandum. This will be the investor’s first touch-point with the business (unless the investor has an existing relationship with your business), and hence it is of great importance that this is compiled in such a manner that justly describes all components of your business. A high-quality Information Memorandum attempts to premeditate areas of question for the reader and answer these questions in advance.

The Information Memorandum is a foot in the door, after which the real fun starts – the investor performing a due-diligence on your business. It is expected that during this phase you will question whether you are comfortable sending across such highly confidential information, such as customer and supplier relationship details, historic bank records, personal income statements and balance sheets of the shareholders. This is standard practice and a part of any professional due-diligence process. An ‘open-cards’ policy that promotes complete transparency is the best approach. Where the investor ‘discovers’ a part of your business that you were trying to hide, this will damage the value of your business and the level of credibility of the information that has been put forward.

There will always be questions in response to the information that you present to the investor, and as long as you can explain yourself, the investor is generally understanding and accepts that running a business is not an exact science.

Conclusion

As a business owner, you can be confident in the fact that no one knows your business as well as you do. You know where your business currently stands, and you know where you would like your business to be in the future. How you will get there, in the context of an investment narrative, is critical. It is a challenge for SMEs to successfully obtain funding in today’s economic environment and even where business owners do manage to raise funding successfully, it is still tricky to secure the right terms and ensure that you are not taken for a ride in the process. Thus, having the right professionals on your team to support you through the process, will add tremendous value.

Perhaps this paints a rather intimidating picture of the investment journey, however, just like most things in life, the fact that it is not an easy process, makes it so much more satisfying when it is a success.

If you have any questions or require support in determining how best to raise funding, please schedule a call.

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