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Elevating Board Decision-Making

The trajectory of every listed company rests heavily on the quality of the decisions made by its directors. It is therefore incumbent on them in the fulfillment of their fiduciary duty to improve their decision-making, no matter how good it currently is.  As Chair, you would understand the weight of this responsibility more than most.

Continual improvement is crucial

While many board members are seasoned, successful professionals, experience alone is not sufficient to guarantee superior decision-making, nor are good intentions. Top-performing companies are led by boards who understand that continual improvement in decision-making is a necessity. They continually refine their thinking, challenge assumptions, and broaden their decision-making toolkit. Top performers in every discipline share this mindset. They recognise that without improvement they won’t get to the top and without continual improvement they will fall behind – and that is because their competitors are improving.

Small improvements to big results

Elite performers whether in sport or business recognise that that even the best can improve, and that small improvements can be exponential. A small competitive advantage can, for example, be sufficient to win a multi-million, even a multi-billion, dollar tender. 

Good is not good enough

Elite performers share another common mindset: they are never satisfied with simply being good. They strive to be the best and understand that to get to the top and remain at the top requires constant refinement of their skills, mindset, and methods.

Overcoming complacency

The danger for many good companies is complacency. They accept “good” as being sufficient. With that attitude they will not become top-performers, and top-performers who don’t continually strive for improvement will soon be knocked off their pedestals. History is replete with companies that were once “good,” even great, but later faltered—not because they were incapable, but because they stopped striving for better. In the business arena, as well as in others, those that stagnate are left behind – because their competitors will be striving to improve and get to the top. Complacency is a significant threat to long-term success and so needs to be identified and rooted out.

Common Thinking, Common Outcomes

Another challenge is to overcome homogeneity of thought. Boards are often comprised of similar people to those of their competitors and draw from similar pools of experience.  They also often solicit advice from the same kinds of advisory people, value the same types of opinions, and frame problems in the same way as their competitors. The likely result of which are similar decisions, leading to similar outcomes. This is counterproductive to outperformance. One can lead a pack, be in the pack or follow the pack. As Chair, that decision is yours to make. It goes without saying that a company won’t outperform by being in the pack doing what everyone else is doing, or by following the pack doing what others did.  To outperform, a board must lead the pack and that requires it to take a different approach to those in the pack. This includes soliciting improvement suggestions from different quarters, from parties that may not be front of mind for the boards of competitor companies.  

Different perspectives

In their quest to make wise decisions in the best interests of shareholders and other stakeholders, the boards of outperforming companies seek different perspectives – including those often overlooked. For instance, when engineers are presented with a problem, they typically approach and solve it from an engineering perspective. Financial analysts, on the other hand, are likely to interpret it through the lens of linear models. Meanwhile, a group of artists might view the problem in an entirely different light, leading them to propose a radically different kind of solution.  Having the benefit of different perspectives far better equips a board to make wise decisions.

Human behaviour

Many business problems are rooted in human behaviour, which – according to behavioural scientists – is predictably irrational. Human behaviour is neither machine-like nor governed by the linear relationships typically reflected in financial models and sensitivity analysis. Recognising this fundamental truth allows boards to better understand how people are likely to respond to a situation. That insight significantly enhances the board’s ability to make sound, well-informed decisions.

A Program Tailored for Excellence

R&M is offering a program covering a wide range of relevant topics to help boards by equipping them with tools and insights to approach challenges from multiple perspectives—including those often overlooked.

Respecting Experience, Enhancing Capability

The program is not a remedial one, nor does it suggest that boards are failing, and nor does it question the intelligence or wisdom of board members.  Rather, it’s about recognising that even the best can improve, that small improvements can be exponential, and that the best decision may necessitate a change in perspective.  It also offers insights that many board members would not typically encounter during their usual careers.

Who will benefit from it

This program is for boards who believe that being “good” isn’t enough, and who are committed to transitioning their companies to ‘great’ and staying there. If that reflects you, as the Chair, consider enrolling your fellow board members.  Those taking seriously their role on the board should welcome the opportunity to sharpen their thinking and broaden their approach – with a view to continually improving their decision-making and becoming even more effective in fulfilling their fiduciary duty.

Good Value-for-Money

The cost of the program is likely to be only a fraction of what a top-tier professional services firm would charge for a similar scope of work, and only a fraction of the potential benefit. In a competitive marketplace where every edge matters and even minor advantages can have a profound effect on profitability and returns on capital, this may be one of the most valuable investments your board can make.

A Final Thought

Chairing a board comes with immense responsibility, so ensuring your directors have access to the best tools, thinking, and perspectives isn’t just prudent; it’s essential. If you agree with that and believe your board can make better decisions, this program could be ‘manna from heaven’ for you.

Discovering more / Schedule an exploratory discussion

Further information on the program is set out on ‘The Program’ page [insert link], as is a list of the modules covered [insert link].  To explore how it can help, please email enquiries@rogersmorris.com.au in that regard.

Have you appointed your company’s external lawyer or accountant to your board of directors or advisory board? Are your board members all current or former senior (in age and position) executives of large corporations? Are all your board members graduates of top-tier universities? Are they all strong in numeracy, logic, and critical thinking?  Do you have similar numbers of men and women on your board?

If you answered in the affirmative to any of these questions, you’ve probably missed the point of having such a board.

R&M offers a module on advisory boards. It covers a lot more than just who to appoint.  More information on what we do, how and why is set out on the advisory page of our website – https://www.rogersmorris.com.au/program

It is likely that you could benefit enormously by your company improving its hiring practices.

A review of your company’s workforce would probably reveal some outstanding performers (those who would be sorely missed), some mediocre performers (those who you would be ambivalent to keeping or losing) and some sub-standard performers (those who you would prefer to replace). If you aggregated the salaries of the sub-standard employees and multiplied that amount by the cost of retrenching and replacing an average employee, you’ll probably find that the total cost of replacing sub-standard employees is enormous. And that excludes the opportunity cost your business has suffered and will continue to suffer until you don’t replace them.  You would probably also benefit enormously if your business could increase its proportion of high achievers.  At least do a ‘back-of-envelope’ calculation to estimate the business value that would be created per an additional 10% of your workforce falling into the high-achieving category.

The challenge for you and your leadership team is to find a cost-effective way to improve your company’s hiring success. Your company needs to recruit people who it is confident will outperform in the role, will fit in and will adhere to your company’s values.  That is easier said than done.

The traditional recruitment process and assessments have their shortcomings, some of which are:

• HR and recruitment agents are unlikely to have an in-depth knowledge of the role, which knowledge is fundamental to recruiting the right candidate. One for example needs an in-depth knowledge to distinguish between those who ‘talk a big game’ and those who ‘play a big game’.
• Psychometric tests can be manipulated (especially by those who you would want the tests to weed-out) and may unwittingly (through strict adherence to assessment criteria) exclude ideal candidates.
• A candidate’s formal education does not reflect the extent of his / her knowledge of the subject matter, even if the person’s grades were exemplary. That knowledge could be outdated and a candidate with no formal relevant education may, through extensive reading and research, have acquired significantly more knowledge.
• A candidate’s current and past employment, who he / she worked for and for how long, is not a reliable way of determining the extent of the candidate’s ability to do the job. The work experience may suggest that the candidate was a decision-maker, when they were only following instructions.
• The referees provided by candidates are unreliable sources of information on the candidate’s capability, personality and character. Candidates will, for example, not list referees they suspect may provide information unfavourable to the candidate.
• The candidate’s current boss is also an unreliable source of information – because the boss may be keen to replace the candidate with someone more capable or less problematic.

As mentioned earlier, recruiting the best people is easier said than done. How do you for example know how good the candidate is at his / her job, and how do you find out whether the candidate will fit in and will adhere to your company’s values? You could for example get HR or AI to compile lists of questions, but they are unlikely to be reliable. The candidate will probably give the interviewer the answer they think will increase their prospects of being offered the job. And even if the candidate gives a truthful answer, that answer may be different to how the candidate will act in a real situation. What people say they will do, is often very different to what they actually do.

While the exercise of improving recruitment assessments and processes can be onerous, the benefits of ‘getting it right’ invariably significantly outweigh the costs and hassle involved. The back-of-envelope calculation suggested above would probably have confirmed this statement.

R&M’s advisory business helps business owners increase the value of their businesses. This includes helping them make better hiring decisions. If that might be of interest to you, further information on what R&M does, how and why is set out under R&M Advisory. – https://www.rogersmorris.com.au/value-creation-what-to-pay-for-it/

Could it be your best option to sell your business to your employees? Is it reasonably achievable? This piece considers both those questions. It mentions some of the advantages of selling an ownership interest to the company’s employees and provides some insight into how the employees could raise the necessary funds.

Many of those selling mid-sized companies, with 7-figure values, mistakenly assume that their company’s employees (including its management team) would not be able to afford the purchase and so deprive themselves of a sale that may have been in their best interests.

The benefits of selling to employees include the following:

• Lower transaction costs – since there is no need for a business broker, much less need for financial and operational due diligence, and there should be savings on lawyer and accountant fees.
• Far less hassle – since little (if any) financial and operational due diligence will be needed
• The risk for the buyer is lower – because there would be far less risk of staff, customer and/or supplier loss post sale and there would be less risk of the buyer not knowing about a looming problem – and due to that lower risk, the employee buyers (and any who invest alongside them) could justify paying a higher price for the business.
• There is far less risk of the buyer retrenching long-serving staff who have been loyal to you and your business, so there is less risk of your employees coming to the view that you ‘sold them out for your personal enrichment’.
• The business brand that you spent so much time and effort building, is more likely to be retained.
• If arranged correctly, from the time you give your employees the opportunity to start buying in (investing in or buying shares from you), you can reasonably expect them to be more loyal, to be more focussed on reducing unnecessary costs and increasing profits, and to be more motivated to ensure your business thrives. All of which should enhance the financial performance of your business, which should increase the value of your business and increase your net sale price.
• A progressive sale, which is much more achievable where the business is sold to employees, enables you to gradually wind down your involvement in the business, at your preferred pace, from full-time in the business, to working only on the business, then to only attending board meetings and finally to fully exiting the business.
• A progressive sale of your business enables you to gradually reduce your involvement in the business, which significantly reduces the risk of suffering mental health problems from the sudden loss of relevance experienced by many who experienced a sudden (even if planned) exit.
• A progressive sale of your ownership interest to employees gives bankers and prospective co-investors confidence that key personnel won’t leave post sale, that the current owner has a vested interest in ensuring a smooth transition, that customers and suppliers will remain and that there are no undisclosed looming problems. This reduction in risk for co-investors and banks should increase the prospect of the sale going ahead and increase the prospect of you getting a higher sale price.
• A sale to a consortium comprising third party investors and an employee group, could attract a new class of buyers, passive investors willing and able to pay a higher price for any given expected return on investment. These people could invest in a portfolio of top-tier listed companies, probably trading on PE multiples of over 25 times (4% pa return on investment) or could invest in your business for a reasonable expectation of a far higher return on their investment, multiples higher!

If these potential benefits, or some of them, could appeal to you, you may wish to consider whether a sale to your company’s employees would be reasonably achievable. If so, here is an arrangement that could increase prospects of success in that regard.

How to achieve it, a sale to employees

• Start the process early, give your employees (including management) a few years to buy a substantial (20% +) shareholding from you.
• Pay performance bonuses in scrip to an employee share ownership trust (ESOT) then do a share buyback (from you) with those funds – so the performance bonuses are effectively used to buy your shares.

Consider a performance bonus arrangement whereby a material proportion (say 50%) of the additional profits or return on capital over current levels, are paid as performance bonuses.

Employees should generally share equally in this bonus, with some who have gone above and beyond receiving more. Once employees discover that they get 50% (50 cents in every $1) of cost savings, and 50% of net revenue increases, they will be a lot more focussed on eliminating unnecessary costs and increasing returns on capital. 

Similar approaches to remuneration have been adopted by the world’s most successful leaders. Genghis Kahn, for example, used it to build an army that defeated the world’s most advanced civilisations at the time, the Khwarazm Empire, the Chinese Western XIA and Jurchen Jin Empires, and his grandson, Kublai Khan, used it to defeat the mighty Song Empire.  Prior to his ascension to power, the Mongol clans allocated their spoils of war mainly to the nobles and elites, with little (if any) going to the ordinary soldier.  Genghis Khan’s soldiers generally shared equally in the spoils of war, with those who outperformed getting more. It was largely for this reason that more and better skilled people joined his army.  Business, like war, is competitive. So, if you want to win you need more and better people fighting on your side to increase profits and returns on capital.  One of the best ways to achieve this, is to give them a handsome share of the extra profits.

• Either provide a ‘vendor loan’ (interest bearing and subject to a repayment plan) to the ESOP to enable it to buy a further circa 20% of your ownership interest from you or retain that ownership interest until you decide to fully exit the business, after say 5 to 10 years. By retaining such a substantial shareholding, one likely to be more than that of any other individual, you should be able to retain a seat on the board and a substantial ‘say’ in the affairs of your business.
• Together with your management team and other employees, invite others (passive investors and perhaps also suppliers and B2B customers) to purchase a parcel (15-20%) of your shares from you.
• Leverage the business to fund a buyback of your remaining shares (excluding the portion you intend to hold until your final exit from the business).

Banks will be far more included to lend to the business (on a standalone basis, without personal guarantees) where the management team stays on and holds a material shareholding in the business, where many employees have invested in the business (directly or through the ESOP) and where other investors also hold a substantial proportion of the shares.

A numerical example reflecting the arrangement outlined above is set out in ‘Annexure A’ below. In this scenario various parties (employees, management and other) bought shares from the owner, who retained a strategic shareholding, in a business valued on a 4 times EBIT multiple and leveraged to the extent of two times EBIT.  At that multiple, those parties would expect a return on investment of 33% pa. Many would find such a return expectation to be attractive – especially when compared against the expected return from a portfolio of equity investments in top listed companies. Their associated indexes are generally commanding PE ratios of over 25 times, 4% pa.

In conclusion

If your preference is to gradually reduce the size of your ownership interest and gradually reduce the time you spend working in and on your business, then a sale to your employees (including your management team) should be worth considering.

It should also be worth considering where you plan to sell in the foreseeable future to an acquirer who would prefer to retain your staff, customers and suppliers, and be concerned about looming problems it may not be aware of.  Having your management team and other employees co-investing with you, together with your being willing to retain a meaningful shareholding in your business, should give prospective investors and other acquirors comfort that all is well with your business and that the sale will have little (if any) adverse effect on the business. Given this lower risk, it could justify paying you a higher price for your shares.

There are however situations where it may not be in your best interest to sell or issue shares to management, other employees and to third parties. One such as is where the prospective acquirer only sees value in your product or IP. Even in such situations it may be worthwhile having management and other employees as shareholders – because they would be more likely to be more motivated to improve the product at the lowest cost.

I hope you found this piece interesting and useful.

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Annexure A

 

Media mogul Kerry Packer was reported to have said “You only ever get one Alan Bond in your life, and I’ve had mind.” For those unfamiliar with that deal: Alan Bond, a 1980s business tycoon from the wild west (WA), approached Kerry Packer out of the blue with an offer to buy his media business for a price that was more than double what Kerry considered the value of it to be.

If an ‘Alan Bond’ arrived at your offices with a fat chequebook, with a willingness to pay you a handsome price for your business, would you be ready to do a deal? Do you know what your business is worth, and why? Do you also know what it is worth to different classes parties who could be interested in your business, and why so?

If you accepted an offer subject to due diligence, which is very likely to be required, would the prospective buyer be impressed with what it found, drop their price or walk away? Plenty walk away and ever more lower their bid prices.  Don’t forfeit what could be the opportunity of your life.

If you are not ready when you get an approach or when the event is put on you, you’ll either miss out on the opportunity or suffer an opportunity cost. If not ready, the interested party could either walk away or pay a lot less than it could otherwise have paid.

Consider whether your business is ready for an approach. Do you know what such a party would be looking for in your business, and what it would be concerned about? Different classes of buyers look for and are concerned about different things.

If you don’t get the assistance of party with expertise in this area, you may well not know what you don’t know as regards what value various classes of buyers may see in your business and what you need to do to justify their paying a lot more than they may otherwise pay.

Ultimately the question for you would be: Does the potential benefit of engaging an expert justify the cost of doing so?  Another blog on R&M’s website discusses this question – https://www.rogersmorris.com.au/value-creation-what-to-pay-for-it/

R&M’s advisory business helps business owners increase the value of their businesses, and get ready for a merger, exit or investor event. If that might be of interest to you, R&M will be pleased to hear from you. Please email your interest to enquiries@rogersmorris.com.au.

As a business owner you’ve probably decided on a performance bonus arrangement for some of or all your employees. If so, are some recipients over compensated while others are undercompensated for their respective contributions?

If the performance bonus plan was designed or recommended by your leadership team, it is quite likely they get the lion’s share of it.  In some cases that is justifiable, but in most it is not.  If the bonus plan is shared equally amongst all employees, including leadership, some recipients could be over overcompensated for their efforts while others under compensated, but the extent of that difference would be much lower than where leadership gets the bulk of it. It is nevertheless still not ideal. If everyone gets the same performance bonus, it removes the incentive for employees to work harder and smarter than their colleagues. The employees may however recognise that if they all work harder and smarter, the company does not need to hire more people – diluting their share of the bonus pool.

If your performance bonus plan results in your leadership team getting the lion’s share of it, you are essentially broadcasting to all employees that you essentially regard them to be machines – they need to turn up, work their allocated hours, meet job specifications and not cause trouble – and don’t see them as having the capacity to make further contributions.  That is not a recipe for success. Nor is it one where employees expect a performance bonus just for showing up and doing the jobs for which they are appointed, and nor is it appropriate for your business to pay performance bonuses until you and any other shareholders get a market related return. One approach is to consider performance bonuses (whether based on a proportion of profits or paid ad hoc) to be additional remuneration for outperformance.

Top-tier business schools study the traits of the most successful leaders in history. One such individual was Genghis Kahn, who rose from a very humble and desperate childhood, even having to escape slavery as a young man, to build and rule the largest contiguous empire in history. One of his many admirable leadership traits was his adoption of meritocracy. Before his time, when the nomadic Mongol tribes joined others to defeat a common “enemy”, the plundered spoils of victory went mainly to the tribal chiefs. He changed that. Under him the spoils were shared amongst all warriors and the families of warriors killed in battle, with those who performed more admirably in battle getting more of the spoils. This earned him great respect and loyalty amongst his people, and significant numbers of warriors from other tribes joined him – giving him an all-conquering fighting force. (Paul Cooper’s book ‘The Fall of Civilisations: Stories of Greatness and Decline’ / Episode 19 (Part 1) of his Spotify podcast ‘Fall of Civilisations’)

Providing more merit-based remuneration is only part of what is needed to encourage employee outperformance. Another is to facilitate bottom-up communication.

Top-performing business owners recognise that their employees are the ones at the coalface getting the job done and implementing strategies decreed by leadership. They also know that the employees together know a lot more about the specifics and intricacies of their business operations than they do, and a lot more than their leadership teams do. They know more about the customers and more about the suppliers than do leadership and know more about the suitability of the business’ operating processes than do leadership.  As a result, employees are often in a far better position than management to identify problems and opportunities. While leadership invariably focusses on the big issues or big picture, employees have the potential to find many relatively small opportunities, which together can be transformative.

Without bottom-up communication, you and your business could suffer an enormous opportunity cost. Consider, for example, the turnaround of Toyo Kogyo (the manufacturer of Mazda vehicles) in the late ‘70s early ‘80s. Within a couple of years of the Arab oil embargo in the 1970s, it was perilously close to insolvency. It was effectively in administration, with its leading bank having installed 8 of their senior executives. Rather than the top-down communication that had been the case, new management encouraged the employees to tell management how to improve the business. It did not just invite suggestions, it facilitated it by establishing 2,000 or so worker groups of 7 to 8 members, who met 2 or 3 times a month, with the group leaders rotating monthly. In 1979 employees submitted 600,000 suggestions, with about 60% adopted. In 1982, 1.8 million suggestions were submitted, some 65 per employee, with a similar proportion adopted. Let that sink in for a moment.

Image how you and your business could benefit from implementing 40 improvement suggestions per employee per year. Most of those would probably be relatively minor improvements, but together the benefit for you and your business could be enormous.  As per the adage – ‘If you look after your pennies, the pounds will look after themselves’.  So, it is bewildering that so many business owners and leadership teams ignore that potential, they don’t actively seek input from their underlings and are generally dismissive of any suggestions they make.

Another important component of encouraging employee outperformance is convincing them that the benefits from doing so outweigh the risks they could be exposed to. If employees perceive there to be a risk of losing their jobs, being denied a promotion, marked as a ‘troublemaker’ or that leaderships may be dismissive of their suggestions, they are far more likely to ‘keep their heads down’.  Overcoming this perception requires one to eliminate the common ‘them versus us’ mentality between leadership and the workforce, where leadership regard the workforce as their underlings and the workforce don’t trust leadership or their puppets (the HR department). Everyone in the business needs to be regarded as a valuable team member, whose suggestions are welcomed and appreciated.

So, getting your employees and leadership team to be proactive in identifying and recommending improvement opportunities is not just about merit-based remuneration. It may well require a change in management style and a change in the culture of the business.

R&M can help business owners in this regard.  Here is a link to a webpage that describes what R&M offers, why, and how it goes about its business – https://www.rogersmorris.com.au/program.

It goes without saying that a business needs a good relationship with all its counterparties, including its employees, customers, suppliers, contractors, advisors (legal, accounting, auditing, and so on), independent directors, and shareholders.

But this raises some questions, such as who needs to have such relationships with whom, what constitutes such a relationship, who is responsible for cultivating it (the provider or the recipient or both), how is it cultivated, what protocols should be adhered to, and how do you ensure compliance throughout your business? Since covering those topics would be well over the preferred length for such a blog, this piece just comments on ‘what is a good business relationship’.

Some would say it is where you get what you want as regards price, supply (volume and frequency) and quality. Others would disagree, saying the relationship needs to be mutually beneficial. The counter to that is, why does one need to settle for less favourable terms than one can get. It is after all one’s duty to act in the best interests of the shareholders of one’s business, and that requires one to strive for the best deal.

If you are the only supplier of a crucial product, do you increase the price of your product as much as you can, even though it puts the buyer under financial strain? If you are a monopolistic buyer, do you demand lower prices and longer credit terms from your suppliers, notwithstanding that it puts them under financial strain. If they continue supplying the quality and volumes you need, do you push them to the edge and take all the cream for yourself? Suppliers want to increase their prices, whereas buyers want lower prices.

Some would say, it is a free market- if you are not happy with the price you get, either stop producing the product or find another market. If for example you’re a beef producer not happy with the price you’re getting and understand your customer (the meat processor) is earning fat margins, what do you do? Do you stop producing beef, find another market, lobby the government for a fairer deal, or just accept your lot in life?   If the buyer can get what it needs in quality and supply at a lower price, why should they pay you a higher price? Again, if they can get longer credit terms from others, why should they accept your shorter credit terms? Nobody is compelling the beef producers in this example to continuing producing beef or compelling them to sell to the same processor. So, under this approach having a good business relationship is not about getting a fairer deal – that’s governed by market forces.

While that may be the case for maximising returns in the short term, is it also the best approach in the longer-term interests of the business? Many (probably most) of those with more power, exercise it to get a better deal for themselves. They bully weaker parties to accept their terms. That is shortsighted. History is littered with examples of city states and empires rising through conquering and subjugation, later imploding after the subjugated people joined forces with a rising power or new entrant to conquer and sack the empire that had subjugated them. The empires who experienced the greatest longevity tended to be those who had good relationships with neighbours and other allies and treated their people well. When faced with a major threat, empires need loyal support from their people, neighbours and trading partners. If they subjugated those people and otherwise treated them poorly, they will not only not get the support they need when they desperately need it, but they’ll also find those subjugated people joining its enemy.

This also applies in the business world. At the time when the dominant party is most vulnerable, when it most needs the support of others – its employees, customers and suppliers – it will find itself not only facing that threat alone if it has treated others poorly but also finding that they have joined the enemy. When parties feel they are getting screwed over, they will look for alternatives.  For lack of alternatives, they may accept their predicament. But believe you me, when a suitable alternative arises, they’ll relish the opportunity to get their revenge. Nobody forgets being screwed over.

It would be foolish of a big and powerful business to think that its dominant position will continue forever. Major disruptive forces could be brewing without it even knowing.  And when such a party arrives, it should expect those it has screwed over to join the other party and relish putting the metaphorical knife into it. That scenario can be avoided by ensuring that it does not abuse its power.

In the Australian market, as Bunnings grew its geographical footprint most suburban hardware stores closed. It became the dominant hardware retailer by a country mile and faced next to no competition. Then a new entrant arrived, the Masters hardware retailer backed by Woolworths (one of Australia’s two largest retailers) and Lowe’s (a large homewares retailer in the USA). Within only a few years Masters folded and closed. It was unable to convince Bunnings’ customers to jump ship. Had Bunnings exploited their dominant market position, their customers would have left in droves and switched to Masters. Bunnings’ management were sensible enough to recognise the importance of not abusing Bunnings’ dominant market position, so did not face a mass exodus. Its customers (retail and tradesmen) remained loyal to it.

It is not only large businesses with a large chunk of market share that can exploit a counterparty. Take, for example, a smaller business that has developed a better product or better business model, that enables it to generate a handsome return on investment for its owner/s:  If it takes that opportunity to generate handsome returns, it is essentially inviting others to enter its market and compete against it. So, if you can charge a much higher price than you need to, be careful – as doing so could be detrimental in the longer term. Others may see your market as being attractive, as generating above market returns, and so would be inclined to enter your market which a competing product or service. To gain market share they are likely to spend a lot more on marketing and advertising and are likely to offer their product / service at a lower price. In order not to lose customers you will then need to do the same – which is likely to severely erode your profit margins and returns on investment. Your customers won’t forget the much higher prices you were charging before competition arrived, so will be more inclined to go with the competition. Nobody forgets being screwed over!

There is a lot more merit in setting your price at a level where you’re able to make a respectable profit, and prospective competitors conclude there is not enough in it to justify the investment needed to enter the market – to offer a competing product or service and pay for the marketing and advertising needed to get sufficient market share. If your corporate customers get the impression that you are price gauging, they are quite likely to approach and persuade others to enter the market to compete against you. If for example, you’ve been outsourcing a labour-intensive service and discover that due to technological or other changes much of that work can be automated, resulting in the cost of providing that service dropping significantly, if your provider does not reduce its price (preferring to keep the extra profits for themselves), you’re likely to conclude that they’re screwing you. In that case, you’ll be determined to find a better deal and terminate your relationship with that party.

So, if you want a long-term relationship, don’t try to get one over the other party.

Having a good business relationship is about a lot more than price and terms of trade. It is includes meeting needs, avoiding problems and where issues arise, resolving them. If there is a problem, or looming problem, it needs to be identified early, solved and in many cases solved quickly.  Take a commercial printing business for example. If they are in the middle of a print job or have a full schedule of jobs lined up for the day, they know they have deadlines to meet, and know those deadlines are crucial for their customers. A magazine, for example, needs to hit the stands on a certain day. So, if there is a problem with the paper or the machine, that needs to be fixed ASAP. The people at the printing business want to talk to someone with a thorough understanding of the product, and if it’s faulty they need it fixed, or a replacement provided, ASAP.  They don’t want to talk to an ‘order taker’ and certainly don’t want to leave a message on an answering machine or talk to an AI answering service.

It is important to decide on the nature of the business relationships you want to have with employees, customers, suppliers and other counterparties and then ensure that your business (your management and employees) reflects that attitude in its day-to-day dealings. This is easier said than done. It needs to be reflected in the values set for your business, incorporated in decisioning processes, reinforced from time to time and importantly it needs to be reflected in your behaviour and that of your management team. Your people will follow your lead, and your customers and suppliers will notice your attitude through the attitude of your employees.

It is also important for you to be alerted to comments made by the employees of your customers and suppliers, because those comments probably reflect the attitude of their superiors. It is not only what is said, but also how it is said, what tone is used.  Only once you discover it is problematic, can you deal with it. So, you will need to design and implement a process through which such comments are picked up and relayed up the line.  If you don’t, it is a lot more likely that you will be unaware of what your customers and suppliers really think of your business and then be surprised when they switch to another provider.

R&M can assist business owners with this exercise. It can help business owners determine how they want their people to deal with their businesses’ various counterparties, devise strategies to implement it throughout the business, and strategies to encourage staff to be alert for comments made by the staff of counterparties.

Here is a link to R&M’s Advisory webpage, which provides more information on what it offers, why and how it goes about its business – https://www.rogersmorris.com.au/program . An email address is provided for those who would like to explore what R&M can do for them.

Few would argue with the statement that it is vital for a business to have a thorough understanding of its customers’ needs, and few would disagree with the statement that it is important for a sales team to have a good working relationship with its B2B customers. But should you (the business owner) develop a friendship with the ultimate decision-makers of your largest B2B customers?

Those arguing for it would say, if you have such friendship, you would be more likely to resolve problems and hiccups, more likely to hear what your competitors are up to, and more likely to get early news of developments in the market and in that customer’s business. All of which can be crucial to the long-term success of your business.

Others would say that role is one for your sales team and that it is not dependant on friendship but on having a good business relationship. They would also say that a good business relationship is developed by meeting customer requirements on product quality and supply, ensuring there are no problems or hiccups your side, and if any arise, that they are solved early. This is not dependant on having fostered a friendship and is not dependant on the nature and extent of entertainment provided. This is not saying that entertainment is not necessary. It often is. There can be a lot of merit in celebrating the award of a contract that required a lot of time and effort on the part of both parties, and merit in entertaining at the start of a new relationship and from time to time to show appreciation for the business.

Complications arise where you’re on first name terms with your B2B counterparties, have included them in your social circles and generally developed good friendships with them. When faced with a business decision regarding such a customer, what hat do you wear– that of your business or that of a friend? While you would endeavour to come to an amicable arrangement, you need to be clear in whose best interests you’ll be acting.  Are you the person who will go above and beyond to help a friend in need or will you have the attitude of ‘it’s not personal, its business’? The former could severely damage your business, the latter your friendship.

Consider this example: Your friend, whose business is one of your largest customers, tells you he’s in a bit of a pickle because one of his major customers is a bit late in paying, so asks you for more time to pay. In return he says he’ll put in a bigger order – buy more from you. You’ve got to know him well, regard him as trustworthy, know that his business is growing well, and you recognise that it could ruin the friendship and jeopardize the business relationship if you don’t agree. So, you agree to give him more time to pay. True to his word, he places a much larger order, takes delivery and continues growing his business. Your exposure to his business has now more than doubled, putting your business at risk. You would probably be aware that many businesses have gone under for growing much quicker than they are able to fund the growth in its working capital, or because their banker lost confidence in their ability to determine who to advance credit terms to and to ensure adherence to such terms. You would also probably be aware that many businesses have faced financial pressures because of a domino effect down the supply chain. If a bank (or other major creditor) pulls the pin on a large business down the supply chain, that can cause a domino effect up the supply chain. While recognising that by giving your friend’s business more time to pay could have an adverse effect on your business, you probably wouldn’t want him to consider you to be a ruthless businessman and pass that conclusion on to your other friends. As a result, the decision would be a difficult one to make.

Having friendships with your business’ largest B2B customers is also a concern for third parties – such as suppliers and their trade credit insurers, lenders, any new investors and any prospective buyers. One of the questions they consider is: What will happen to your business if you are no longer there – due to a sale or unplanned early loss to the business, whether through illness or death.  They will be worried about your business losing customers and sale revenues after you leave the business or are lost to it. They may also be concerned you may advance credit terms when you would otherwise not have done so. This reduces the value they regard your business to have and may even result in them declining to lend, invest or buy.

Suppliers, trade credit insurers, bankers as well as any prospective investors or buyers of your business will probably ask subtle questions to establish the nature of your relationship with the decision-makers of your business’ major customers.  Don’t think that because the questions aren’t blatant, the matter is not important to them. They also have ownership and employment interests they need to protect.

While it is probably not wise to cultivate a friendship with your businesses largest B2B customers and not wise to be perceived as such by those parties, it is important to foster a good business relationship with the decision-makers. That’s because – if a problem arises that cannot be resolved at a lower level of the two businesses, you can get together with your counterparty to work out a solution.  And you’re more likely to get a better outcome for your business if you understand his or her character, motivation and pressures.

There is merit in the phrase – at home I’m a communist, amongst my friends I’m a socialist, in my business I’m a capitalist with a conscience – and merit in keeping those relationships separate.  This does not suggest that one should not do business with friends. It merely shows that difficulties can arise from such relationships. So, if you decide to supply a friend’s business, it is probably best to ensure it represents only a small proportion of your sales and that it is clear from the outset that it’s a relationship between two businesses and that your friendship sits outside it. While that is easier said than done, it is important to set out at the outset the basis on which you’ll do business.

R&M can assist you to implement processes to protect your business from pressures you may face from parties who may consider you to be friends.  For some insight into what it offers, why and how it goes about its business, see R&M’s Advisory webpage –  https://www.rogersmorris.com.au/program .

This piece discusses three issues that are seldom given sufficient consideration by business owners when contemplating retirement.  One is, what impact will a sale of the business have on their annual income? Another is, what the impact will the sale have on your mental health, and a third is whether to sell the business to one of their children.

In considering the first question (the impact of a sale on their annual income) you need to distinguish investment income (dividends) from income derived from working in the business.

To state the obvious, if you sell your business, you will lose the income you would otherwise have earned from working in the business, such as salary, performance bonuses, company vehicles, and personal expenses paid by the company. You would generally lose all that income on settlement or if the sale is subject to an earnout, lose some of it on settlement and the rest by the time that earn-out period has elapsed.

If you decide not to sell but appoint one or more people to run the business for you, your income from working in the business could gradually reduce, as you transition from working a 5- day week to 4 days, then to 3 and so on until you are no longer working in the business. In such a scenario you would stay on the board and could justifiably have the business pay you a fee for that role. At some point in time, you would relinquish that role as well. This additional income should be considered in deciding whether it is in your best interests to sell.

If you sell the business, you can invest the net sale proceeds. If you decide not to sell, you’ll get dividends from your business. So, it is important to recognise the difference in the expected returns from these alterative options. For this you’ll need to do some math.

Here is an example where I have assumed a $3 million EBIT business sells (on a 4-times EBIT multiple) for $12 million. Any debt needs to be deducted from this figure as do the costs of selling the business (business broker, lawyers, and so on). You’ll notice from the table below that I’ve assumed $1 million in sale costs and in one case $6 million in debt (2 x EBIT) at a 7% pa interest cost and in the other case there is no debt. I have also assumed a 25% income tax rate.

You’ll also notice that I have assumed the expected return that you will earn on your net sale proceeds is 5% per annum. Here’s why I made that assumption:

If you sought the advice of a wealth manager you would probably be advised to invest your net sale proceeds in diversified portfolios of shares in top-listed companies, listed property trusts and bonds. In the current market, the aggregate of the dividend and interest income from such a portfolio is likely be less than 5% per annum of the capital invested, and even less post tax. [The current 10-year Australian Government Bond yield is about 4.45% and the S&P/ASX 200 is trading on a dividend yield of about 3.7 times (as at end Jan. ’25)] So, your potential annual income (dividends and interest) would, in the current market, probably be less than 5% per annum.

The calculation and result are set out in the table below:

Both sale scenarios show a significant loss of annual investment income compared to retaining ownership of your business. Ouch! This is in addition to the loss of salary and other drawings you make from your business.  Double ouch!

The calculation did not include capital appreciation on the investment portfolio or on your business because it applies to both sides. Unless it is likely that it will differ materially between the two, listed shares and units on the one hand and that for your business on the other, it is reasonable to exclude it from both sides. If it is expected to be materially different, the difference should be included in the calculation.

Another major consideration in determining whether to sell your business is the impact retirement may have on your mental health. One generally assumes this would be positive – since you’ll have more time to relax and exercise and generally potter about. The reality for many is quite different. The sudden and dramatic loss of relevance can have an adverse impact on one’s mental health.  As the owner/ operator your staff, customers and suppliers bring problems to you to solve up to the day you retire. Thereafter you are of no need to them – so your phone stops ringing. This loss of relevance can be hard on one’s mental health. And that’s not the end of it. Once you retire, you’ll be spending considerably more time at home, and that change may not sit that comfortably with your wife. She may adore you but suddenly having you home 24/7 could put strain on your relationship.

Given the above, there is a lot of merit in not selling your business and gradually transitioning to full retirement. During this transition you could give staff and others the opportunity to invest in your business and you could gradually sell down your stake to them should you need additional cash or wish to diversify your investment portfolio.

A third consideration arises where one of your children is working in the business and could run it. In this case, do you sell your business to that child? Many do and when they do, they give the child favourable payment terms. Such arrangements cause family problems, as the one taking over the business will be considered by your other children to have received much more. A potentially far more harmonious arrangement would be to retain ownership of your business (or transfer it into a family trust) and pay your child a market related salary package (salary and performance bonus) for working in the business.

Whether you expect one of your children to take over from you as the CEO or one of your senior staff is to be appointed to run the business, it is best to gradually transition the preferred person into your role, where over time you relinquish more and more responsibilities to the appointed person. A transition is also wise where you recruit an experienced executive to take over as the CEO, but that transitioning period could be a lot shorter.

R&M can assist you and your business make this transition – from you working in your business to working on it, and ultimately to being comfortable not working in or on it but still retaining an ownership (directly or through a family trust) in it. Follow this link for more information on what R&M does, why and how – https://www.rogersmorris.com/staging.au/rm-advisory/

The answer to that question essentially depends on how confident you are that the increase in value will be achieved. It goes without saying that the more confident you are, the more you would be willing to pay. The more difficult questions are, however, how much would you be willing to pay at different levels of confidence for the expected increase in value, and how confident are you in achieving that potential value creation?

For example, if your company were generating a $3 million annual EBIT and commanding a 4 times EBIT multiple, and you were fully (100%) confident of increasing EBIT by 20% and that value multiple by one point to 5 times, what would you be willing to pay to get the $6 million increase in value? What would you be willing to pay at a 70% confidence level, or at 50% or at some other figure?

This piece attempts to help in that decision.

At a 100% confidence level you wouldn’t generally pay fully value – in other words you wouldn’t pay $6 million to get a $6 million value increase. That wouldn’t generally make rational sense. Given that capital has a cost, if you need to raise the capital to pay for the value increase, you need a return that is higher than your marginal cost of capital. If trading on a 4-times multiple, per the example above, you need to earn at least 25% pa on your investment. At a 5-times multiple this would be 20% pa. If on the other hand your business can fund the cost with its internal cashflows, it needs to earn a return at least equating to its opportunity cost – as the money could otherwise have been allocated elsewhere.

The chart below depicts the relationship between confidence in achieving the expected ROI (y-axis) and the expected ROI (x-axis).

Basis of calculation:  If 100% = 20% pa expected return, then the expected return at an 80% confidence level would be 25% pa (100%/80% x 20%). Similarly, at a 50% confidence level, the expected return would be 40% pa (100% / 50% x 20%).

The decision (as to the minimum expected returns at different levels of confidence) however is more complicated than depicted on this formulaic chart. It requires you to give more thought to: what is the expected benefit, and what is the impact of the downside?

As regards, quantifying the benefit a few questions come to mind:

One is, without putting your business on the market, how can you reliably determine the extent of the value added? Given the nature of their approach, being comparative sales, many valuers are ill-equipped to determine value. That is because they don’t have sufficient information on the comparative sales to establish the factors that led to the value concerned. They essentially only know the industry, nature of business, revenue and/or EBITDA and the sale price. There are significantly more factors that determine the value of a business. That notwithstanding, even their core information is of questionable relevance. EBITDA and EBIT are insufficient as they do not reveal how much capex will be required and when, and the sale price can depend on the structure of the sale. For example, a sale price with an earn-out contingent on the achievement performance thresholds would justify a higher sale price. If those performance thresholds are not met, the sale proceeds could be a lot less than the stated sales price.

Another is, where you sold your business, did you get full value for it? Did you accept a lower price in return for extracting assurances, such as keeping your business as a standalone entity and not firing your loyal staff? And did you engage the right business broker for the job, and did they do a proper job? The approach to selling businesses of radically different sizes is materially different and the approach to selling businesses in some industries can also be very different to selling businesses in other industries.

A third question that comes to mind is, how do you quantify the longer-term benefits? As a business generates higher profits and commands a higher value multiple, more doors open for it. Its cost of capital reduces, which lowers its return threshold for pursuing growth opportunities, which in turn gives it more opportunities to pursue. It is also able to raise more capital – as more markets open to it – giving it further opportunities. At some point the banking sector will be willing to waive the need for personal guarantees from directors and shareholders. Then they can inject a lot more capital into the business without increasing their exposure to the business, which in turn presents opportunities the business would otherwise not have been able to pursue. Given these significant longer-term benefits, business owners can justify paying a lot more to increase the value of the business than the formulaic increase.

Another flaw in a comparative-sales based valuation is where a business may have wasted money or incurred costs the buyer considered unnecessary. These costs would have reduced its profits, which in turn could have shown it to have sold for an above-market value, while the buyer, after eliminating (adding back) those unnecessary costs would base its price determination on a higher level of profits, resulting it having paid a below market value.  This distinction would generally be lost in a comparative-sales based valuation.

The other complication, as mentioned above, is: What will be the impact on the business and the business owner if, for whatever reason, the increase in value does not materialize or is materially less than expected?  This could, for example, be due to unforeseen industry changes that are out of the business owner’s control. In this hypothetical worst-case scenario, would the money paid to increase the value of the business be ruinous for it? Would the payment be the ‘straw that breaks the camel’s back’? In such an extreme scenario it is more likely the business would have collapsed any way, and if you were concerned about such a scenario, it would be best for you to get out (sell) sooner rather than later. So, a more relevant question is: On a business-as-usual basis, what impact would payment for the expected benefit have on the business if that benefit was not realised? Would it survive? This is also an unrealistic scenario and so should be dismissed. You should rather consider the range of realistic value scenarios – pessimistic, most likely and optimistic – and ensure the business will not be fatally wounded if that pessimistic scenario eventuates.

If concerned about the adverse impact under the pessimistic scenario, you could consider various risk mitigating strategies. One is, to raise equity capital to fund the costs rather than using surplus cashflows or burdening the business with more debt. Similarly, you could negotiate to pay some or all the cost with scrip / shares.   Another risk mitigating strategy is negotiating to pay a sizeable portion of the costs on success – after you are satisfied the value has been added. In such a case it would be reasonable to expect that you would need to pay more on success than if payment was to be upfront.

In conclusion:

While the chart is a useful guideline, the decision is more complex. It requires you to consider the position your business is in and requires you to have a good understanding of the factors that drive value for different classes of investors and perhaps even for different investors in the same class. Your business may, for example, be able to add a lot more value to one trade buyer than it would to another.  Once you understand how different investor classes and different prospective trade buyers would determine the value of your business, you should be able to come to a reasonably justifiable value range for your business. Then use this basis for your decisioning. You will have a better understanding of the value of your business and a better understanding of what you need to do to increase that value.

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R&M aims to offer its clients an outstanding expected return-for-risk. The expected benefit would generally be more than 20 times the cost of its fees, and its approach significantly reduces the risk for its clients. This it achieves through the following arrangements: 1) It does not seek up-front payments or commitments. It charges on an ‘as use’ basis for each module on which it is engaged. 2) While offering 25 modules, it does not require or even generally recommend that it be engaged on all of them. 3) It assists business owners determine whether to engage it on a module by posing various questions for the business owner to consider in relation to that module – this helps business owners decide whether, and if so to what extent, they will benefit from the module concerned. 4) It recommends that the business owner consider the module, implement strategies and otherwise do what’s preferred before engaging it to deliver another module – this is to ensure the necessary action is taken to increase value. 5) It generally recommends the program be delivered on a module per fortnight basis – so over about 12 months for all 25 modules.

Here is a link to R&M’s Advisory webpage, which provides more information on what R&M offers, why and how it goes about its business – https://www.rogersmorris.com.au/program . An email address is provided for those who would like to explore what R&M can do for them.