Thursday, December 27, 2012

A Major Trend That Should Concern Business Owners

Heading into a New Year is the perfect time to reflect upon the challenges and successes of the past year and set new goals for the coming year.  Many business owners may be planning to sell their business in 2013.  Perhaps some boomers have already delayed this event, for various reasons, and are hoping 2013 will be the year they begin the transition out of their business. 
One thing is certain - all business owners will one day sell their business.  For some business owners this will occur voluntarily, on their terms at a time of their choosing.  For many business owners, however, this will occur involuntarily due to burnout, illness, disability, divorce or death.   
The Current Situation:
"According to CIBC, an estimated $1.9 trillion in business assets are poised to change hands over the next 5 years, $3.7 trillion over the next 10 years – the biggest transfer of Canadian business control on record." [1]

This transfer of wealth translates into approximately 310,000 businesses over the next 5 years and 550,000 businesses over the coming decade.
The Problem:
The increasing supply of businesses for sale over this time period will create a buyers’ market putting downward pressure on sale prices.  Without a proper plan, business owners will find themselves selling for a significant discount to those that come to market prepared. 
This is a major problem for business owners that want to maximize the price they receive in an eventual sale of their business.  As more and more businesses are put up for sale over the coming decade, buyers will only pay top dollar for the most attractive businesses.
The Solution:
Ensuring you have a business that will be attractive to potential buyers when it comes time to sell will be essential to dealing with this problem. 
Whether you are working to build a salable business or striving to maintain an already attractive business, proper planning and unwavering implementation will be vital.  Exit planning, including the implementation of value enhancement initiatives, is a process that takes time and must begin 3 to 5 years prior to an eventual sale.
Many people understand the importance of planning, but successful people excel at the implementation of an action plan (or seeking the assistance of professionals).  The VSP 6-Step Value Enhancement Process assists business owners with the development and implementation of an action plan and consists of the following steps: 
  1. Benchmark Business Valuation 
  2. Detailed Value Driver Analysis 
  3. Prioritize the Key Value Drivers 
  4. Develop Action Plan 
  5. Implement, Monitor and Follow-up 
  6. Updated Business Valuation
We take the business owner through steps 1 to 4 above within approximately 3 months.  Step 5, however, is the most critical and is where many business owners fall short without assistance.  We schedule quarterly meetings, with those held accountable for completing tasks, to ensure the successful implementation of the value enhancement action plan.
The VSP 6-Step Value Enhancement Process provides the following benefits to business owners:
  1. Increase the value and salability of the business 
  2. Stand out from the crowd as an attractive target for potential purchasers 
  3. Ensures the implementation of an action plan 
  4. Owners can continue to focus on the day-to-day operations of the business 
  5. Significant return on investment (spread over a 2 to 3 year time frame) is realized 
  6. Helps prepare the business owner in event of burnout, illness, disability, divorce or death  
As a business owner, do your plans for 2013 include value enhancement initiatives?  If you are planning to sell your business over the coming decade perhaps they should – especially in light of current statistics on the expected increasing number of businesses for sale over this time period!

1.    Source: Ottawa Citizen, November 13, 2012.

Tuesday, December 18, 2012

Critiquing an Expert Report: Step 6 – Identify the Damages Period

Step 6 to critiquing an expert report on damages involves identifying and assessing the reasonableness of the period over which the expert has calculated damages.  The damages period is often one of the major assumptions underlying a damages calculation which, if altered, can have a significant impact on the conclusions.
There may be situations where an expert has quantified damages under a breach of contract by calculating the lost profits suffered for a one year period and then capitalizing this annual loss by a multiple to arrive at a lump sum value.  This approach implies an infinite damages period, which may not be appropriate.
Where the expert’s damages period assumption is not reasonable under the circumstances, you should consider the impact of using a more appropriate damages period assumption on the conclusions.
For guidance on assessing the reasonableness of the assumed damages period in a breach of contract matter look to the agreement.  Is the assumed damages period consistent with the term in the contract?  How does the contract deal with termination?  Is the "reasonable notice period" concept relevant and, if so, how has the expert addressed this?
According to Recovery of Damages For Lost Profits:
"When a contract contains a provision that it may be terminated on given notice, unique questions arise.  If the contract is breached, are lost profits recoverable for the entire term of the contract?  Or only for the period of notice?  Most of the cases limit damages recoverable to those suffered within the notice period.  However, there have been cases where the courts have awarded damages for a period of time longer than the notice period."
"If a contract specifies no time period for performance, it may be regarded as cancellable on reasonable notice.  If reasonable notice is implied, the injured party may then recover damages for loss of profits during a reasonable period after cancellation of the contract.  The duration of the reasonable notice, however, is a question of fact for the trier of fact."
What constitutes "reasonable notice" will depend on the circumstances of each case.  Some of the factors considered by Canadian courts in breach of distribution agreement matters include:
  • The length of the association between the parties;
  • The dependency of the distributor on a principal’s line of business;
  • The amount of investment made by a distributor to distribute a principal’s product;
  • The volume of business derived from the sale of the principal’s product; and
  • The established practice, if any, in the trade or the business.
When reviewing expert reports on damages we always consider the expert’s assumption regarding the damages period.  We were retained to review the plaintiff’s expert report in a breach of tender matter with respect to a claim for lost profits.  The plaintiff’s expert quantified damages for an infinite period despite the fact that the tender documents and subsequent contracts were for a specific time period (one year).  Our responding report highlighted this, among other things, as one of our major concerns.  The case ultimately settled out of court for an amount much less than the plaintiff’s expert had quantified.
The damages period is often a major assumption underlying a damages calculation.  Taking the time to understand what the expert assumed in this regard and assess its reasonableness in light of the facts and circumstances of the case is critical to conducting an effective review of that expert’s report.
1.  Recovery of Damages For Lost Profits, 6th Edition, Robert L. Dunn, pages 530 – 535.

Tuesday, December 11, 2012

Critiquing an Expert Report: Step 5 – Identify the Damages Approach

You have researched the author’s credentials, checked for scope limitations, identified the underlying assumptions and assessed the nature of the opinion being provided.  Step 5 involves identifying and assessing the damages approach adopted by the expert. 
"There are many ways to approach an analysis of a loss resulting from a particular set of facts. Part of the expert’s role is to identify all of these alternatives and determine which is the most appropriate." [1]
The quantification of economic damages is based on the premise that an award of damages should place the plaintiff in the same financial position that it would have been in had the alleged wrongdoing or breach never occurred.  The independent expert valuator must develop an economic model to project what would have happened "but for" the defendant’s alleged acts to compare to what is actually expected to happen as a result of the alleged acts.

Common approaches for quantifying damages in a commercial dispute (e.g. breach of contract, patent infringement, etc.) include:
  1. Lost royalties approach – the royalties the plaintiff could have generated by licensing the right to use the patent, trademark or brand name that is being infringed upon
  2. Lost profits approach – the profits the plaintiff would have enjoyed "but for" the alleged breach less the profits that will actually be earned by the plaintiff despite the alleged breach
  3. Accounting for profits approach – the profits that the defendant actually enjoyed as a result of the infringement or alleged breach
  4. Increased operating costs and/or out of pocket costs – the costs incurred by the plaintiff as a direct result of the alleged breach
  5. Lost value of business – the lost or diminished value of the business, division or product line suffered by the plaintiff as a result of the alleged breach
It is the expert’s role to determine which approach is appropriate in light of the case-specific facts and circumstances.  For example, the lost profits/royalties approach or the accounting for profits approach is often considered in patent infringement matters.  In breach of contract matters, it is common to see the lost profits approach applied. 
In reviewing the expert report, the following questions should be addressed:
  1. What damages approach was adopted?
  2. Is the damages approach appropriate under the circumstances?
  3. Would an alternate damages approach be more suitable?
  4. What would be the impact on the conclusions if a more suitable damages approach was applied? 
  5. Would adopting an alternate damages approach corroborate or refute the damages calculated under a primary approach?
Consider an expert report where the valuator has quantified damages using a lost profits approach in a breach of contract matter.  In critiquing the report you should consider what the damages would have been had the entire business been destroyed (i.e. the value of the business immediately before the breach).  If the value of the entire business is lower than the expert’s lost profits calculation, this could indicate that the damages have been overstated.
In my experience, experts will typically agree on an appropriate damages approach.  It is the application of the approach and/or the underlying assumptions where experts will often differ.  However, identifying and understanding the damages approach adopted by the expert is critical to an effective review and critique of that expert’s report as, in those instances where an inappropriate approach has been applied, the conclusions could be significantly inaccurate.

1.   The Litigators Guide to Expert Witnesses, Mark J. Freiman and Mark L. Berenblut, p. 87.

Thursday, December 06, 2012

7 Things To Do Before Signing a Letter of Intent

Approximately $1.9 trillion in business assets (or 310,000 businesses) are poised to change hands over the next 5 years, increasing to $3.7 trillion (or 550,000 businesses) over the coming decade.  This will be the biggest transfer of Canadian business control on record. [1]
What are the implications to business owners in Canada?
The increasing supply of businesses for sale will create a buyer’s market, putting downward pressure on sale prices.  Without a proper plan, business owners will find themselves selling at a significant discount to those that come to market prepared.
If you are planning to sell your business in the coming decade there are a host of things you need to consider to ensure a successful transition, including being prepared for the day you receive a letter of intent (LOI) from an interested buyer.
Having an attractive business provides you with leverage, but only up to the point where you sign a LOI which will likely require you to terminate discussions with other potential buyers during the due diligence process.
After signing the LOI, the balance of power in the negotiation swings in favour of the buyer, who can then take their time investigating your company.  With each passing day you will likely become more psychologically committed to selling your business.  Savvy buyers know this and can drag out diligence for months, coming up with things that justify lowering their offer price or demanding better terms.  With your leverage diminished and other buyers sidelined, you are left with the option of accepting the inferior terms or walking away.
Seven initiatives to focus on, even before putting your business up for sale, to minimize this power shift include:
  1. Have "successor" clauses in your customer contracts - these ensure that the obligations of the contract survive any change in company ownership.
  2. Nurture and prepare a list of 10 to 15 "reference-able" customers - a potential buyer will want to ask your customers why they do business with you and not your competitors.
  3. Ensure your management team is on the same page - a potential purchaser will want to interview management, without you in the room, to ensure everyone in the company is pulling in the same direction.
  4. Consider getting audited financials - an acquirer will have more confidence in your numbers and will perceive less risk if your financial statements have been audited.
  5. Disclose the risks up front - every company has some risk factors. Disclose up front what the company’s plans are for dealing with its weaknesses and threats.
  6. Negotiate down the due diligence period - do your best to reduce the due diligence period from a period of 60 or 90 days to between 30 and 45 days. If nothing else, you'll alert the acquirer to the fact that you're not willing to see the diligence drag out past the agreed-upon close date.
  7. Make it clear there are others at the table - explain that, while you think the acquirer's offer is the strongest and you intend to honour the "no shop" agreement, there are other interested parties at the table.
You may not be actively looking to sell at the current time but you will exit your business one day.  Focusing on these seven things will help you protect the value of your business as the balance of power begins to shift away from you in negotiations with a potential purchaser.
1.   Inadequate Business Succession Planning – A Growing Macroeconomic Risk, CIBC In Focus November 13, 2012.