Archive for January, 2009

Fears are but fears

January 30, 2009

Mistakes are how we learn to do something new — because if you succeed at something, it’s probably something you already knew how to do. You haven’t really grown much from that success — at most it’s the last step on your journey, not the whole journey. Most of the journey was made up of mistakes, if it’s a good journey.


So if you value learning, if you value growing and improving, then you should value mistakes. They are amazing things that make a world of brilliance possible.


Celebrate your mistakes. Cherish them. Smile.


When I endorse that, I don’t exactly mean go sing “Oh…la…la…la…  I’ve made a mistake”.  It’s enough if we don’t sulk over it excessively or feel suicidal.  It’s ok to lose some sleep over it so long as it is therapeutic, a form of longish meditation that helps you go over what went wrong and vow to get back at it in reparatory mode.  I can personally vouch for this since I had left my day job long back and set out on my own, making a few mistakes before deciding which road to take for my own enterprise (that center around securing private and public investing for other enterprises besides making some on my own) and feeling entirely happy and relaxed in the end because I never had to spend another second amidst crushing mediocrity that consistently drained my spirit to excel, leaving me to rot years on end. No more ruinous bosses, no more bitching peers, no more clumsy subordinates – it’s a complete sense of liberation giving me total control over myself and what I do with my time.  Envy me. How many of you have that luxury?


To that moral I might as well add – Conquer your fears.  It’s worth it because – fears after all, are just that

Valuation during recession

January 14, 2009

 What characterizes a recession? When exacerbated by liquidity crunch and credit crisis, the R word becomes an obsessive national metric, that is two consecutive quarters of negative GDP growth.  We are now staring at one clearly.


In these times, the normal methods of valuation of businesses don’t fit.  Net Asset Value, Sum of Parts, Discounted cashflows, multiples of future revenues – nothing seems acceptable.  That is because business growth depends on resurgence of demand that depends on restoration of economic normalcy that still eludes the horizon.  It is a chain reaction that covers economic well being of your stakeholders one and all.  If your suppliers are well off, they extend good credit terms.  If your customers are doing well, they’ll place large orders and if you are doing well, you’ll get to hire the best in business by paying the top dollar.  But that wholesomeness is what is lacking today and nobody knows when it will get back to normal.  So, you don’t believe projections of target companies in your radar because things are so fluid.


Then why buy in murkier times ?


But then, that’s exactly when assets come cheap and you can bargain hard. With a bit of fine combing, the obscurity can be turned into an enormous opportunity.  Push for a calibrated mechanism where you don’t close valuation in one go, rather you let the target run its business and prove its projections at appropriate timelines.  (In good times, no seller will agree for stretching out deals; it’s often take it or leave it). This is known as `earn-out’ method – a deal financing mechanism where the buyer agrees to make future payments to the seller if certain agreed-upon financial or operating targets are reached after closing. The future payments are usually in addition to amounts paid at closing and can be in the form of cash, stock or bonds or some combination thereof. The performance targets are typically based on the future earnings or sales of the target in the one to five years after the deal.

Earnouts have been widely employed in a variety of industries and can be critical to getting a deal done when the parties’ views on the value of the target business are too divergent to agree on a price up front.


For example, that target company you’ve been eyeballing may be a privately-held start up with a patent portfolio that has promising, yet unproven, commercialization potential. The company’s founder may be more optimistic about its prospects than you but wants to sell today, perhaps because the company needs access to more capital to fund growth. He thinks the company is worth about $100 million. Nonetheless, while you’re intrigued by the company’s technology, you’re not convinced it will achieve broad enough market acceptance to yield a satisfactory return at the seller’s valuation. You would say a more realistic valuation is in the $75 million range.

So you compromise. You agree to an up-front cash payment of $50 million with as much as $50 million more if the target’s performance is consistent with the seller’s projections for the next three years. You call your lawyers and tell them to start working out the details.


The risks and metrics

But that, as the saying goes, is just where the devil is lurking. Failure to get the details right can transform your deal from accretive to ruinous. Post-closing disputes over earnouts are common, with disputes generally center around whether the performance target calculation was done properly and whether each party complied with any covenants that could have impacted the achievement of targets.

Consider what metric you’ll use for performance targets. You have a broad set of options, including revenues, sales (gross or net), gross profit, operating income (EBIT), operating cash flow (EBITDA), net income or the occurrence of specific contingencies, such as receipt of favorable regulatory approvals. The farther down the in-come statement the line items included in the earnout formula appear, the more susceptible the results are to accounting judgments and possible manipulation. On the other hand, the farther down the income statement you go, the better the line items reflect the actual financial benefit to the buyer of the acquired business.

The middle of the road

Limiting the parties’ ability to manipulate future financial results while enabling them to rely on performance measures that reflect real value to the buyer requires agreeing to detailed, well-defined formulas. So, to reduce the risk of earnout disputes, accounting methodologies should be consistent with those historically used by the seller, and, if practicable, audited financial statements should be used. The treatment of certain items should also be specified in the earnout formula, which may include one or more of the following:

a)  amortization of the goodwill resulting from the transaction;

b) the amount of overhead (i.e., accounting, legal, public relations, advertising and other shared expenses) charged to the acquired company;

c) R&D expenses;

d) Interest on the buyer’s capital contributions to the target;

e) capital gains;

f) capitalization of expenses;

g) affiliate transactions;

h) staff costs;

i) fixed asset depreciation;

j) income or charges from extraordinary or non-recurring items;


k) income derived from newly acquired operations financed by the buyer.


In addition, the earnout formula should address the treatment of contingencies, which could include a force majeure event, the buyer’s decision to sell the business before expiration of the earnout period, the target company’s failure to receive anticipated regulatory approvals, the departure of key personnel and so on.


Grey areas and complexities

Agreeing on the formula for calculating performance targets, however, mitigates only some of the risks inherent in using earnouts. Because the ultimate price payable through an earnout depends on future performance, the parties must enter into the transaction knowing how the business will be operated going forward.


Ordinarily, buyers manage the business post-closing, but sellers will expect the business to be operated in the ordinary course consistent with past practice or otherwise be compensated for losses attributed to deviations. Sellers may also request approval rights or other involvement in major business decisions, such as expansion plans, hiring or firing key personnel, capitalization, dividend policy or combining the business with other businesses. Although buyers will of course resist perceived encroachments on their ability to manage acquired companies, it is pru-dent to agree upon reasonable, objective parameters for operations during the earnout period to avoid grounds for later disputes.
These and other complexities associated with earnouts must be managed carefully and with due regard for their susceptibility to dispute. Learning to do so can make the earnout a useful tool in your implementation of successful M&A transactions in uncertain times.  
PS – This article does not constitute legal advice. If further explanation of the subject matter is required, please contact the author.




What makes us buy stuff – rationality or emotions?

January 14, 2009


Dan Hill, author and President of Sensory Logic on the relevance of emotions in consumer buy calls.


“Over-complex campaigns that rely on digital technology forget the simple truth; that even the most jaded heart still seeks to believe that it has found a reliable ally. You’ll know you’ve reached the point where there’s an emotional bond when the stories consumers tell about your brand spontaneously involve the use of first-person pronouns, and are told with a burst of spontaneous feeling.

Above all else, remember that it is easiest to sell loyalty when the brand resonates with the consumer’s sense of self. When you address who people are, what they associate with, and what they do and value, you create an emotional connection so deep that consumers no longer think about what to buy.

Great brand worth becomes internalised and accepted as a reflection – and extension – of the consumer’s own beliefs. Fail to make an emotional connection, and you lose out, because value is determined emotionally. Brand attributes are like the claims related to a product. They are merely assertions unless the consumer’s emotional brain finds them valid and worth embracing.


….Value is determined emotionally because our brain’s decision-making process returns to the emotional segment to ‘sign the cheque’ . Only the sensory and the emotional parts of the brain connect to muscle activity. To translate branding efforts into sales, you should bear in mind that the rational brain is more like a lobbyist than a legislator: its role is simply to influence how the emotional brain will ‘vote’ on a potential purchase….”


Terrific insight.  I have experienced it myself at several supermarkets.  The product that I end up buying may not exactly be the product that often is larger in size or better in economics. It’s sometimes the one which appeals to me at that moment because my daughter used to like it while she was younger – an emotional connect as Dan says.


Anywhere it’s paradise…

January 13, 2009


Wistfully looking up the BW happiness ranking.   Usual suspects steal the show starting with Denmark, Switzerland and Austria filling up the top three slots.  I wound down to no.8 and froze.  There it read, Bhutan, wow – the only asian country to figure in there.  U.S ranked 23rd, China 82 and India way back at 125.  African countries like Zimbabwe and Tanzania bring up the rear.


Why am I doing this?  Why does it really matter?  What has always made a hell on earth has been that man has tried to make it his heaven.  Francis Bacon said “Prosperity is not without many fears and distastes, and adversity is not without comforts and hopes”.   Fate often puts all the material for happiness and prosperity into a man’s hands just to see how miserable he can make himself with them.  It helps build a world of contended bodies and discontented minds.  If prosperity guarantees progress, then it also imposes new possibilities together with new restrictions. 


Consoled?  Like hell.  That’s all bunkum.  It means a lot to be rich. Obscenely wealthy. There is nothing wrong in being rich. No sense of guilt attached to being wealthy.  Just that when prosperity comes, do not use all of it.  Not all wear their pearls around the neck with stones upon the heart.  That is propagated by those who wear stones around their necks while dreaming of pearls replacing them some day.  Luxury, if it corrupts the rich by possession, it distorts the poor by covetousness.


My advise to the world. Covet prosperity by all means.  To get there, you can start by staying positive. A positive attitude may not solve all your problems, but it will annoy enough people to make it worth the effort. Happiness is an attitude.  We either make ourselves miserable, or happy and strong.  The amount of work is the same.  Just because you’re miserable doesn’t mean you can’t enjoy life. We may all be in the gutter, but some of us are looking at the stars.


Anywhere is paradise.  It’s up to you 🙂