There are many ways of heating up a chilly Friday night in Northern VT, but for 11-year-old Noah there is only one with any real interest now that the Red Sox season is over – Red Sox Monopoly.
My wife Annie and I were providing D.C.C.P. services (as in Designated Child Care Providers) to Noah and his brother and sister a couple of weekends ago when he offered to introduce us to yet another spin-off of the Sox’ most successful season in our lifetime. The terminology had changed – Boardwalk and Park Place were Fenway Park and Ted Williams Way – but the numbers and rules were all the same.
Annie and I were a little rusty, but we quickly got caught up in Noah’s strategy of never passing up a buying opportunity. He also proved to be a pretty shrewd trader, in no time accumulating hotels in the low-rent district – Landsdowne Street and Yawkey Way (Mediterranean and Baltic) – while we were still trying to buy houses for our more upscale properties.
Ultimately, my strategy of concentrating all my resources on my one color code – Fenway and Williams Way – coincided with Noah’s unlucky landing on Fenway (three houses – $1,400) to wipe him out, but not before I had to mortgage a few of my properties to stay in the game. Facing the immediate potential of four hotels of mine clustered around “GO,” Annie quickly sized up the situation and retired to her reading.
In the following week, a couple of client situations offered some parallels to Monopoly. In both cases, my clients have recognized the limitations of internally- generated growth, of adding houses and hotels one color code at a time. They’re seeking to grow more quickly based on a) strong management; b) a history of profitability; c) insight and knowledge of their respective industries; and d) a financeable balance sheet.
Equally important, they’ve learned what Noah is just beginning to appreciate, something I didn’t learn until I was much older than he is – that there are key metrics in the acquisition game, just as in Monopoly, that you ignore at your peril.
In Monopoly, the color code which provides the best return on investment is the orange – traditionally, St. James, Tennessee, and New York – based on the probabilities of going to jail, advancing token to nearest utility, advancing to St. Charles Place, etc. You’re not a guaranteed winner if you control those properties, but you’re far more likely than if you have the worst set, the green (Pacific, North Carolina, and Pennsylvania). (For a complete list of the probabilities, advance your token to this site.)
Similarly with buying companies. Both of my clients have a strong sense for how the competition’s products and services could supplement their own line and what it might be worth to fill in a “color code.”
The basic determination, however, still comes back to the numbers: the only certainties (subject to due diligence) are the historical numbers on the income statement and balance sheet. To the extent that recent results are replicable in future years, a combination of yardsticks (see sidebar) can yield a consensus valuation.
If, as in one client’s case, you’re buying a company whose expertise is largely concentrated in one person, the bulk of the value is in the potential, at least some of which is attributed to what you, the acquirer, bring to the table. In the usual case, this deal is structured as an earn-out: the owner(s) of the acquired company are paid over 2-5 years based on results – revenues, margin, profits, return on investment, or a combination of all, with the terminology precisely defined.
In my other client’s situation, the target product line is well-established, the market is reasonably stable, the principals want to retire, and the underlying value is represented by several designs and trade names. My client knows all of the costs, so the challenge is to determine the value today of the stream of earnings being added by the acquisition. Understood by every MBA student and incorporated in Excel software since the earliest versions, the Net Present Value calculation is the standard method of doing this.
So as I think about all of my clients and their opportunities in The Great Game of Business (with credit to author Jack Stack ), I revert to the lessons I’m trying to convey to Noah through Monopoly:
- Without a strategy, every property looks like a great opportunity. You can run through your time and money very quickly pursuing every opportunity.
- The railroads and utilities can be useful as deal sweeteners, but they’re not going to win the game for you. Similarly with long-term employment contracts: guaranteed compensation is seldom accompanied by guaranteed motivation.
- Life isn’t built around winning the Lottery, so there are no jackpots for Free Parking. Nor is the value of a target company to be predicated on the long-hoped-for Big Contract or the projected break-out year.
- Knowing the odds may allow you to trade your greens (Pennsylvania et al ) for your opponent’s oranges (St. James et seq ) and win the game. Knowing your industry’s economic model and making it work leaves you no worse than even in any negotiating session. You can always walk away.
- The only way to avoid risk is to be the banker (ref. Howe’s Bayou, November 2005 ). I’ve never been in a Monopoly game played by the official rules in which the Bank went bust.
The next day Noah was back to the Monopoly board, playing a game against himself to test the various strategies. “There’s a kid,” his proud grandpa thought to himself, “who’s figured out how to avoid losing – truly a budding Monopolist.”
Unlike Bill Gates, the most self-acknowledged would-be monopolist of the current day is “The Donald.” Not satisfied with his efforts to monopolize the Atlantic City Boardwalk with Trump Plaza, Trump Marina Hotel, and Trump Taj Mahal, Donald Trump has sought to trumpet his latest claim to fame on “The Apprentice” (NBC) by copywriting and thereby monopolizing his most powerful catchphrase, “You’re fired!”
But, as reported by Attorney Irwin R. Kramer ( www.KramersLaw.com ), “Trump’s toughest competition may be a little-known Michigan entrepreneur who never applied for a federal trademark. As the owner of You’re Fired, Inc., Sallyjo Levine’s small ceramics studio boasts sales all over the country and features an online store where visitors can buy “You’re Fired” coffee mugs, T-shirts, boxer shorts, baseball caps, and tote bags.
“How could Sallyjo possibly beat The Donald? In short, it is because her company has marketed the phrase for years. This means that, even without federal trademark registration, Sallyjo has the exclusive right to use this ‘common law trademark.’
“Ordinarily, that right would be limited to her own state. But Sallyjo’s presence on the World Wide Web arguably provides her with nationwide rights that could trump Trump’s.
“Sallyjo doesn’t have a fancy boardroom. But, if Trump doesn’t mind the smell of unglazed pottery and paint, he might just want to come to her negotiating table before he can fully exploit his trademark phrase.”
– FindLaw’s Legal Commentary
Draining the Swamp
The classic definition describes a true company value as one arrived at by negotiation between a willing and knowledgeable buyer and a willing a knowledgeable seller, neither of whom is under any compulsion to buy or to sell. Many books and articles have described the process by which one arrives at the starting point of negotiation.
At base, however, there are five quantitative techniques which combine to provide guidance in arriving at a “ballpark” of reasonable value:
- Book Value: a company’s equity, derived by subtracting its liabilities from its assets;
- Liquidation Value: the sum of the discounted value of assets (e.g. 75% of the book value of accounts receivable, 25% of inventory) that might be realized in a liquidation process, less the negotiated settlement cost (if any) of liabilities;
- Multiples of Sales, or of Profits, or of Cash Flow: often based on industry benchmarks, most useful in a stable operating and financial environment;
- Comparative Value: as in real estate valuation, based on a comparison of the selling price of similar companies in the same, or closely-related, industries;
- Net Present Value and its corollary, Discounted Cash Flow: the sum of the projected annual earnings or of cash flow, usually for the next five years, discounted by a targeted rate of return (e.g., 20%, 30%) to an estimated current value.