Manual for Opening a Business

business
The positive economic atmosphere in the market is also felt in the large number of new businesses opening in Israel. Each day, many new businesses are opened, most of them small and medium sized. More than once this relates to young people who have finished their world tour and now are full of energy and attack the market with a view to conquering it. Our office feels the reawakening of the economy and mentioned that recently there has been a sharp increase in the number of those contacting us in order to receive advice and to open a new business. Also, the new reforms planned by the Ministry of Finance make the establishment of new businesses more worthwhile and more profitable.

Nevertheless, even if a business owner has a fantastic idea and a tremendous potential for success, incorrect decisions at the start of the road may decide the fate of the business already at its infancy. Most of these incorrect decisions in opening a business result from a lack of knowledge of legal and accounting affairs connected with establishing a business. In order to assist businesses at the outset, we hereby submit a complete manual for opening a business:

Location of the business

Throughout the country and in the center of the large cities, there are many areas available for leasing. The prices are lower than at any time and one can choose the most suitable building for the business’s needs. In a new business, it is not recommended to sign a lease for over a year, but to have an option to extend the lease under identical conditions. A short-term agreement will ensure the transferring of the business to another place should the chosen location not be successful from the business’s point of view. When choosing the location of a business, remember that the costs of transferring it are very high and include transport, renovations, etc.; and therefore, it is most important to choose a suitable location.

Bank and credit frameworks

Despite the fact that many self-employed continue to run the business also using their private bank account, this is not recommended. The management of a separate account for the business provide a more precise indication of the business result and makes the management of cash flows in the business easier. In addition, in order to recognize bank expenses and commissions as recognized expenses, the tax authority requires the business to have its own account.

It is recommended that the business account will not be kept in the bank in which the private account is kept. Generally, the bank will see both accounts as one account for the purpose of giving credit frameworks and calculating indebtedness. The opening of a bank account with another bank can increase the credit framework given to the business.

It is very important to see the bank as a partner and to maintain a positive reputation with it. When a problem is expected in cash flows, it is recommended to inform the bank and come to a joint solution. Cooperation with the bank is even more important due to the new regulations which forbid the bank to allow an overdraft without approval as from July 1, 2006. Maintaining good relations with the bank does not contradict that it is recommended to negotiate the amount of interest and commissions, and in this way to save money.

Funds for small businesses

One of the central problems of new businesses and businesses in general is credit difficulties. In Israel, there are many funds that operate and encourage new, small, and medium – sized businesses with the method of granting credit changing from time to time.

Generally, assistance is given to businesses that already exist and operate, but there are also funds that give loans to businesses being established. At the time of taking credit, it is important to ensure that the business can meet the monthly repayment. For businesses that cannot meet immediate repayment, there are loans where repayment is made only after a period which is decided in advance.

Value Added Tax

The business can operate only after registering and opening a VAT file.

There are two types of independent business:

a. An exempt business – where the expected annual turnover will not exceed NIS 65,720 – generally, these are small business and employees who are only starting their activities as self employed. Such a business only reports once a year to the VAT and does not collect and cannot set – off VAT. Businesses such as the liberal professions cannot register as exempt businesses, no matter what their revenues

b. A taxable business – anyone whose annual turnover is expected to exceed NIS 65,720 must be registered as a licensed dealer.

When filing an application to the VAT authorities for opening a business, you should have the following documents: an application to open a business signed by the dealer/partners, a photocopy of an identity card/identity cards, a cancelled bank check / any other document showing details of the bank account and details of the holder of the bank account and the rental contract.

In certain cases, the Value Added Tax Authorities are entitled to demand additional documents such as future engagement agreements etc.

Income Tax

After the change in the law, about a year ago, dealers are required to report to the Income Tax on the opening of a business, and anyone who does not do so is exposed to administrative fines. In order to register an independent business, an application to register one must be made with the assessing officer. Despite the fact that it is possible to open a business with the tax authorities independently, it is recommended to obtain the assistance of a CPA to do so.

Opening a deductions file for employees

If the business employs people, a deductions file must be opened with the assessing officer. The opening of a deductions files with the National Insurance Institute is carried out automatically by obtaining data from the Income Tax Authorities.

National Insurance Institute

In addition to registering VAT and income tax, an independent dealer must register also with the National Insurance Institute. Registration is done by completing the annual report form. The Institute requires that the number of hours expected and the level of expected income. There are two types of self employed in National Insurance:

1) A self employed person who meets the definitions of a self employed person – pays advances on account and insures the income for which he pays advances.

2) An independent who does not meet the definition – a dealer who works in the business less than 12 hours a week and earns less than NIS 3,692 per month. This status generally is suitable for employed people where the business provides him with complementary income. When the business is registered with the National Insurance Institute – the Institute examines whether insurance fees were paid from the age of 18 until the age of opening the business -whether there are periods where the dealer was abroad or did not work – he will be required to pay for these periods.

Keeping books of accounts

Every person who has income from a business or profession must keep books. The method of keeping books changes according to type and size of the business. At the start, it is recommended to keep close contact with a professional person – certified public accountant or tax consultant in order to obtain a detailed explanation of the method of managing the books and the procedures of issuing invoices and receipts. In addition, cooperation with a certified public accountant assists the business in understanding more correctly and releasing its owners from waiting unnecessary time.

Non keeping of proper books causes their disqualification by the tax authorities. This sanction is likely to result in a situation where the assessing officer will determine for himself the annual assessment that the business owes, and its owner will have to prove the exact income according to which the tax is paid.

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For additional details regarding the specific requirements of every client, send us your query and we will gladly get back to you with a response regarding your specific needs.

By: Alex Sutovsky

About the Author:

The Azulai – Sutovsky Firm of Accountants, israeli cpa office.

Kansieo.com

Steps to Starting your Own Business

business
Introduction:

Thinking of starting a business? My hat is off to you, and I hope that this blog can provide resources for you to get started. Since my retirement from industry six years ago, I have been a SCORE volunteer (Service Corps of Retired Executives). Over these years I have met many clients who dream of starting their own business. Their motivation to start a usiness may vary, but their common goal is a desire to be successful and to be their own boss. My experience has imparted to me a good sense of those who will be successful and those who will not be successful. It is those people who are prepared and have a strong urge that are successful. From my training and experiences I have prepared a suggested road map to start your own business. Do take advantage of your local SCORE volunteer while planning for your business. The service is free and the volunteer can be found through your local Chamber of Commerce.

The Business Idea

The idea to start your own business can come from many sources: your hobby, your work experience, your desire or a situation you found where a service was not being met. To confirm that you have a sound plan you have to: – Describe the business in a paragraph or less. – Decide if the product or service is unique… cheaper or faster, etc.? – Decide whether this business meets your personal goals? – Commit to investing many hours to make your business successful? There are many other questions that you will need to answer truthfully to yourself and then discuss them with your spouse and close friends. Once you are comfortable with the answers then you are ready to proceed to the next steps. The Small Business Administration has a full list of questions to help fulfill this part of the journey. http://www.sba.gov Above all, your business has to “solve your client’s problem”. It is this objective that makes a business successful. If this main objective is met, then all your other needs can be fulfilled.

Start Preparing for Your Business Plan:

You need to do some basic work before you prepare your business plan.

Finding a Business Name: You need to derive a business name that represents your dream of a business yet does not infringe on another business. Your State’s Secretary of State can readily tell you if you have a unique name. You will find that this is important as you get deeper into your business plan. Try to derive the most attractive name you can identify.

Finding a Potential Location: Is your business going to be a storefront, web site, home or perhaps out of a van business? Inputs to your business plan will require lease or rental expenses, insurance and other facility expenses. Just as importantly, you will have to determine the traffic past your selected location and how many potential customers your business will attract. The more attractive locations will attract more business but will be more expensive. A local commercial real estate agent is of great value to help you with this decision.

You need a Logo: I believe that all businesses should have a logo. It will be added to checks, business cards, literature and other materials. In my opinion, it brings the business together. The logo will be used on business cards, letter heads, web sites and all other forms of advertisement. Take a look at http://www.logomaker.com/index.html for a very reasonable logo design.

Business Structure: You need to decide on your legal business structure. The options are: Sole Proprietorship C Corporation S Corporation Partnership Limited Liability Corporation (LLC) For the majority of my clients, the Limited Liability Corporation is the best fit. For a reasonable fee you can have a business entity that has limited liability for business debts, which protects your personal properties. You can form the LLC with your State’s Secretary of State. A good Web Site to review the four business structures is: http://www.quickmba.com/law/org/

Employer ID Numbers (EINs): You should get an Employer ID Number (EIN) from the Federal Government. The number is issued by the IRS and it is free. http://www.irs.gov/. At the minimum this will save your using your Social Security Number for identification. The IRS site has lots of good information on small businesses that can be of benefit to you.

Write Your Business Plan: The business plan is the most important document for starting your business. The Small Business Administration has a template that you can use to write the business plan. http://www.sba.gov The business plan document should have the objectives of the business, its structure and it financial road map. This document will always be used to keep all participants on the same roadmap. It is the most laborious yet important document you will derive. This document should be reviewed by your spouse, good friends, and SCORE Counselor. A good web site to find samples of business plans is http://www.bplans.com/. This site shows examples of successful business plans and also has good information for starting a business. Again, I must emphasis that you need to keep the overall objective of “What Problem am I solving for the Client” in front of you. If you fulfill this objective the rest will fill in.

Financing: You have finished the business plan and now will decide if you need financing to start your business. How much do you need? Most of the clients that I see can actually finance their business with a credit card. They need a financial record of 650 or better to get a card and probably can use the card for up to $10, 000.00 financing. Perhaps you can provide money from your savings or take in a financial partner.

If you require more money to finance your business, prepare for battle. The banks are tough and you are competing for time with people who will be doing much larger business with the bank. This is what you will need: A polished business plan A list of start-up costs Past three year personal tax returns. A statement of personal histories Credit reports from Equifax (1-800-658-1111), Experian (1-800-682-7654) and Tran Union(1-316-636-6100)

Be prepared to answer all questions on your finances and needs. Be prepared to show that you are conservative in your plan. Seek out used or rental equipment or other innovative techniques to save money. You should remember that the banker is usually interested in helping start a small business if they have a stong plan and collateral. You have to be prepared because his or her time is limited.

Further Steps for Success: Hopefully, you will make it through these hurdles and be ready to open your business. You are to be congratulated because this is a great accomplishment. You are your own boss and in charge of your future. Do not celebrate too much for now, though, as you still have to hire employees, choose the technology you require for running your business and wade through many other details. May it be rewarding and profitable.

By: Paul Calhoun

About the Author:

I have a BS and MS in Metallurgical Engineering. Thirty six years spent in the development of semiconductors. Business experience in start up business plan. Currently, an oyster farmer and interested in helping the environment by deploying solar energy. Visit my Blog, http://environmentalhelp.typepad.com/ for continued information on renewable energy E Mail: p_calhoun@bellsouth.net

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Become a Better Business Person

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Let me ask you this… What makes a successful business owner?

Well for me, a successful business owner is someone that earns well into six figures or more each year from their business, working around 3 to 4 days (or less) per week.

I call this ‘successful’ because if they can make a few hundred thousand a year from their business, and only work a few days per week they have to have a lot of great things in place…

Not just in their business but in their personal life.

It tells me that in their business they have fabulous systems and staff members that are willing and able to work even when the owner isn’t there.

And the business would have great information systems so that the business owner would know everything that’s going on (even though they’re not there) so they can still ‘control’ the business.

They’d have excellent marketing and sales systems that day in day out draw in ‘ideal’ customers that willingly buy from the business, at full price.

Plus because of the level of service and quality in the business the customers are loyal and enthusiastically refer other people to the business.

The business owner would also have a high level of trust in their staff to run the business which shows me a couple of things.

Number 1, they’d have excellent staff recruitment and training programs to build their staff into competent team members.

And Number 2 They’d have a high level emotional maturity to allow this to happen.

In their personal life, I’d consider these business owners successful because they would have enough free time during the week to spend on their own doing exercise or their favourite hobbies.

This recharges their ‘batteries’ and keeps them fresh. Thus they always seem to be ‘on-the-ball’.

Plus, they spend good quality time with their partner at home and their family.

And that’s crucial.

Just ask anyone whose business has caused a marriage break up, and/or illness through stress.

You see, growing a business that overtakes your life is very, very easy. Most business owners achieve this within the first couple of weeks of starting!

Growing a business that also enhances your lifestyle is a lot more difficult.

But it is possible.

And that’s what I do with the business owners I work with.

We create profitable business growth that enhance their lifestyles

For me it’s about Business and Life Harmony.

So what’s the underlying secret to achieving it?

Commit to becoming a better business person.

Every successful business owner will tell you this…

It’s not one single thing that will make the difference to your business growth.

It’s a lot of things.

You see most business owners are waiting for the ‘one big’ order or the ‘one great year’ or the ‘one great staff member’ that will make all the difference.

The successful business owners know differently.

The successful business owners know that to have an extraordinary business they must be an extraordinary business person.

They know that if they want to grow to $2 Million… they have to learn how to become a $2 Million business owner. And this requires improving their business skills.

There are many skills to learn.

You’ve got to know how to make the product or deliver the service.

You’ve got to know how to market your business

How to sell, how to find suppliers, how to negotiate, how to hire people, how to train people, how to read and understand financial statements the list goes on and on.

Yet it can be, and is simple… when you learn how to do it simply.

And that’s my role with you.

You see as a business coach my skill is making your business growth predictable, controllable and a hell of a lot easier.

All of my clients will tell you that.

So back to you.

If you want to grow your business you may realize that you need to learn some new information and skills.

And that’s what Super successful business owners have done before you.

They realize that to really grow their business they MUST become a better business person.

Most ‘unsuccessful’ business owners believe that the way to grow their business is by making a better product, or providing a better service.

They feel that if they have the ‘best’ product the market will come to them.

Well the product or service is only one part of your business. It’s not enough.

Super successful business owners initially build their business on a good product or service. Then when it comes time to grow… they focus on areas that will grow their business.

Super successful business owners focus on areas that most unsuccessful business owner’s neglect or are too busy to focus on.

Areas like…

– Creating Vision, Mission and Values Statements

– Marketing

– Sales

– Customer Care

– Operations

– People

– Team building

– Financial statement

– Financial analysis

– Taxation

– Law

– Technology

– Key Performance Indicators

– Business/life balance

-And building their wealth through

All of these areas sound separate yet they are extremely interconnected and dependant on each other. And as we travel through each session you’ll hear how each topic is linked to, and how much each topic relies on the other topics for its success.

That’s what makes a great business person using all the areas.

It may seem like a long list. If it does or doesn’t don’t worry. It’s a list that I’m absolutely passionate about helping you with.

Because that’s the first step to growing your business.

Become a better business person by working on your business, rather than just working in it.

It’s what I do with clients that I work with one-on-one over a couple of years in my Business Coaching Program.

Copyright © 2006 by Casey Gollan. All Rights Reserved

By: Casey Gollan

About the Author:

Business Coach, Mentor And Growth Specialist
Casey Gollan, Business Coach, Mentor And Growth Specialist. Grows $1 Million p.a. Small Businesses Into $2 to $5 Million p.a. Businesses Over a 2 to 3 Year Period.

Kansieo.com

Prepare Your Small Business to Survive Bad Economic Conditions

business
 

Economies all over the world are experiencing a decline, businesses are laying off many people in order to cut costs and stay profitable. Those who retain their jobs are faced with rocketing food and gas prices.

When you are an owner of a small business, the challenges are even greater, under the circumstances, you are more likely to experience a decline in traffic to your store, raising costs of supplies, employees demanding (understandably) higher wages, higher fees in marketing your business using mainstream media, higher costs in renting business space and insurance costs. If you are an accountant you might have probably figured that under this circumstances, unless you are selling magic items, you would see higher expenses than income. Business is not about how much money you make, but it is more about how much of the money you make actually stays in the business. A business that makes a million a year and spends a million is the same as the business that does not do business at all, except in the earlier case, the owner is actually at a loss because they are putting in more effort than they are making.

So how do you survive that? That was exactly the same question I asked myself a few months ago. Here I have compiled some notes that some in the same situation as I was might find helpful.

1   Constant Evaluation  and process streamlining.

 

Constant evaluation is the blood and soul of every business. As the saying goes “What got you to where you are may not be able to get you where you want to be”. To be honest, I have never met any business person, whether it is in the formal or informal sector who wanted their business to stay the same for a long period of time, no matter how well they were doing. Being on top of your class does not stop your competitors from doing what it takes to beat you. We see a lot of big businesses laying people off, going through mergers and acquisition. This is process streamlining on a large scale. They evaluate their positions, get rid of inefficient processes, redundant positions and so on. Don’t feel guilty if you have to do it for your small business… If you find yourself with more employees than you need or using a process that is costing you more than it brings in, cut it off and replace it with something that works better.

I will tell you a secret. A few years ago, I read an article about how one could make a lot of money on FOREX, if you do not know what it is, basically the business is about speculating on whether a certain currency’s value would get stronger or weaker and then you would either buy or sell a specific currency in exchange for another currency.

I thought that was a pretty easy thing to do and got a lot of books telling me that it is a lucrative business. I am not disputing that, but there are also a lot of people that loose money this way. I also got a few articles somewhere that warned me about what happens on FOREX, but  at the same time I was getting drawn to it, not by the money but by the fact that I could learn a lot about financial discipline.

After two months, I had almost lost all that I had in my account, but I had also learned a lot of things. One of the important lessons is to cut your losses short and let your profits run. Get me right, this is not the same as giving up too soon. This is giving up soon after knowing that the business is heading no where. This may sound like a greedy game, but it works. To me money not spend is money saved, it is as simple as that.

Why am I telling you this? I am telling you this because A few years later I would start a small business that did not really fit my lifestyle but it had the potential to take off. I would spend most of my starting capital on advertising and rent and then on wages for my staff. Being what it was, the business was not generating enough revenue to cover its expenditure, because the marketing media and approaches we used were not working and were difficult to evaluate whether they were effective or not and given the my lifestyle, I was learning that there is no way I would be able to take the business to the next level using the resources I had. I had a choice to either wait and let it wipe me out of my hard-earned cash or cut my loses short and explore other alternatives.

By talking to other small business owners, I would find out that many were facing the same problem that I was. I then put some time aside and develop a web-based platform to sell my stuff. This was the birth of SME Promotions Portal,  the idea was not only simple, but it also helped me cut my business expenses by more than 50%, I got rid of the rented space and let go of my staff who were bringing in much less than I was paying them. I get most consulting assignments through the site and have automated a lot of the processes behind my business dealings to save me time so that I can concentrate on what I do best.

This site is not only for me, other people have started using the site to sell their products for a small fee. Giving them an opportunity to only pay after their products are sold. How does that help? If you are in a situation that I was in, having to pay upfront for everything sucks up all your working capital and spoils your prospects and leaving your business with no cash to work with. This leaves the business with a little bit of money to spend on basic needs.

Sorry if this sounded like bragging, it was not intended to and I urge you to keep reading, you might just be able to find something that works for you here.

2   Break away from conventional marketing practices.

 

If you started a business the way I did then you would know about what I am about to say. Many people out there think having a business is about having merchandise in store and putting ads everywhere to let people know where to find you; or even worse hoping that people will easily come by your store looking for what you got.

Others spend most of their starting capital on radio and TV commercials like I did, when they know they have no way of measuring where the traffic is coming from, so that they can cut out stuff that is not working. The sad thing is that many advertisers out there do not care whether you get your returns out of your advertising dollar and honestly, they shouldn’t, because they are in business to make money. Otherwise how would you feel if somebody told you that every time you sold a frying pan to a family, you would have to follow them around to make sure they are using it. It is not your business, your business is selling frying pans and you should stick to that.

To make sure your business can survive, you have start talking to people you know and trust or people that trust you, about what you are offering. Do not try to push it on to them, just tell them know about it. Chances are, that next time they hear somebody looking for what you have, they would refer them to you. The idea is that the few that you know are going to tell a few others that they know and the game continues… viral marketing… if you get where I am heading. The best tool for viral marketing is word-of-mouth, you either learn to use it or loose business.

Save your marketing dollar, by cutting out all the stuff that does not work, the world is bombarded with marketing messages every second and many people are beginning to ignore marketers who interrupt them with a sales proposition. Watch your competitors see what they are doing wrong and learn from it.

My nephew Sylvester had just learned a hard lesson from interruptive marketing, we were distributing flyers about our business and most of the time he would get a mean look and be told that people did not have time for what he was trying to sell them. After going through the pile of flyers, we would sit and talk about how people are responding, why they are responding that way? and what we needed to do to overcome that?. Just make sure you do this all the time, otherwise you are going to waste a lot of your resources and not understand what is going on when they do not show up at your store.

If your business is too small, try online merchandising. You look for a cheaper way  to sell your products on the internet. This will cut your expenses in terms of rent, expensive advertising and even the commuting time as this will enable to work from home. Besides, you will be able to market to a wider audience and do not have to be awake to take orders. This is not an easy cookie though, you will have to spend some time researching internet marketing and optimizing your website for best results.

3   Help your customers find the help you do not offer.

Customers are very interesting people, one thing is that many of them do not want to be sold something. They want to buy something and hopefully from you. They tend to ask people they trust of their opinion on other businesses or even products.

No matter how much you hate your competitor or how desperate you need their dollar, if you do not have what they are looking for, politely tell them that you can not provide it and they should check with your competitor or some of your non competing partners for that matter.  Never delay their purchase out of greed until you have the product to sell to them, leave that to them to decide.

Never bad-mouth a customer, even when you catch them buying the product you have from your competitor when you believe they should be buying from you. I have had someone from my household buy something I was selling from a competitor. I watched them do it and they later thought they should have bought from me. Whether out of guilt or something else, they told five of their friends that I had the product and all five bought from me. Had I reacted differently, the best case would have been that they would return the product to the store and buy from me and never bring anyone. The worst case would be not returning it, not referring anybody to me and decide not to ever talk to me. The funny thing about customers is that the more you help them, the more they get to trust you and they might even bring their friends to your business knowing that they will get help regardless of whether you have what they are looking for or not. Why is this important? People get to  you first before they get to somebody else, thus you have a chance to sell them something first before your competitor.

4   Ask non-competing business owners for help and return the favor.

 

If you are to survive in business, you have to acquire some friends hopefully people that are already in business but are not your direct competitors. You should do this for a few reasons, one is that since you are not competitors, you are more likely to need what they offer and so are they. These people might end up being your biggest customers or they may even refer their customers to your business.

Two, Since they are already in business, it is very likely that you think the same way. This gives you an opportunity to pick their brains on something that you need help with. Remember for the most part, we are defined by who we associate with. If you hang around thieves, you will be considered a thieve; and if you hang around very successful people, you will be considered successful, as long as you work hard enough to think and behave like them, for them not to run away from you.

Three, people around you are watching even when you think they are not. What you say to one about other people may come to haunt you. If you have hanged around somebody that gossips a lot, would it not bother you as to what they say behind your back? Or rather as to what would stop them from saying about you what they say to you about others? The same thing happens in business, when things are not going well, you reach out to others for help. This almost always works as long as you remain  accommodating about others reaching out to you. Keep what they tell you in confidence, confidential. This will earn you a good reputation, trust and in many cases new business or referrals.

<h4>5   Be Careful of hyped advertisers trying to take your last pennies.

 

How often do you see something like this? “Get ranked high on major search engines in 24 hours for a small fee” or rather an interesting one “Make up to $400 a day working at home using our proven system” and at the end of the page, they ask you to pay $300 to get you started.

These are all people wanting to get your money for their own benefit. First of all the web is full of people competing for the top ranking. Even if it was true that they would get you top ranking on Google or Yahoo, how long do you think you will stay there. Besides, these ads go to millions of people who maybe in the same business category that you are in, and just out of curiosity, how many millions would fit into Google or Yahoo’s top 10 ranking?

I am not completely dismissing the fact that some of them may be good, but if you are going to give somebody your money to use an automated system to put you on these search engines, then you got to think twice, because some search engines may be smart enough to know these tricks. Besides, if Google and/or Yahoo gets their money from online advertising, would you not think that they would watch out for sneaky marketing approaches like this, using their space to make money from you?

Secondly, Have you ever looked for a job and your employer tells you to pay them first before they gave you the job? If they did then, I would question the legality of their business.

What I am saying here is that you do not have to jump at every marketing message you hear, which is very common when you are desperate to see your business idea take off; or even to simply put something on the table. So trade wise, learn a lot by reading a lot and let your business grow. If you are going to succeed with online marketing your keyword research has to be done by you, since you and only you knows what you would like to get out of it and how much you want to pay for it.

6   Combine forces and let your marketing dollar take you a little farther.

 

My seventh grade teacher once demonstrated to me how powerful you can be by combining forces with other people for greater results. This may have nothing to do with business, but just hear me out.

This guy had noticed that kids in his class were not getting along, so he decides he is going to make the class sing, but everyone singing a different song, then asked three students to stand outside the class, so that after the song, they would come back and report on what they got from the song. After the first song, the three students came back into the class an reported different things about the same song, all of which were not accurate.

Then he decided to get the class to sing one song, with everyone singing to the same song at the same time. While the students were singing, he asked the three students to go a little farther from the classroom. After the second song, he invited the three students back into the class and asked them to report on the song they had just listened to. All three reported accurately.

So, what is the deal here? There are many people out there who think, they can do it on their own, ignoring the fact that their potential customers are getting bombarded with marketing messages from all over the place. The sad thing is that they end up spending a lot of money trying to get the word out, but because they are not in tune with others their messages do not get to the intended recipient. They finally grow tired and quit, even when there is a huge potential for success.

The best survival skill is to learn to play along with others while at the same time acknowledging that there are things that affects us differently from the way they affect others, even those closest to us. Anybody who had done stock trading would tell you “Never fight against the trend, if you plan on winning”. Take some time, listen to what people are saying about certain products, research a little to see if there is real demand for the product or service, determine whether people who are talking about it are real buyers and not just people who would want something of great value for almost nothing.

Why am I saying this? A lot of times, people would tell you about what they want, you get it to them, you realize they want it for much less or even worse, you realize that they are actually among the 80% who wants people to talk to them, but have no interest in buying anything. Watch out for those, if you come across one, politely excuse yourself and move on. Otherwise you will spend 80% of your time and resources selling to non-buyers.  Be careful though to distinguish non-buyers from potential buyers who are skeptical about your product.

7   Deliver what is promised on time.

A few months ago, a friend of mine came to me and said “I hear you do computer stuff, My computer is not starting and I would like you to take a look”. I asked him a few questioned and had determined that his problem is likely to be a hardware issue. I told him I would take a look, but at the same time I also told him that I was a software guy and I knew of another guy that did hardware stuff. As soon as I mentioned his name, the guy goes “Nope, I am not going back there, because he takes a long time to get things done”.  This had been the second person to say the same about this guy.

Although I was not a customer, It sort of made me hesitant to recommend him to anyone. If they did not get the service they deserved with this guy, it would put my credibility on the line. Now every time somebody asks me where to get their computers fixed, I would say I was not sure or would at least warn them before referring them to him. Who knows how much business he is loosing as a result of this? His former customers might be telling their friends to not go there.

Speedy and high quality service has proven to be the key to small business success. Follow up to make sure they are satisfied. This way you show that you are not only interested in getting rid of your product but also care about how they feel about the product. Just do not go overboard and get into how and whether they use the product, that is their business. Keep focused on delivering the best quality products and/or service and make sure they can come back or bring their friends for more. That is your part, the rest is up to them.

 

By: Simon Mangundu

About the Author:

 

Simon Mangundu is has been a business systems analyst for organizations in both public and private sectors for the last six years. He is specialized in software development and has extensive experience working with small and medium sized businesses, at home and overseas. Simon is also the owner and developer of SME Promotions Protal

Kansieo.com

Business Valuation

business
BUSINESS VALUATION

Business valuation is a process and a set of procedures used to determine the economic value of an owner’s interest in a business. Business valuation is often used to estimate the selling price of a business, resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among the business assets, establish a formula for estimating the value of partners’ ownership interest for buy-sell agreements, and many other business and legal disputes.

Standard and Premise of Business Value

Before the value of a business can be measured, the valuation assignment must specify the reason for and circumstances surrounding the business valuation. These are formally known as the business value standard and premise of value.

Business valuation results can vary considerably depending upon the choice of both the standard and premise of value. For example, a business buyer and seller may bargain to establish the value of business assets that approaches the fair market value standard.

However, the value conclusions based on the going concern premise and that of assemblage of business assets may be quite different. One reason is that an operating business creates value by means of its ability to coordinate its capital, human and management resources to produce economic income. The same set of assets not currently used to produce income is generally worth less.

Reasons for Business Valuation

Business people may need to conduct business valuation for a number of reasons including sale, estate tax planning, estate tax valuation, divorce, business purchase price allocation, collateral documentation, litigation and documenting that a sales price is equitable.

Fair market value

“Fair market value”, a central standard of measuring business value, is defined as the price at which property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. See IRS Rev. Rul. 59-60, 1959-1, Cum. Bulletin 237, codified at 26 C.F.R. § 20.2031-1(b).

The fair market value standard incorporates certain assumptions, including the assumptions that the hypothetical purchaser is reasonably prudent and rational but is not motivated by any synergistic or strategic influences; that the business will continue as a going concern and not be liquidated; that the hypothetical transaction will be conducted in cash or equivalents; and that the parties are willing and able to consummate the transaction.

These assumptions might not, and probably do not, reflect the actual conditions of the market in which the subject business might be sold. However, these conditions are assumed because they yield a uniform standard of value, after applying generally-accepted valuation techniques, which allows meaningful comparison between businesses which are similarly situated.

Elements of business valuation

Economic conditions

A business valuation report generally begins with a description of national, regional and local economic conditions existing as of the valuation date, as well as the conditions of the industry in which the subject business operates. A common source of economic information for the first section of the business valuation report is the Federal Reserve Board’s Beige Book, published quarterly by the Federal Reserve Bank. State governments and industry associations often publish useful statistics describing regional and industry conditions.

Financial Analysis

The financial statement analysis generally involves common size analysis, ratio analysis (liquidity, turnover, profitability, etc.), trend analysis and industry comparative analysis. This permits the valuation analyst to compare the subject company to other businesses in the same or similar industry, and to discover trends affecting the company and/or the industry over time. By comparing a company’s financial statements in different time periods, the valuation expert can view growth or decline in revenues or expenses, changes in capital structure, or other financial trends. How the subject company compares to the industry will help with the risk assesment and ultimately help determine the discount rate and the selection of market multiples.

Normalization of financial statements

The most common normalization adjustments fall into the following four categories:

Comparability Adjustments. The valuator may adjust the subject company’s financial statements to facilitate a comparison between the subject company and other businesses in the same industry or geographic location. These adjustments are intended to eliminate differences between the way that published industry data is presented and the way that the subject company’s data is presented in its financial statements.

Non-operating Adjustments. It is reasonable to assume that if a business were sold in a hypothetical sales transaction (which is the underlying premise of the fair market value standard), the seller would retain any assets which were not related to the production of earnings or price those non-operating assets separately. For this reason, non-operating assets (such as excess cash) are usually eliminated from the balance sheet.

Non-recurring Adjustments. The subject company’s financial statements may be affected by events that are not expected to recur, such as the purchase or sale of assets, a lawsuit, or an unusually large revenue or expense. These non-recurring items are adjusted so that the financial statements will better reflect the management’s expectations of future performance.

Discretionary Adjustments. The owners of private companies may be paid at variance from the market level of compensation that similar executives in the industry might command. In order to determine fair market value, the owner’s compensation, benefits, perquisites and distributions must be adjusted to industry standards. Similarly, the rent paid by the subject business for the use of property owned by the company’s owners individually may be scrutinized.

Income, Asset and Market Approaches

Three different approaches are commonly used in business valuation: the income approach, the asset-based approach, and the market approach. Within each of these approaches, there are various techniques for determining the fair market value of a business. Generally, the income approaches determine value by calculating the net present value of the benefit stream generated by the business (discounted cash flow); the asset-based approaches determine value by adding the sum of the parts of the business (net asset value); and the market approaches determine value by comparing the subject company to other companies in the same industry, of the same size, and/or within the same region.

In determining which of these approaches to use, the valuation professional must exercise discretion. Each technique has advantages and drawbacks, which must be considered when applying those techniques to a particular subject company. Most treatises and court decisions encourage the valuator to consider more than one technique, which must be reconciled with each other to arrive at a value conclusion. A measure of common sense and a good grasp of mathematics is helpful.

INCOME APPROACHES

The income approaches determine fair market value by multiplying the benefit stream generated by the subject company times a discount or capitalization rate. The discount or capitalization rate converts the stream of benefits into present value. There are several different income approaches, including capitalization of earnings or cash flows, discounted future cash flows (“DCF”), and the excess earnings method (which is a hybrid of asset and income approaches). Most of the income approaches consider the subject company’s historical financial data; only the DCF method requires the subject company to provide projected financial data. Most of the income approaches look to the company’s adjusted historical financial data for a single period; only DCF requires data for multiple future periods. The discount or capitalization rate must be matched to the type of benefit stream to which it is applied. The result of a value calculation under the income approach is generally the fair market value of a controlling, marketable interest in the subject company, since the entire benefit stream of the subject company is most often valued, and the capitalization and discount rates are derived from statistics concerning public companies.

Discount or capitalization rates

A discount or capitalization rate is used to determine the present value of the expected returns of a business. The discount rate and capitalization rate are closely related to each other, but distinguishable. Generally speaking, the discount rate or capitalization rate may be defined as the yield necessary to attract investors to a particular investment, given the risks associated with that investment. The discount rate is applied only to discounted cash flow (DCF) valuations, which are based on projected business data over multiple periods of time. In DCF valuations, a series of projected cash flows is divided by the discount rate to derive the present value of the discounted cash flows. The sum of the discounted cash flows is added to a terminal value, which represents the present value of business cash flows into perpetuity. The sum of the discounted cash flows and the terminal value is the value of the business.

On the other hand, a capitalization rate is applied in methods of business valuation that are based on historical business data for a single period of time. The after-tax net cash flow capitalization rate is equal to the discount rate minus the long-term sustainable growth rate. The after-tax net cash flow of a business is divided by the capitalization rate to derive the present value. Capitalization rates may be modified so that they may be applied to after-tax net income or pre-tax cash flows or income. There are several different methods of determining the appropriate discount rates. The discount rate is composed of two elements: (1) the risk-free rate, which is the return that an investor would expect from a secure, practically risk-free investment, such as a government bond; plus (2) a risk premium that compensates an investor for the relative level of risk associated with a particular investment in excess of the risk-free rate. Most importantly, the selected discount or capitalization rate must be consistent with stream of benefits to which it is to be applied.

Build-Up Method

The Build-Up Method is a widely-recognized method of determining the after-tax net cash flow discount rate, which in turn yields the capitalization rate. The figures used in the Build-Up Method are derived from various sources. This method is called a “build-up” method because it is the sum of risks associated with various classes of assets. It is based on the principle that investors would require a greater return on classes of assets that are more risky. The first element of an Build-Up capitalization rate is the risk-free rate, which is the rate of return for long-term government bonds. Investors who buy large-cap equity stocks, which are inherently more risky than long-term government bonds, require a greater return, so the next element of the Build-Up method is the equity risk premium. In determining a company’s value, the long-horizon equity risk premium is used because the Company’s life is assumed to be infinite. The sum of the risk-free rate and the equity risk premium yields the long-term average market rate of return on large public company stocks.

Similarly, investors who invest in small cap stocks, which are riskier than blue-chip stocks, require a greater return, called the “size premium.” Size premium data is generally available from two sources: Morningstars’ (formerly Ibbotson & Associates’) Stocks, Bonds, Bills & Inflation and Duff & Phelps’ Risk Premium Report.

By adding the first three elements of a Build-Up discount rate, we can determine the rate of return that investors would require on their investments in small public company stocks. These three elements of the Build-Up discount rate are known collectively as the “systematic risks.”

In addition to systematic risks, the discount rate must include “unsystematic risks,” which fall into two categories. One of those categories is the “industry risk premium.” Morningstar’s yearbooks contain empirical data to quantify the risks associated with various industries, grouped by SIC industry code.

The other category of unsystematic risk is referred to as “specific company risk.” Historically, no published data has been available to quantify specific company risks. However as of late 2006, new research has been able to quantify, or isolate, this risk for publicly-traded stocks through the use of Total Beta calculations. P. Butler and K. Pinkerton have outlined a procedure using a modified Capital Asset Pricing Model (CAPM) to calculate the company specific risk premium. The model uses an equality between the standard CAPM which relies on the total beta on one side of the equation; and the firm’s beta, size premium and company specific risk premium on the other. The equality is then solved for the company specific risk premium as the only unknown. While this is ground-breaking research, it has yet to be adopted and used by the valuation community at large.

It is important to understand why this capitalization rate for small, privately-held companies is significantly higher than the return that an investor might expect to receive from other common types of investments, such as money market accounts, mutual funds, or even real estate. Those investments involve substantially lower levels of risk than an investment in a closely-held company. Depository accounts are insured by the federal government (up to certain limits); mutual funds are composed of publicly-traded stocks, for which risk can be substantially minimized through portfolio diversification; and real estate almost invariably appreciates in value of long time horizons.

Closely-held companies, on the other hand, frequently fail for a variety of reasons too numerous to name. Examples of the risk can be witnessed in the storefronts on every Main Street in America. There are no federal guarantees. The risk of investing in a private company cannot be reduced through diversification, and most businesses do not own the type of hard assets that can ensure capital appreciation over time. This is why investors demand a much higher return on their investment in closely-held businesses; such investments are inherently much more risky.

Capital Asset Pricing Model (“CAP-M”)

The Capital Asset Pricing Model is another method of determining the appropriate discount rate in business valuations. The CAP-M method originated from the Nobel Prize winning studies of Harry Markowitz, James Tobin and William Sharpe. Like the Ibbotson Build-Up method, the CAP-M method derives the discount rate by adding a risk premium to the risk-free rate. In this instance, however, the risk premium is derived by multiplying the equity risk premium times “beta,” which is a measure of stock price volatility. Beta is published by various sources (including Ibbotson Associates, which was used in this valuation) for particular industries and companies. Beta is associated with the systematic risks of an investment.

One of the criticisms of the CAP-M method is that beta is derived from the volatility of prices of publicly-traded companies, which are likely to differ from private companies in their capital structures, diversification of products and markets, access to credit markets, size, management depth, and many other respects. Where private companies can be shown to be sufficiently similar to public companies, however, the CAP-M model may be appropriate.

Weighted Average Cost of Capital (“WACC”)

The weighted average cost of capital is the third major approach to determining a discount rate. The WACC method determines the subject company’s actual cost of capital by calculating the weighted average of the company’s cost of debt and cost of equity. The WACC capitalization rate must be applied to the subject company’s net cash flow to invested equity. One of the problems with this method is that the valuator may elect to calculate WACC according to the subject company’s existing capital structure, the average industry capital structure, or the optimal capital structure. Such discretion detracts from the objectivity of this approach, in the minds of some critics.

Once the capitalization or discount rate is determined, it must be applied to an appropriate economic income streams: pretax cash flow, aftertax cash flow, pretax net income, after tax net income, excess earnings, projected cash flow, etc. The result of this formula is the indicated value before discounts. Before moving on to calculate discounts, however, the valuation professional must consider the indicated value under the asset and market approaches.

 

Careful matching of the discount rate to the appropriate measure of economic income is critical to the accuracy of the business valuation results. Net cash flow is a frequent choice in professionally conducted business appraisals. The rationale behind this choice is that this earnings basis corresponds to the equity discount rate derived from the Build-Up or CAP-M models: the returns obtained from investments in publicly traded companies can easily be represented in terms of net cash flows. At the same time, the discount rates are generally also derived from the public capital markets data.

Asset-based approaches

The value of asset-based analysis a business is equal to the sum of its parts. That is the theory underlying the asset-based approaches to business valuation. The asset approach to business valuation is based on the principle of substitution: no rational investor will pay more for the business assets than the cost of procuring assets of similar economic utility. In contrast to the income-based approaches, which require the valuation professional to make subjective judgments about capitalization or discount rates, the adjusted net book value method is relatively objective. Pursuant to accounting convention, most assets are reported on the books of the subject company at their acquisition value, net of depreciation where applicable. These values must be adjusted to fair market value wherever possible. The value of a company’s intangible assets, such as goodwill, is generally impossible to determine apart from the company’s overall enterprise value. For this reason, the asset-based approach is not the most probative method of determining the value of going business concerns. In these cases, the asset-based approach yields a result that is probably lesser than the fair market value of the business. In considering an asset-based approach, the valuation professional must consider whether the shareholder whose interest is being valued would have any authority to access the value of the assets directly. Shareholders own shares in a corporation, but not its assets, which are owned by the corporation. A controlling shareholder may have the authority to direct the corporation to sell all or part of the assets it owns and to distribute the proceeds to the shareholder(s). The non-controlling shareholder, however, lacks this authority and cannot access the value of the assets. As a result, the value of a corporation’s assets is rarely the most relevant indicator of value to a shareholder who cannot avail himself of that value. Adjusted net book value may be the most relevant standard of value where liquidation is imminent or ongoing; where a company earnings or cash flow are nominal, negative or worth less than its assets; or where net book value is standard in the industry in which the company operates. None of these situations applies to the Company which is the subject of this valuation report. However, the adjusted net book value may be used as a “sanity check” when compared to other methods of valuation, such as the income and market approaches.

Market approaches

The market approach to business valuation is rooted in the economic principle of competition: that in a free market the supply and demand forces will drive the price of business assets to a certain equilibrium. Buyers would not pay more for the business, and the sellers will not accept less, than the price of a comparable business enterprise. It is similar in many respects to the “comparable sales” method that is commonly used in real estate appraisal. The market price of the stocks of publicly traded companies engaged in the same or a similar line of business, whose shares are actively traded in a free and open market, can be a valid indicator of value when the transactions in which stocks are traded are sufficiently similar to permit meaningful comparison.

The difficulty lies in identifying public companies that are sufficiently comparable to the subject company for this purpose. Also, as for a private company, the equity is less liquid (in other words its stocks are less easy to buy or sell) than for a public company, its value is considered to be slightly lower than such a market-based valuation would give

Guideline Public Company method

The Guideline Public Company method entails a comparison of the subject company to publicly traded companies. The comparison is generally based on published data regarding the public companies’ stock price and earnings, sales, or revenues, which is expressed as a fraction known as a “multiple.” If the guideline public companies are sufficiently similar to each other and the subject company to permit a meaningful comparison, then their multiples should be nearly equal. The public companies identified for comparison purposes should be similar to the subject company in terms of industry, product lines, market, growth, and risk.

Transaction Method or Direct Market Data Method

Using this method, the valuation analyst may determine market multiples by reviewing published data regarding actual transactions involving either minority or controlling interests in either publicly traded or closely held companies. In judging whether a reasonable basis for comparison exists, the valuation analysis must consider: (1) the similarity of qualitative and quantitative investment and investor characteristics; (2) the extent to which reliable data is known about the transactions in which interests in the guideline companies were bought and sold; and (3) whether or not the price paid for the guideline companies was in an arms-length transaction, or a forced or distressed sale.

Discounts and premiums

The valuation approaches yield the fair market value of the Company as a whole. In valuing a minority, non-controlling interest in a business, however, the valuation professional must consider the applicability of discounts that affect such interests. Discussions of discounts and premiums frequently begin with a review of the “levels of value.” There are three common levels of value: controlling interest, marketable minority, and non-marketable minority. The intermediate level, marketable minority interest, is lesser than the controlling interest level and higher than the non-marketable minority interest level. The marketable minority interest level represents the perceived value of equity interests that are freely traded without any restrictions. These interests are generally traded on the New York Stock Exchange, AMEX, NASDAQ, and other exchanges where there is a ready market for equity securities. These values represent a minority interest in the subject companies – small blocks of stock that represent less than 50% of the company’s equity, and usually much less than 50%. Controlling interest level is the value that an investor would be willing to pay to acquire more than 50% of a company’s stock, thereby gaining the attendant prerogatives of control. Some of the prerogatives of control include: electing directors, hiring and firing the company’s management and determining their compensation; declaring dividends and distributions, determining the company’s strategy and line of business, and acquiring, selling or liquidating the business. This level of value generally contains a control premium over the intermediate level of value, which typically ranges from 25% to 50%. An additional premium may be paid by strategic investors who are motivated by synergistic motives. Non-marketable, minority level is the lowest level on the chart, representing the level at which non-controlling equity interests in private companies are generally valued or traded. This level of value is discounted because no ready market exists in which to purchase or sell interests. Private companies are less “liquid” than publicly-traded companies, and transactions in private companies take longer and are more uncertain. Between the intermediate and lowest levels of the chart, there are restricted shares of publicly-traded companies. Despite a growing inclination of the IRS and Tax Courts to challenge valuation discounts , Shannon Pratt suggested in a scholarly presentation recently that valuation discounts are actually increasing as the differences between public and private companies is widening . Publicly-traded stocks have grown more liquid in the past decade due to rapid electronic trading, reduced commissions, and governmental deregulation. These developments have not improved the liquidity of interests in private companies, however. Valuation discounts are multiplicative, so they must be considered in order. Control premiums and their inverse, minority interest discounts, are considered before marketability discounts are applied.

Discount for lack of control

The first discount that must be considered is the discount for lack of control, which in this instance is also a minority interest discount. Minority interest discounts are the inverse of control premiums, to which the following mathematical relationship exists: MID = 1 – [ 1 / (1 + CP)] The most common source of data regarding control premiums is the Control Premium Study, published annually by Mergerstat since 1972. Mergerstat compiles data regarding publicly announced mergers, acquisitions and divestitures involving 10% or more of the equity interests in public companies, where the purchase price is $1 million or more and at least one of the parties to the transaction is a U.S. entity. Mergerstat defines the “control premium” as the percentage difference between the acquisition price and the share price of the freely-traded public shares five days prior to the announcement of the M&A transaction. While it is not without valid criticism, Mergerstat control premium data (and the minority interest discount derived therefrom) is widely accepted within the valuation profession.

Discount for lack of marketability

Another factor to be considered in valuing closely held companies is the marketability of an interest in such businesses. Marketability is defined as the ability to convert the business interest into cash quickly, with minimum transaction and administrative costs, and with a high degree of certainty as to the amount of net proceeds. There is usually a cost and a time lag associated with locating interested and capable buyers of interests in privately-held companies, because there is no established market of readily-available buyers and sellers. All other factors being equal, an interest in a publicly traded company is worth more because it is readily marketable. Conversely, an interest in a private-held company is worth less because no established market exists. The IRS Valuation Guide for Income, Estate and Gift Taxes, Valuation Training for Appeals Officers acknowledges the relationship between value and marketability, stating: “Investors prefer an asset which is easy to sell, that is, liquid.” The discount for lack of control is separate and distinguishable from the discount for lack of marketability. It is the valuation professional’s task to quantify the lack of marketability of an interest in a privately-held company. Because, in this case, the subject interest is not a controlling interest in the Company, and the owner of that interest cannot compel liquidation to convert the subject interest to cash quickly, and no established market exists on which that interest could be sold, the discount for lack of marketability is appropriate. Several empirical studies have been published that attempt to quantify the discount for lack of marketability. These studies include the restricted stock studies and the pre-IPO studies. The aggregate of these studies indicate average discounts of 35% and 50%, respectively. Some experts believe the Lack of Control and Marketabilty discounts can aggregate discounts for as much as ninety percent of a Company’s fair market value, specifically with family owned companies.

Restricted stock studies

Restricted stocks are equity securities of public companies that are similar in all respects to the freely traded stocks of those companies except that they carry a restriction that prevents them from being traded on the open market for a certain period of time, which is usually one year (two years prior to 1990). This restriction from active trading, which amounts to a lack of marketability, is the only distinction between the restricted stock and its freely-traded counterpart. Restricted stock can be traded in private transactions and usually do so at a discount. The restricted stock studies attempt to verify the difference in price at which the restricted shares trade versus the price at which the same unrestricted securities trade in the open market as of the same date. The underlying data by which these studies arrived at their conclusions has not been made public. Consequently, it is not possible when valuing a particular company to compare the characteristics of that company to the study data. Still, the existence of a marketability discount has been recognized by valuation professionals and the Courts, and the restricted stock studies are frequently cited as empirical evidence. Notably, the lowest average discount reported by these studies was 26% and the highest average discount was 45%.

Option pricing

In addition to the restricted stock studies, U.S. publicly traded companies are able to sell stock to offshore investors (SEC Regulation S, enacted in 1990) without registering the shares with the Securities and Exchange Commission. The offshore buyers may resell these shares in the United States, still without having to register the shares, after holding them for just 40 days. Typically, these shares are sold for 20% to 30% below the publicly traded share price. Some of these transactions have been reported with discounts of more than 30%, resulting from the lack of marketability. These discounts are similar to the marketability discounts inferred from the restricted and pre-IPO studies, despite the holding period being just 40 days. Studies based on the prices paid for options have also confirmed similar discounts. If one holds restricted stock and purchases an option to sell that stock at the market price (a put), the holder has, in effect, purchased marketability for the shares. The price of the put is equal to the marketability discount. The range of marketability discounts derived by this study was 32% to 49%.

Pre-IPO studies

Another approach to measure the marketability discount is to compare the prices of stock offered in initial public offerings (IPOs) to transactions in the same company’s stocks prior to the IPO. Companies that are going public are required to disclose all transactions in their stocks for a period of three years prior to the IPO. The pre-IPO studies are the leading alternative to the restricted stock stocks in quantifying the marketability discount. The pre-IPO studies are sometimes criticized because the sample size is relatively small, the pre-IPO transactions may not be arm’s length, and the financial structure and product lines of the studied companies may have changed during the three year pre-IPO window.

Applying the studies

The studies confirm what the marketplace knows intuitively: Investors covet liquidity and loathe obstacles that impair liquidity. Prudent investors buy illiquid investments only when there is a sufficient discount in the price to increase the rate of return to a level which brings risk-reward back into balance. The referenced studies establish a reasonable range of valuation discounts from the mid-30%s to the low 50%s. The more recent studies appeared to yield a more conservative range of discounts than older studies, which may have suffered from smaller sample sizes. Another method of quantifying the lack of marketability discount is the Quantifying Marketability Discounts Model (QMDM).

By: Kiran Kumar Cherupalli

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