Every time I take my car for a warrant of fitness I have a sense of foreboding. I’ve gone through the carwash on my way and I’ve binned all the empty pie wrappers from under the driver’s seat. That’ll help, I think.

I pay my fee and get the clipboard with the checklist. But deep down, all is not well. I know I should have fixed the handbrake they warned me about in the last check, and the tyres that scraped through last time have done a few kilometres since. I rifle through the pile of old magazines in the waiting room looking for something suitably masculine to pass the time. The guy with the overalls and the clipboard has control— and he knows it!

Is this how you want to feel when you are selling your business? Do you want the purchaser to be like the clipboard guy and control your sale? Or is there a better way? The answer is ‘yes’. Read on to find out how.

‘Vendor due diligence’ is a bit of a buzz phrase but it’s really just another term for a pre-sale business warrant of fitness. An independent check of your business against a checklist of points to flush out problems and, having completed the check, dealing with the necessary corrective actions.

Typical legal issues for a vendor warrant of fitness check include:

• contracts/agreements— do they exist? What are their terms? Can they be assigned?
• employment—do your agreements comply with employment laws, are there redundancy or other issues?
• intellectual property (IP) and information technology (IT)—is IP protected and is IT and software compliant?
• property and leases—are leases reasonable, do they have sufficient time to run? What are the assignment terms?
• litigation—is there any current litigation?
• regulatory issues and corporate records—where are the business and corporate records and are these compliant? Are all regulatory requirements up-to-date?
• structuring—is there any restructuring that is desirable or necessary prior to sale?

So why don’t business owners do a pre-sale warrant of fitness check? I put it down largely to time and cost. Vendors don’t see the investment value in time or money. But the value is there!

To fully understand why the vendor due diligence is so critical, it is useful to fast forward to the negotiation and documentation of the deal. Timing is often critical. Once a potential purchaser is on the hook it is essential to be in a position to anticipate purchaser information requirements and provide clear, concise information in accordance with a tight timeframe.

The vendor also needs to anticipate the terms a purchaser will likely require in a sale and purchase agreement. Even better, prepare a pro-forma of the agreement and present it to the purchaser and dictate these yourself.

Another key issue in any vendor due diligence involves considering those issues which will likely be the subject of warranties in a sale and purchase agreement. If you haven’t undertaken a due diligence as vendor, how can you be satisfied that the information and warranties you provide are correct? Remember, a breach of warranties could lead to a damages claim.

My experience from involvement in many business sale transactions over recent years provides some salutary lessons for vendors who don’t undertake a pre-sale warrant of fitness check and necessary corrective actions.

Some examples include:

• Most businesses are taken to market too early and without adequate preparation.
• Almost without exception the preparation and presentation of businesses for sale has been haphazard (at best).
• In many cases instead of the seller driving the sale process, a lack of seller preparation means the process is hijacked by the buyer.
• Buyers seldom proceed without undertaking their own buyer due diligence.
• Buyer due diligence inevitably turns up issues which could have been rectified by some simple planning and corrective actions.
• The buyer in many cases used its due diligence findings to leverage price downwards— commonly by tens of thousands of dollars and, in some cases, hundreds of thousands of dollars.
• The sale has fallen over altogether for seemingly quite minor issues.

In all cases this could have been avoided by the seller doing a pre-sale warrant of fitness check. By the way, my car failed so, my advice is, take the time and make the investment. It will save a lot of heartache in the end.

JOHN KIRKWOOD is a corporate and commercial partner with law firm Hesketh Henry.

After the next Rugby World Cup, All Blacks’ management, coaches and the players will construct a strategy on how to build the next champion team.

They won’t be alone. Olympians do it, footballers do it, Formula One drivers do it. Even referees plan for improvement. As armchair critics we do the same for our favourite teams. So, why don’t we as business owners take the same dedicated approach to growing business value?

Planning, control, vision and purpose are all strong words we associate with winners. Practicing clichés such as ‘flying by the seat of your pants’ or ‘winging it’ aren’t acceptable by today’s business leaders. These leaders know that proactive planners will always have the jump on the reactive followers. Which do you want to be? Now is when we should be building strategies to ensure our businesses continue to be stronger and more profitable come the 2011 Rugby World Cup.

I suppose the reason we avoid such planning is because it’s hard. It requires your board and senior management team to step out of the day-to-day operations to focus on the big picture. Consideration needs to be given to the strengths and weaknesses, (internal factors) plus the opportunities and threats (external factors) affecting your business. This process is outside the comfort zone of many owners.

Where do we start and what are some key issues we should consider? If there are any known holes or skeletons in your business today, then these should be addressed first as growth will only exploit a weakness. An honest criticism of your current situation is critical to success. Your business can’t afford to be suffering any internal bleeding when chasing a new battle. There are, however, recurring issues that should continually be revisited to ensure your business remains the benchmark in its industry:

Embrace the latest technology

If you’re serious about working smarter not harder and offering new solutions then you need to find new ways to do it. Introduce technology into your warehouse, operations, manufacturing, sales force, product lines, and finance. Ongoing research and development into all parts of your business are essential. It needs your energy and cash reserves but offers a return in growth and security, two qualities that are crucial to success.

Review staffing resources

Employees are what many business owners believe are their biggest asset. The labour market is tight and it’s not expected to improve. Addressing the differing needs of the X & Y generations is hard. What will the needs of the next generation be? Glide time, hours of accessibility, training and transfer of knowledge, motivational tools, culture and a friendly working environment take effort and fine-tuning. What about recruitment? How many, when, how much will they cost, and where from?

Creating your next Unique Selling Point (USP).

This is what separates your business from the crowd and allows you to operate in that top quartile of businesses in your industry. If you have one, look for your next one. If you don’t have one, get one. To grow your bottom line you must grow your top line. You must have a product or service that everyone wants. Create the demand. That next USP could include improving quality or performance of existing products, introducing new products, or developing a new business altogether. Whatever your USP, make sure it’s in your marketing.

Assess your capacity to perform

Is investment into capital expenditure required so that you will be able to cope with your growth plans? Are assets tired and in need of upgrade? Are your current assets costing you in efficiency? The outcomes derived from the three issues above will invariably impact on your capital needs. How are you going to fund it? Cashflow forecasting will be required and a timetable of events will unfold for product development, asset replacement, and marketing. You can’t get the sales in the door then buy the capital equipment to produce it, as you’ll lose the sale and customer goodwill.

Back to the sports field, why not ask yourself: Where do you want your business to be after the 2011 Rugby World Cup, and more importantly, how are you going to get there?

Aaron Wallace is a business improvement director with Hayes Knight

At some point, most business owners will consider selling their business. But to whom? And do the buyers actually have enough resources to see the deal through? At ASB we get involved in many such transactions. Sometimes we get asked to outline all the options. That’s a tough one, because there’s no one single way to transition a business. But there are some key facts about the who and the how.

Who

Family

As the majority of New Zealand businesses are privately owned, selling the business to family members is an obvious option. But there are plenty of questions that go with this: can they afford it, assuming it is not being gifted outright to them? Are they capable of running it? Do they actually want to? Family businesses also have an additional challenge— the emotional connection. Not every family is equipped for inter-generational succession.

Trade player

For many years, this was, along with family, probably the most popular option for Kiwi businesses. It is still a natural possibility as trade players know the industry and can introduce synergies and cost savings which may allow them to pay more.

Existing management team

This group is a very logical buyer, especially where the owner has devolved responsibility to them over time. One of the perceived problems is ‘can they afford it?’ With the right structure the answer is yes, but there have been plenty of times when highly capable managers have missed out buying the business simply due to a perception that funding would be an issue.

New management team

Hired specifically one to two years prior to sale with a view they will become the new owners. The team is often provided equity through their employment package as an incentive. The trade-off here is to balance interim performance against the ultimate purchase price.

External (new) managers/owners

Sometimes called a ‘management buy-in’, this type of sale involves a new team buying and managing the business. It could be an experienced manager from a competitor or someone with enthusiasm and capability. This form of buy-out carries slightly higher risk due to the new owner’s possible lack of specific experience.

Private Equity

This is synonymous with high profile New Zealand and offshore professional firms and deals such as Yellow Pages, NZ Crane Hire, Max Fashions and Kathmandu. But private equity also works at a more basic level when an individual or a group, with access to capital (the equity), makes the acquisition and raises debt against the business cash flows to pay for the balance, usually looking to appoint or retain a management team to run the business.

Combinations of the above

Any number of permutations of the above could occur, there is no single formula. For example, the existing owner may retain some shareholding alongside management (existing or new), there could be a combination of new and existing management buying the business (a BIMBO – Buy-In/Management Buy- Out), and private equity firms will incentivise management with shares in the enterprise.

How can a buy-out be funded?

There are three main ways to fund a purchase.

Equity

Most purchases will require a level of equity to be put into the deal. Some purchasers will have the cash or can borrow against other assets or from other sources for their ‘equity’.

Debt

This may provide the majority of the purchase price. The debt can typically be raised against the cash flows of the business or other businesses/assets the purchaser owns. The key is to be able to buy 100% of the business to access those cash flows.

Vendor and current owner

This can be a good source of funding. Often the vendor will play the role of the ‘subordinated’ or secondranking funder behind the bank but ahead of the new owner. Clearly the vendor, understanding the business, will be comfortable to ‘lend back’ some of the sale proceeds. Another popular mechanism is the ‘earn-out’ whereby the vendor gets part of the payment on settlement with the balance being staggered payouts over an agreed period of time.

Whatever the sale process, the good news is that there are numerous ways to fund it. ASB is equipped to help as we understand business succession, for both large and small organisations, better than most banks.

DAVID VERRY is a corporate banking relationship executive at ASB

What kind of risk taker are you? We’ve found New Zealand employers fall into three broad categories when it comes to compliance with employment law:

• Compliance avoiders
• The “halfway house” business owners who comply in some respects, but not others; and
• Those who attempt to comply fully.

Compliance Avoiders.

Their risk-taking attitude tends to flow through most aspects of their business – tax, health and safety and, of course, employment.

Recruitment also gets short shrift, with employers going by ‘gut feel’ at an interview, or employing a mate of a mate. Employment history and references are only glanced at, if checked at all.

Not that avoiders have unsuccessful businesses. Often a great product or great people keep the business afloat, despite a lack of proper systems. Particularly for a startup company, systems and compliance appear as costs, distractions from the main goal of getting the product to market and growing the business.

But there’s a flip side. Every successful business outgrows the start-up entrepreneurism of its founder or founding team. That’s what growth is all about. And when the founder’s personal dynamism is no longer enough to drive the business, you need systems already in place to sustain that growth. ‘System’ sounds dreadful, like an institution, but systems are the only way of consistently applying the same ethos to all parts of the business. It is necessary. One person can no longer do it all.

Halfway Houses

Believe it or not, halfway houses are worse offenders than compliance avoiders. At least compliance avoiders have decided to take the risk; most halfway houses – in fact most businesses – mistakenly assume they’re not taking risks. We’ve found many halfway houses have rigorous systems – but only in areas managed by someone with enough clout to insist on those systems, such as finance. The business needs an overall view with a consistent risk management ethos that focuses its resources at its biggest risks. Just as you need systems to streamline production or service delivery, you need systems to ensure your business reduces its risks. This includes identifying a team of employees who believe in the business, and can carry it forward.

When you use a consistent approach to allocating budget, you may discover you need to do more marketing, develop your product or sort out your financial systems. It may also reveal that you’re at risk from a lack of employment compliance, at risk of losing key staff or you simply don’t have key staff.

A Risk Management Culture

Sometimes employment regulations seem like a barrier to getting things done, but in reality they provide an opportunity to develop rigorous systems, gear up your company for growth, and make it an attractive asset for a potential buyer.

A risk management culture will not only sort out your compliance but help you make the right decisions throughout your business. By making decisions systematically, you’ll be seen as a safer bet by potential investors or lenders – especially in tight financial times.

Compliance and Succession

Succession is not just about exiting your business; it’s about taking you and your business to the next level.

Succession can mean raising capital by borrowing, encouraging direct investment, or forming strategic partnerships. There are different ways of doing this, including selling shares to external investors, selling or issuing shares to senior employees, and a myriad of external options.

No matter how capital is raised for the business, it’s important to move the brilliance of your founders from an operational to a strategic role. Leave operations to the key group of employees in the business. Maybe that key group just isn’t there yet. In that case, your task is to identify the kind of people your business needs.

This is where getting your ducks in a row goes back to the beginning: recruitment. To make the right recruitment decisions, you need the right processes. If your processes are based on risk management principles, you’re far more likely to make the right choice, every time.

JIM ROBERTS is an employment law partner with law firm Hesketh Henry

I remember my trip last spring to the Barrier with the boys vividly. Off we set for a five-day adventure, with nothing in our heads but how many crays we were going to get, whether to go after Kingfish or Hapuka, and who was going to land that elusive 20lb snapper.

Day one: A blown dive regulator air hose and a weight belt left back in Auckland meant the boys had to dive in shifts - eating into valuable fishing time.

Day three: Two dive tanks out of test and unable to be filled.

Day four: Finally hooked that 20lb snapper! But then the reel seized, the line snapped. We came home with a sinking feeling - and no fish. We all knew we were better than that. Why hadn’t we addressed the basics and planned properly?

Back at work the following week, a client called me.

“I’ve got this opportunity to tender for a major contract, but I need to state some key facts about my business,” he said. “They want to know my asset replacement policy, my capacity to fund high stock levels, my ability to give priority service at short notice and to attract new employees, my reliance on key suppliers...and so on.”

My client could clearly perform the contract to a high level, but these questions painted his business in a poor light. I felt a chill of recognition as he said, “We’re better than this, but I just haven’t spent the time on the basic building blocks of my business.”

There was one important difference. I missed a 20lb snapper. My client faced missing an important deal for the future of his business.

Sometimes we need to understand when to cut bait and when to go fishing. Too many times we’re searching for growth and that “next big one”, but neglect to address the basics that’ll get us there.

We need to put some time aside to dissect our businesses and discover what areas need better focus. More importantly, we must choose to act on those issues once unearthed. Your business needs a ‘health check’ from time to time, and you need some independent help to ensure you reveal your company’s true position.

But what does a health check entail? Simply put, it leads to a review of the bones of the business and its stability. It can include a breakdown of each operating unit, branding and marketing strategies, financial stability and returns, customer dependability, competitor analysis, employee issues, environment (industry and economic sustainability), suppliers and fulfilment of compliance matters.

Each business will have it’s own hot issues to address. It’s a matter of accepting what action is required, by whom and by when. An honest business health check will help build a business plan and launch a business to the next level. In conjunction with this plan, you should also perform cash flow modelling, which incorporates marketing initiatives and capital expenditure, so you know what to expect and the timing of your working capital requirements.

Too often we concentrate on the financial indicators (including sales growth) but overlook the non-financial values. Employee attraction and retention, energy into innovation, and reducing reliance on the owners are examples of focusing on the non-financial lifelines of a business. Improve these and you will improve business value.

In planning for succession we need to reduce business risk. This will help increase business attractiveness and ultimately provide a better chance of realising that desired sale price. Your business should be robust enough to ride through an economic storm, recover from a poor contract or sales line, and have a strong base from which to launch growth or win that major job opportunity. Buyers are looking for future cash flows and the lowest risk possible in realising them.

Succession is a journey, not an event. It starts with a thorough investigation of where your business is now, so you can reel in that big one!

As you probably know well, events way beyond our shores can have a significant, often negative, impact on your operation.

For example, the ongoing fallout from the US sub-prime market is squeezing some New Zealand exporters in two ways. On one hand, the crisis has caused borrowers’ premiums to rise, even though sovereign debt yields have fallen.

At the same time, the crisis has generally weakened the US dollar against a number of cur­rencies, including the NZ dollar. That makes life pretty difficult for NZ exporters selling in US dollars with local borrowings.

Banks, through their Treasury operation, have a number of products that can help stabilize the cashflow of business clients by giving certainty of revenue or cost throughout an agreed period. While there’s a range of instruments to choose from the Treasury arsenal, the most commonly used products are IR swaps, IR caps, IR collars, and IR swaptions for IR risk, and for­ward exchange contracts (FEC) and FX options for FX risk.

Treasury products generally fall into one of two categories, i.e. Options (FX Option, IR Cap, IR Swaption) or Contracts (FEC, IR Swap, IR Collar). With all options a business does not have to exercise the instrument if prevailing market conditions are more favourable than the exercise rate of the option at its maturity.

Because of this inherent flexibility, the business pays an upfront premium for any option. This cost is based on a number of factors including:

• volatility of the market in which protection is sought
• the term of the option, and
• the proximity of the exercise rate to the current market rate.

Options are normally used for uncertain future events, e.g. tendering for business, when you’re not sure of future rate movements but believe they will move in your favour, and uncer­tainty around current exposures -for example a loan that might be repaid early.

In contrast, Contracts incur no cost to set up, but there is an obligation on a business to deal at the agreed rate with a bank (FX or IR), even if prevailing market conditions are more fa­vourable during the agreed term of the contract. Contracts are normally used for certain future events, e.g. receipt of offshore trade receivables.

IN BRIEF:

• IR Swap. More versatile than a vanilla fixed rate loan. Enables a business to swap its floating interest rate for a fixed rate for an agreed term. Suits businesses that want to separate their funding decisions from their interest rate views. For example, forward book­ing a borrowing rate or loan restructuring during the fixed rate period.
• IR Cap. An option that lets your business cap its inter­est rate at an agreed maximum for an agreed period while still enjoying any lower rates that prevail during the term.
• IR Collar. Lets your business trade within a band of interest rates, contained within a ceiling and a floor, over an agreed period. Normally at no cost, a collar enables a business to cap a maximum interest rate during the agreed term. A col­lar also allows the business to enjoy any lower rates down to the floor that prevail during the term of the collar.
• IR Swaption. A hybrid of an option and a contract. A swaption gives a business the right but not the obligation to uplift an IR swap at some future date. A swaption is useful for businesses where a transac­tion may or may not go ahead (e.g. property syndicate). If the swaption is exercised and an IR swap is entered into at the agreed rate, there is an obliga­tion on the business to pay that rate during the swap term.
• FEC. A contract in which a business agrees with a bank to buy or sell a currency at some future date at an agreed rate.
• FX Option. An option that gives a business the right but not the obligation to buy or sell a currency at an agreed rate at or before an agreed future date.

In the past, Treasury products have been mostly used by institutional clients to help mitigate IR and FX risk. That’s changing fast, as more small to medium business owners discover the benefits.

DAVE CHAMBERS is National Manager, Business Development for Business and Corporate Banking at ASB.

This article is provided for information purposes only. Derivative transactions involve numerous risks including, among others, market, counterparty default and liquidity risk. In preparing this article, your financial situation or particular needs were not taken into consideration. Accordingly, you should not take any action in reliance of this article without considering your particular circumstances and, if necessary, taking appropriate professional advice.