As Seth Godin observed years ago, beware the CEO (or corporate) blog! While the benefits can be great, so is the time and effort required. An English proverb sums it well, “Effort is important, but knowing where to make an effort makes all the difference!”

We’ll see you again when we’re able to meet at least four of the factors that Seth believes make a blog work:

• Candor
• Urgency
• Timeliness
• Pithiness and
• Controversy
• (maybe Utility if you want six).

(Please note our disclaimer and that nothing on this blog or website is intended to be construed as investment advice.)

Financial analysts will find “Part II–Tools for Thinking” of particular interest. A look at that section’s topics highlights many similarities in intelligence analysis and valuation analysis.

• Chapter 4: Strategies for Analytical Judgment: Transcending the Limits of Incomplete Information. “When intelligence analysts make thoughtful analytical judgments, how do they do it? In seeking answers to this question, this chapter discusses the strengths and limitations of situational logic, theory, comparison, and simple immersion in the data as strategies for the generation and evaluation of hypotheses. The final section discusses alternative strategies for choosing among hypotheses. One strategy too often used by intelligence analysts is described as “satisficing”–choosing the first hypothesis that appears good enough rather than carefully identifying all possible hypotheses and determining which is most consistent with the evidence.”

• Chapter 5: Do You Really Need More Information? “The difficulties associated with intelligence analysis are often attributed to the inadequacy of available information. Thus the US Intelligence Community invests heavily in improved intelligence collection systems while managers of analysis lament the comparatively small sums devoted to enhancing analytical resources, improving analytical methods, or gaining better understanding of the cognitive processes involved in making analytical judgments. This chapter questions the often-implicit assumption that lack of information is the principal obstacle to accurate intelligence judgments.”

• Chapter 6: Keeping an Open Mind. “Minds are like parachutes. They only function when they are open. After reviewing how and why thinking gets channeled into mental ruts, this chapter looks at mental tools to help analysts keep an open mind, question assumptions, see different perspectives, develop new ideas, and recognize when it is time to change their minds. A new idea is the beginning, not the end, of the creative process. It must jump over many hurdles before being embraced as an organizational product or solution. The organizational climate plays a crucial role in determining whether new ideas bubble to the surface or are suppressed.”

• Chapter 7: Structuring Analytical Problems. “This chapter discusses various structures for decomposing and externalizing complex analytical problems when we cannot keep all the relevant factors in the forefront of our consciousness at the same time. Decomposition means breaking a problem down into its component parts. Externalization means getting the problem out of our heads and into some visible form that we can work with.”

• Chapter 8: Analysis of Competing Hypotheses. “Analysis of competing hypotheses, sometimes abbreviated ACH, is a tool to aid judgment on important issues requiring careful weighing of alternative explanations or conclusions. It helps an analyst overcome, or at least minimize, some of the cognitive limitations that make prescient intelligence analysis so difficult to achieve.ACH is an eight-step procedure grounded in basic insights from cognitive psychology, decision analysis, and the scientific method. It is a surprisingly effective, proven process that helps analysts avoid common analytic pitfalls. Because of its thoroughness, it is particularly appropriate for controversial issues when analysts want to leave an audit trail to show what they considered and how they arrived at their judgment.”

When will we implement staggered due dates, like many motor vehicle departments have implemented for registration renewals?

• Asbury Automotive Group, Inc. (ABG) “We expect the U.S. automotive retail market will experience a modest recovery in 2010, as we believe that the majority of automotive manufacturers have stabilized production levels in response to the economic slowdown and will focus on using a combination of vehicle pricing and financing incentive programs to increase demand in 2010, although no assurance can be provided in this regard.”
• AutoNation, Inc. (AN) “While we believe that new vehicle sales will gradually improve in 2010 as compared to 2009, we also believe that the automotive retail market will remain challenging and that the annual rate of new vehicle sales will remain depressed by historical standards in 2010. In addition, we expect that the decline in new vehicle sales over the past few years, which has led to a decline in the number of recent-model-year vehicles in operation, our primary service base, may have an adverse impact on our parts and service business for the next several years.”
• Group 1 Automotive Inc. (GPI) “Despite the recent economic downturn and resulting negative impact on our business, we remain optimistic about our business model and expect that, over the long term, industry sales will rebound, reflecting a significant level of pent-up demand.”
• Lithia Motors Inc. (LAD) “Our business is heavily dependent on consumer demand and preferences. The recent downturn in overall levels of consumer spending has materially and adversely affected our revenues. We expect this downturn to continue through at least 2010.”
• Penske Automotive Group, Inc. (PAG) “During 2009, there has been continued weakness in consumer confidence and spending in the markets in which we operate, which we believe has resulted in reduced customer traffic in our dealerships. While we have experienced increased vehicle sales and customer traffic in recent quarters, we expect our business to remain significantly impacted by difficult economic conditions in 2010.”
• Sonic Automotive Inc. (SAH) “Current industry analyst expectations for new vehicle sales volume in 2010 are between 11.0 and 12.0 million vehicles, a 5.8% to 15.4% increase from 2009. Changes in consumer confidence, availability of consumer financing or changes in the financial stability of the automotive manufacturers could cause 2010 industry results to vary.”

For those scoring at home, let’s call it…

• 3 cautiously optimistic (ABG, AN, and GPI)
• 2 pessimistic (LAD and PAG)
• 1 on the fence (SAH)

What I have not seen discussed often is the tax affect issue related to not-for-profit entities. Deals involving not-for-profits occur routinely in the health care industry. For instance, a study in 2008 referenced in this article indicated that 78% of hospital mergers and acquisitions involved non-profits as buyer, seller, or both.

Let’s say you were valuing a non-profit entity for financial reporting purposes (e.g. fair value standard) using a discounted net cash flow analysis. Would you apply an income tax effect to the net cash flow stream? Why or why not?

Rather than an either/or approach, what about using a weighted tax affect based on the probable market participants?

Using the hospital reference above, one might argue a 64% chance the buyer would be a non-profit (e.g. no tax affect) and a 36% chance the buyer would be a for-profit (e.g. a C Corp. or pass-through entity with some sort of tax affect). If non-profits have a lower hurdle rate due to tax status, it seems they would constitute the majority of buyers as appears to be the case in the hospital industry.

Of course, there are plenty of other reasons non-profits might have different hurdle rates or acquisition motives, but income taxes seem to be a material factor.

• BVWire News (http://www.bvwirenews.com/) – Frequent updates on a broad range of business valuation topics.
• BW Price’s Marketing U (http://bwprice.blogs.com/marketingu/) – Insights on professional services marketing from the CMO of Mercer Capital.
• CPA.Net Blog by Mark Dietrich (http://cpanet.typepad.com/cpanet/) – Irregular updates focused on health care valuation issues.
• IBA News (http://www.go-iba.org/news/) – Great “hands-on” topics and advice for the valuation practitioner by Rand Curtiss.
• Musings on Markets by Aswath Damodaran (http://aswathdamodaran.blogspot.com/) – Observations on international markets, risk premiums, and current events.
• peHUB (http://www.pehub.com/) – Daily roundup of private equity happenings.

I’m sure there are plenty I’ve missed. What BV blogs do you follow?

A sidebar in the print edition notes five key questions to consider long before you’re ready to retire.

1. Are you trying to raise as much money as you can for your own retirement?
2. Can you imagine life without thinking about the business?
3. Are your heirs interested?
4. Do you want to maximize the wealth you leave for your family?
5. Is the value of your business increasing or decreasing?

A business owner’s answers to these questions are critical to finding the right succession or exit strategy for them.

Most owners underestimate the time required to carry out a viable exit plan. Sure, some “win the lottery” through a quick strategic sale for top dollar, but those cases are rare. The article notes that crafting a viable exit plan can take as long as seven or eight years.

I’m reminded of the poll conducted last year by George S. May International. The poll found that 58% of business owners have not recently valued their business and do not plan to do so in the future, while 42% of the respondents plan to sell their business within 10 years.

Peter Drucker said, “What gets measured gets managed.” If that’s true, 58% of business owners aren’t managing what is presumably their largest asset. That has significant implications not just for their net worth, but also for their heirs and their communities.

This post is part of a series, “How to Boost the Value of Your Business.”

With apologies to Homer Simpson… To debt: the cause of — and solution to — all of your business problems.

This post has several parts:

1. Pros and cons of using debt financing in your business
2. How to evaluate if your business has high financial risk
3. Action steps to boost your business value by reducing your cost of debt

Business Debt Pros

The upsides of using financial leverage in business are clear.

• It’s not your money
• Fund expansion or acquisitions
• Even out cash flow for seasonal businesses
• Lower cost of capital than equity
• Amplifies success

Business Debt Cons

The downsides of financial leverage are also clear, or should be after everything we’ve seen the past couple of years.

• You no longer control 100% of your business
• Interest rates can be raised, lines of credit dropped, covenants changed, etc.
• Often used to mask operational problems
• Reduces net cash flow and/or eventual sales proceeds to the owner
• Amplifies failure

How Leveraged Are You?

One of the most common ways to measure leverage is the debt to equity ratio. However, in recent years many tools that are more sophisticated have been developed. One of the most popular of the recent tools is the Altman Z-Score, a formula for predicting bankruptcy.

You might be surprised at what it takes to qualify as high-risk. According to the latest Duff & Phelps Risk Premium Report, nearly 25% of public companies fall into their “high financial risk” category. This includes:

• Companies in bankruptcy or liquidation
• Companies with negative 5-year average earnings
• Companies with negative book value
• Companies with debt-to-total capital of more than 80%

The average debt to market value of invested capital (MVIC is debt financing plus equity value) ratio for this high-risk group ranged from 25% to 60%. For companies in the “gray” or “distressed” zone (measured by Z-Score), average debt to MVIC was roughly 50% or more.

Does high financial leverage really make a difference? High financial risk companies pay a higher rate on debt financing. Importantly, high financial risk companies have a higher cost of equity capital (e.g. opportunity cost to the owners) in addition to higher direct financing costs.

Action Steps

Don’t be afraid to talk with your banker. Most bankers I know wish they were able to have candid conversations with their customers and work with them to improve their business. If you’re afraid of your banker, you might need a new financing partner or you have something to hide.

Ask your lender what it will take to eliminate personal guarantees, simplify or eliminate restrictive covenants, reduce your interest rate by 1/4 point, 1/2 point, etc. Develop a plan to meet the targets and demonstrate your ability to manage your business.

Too many business owners run from fire to fire rather than stopping to take an objective look at their operations. Doing so will improve your borrowing relationship, lower your borrowing costs, and ultimately increase the transferable value of your business.