(Set up by an Act of Parliament)
COMMITTEE FOR MEMBERS IN INDUSTRY
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
BUSINESS PLANNING
BUSINESS PLANNING
© The Institute of Chartered Accountants of India
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First Edition : September 2006
Second Edition : August 2012
Third Edition : July 2015
Committee/ Department : Committee for Members in Industry
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FOREWORD
Business planning is a blueprint to guide the organizational policies and strategies, which
are continuously modified as conditions change, new opportunities emerge and threats
are faced. It is a litmus test for the business. Setting goals and objectives is one thing, but
determining the steps needed to accomplish these goals is quite another. The planning
process allows the entrepreneur to determine what might and what might not work. A
business plan will lay out a written plan from marketing, financial and operational point
of view.
Business planning is important not only for starting a new business but also for many
other strategic reasons. It is vital for running a business, whether or not the business
needs new investments. Business needs plans to optimize growth and development
according to priorities.
A normal business plan includes components such as descriptions of the company,
product or service, market, forecasts, management team, and financial analysis and
requires investigation, careful assessment of all known factors, and projecting potential
results of different options that are open to the company.
In the present business environment, ICAI is playing a crucial role in helping the
Chartered Accountants to update their knowledge, skill set, concepts related to every
aspect of the business encompassing its marketing, finance, operations, human resource
and legal. All these aspects require careful business planning, clear vision, mission and
strategy for an organization to emerge successful.
It is really heartening that the Committee for Members in Industry of the Institute of
Chartered Accountants of India has come up with this revised edition of the book
‘Business Planning’. The book shall provide its readers, valuable insights on management
tools used to guide the growth of both startups and existing businesses, to help identify
not only strengths of a business, but also areas that need improvement and gaps that need
to be filled. I compliment the endeavor of CA. Charanjot Singh Nanda, Chairman, CA.
Shyam Lal Agarwal, Vice Chairman and other members of CMII for bringing out this
edition.
I am sure that the book would prove to be a value addition to the knowledge base of the
readers.
New Delhi CA. <PRESIDIO_ANONYMIZED_PERSON>
29th June, 2015 President, ICAI
PREFACE
We've all heard the old adage that failing to plan is planning to fail, and this is true when
it comes to business. A business plan is a blueprint to the business's future.
The Business Plan format is a systematic assessment of all the factors critical to the
business purpose and goals. In its simplest form, a business plan is a guide—a roadmap
for the business that outlines goals and ways to achieve those goals. Often, it involves the
use of resources within the company as well as engaging the services of professionals to
assist in designing and implementing the plan.
It may seem like a lot of work at the outset, but a well prepared business plan can save
time and money in the long run. It not only set the direction for the business but also acts
as a reference point for measuring performance. Most importantly, a business plan
incorporating a feasibility study will help to determine whether idea is commercially
viable and any issues which are needed to address or plan for along the way.
The primary value of the business plan will be to create a written outline that evaluates all
aspects of the economic viability of the business venture including a description and
analysis of business prospects. Creating a business plan is an essential step for any
prudent entrepreneur to take, regardless of the size of the business. The plan will lay out
a written plan from a marketing, financial and operational viewpoint.
The Committee for Members in Industry of the Institute of Chartered Accountants of
India is committed to update its members with the new areas of the business field and
enhance their awareness in topics relevant to the present dynamic business scenario.
Bringing out the revised publication ‘Business Planning’ is aimed at equipping the
readers with the comprehensive business planning process and to examine the business
idea from different angles which is very important for its existence, sustenance and
success.
Someone has rightly remarked,
‘Your business, like most things in life, won't look after itself so it's important to spend
some time working on the business, not just in it.’
I highly rever the hardwork put in by CA. Anjana Vivek in revising this book for the
benefit of the members. I also appreciate the efforts of the entire team of the Committee
and the secretariat.
New Delhi CA. <PRESIDIO_ANONYMIZED_PERSON>
29th June, 2015 Chairman
Committee for Members in Industry
INDEX
FOREWARD
PREFACE
CHAPTER 1 Prelude to Planning 1
CHAPTER 2 Business Planning and Strategy Formulation 6
CHAPTER 3 The Writing of a Business Plan 13
CHAPTER 4 Valuation and Value Creation 32
CHAPTER 5 Mergers and Acquisitions 48
CHAPTER 6 The Due Diligence Review Process 58
CHAPTER 7 Negotiations 67
APPENDIX Case Studies:
I Business Plan Preparation 74
II Business Plan Review 85
With questions for case analysis
References 103
CASELETS
Caselet 1: Planning for a venture
Caselet 2: Strategic planning
Caselet 3: Writing a business plan
Caselet 4: Value creation in an acquisition
Caselet 5: Proposal for M&A
Caselet 6: Preparing for a due diligence review
Caselet 7: ROLE PLAY - An exercise in valuation and negotiation
FIGURES
Figure 1: Dynamic business planning
Figure 2: The strategic business planning and implementation cycle
Figure 3: Broad classifications of valuation methods
Figure 4: Net present value
Figure 5: The valuation process
QUICK REFERENCE TOOLS
Quick Reference Tool 1: A quick guide to the business plan writing process
Quick Reference Tool 2: A quick guide to forecasting methodology
Quick Reference Tool 3: Special case of valuation: Intangible assets
Quick Reference Tool 4: A quick guide to M&A and alliance partnerships
Quick Reference Tool 5: A summary of the due diligence review process
Quick Reference Tool 6: List of information required during a due diligence review
Quick Reference Tool 7: Valuation and negotiation: Five points to note
©AV Page 1
CHAPTER 1
Prelude to Planning
Are you planning for the future based on future expectations?
Or
Have you just extrapolated the past experience into the future?
Change is inevitable; change is rapid in this century, more than in any other century that
has gone by. Peter Drucker, described as „the most enduring management thinker of our
time‟ by Business Week, has said in his book “Management Challenges for the 21st
Century,” that one cannot manage change, one can only be ahead of it. In periods of
upheavals, such as the one we are living in, change is the norm. He goes on to say that in
times of rapid structural change, the only ones who survive are the Change Leaders.
Many of you may have observed this for yourself. Companies which were well known in
their fields as little as a decade ago are also grappling with change and the impact on their
business. Some of these are new age ventures; some are traditional companies, with a
history of having been successful for several decades; others are those who showed great
promise a few years ago.
In her book, “THE SHIFT: The future of work is already here,” Lynda Gratton, Professor
at the London Business School, gives an example of how in 2000, she and her colleague,
the Late Sumantra Ghoshal, had chosen 4 companies who were leaders and generally
admired companies in their respective sectors. The idea was to develop extensive case
studies for teaching at the London Business School as well as around the world. The
chosen four were the Royal Bank of Scotland, British Petroleum, Goldman Sachs and
Nokia. By 2010, three of these companies, excluding Nokia, had fallen significantly in
public esteem and were grappling with multiple issues. Subsequently, even Nokia, is off
this list of leading companies.
Let us look at an example, closer home in India, of a business sector that is currently
taking a leadership position, particularly when it comes to valuations. This is the ecommerce
sector. Some experts and finance managers look at the opportunity in
addressing the needs of a large untapped market of buyers in the country. These experts
are of the view that the digital commerce companies can tap into this market and create
enormous value in the coming years. They justify this based on the global experiences,
specifically in the US and in China, in the recent past. Such digital commerce companies,
typically, have limited physical assets as compared to the more traditional business. A
few of these ventures in India have managed to command enormous valuations and raise
large sums of money from investors. The investors include Venture Capital Funds (VCs),
Hedge Funds, FIIs, Overseas investors, HNIs and some well-known Indian Business
leaders and Indian companies.
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There is another set of professionals and finance managers who view investment of large
sums of capital in such companies with skepticism and distrust. As valuations are
increasingly driven by future expectations and intangibles, they feel that such investments
are speculative in nature and are not backing true business growth opportunities.
Time will tell whether either of these extreme views is correct and whether there is true
value being created for the future or there is a speculation bubble that will burst. Perhaps,
the reality is something in-between. A May 2015 article in The New York Times by
Conor Dougherty mentions that while some persons are talking about a tech valuation
bubble, there are others who say this is not really a bubble; some call it overvaluation and
froth.
To create long term value that is sustainable, these companies need to provide
profitability in addition to revenue at some point. It is also not easy to predict who would
be the leaders in the e-commerce retail space in India and the leading companies of India,
say a decade from now. Currently, the assumption is that, to get ahead and stay ahead in
this race, huge investments are to be made and that the leaders will be from those
companies where such large investments have been made.
The world is getting reset today. Technology has changed the way we work, the way
corporates function and also the way we live. For decades, computers were used to
communicate and access information. Today we can access much of this information,
through our mobile phones. In the days to come many other devices will get connected.
There is talk of clothes becoming sensitive to our needs and monitoring our temperature.
What was earlier in the realm of science fiction is moving closer to fact than fiction.
Neelima Mahan in an interview with Don Tapscott, a well-known author, consultant and
speaker, specializing in business strategy and organizational transformation has touched
on some aspects of the role of technology in business and society. In this interview “the
digital disruption‟ published in Live MINT, Don Tapscott speaks of how underlying
technology is bringing about profound change to the deep structure and architecture of
institutions and his view that the digital economy is the economy.
This ever widening and deepening influence of technology has impacted the way
business is done and can grow. Companies that do not have a technology play, whether it
is in their core business idea, or in any activity or combination of activities will get left
behind. These activities include, but are not limited to operations, human resource
management, sales and marketing, communications including through social media etc.
Change in the coming years will be even more rapid. Such rapid change poses a
challenge for all. How can a business leader plan and grow the business that not only
grows and creates value in the near term, but is sustainable and maintains leadership
position over the years? This is not an easy question to answer.
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The true leaders will be those who can periodically think through the challenges and
opportunities ahead and can strategize to address these. The true leaders will be those
who can think through different dimensions of time, i.e. the immediate and near-term, the
medium-term and the long-term. For the near-term the focus will be more on the
operational, executable business plan and cash flow. For the medium-term, it will be
more of a view of trends and maintaining a balance between cash flow and value
creation. For the long-term it will require a very different way of thinking, of value and
growth and sustainability. It will need a leader to think about what the future could look
like and the possibilities and probabilities of where one‟s business could be in the
business landscape at that point in time.
A leader, therefore, will need to think in multiple dimensions of time and will need to
periodically flip between all these; in addition to thinking about the multiple dimensions
of running a business. In this book, we try to share some tools and techniques that can
help finance professionals and business leaders think in these multiple dimensions.
Organizations need to constantly review their business strategy and business models to
see that they are not left behind. The term „Business Model‟ has gained in popularity over
the last few years. A business model addresses how a company operates and functions,
sets out its target customers and revenue generation streams and focuses on how it grows
and creates value for itself and its various stakeholders. Most importantly, it looks at
multiple aspects of a business and addresses financial and non-financial parameters.
For example, if we try to understand who is a customer of Google, is it a paying
advertiser or a non-paying user of Gmail and Google search? If Google does not pay
attention to the non-paying user, it may not be able to attract a paying user. So the nonpaying
user also needs to be treated with care. Thus a non-paying user is a customer, but
not a direct revenue-stream for the company.
If you are interested in looking at the various ways in which this term Business Model is
defined, the 2015 article in the Harvard Business Review by Andrea Ovans, titled “What
is a business model?” is worth a read. A list of books and references are provided at the
end of this book.
The handbook, “Business Model Generation,” written by Alexander Osterwalder & Yves
Pigneur, provides a useful tool, the “Business Model Canvas” popularly referred to as the
“BMC”. This helps analyze and design business models, for a variety of organizations,
from idea stage to early stage to large corporates and MNCs. This book itself has been
written innovatively; the authors state that this has been co-created by a crowd of 470
practitioners from 45 countries! If you are looking at reviewing and taking stock of your
business and your business model, this is a tool that is worth looking at. It is also freely
available online.
Business model innovations redefine the way companies run. The change could be in
financial aspects with an impact on revenue, costs and cash flow. Non-financial
parameters, such as business relationships and customer expectations may also be reset.
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Many companies are experimenting with business model changes. A company in India
pioneered a different way of paying mall rentals. Instead of paying a fixed amount every
month, rent was linked to revenue collections. Thus, in addition to the impact on cash
flow management, this helped the company in other ways. The mall owner moved from
being a landlord, to a partner, who was also interested in increasing the revenue in the
store. Thus, strategically, the business model innovation changed the relationship
between the two parties from landlord and tenant, to a more meaningful partnership for
mutual benefit. The reader may like to take this as an exercise and view how this could
impact the financials of the business, the Profit and Loss Account and Balance Sheet and
the accounting impact if any. This could also be done through a scenario analysis, i.e.
from low sales to average sales to high sales.
In recent years, some companies have converted capital expenditure costs into payments
linked to revenues. This has helped in cash flow management by converting a high onetime
cash outflow to periodic flexible cash outflows linked to cash inflows from
revenues. Fixed costs for assets have moved into flexible payouts based on revenues. Of
course each such change in business model comes with its own set of advantages and
risks. Here too the reader may like to analyze the impact on the financials and the nonfinancial
impact, for different scenarios.
There are many such examples of companies that have thought about the future very
differently from the way business has been conducted in the past. The leaders of the
future will be such companies, who continuously think, innovate, experiment and move
on to create value for themselves and society.
Planning for the future needs to take care of multiple factors. Some aspects include the
impact of globalization and growth. One need not be an exporter to get impacted by
people in other countries. We have many persons from other countries coming in to do
business in India. If local firms do not provide quality service and goods, they could very
well lose business to people from other countries.
While undertaking an exercise in business planning, attention must also be paid to
understanding the impact of business policies on issues that have not been given much
thought till now. Companies that succeed may need to closely look at their policies
related to the environment, corporate governance and ethics and also understanding the
true needs of employees.
Today, we are in an age where information is available at one‟s finger tips. Whether you
like it or not those who want to work with companies will search for information about
this on the internet and on social media pages. This leads to a need for greater
transparency and disclosure requirements. People are watching and this will keep
businesses on their toes.
A customer at an outlet of a leading coffee chain in India was asked to leave after the bill
was paid. This customer was offended and immediately sent out a Twitter message
©AV Page 5
saying that this company was offensive. Within minutes of this posting, the message was
re-tweeted to the world at large. The company had to take quick steps for a damage
control exercise. They sent out their own Tweets and requested their fans to support
them.
This was an eye-opening incident; it forced the management of the company to revisit
their policies, particularly those related to store and outlet management. In today‟s times
even one irritated customer can do much damage, with the power of the internet that is
available and with social media access.
The leaders of the future have therefore to be much more than efficient in operations.
They need to understand the power of the individuals too.
Therefore, if the business planning exercise is done based on past experiences and
financial numbers are projected without paying attention to the impact of a rapidly
changing world, the exercise may not be meaningful.
So …Are you planning for the future based on expectations of a dynamic world or
have you just extrapolated the past?
©AV Page 6
CHAPTER 2
Business Planning and Strategy Formulation
Business planning is a critical function, a continuous function, whatever be the size or
nature of the organization. In fact the importance given to it is such that it is said that
failing to plan is planning to fail. In this book on business planning, we look at some of
the key areas in planning. In this chapter, we look at the various aspects of business
planning and business strategy and set the tone for the rest of the book.
All businesses strive to be successful and create value in the long term. Some businesses
fail and some succeed. It is easy in hindsight to look back and point out the reasons for
failure. The signals of failure which were earlier missed may later appear so obvious.
What one would like to do is, plan in advance, so that the chances of failure are
minimized.
Paul Light, in his book, “The Four Pillars of High Performance,” has tried to extract key
traits common to all robust organizations. A robust organization is said to be one that
possesses the agility to adjust to changes in the external environment at a moment‟s
notice and the compass needed to maintain a steady fix on its strategic horizons. This is
no easy task, on the one hand one attempts to maintain a steady path, on the other hand
one needs to be adept at changing. On the face of it, this appears like a contradiction.
However, if we look at this closely, we will see that this is just like an equation that needs
to be balanced – pictorially we may represent this as follows:
Figure 1: Dynamic business planning
The book, “The Four Pillars of High Performance,” is based on reviewing and studying
of information resources of The RAND Corporation, which has been an international
leader in the study of organizational performance for nearly six decades. An in-depth
analysis has been made to understand how one can create and sustain high performance.
The book highlights the fact that we must plan for uncertainty. It states that if there is one
thing that is known to RAND researchers, it is the fact that the future is likely to be
different from the past and that the key is to plan and prepare for this.
Maintain
Charted Path
Quickly adapt
to change
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RAND researchers have observed that uncertainty cannot be reduced by merely working
hard. At the same time, one cannot just sit back. One needs to get on with business,
learning to plan in such a way that includes the expectation of surprises and the need for
adaptions. As firms set goals and make choices, they must constantly challenge these
very same goals.
So how do you set out to make sure the business you are working with or associating
with, is robust? How do you try to make sure the business is sustainable? How can the
business create sustainable value? What can set the business apart?
Let us look at two successful enterprises, one Indian and one foreign; Infosys, in India
and Microsoft in the US. In the early days of starting their respective enterprises, the
entrepreneurs, Bill Gates of Microsoft and Narayana Murthy of Infosys, spent time on the
operational day to day management of the business. As the companies became successful
and transitioned to a different level, the very same entrepreneurs moved out of the
operational role. They identified others who would be responsible for the management
and running of the business and they took on the role of the „Thinkers,‟ i.e. Planners.
This is the kind of importance that these successful leaders give to planning.
The thinking exercise is not limited to planning for the next year or three years; it has
many components to it. One, there has to be some idea of the overall direction in which
the business is headed. The direction for the next year is reasonably clear, but the
direction five years ahead is not so clear. The direction 25 years ahead is even less clear.
This is particularly so in the modern day world, where emerging technologies are
changing the way the world is functioning. Would many of us have had any idea of the
impact of technology and the internet on business, 15 years ago?
Often businesses are so focused on attending to their immediate needs and short term
requirements that they ignore the long term needs. In Banwarlal Private Limited (BPL), a
manufacturing company, there was a strong focus on raising cash to meet the shortfall in
working capital. Funds were also required to buy machinery to increase the capacity and
grow the business in a competitive environment. The promoters were so focused on
raising funds to meet the working capital requirement, that they did not pay attention to
the long term export potential. As a result, they did not invest enough time and resource
in building up the potential markets in US and in Europe. If they had spent a little more
time and done a detailed planning, they could have focused on raising funds for working
capital as well as for growth and expansion into foreign markets. They could have looked
at options such as taking a loan from the bank or looking for equity investment or perhaps
even borrowing overseas. All the energy was instead invested in and focused on raising
the funds to meet the immediate requirement, so much so that they neglected to look at
the long term picture. In the process the company did not reach its potential; when the
economy slowed down they were badly impacted.
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CASELET 1: Planning for a venture
Friends, Dinesh, Mukesh and Khan, decided to start a company to sell a product they
wanted to develop. They undertook market research and spoke to leading potential
customers before they developed their software product. The potential customers
unanimously agreed that the idea was good and that they would readily buy such a
product if it was available in the market. The developers put their own money into the
project and finally in two years time had a developed product which they took to the
potential customers. At this point, they were in for a rude shock; the potential buyers said
that they did not need such a product. When questioned further, they said that while two
years ago, there was a need for such a product, there was no need for it at this point in
time.
Thus these persons who had put in a substantial amount of their life savings, failed to
convert their idea into a financially viable business. They did not account for the fact that
business does not work in a static environment. What is good at one point in time, may be
irrelevant or useless at another point in time. One cannot work blindly assuming that the
future will be a direct extrapolation of the present.
Q. If you had been one of the promoters, would you have proceeded differently in this
matter?
Q. How would you have planned to go ahead with this venture?
Q. What would be your fall back plan if things did not go the way you had envisaged?
END OF CASELET
Management in firms often avoid going through an exercise of rigorous planning, giving
the excuse that the future itself is uncertain. In such an unclear scenario, how does one
plan, strategise and implement strategies?
The answer to such questions is that, while the future is uncertain, one can think through
what could be the possible outcomes if certain steps are taken (or not taken). This is like a
student in the 12th standard planning on her future. She may have the options of taking a
degree in science, or medicine or law. Ultimately, she will decide on one of these, which
may not be the final area of her specialization. Assuming she takes up medicine, she
finally may not become a practicing doctor. There are several medical doctors who have
gone on to take up the civil services entrance exams or to study for a management degree.
However, at the time of deciding on the next step at the 12th standard level, the student
has to plan for the immediate next step, keeping some broad-level, long term goal in
mind. Thus, while she may not be clear about the final goal, or the goal may change
along the way, she will not avoid planning completely.
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Business planning helps one think through possible future scenarios. The idea is to put
down alternate scenarios and think of what one would do in these alternate scenarios. In
one case we can assume that the business does better than expected, in another we have
normal expectations and in the third we can take a pessimistic view. More than the
scenarios we put down on paper, the planning process is the one which helps us develop
better knowledge and understanding of where we are today, why we are there and the
alternate options before us.
Scenario analysis also helps chalk out fall back options; how will one react if things go in
direction A, B or C? Corrective action can be taken or steps modified/retraced with
limited time spent on this.
Strategy and business planning
What is strategy? It is a long term plan of action, designed to achieve a particular goal.
Henry Mintzberg, Bruce Ahlstrand and Joseph Lampel in their book, “Strategy Safari,”
have analysed and looked at different schools of strategy. They state that this is
considered to be the high point of managerial activity.
The field of strategic management is one area which has fascinated practicing managers,
consultants and academicians. If the business is successful, one would say that the
management strategy has worked well. If the company does not do well, it is assumed
that management has either failed in having a proper strategy or has failed in
implementation of its strategy.
All businesses can benefit from time and effort spent in periodically reviewing their
strategy. The degree and details to which the strategy plan is thought through and the
implementation plan put in place, may vary.
Strategy may be considered from the overall business perspective. It can also be
considered from a functional perspective. The management may have a marketing plan
and strategy, they may have a HR strategy, or they may have a financial strategy. These
all get captured sometimes in the overall business strategy.
Let us take some examples to understand how funding strategy can impact the overall
business strategy. If a company in the manufacturing sector intends to expand its
operations and has collateral, it may decide to take a loan for expansion. In such a case,
the focus of the business will be to increase the cash flow in the initial stages of
expansion. This will enable it to generate sufficient funds to pay the interest charges as
well as repay the principal amount.
Many firms in the information technology space in India, do not want to take loans, i.e.
they want to be debt free. Their financial plan and strategy is to raise funds in the start up
stage from venture capitalists or strategic investors and not from banks or financial
institutions. They would rather give a percentage of the equity stake in their company to
the investors than take a loan from a bank. This impacts the overall way in which the
©AV Page 10
business is run. An equity investor looks for different returns as compared to a traditional
debt financier. In the case of equity investment by a venture capitalist, the focus is on
maximizing the value of the business over a period of time, rather than on increasing the
cash flow to service debt in the initial stages.
Within equity investors, angel investors or informal financiers, such as family and friends
have different reasons for investing in the firm as compared to strategic and corporate
investors or as contrasted to venture capitalists. A company may try to align its style of
operations to obtain results which are aligned with the interests of their investors.
Thus a company which has strategic investment will probably work towards producing
goods or services that complement and/or supplement the business of the investor. A
company which has venture capital investment will aim to grow the equity share value to
meet the investor‟s financial targets. A company which has taken a loan will try to
generate sufficient cash flow to make payments to the debtor and so on.
There are a variety of methods in which organizations can approach their strategic
planning exercise. In their book, Mintzberg et al., state that there are hundreds of
different strategic planning models. They further state that most of these are based on the
SWOT model. The SWOT model is a popular tool for many managers. In this the
business is analysed in terms of its Strengths (S), Weaknesses (W), Opportunities (O) and
Threats (T).
Strategic business planning exercise
The SWOT analysis has the advantage that it considers factors both internal and external
to the company. The strength and weakness are factors that depend on the organization
structure, the management and other parameters. The opportunities and threats are on
account of the external environment, be it the industry scenario, the political scenario or
the global economic scenario.
As an exercise those who are preparing the SWOT analysis of their business may also try
to identify and look for links between the various components. For example, what is an
opportunity because of certain factors today may very well become a threat in the future.
SWOT analysis has its own set of detractors, who feel that the model is not a dynamic
one and hence there are some who prefer not to use this method, but try to analyse based
on other parameters.
Strategy formulation is an ongoing continuous exercise. A business which has a vision
and goal can go much further than one which does not. Another important factor is
implementation of strategy. Many Organizations fail, not because they do not think
through their strategy, but because they do not think through the steps in implementing
their strategy. The strategy and plan for strategy implementation is to be communicated
to all employees in the organization and not just remain with the top few members.
©AV Page 11
The strategy setting and business planning exercise is a continuous one, and cannot be
done in a piece meal fashion. This can be represented as follows:
:
Figure 2: The strategic business planning and implementation cycle
The strategic business planning exercise has to consider a variety of factors, such as
macro level economic indicators, business and political environment, industry and
company specific information and the regulatory environment or environments under
which the business operates.
Strategic business planning is process whose time has come. In the past, many companies
have planned to a limited extent such as in setting out budgets and sales targets. Most
businesses have not gone beyond this to actually consider the strategy in depth. Further,
many times, Chartered Accountants, have not been privy to such strategic considerations.
Even if the have been privy to this, their roles have been typically limited to looking at
profitability, financial implications, cash flow, regulatory and tax aspects. Only a few
among them have looked at business models, at how future plans will impact the brand
image of the company and at value creation in a global business environment.
In the chapters that follow, we look at some key areas where awareness and strategic
planning can play a significant role in the future of the business. We also look at some
tools and techniques which help in the planning process.
Strategy
formulation
to achieve
goals
Monitoring
and review
of
performance
Vision and
goal
setting
Strategy
implementation
plan
©AV Page 12
CASELET 2: Strategic planning
NewTech Private Limited (Newtech) is a technology based company, based in Pune. The
company has been promoted by Ram Kishore, Kumar R and Sulekha Sharma, who are all
technology experts, i.e. they understand the domain and industry in which the company is
operating.
Newtech is completing its third year of operations and has about 150 employees on its
rolls. There is a lot of potential in the business, so there is a chance of it becoming a
globally recognized company. The promoters are technology experts who have held
senior positions, so they are in a position to reach out to potential customers and convince
them of the quality of their product. On the other hand, there are high risks in
implementation and the path to reach the stage of having a robust, high growth, high
value business is not so straight. Technology is changing rapidly. Competition is intense
as there are other companies, whose founders also have a good academic qualification
and good quality work experience.
As they are shortly entering into the fourth year of business, the promoters feel that they
need to take stock of the business, the opportunity and the potential they have to make
their mark in the world. They are trying to understand what they need to do and do right
in order to grow and reach their potential.
Sulekha has recently been introduced to Vinay Rao, the owner of a Pune based strategy
consulting firm, B Strat. Vinay‟s firm specializes in helping companies in Business
Planning. Sulekha suggests that Newtech can consider taking the help of B Strat to put
together a business plan to achieve significant growth. She says that they need to set out
their plan for growth and set a target for themselves, five years from now. Kumar is not
enthusiastic about this idea. He feels that the business environment is rapidly changing
and so business planning for the future may not be a really meaningful exercise. Ram
suggests that they can talk to Vinay and set up a meeting before taking a view.
You are one of the senior consultants of B Strat. You have been given a brief company
background and have been informed that the promoters need to be convinced that
Business Planning is a meaningful exercise.
Q. How will you convince Newtech promoters that business planning is an important
exercise, particularly in a rapidly changing business environment, when what you plan
today may not be relevant to business tomorrow?
Q. How would you go about the exercise of business planning in Newtech?
Q. How would you plan to meet the short term and long term needs of the company?
END OF CASELET
©AV Page 13
CHAPTER 3
The Writing of a Business Plan
Many persons want to write business plans, for a variety of purposes. This may be for
internal reference, for raising debt or equity, or to show to a key stakeholder such as a
Board Member or an existing investor. The process of planning is the first stage in
writing a business plan and is a critical one. Once one’s thoughts are in order, writing the
plan becomes much easier.
It is often assumed that a strategic business planning exercise automatically will translate
into a business plan. This is not necessarily true. An exercise in strategic planning should
ideally lead to:
 Long term organizational goals being set and
 An implementation plan for achieving the goals.
Sometimes one may not want to or need to write a detailed business plan. There is often
the perception that a third party reading the Plan may adopt or copy the ideas or plans set
out. The solution for this is not to avoid writing a Plan, instead one could prepare a
business plan with macro level details and avoid disclosing finer details in this if it is
shown to an outsider.
Another way to address this concern is to have one business plan to show others and
another, more detailed version, for internal use. The detailed plan may have additional
chapters or sections, which are disclosed only to select persons. In such situations, it is
important to keep a control on the multiple versions and to keep track of what each
version contains. If there are updated versions, based on some change in the business
model, one will need to keep a close watch on changes made.
The purpose of the plan
At the start it is useful to have some clarity as regards the purpose of the plan. Is it to
commit thoughts to paper, or to show a potential equity investor or a potential alliance
partner? While it is easier to prepare a single business plan for all purposes, each of these
persons will review the plan differently. For example:
 A lender will be looking at financial projections to review profits and cash flow in
the business. The interest cover and principal cover will also be viewed.
 A venture capitalist (VC) will be looking at the business plan to see the potential
for high growth. The VC may not be concerned about negative cash flow in the
early years of the investment and will be interested in exiting from the business in
a time frame of about 3 to 7 years and will look for an exit plan in the business
plan.
 A potential acquirer will try to understand the synergy of the merged entity and
try to see what value can be created from the acquisition.
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 A Board Member will focus on growth opportunities, value creation and
sustainability.
Getting one’s thoughts in order
It is important to spend time in brainstorming with colleagues, advisors, mentors and
other knowledgeable persons before putting together a business plan. Questions should be
asked, ranging from the business idea, implementation plan to financial projections.
Some illustrative questions could be:
 What is the gap in the market the business is attempting to address?
 Is this an existing gap or is the firm trying to create a new market?
 Why would customers buy from the firm? (The answer to this cannot be given at
the macro level, one has to closely examine why anyone would really become a
customer. One should not just assume that customers will be attracted by superior
quality of goods, quick after sales service etc. many persons who have not
planned and gone into details find that the plan on paper does not translate into a
robust business in reality.)
 How will the product or service be marketed?
 Who are the competitors?
 Is there a good management team in place or are there some vacancies to be
filled?
 Who are the external advisors and mentors?
 Who could be a board member?
 What are the requirements for funding?
 How much of the funds will be raised from internal sources and how much from
external sources?
 Is the market being targeted in phases or is the company planning to target a big
share of the market all at once?
Such questions need to be raised and answers sought before proceeding with the writing
of the business plan.
The first steps
When writing a business plan, one must focus on the key areas, such as the business idea,
the team, the market and the financials. One must look at the business model of the
company as compared to peers and competition. As mentioned in Chapter 1, the Business
Model Canvas is a helpful tool to review and take stock of the current business.
Preparation of a SWOT analysis (Strengths, Weaknesses, Opportunities and Threats)
does help. This is a simple way of getting one to look closely at the business
environment, both internal and external to the firm. Many persons are not keen to prepare
the SWOT analysis, because it forces one to look at the negative points about the
business. Some persons feel uncomfortable even acknowledging to themselves, that there
could be flaws in their plan. They are not keen to expose any flaws to the reader. Others
©AV Page 15
are of the opinion that setting out weaknesses could invite trouble and could
unnecessarily invite negative comments from potential investors. This could, in turn,
drive down the valuation of the company. Such a view is short sighted. Investors know
that, in a realistic scenario, there will be positive and negative factors. In business, as in
life, there are positives and negatives and the business plan has to reflect this reality. A
SWOT analysis helps one face the possibility of what could go wrong; it is a tool for
planning.
Hence, when starting to prepare a business plan, one needs to first examine and list the
business idea, its strengths and constraints. The next step is to think through how one can
leverage on the strengths and how one can address the constraints or accept them and
plan keeping these in mind.
The structure of the plan
Communication of the core business idea is the key to writing a good business plan. The
plan should make sense to the person reading this. Ideas need to be captured in a clear
and reader friendly manner.
The elements to be covered in the plan, include inter-alia, the background and history of
the business if this is for an existing business, the business idea, the business strategy and
implementation plan and most critical details of the promoters of the business and the key
management team. The implementation plan should include details about the sales and
marketing plan, management team and financials, including the sources of funding,
utilization plan, expected revenues, expenses and cash flow. For an existing business, the
financials of the past three to five years should be included and key points summarized.
The marketing plan and competition analysis must talk about any USP (unique selling
proposition) of the firm and the barriers to competition and give details of how the target
market is actually going to be addressed. Specific implementations ideas are to be
included and explained, since in most cases failure is not on account of a bad idea, it is
because of poor implementation.
Due care in writing
Due care is to be taken in writing the plan. Many plans are written without adequate
attention being given to consistency in spelling and grammar. This is not appropriate,
since the readers of the document may be negatively influenced by a shoddy report. The
reader may perceive that one who cannot pay attention to preparing a neat and
professional document may bring the same careless attitude to running the business.
In addition to the grammar and content, one must also pay attention to the style of
presentation. Formats used throughout the document must be consistent. For example,
Chapter 1 may have been written in Arial fonts and Chapter 2 in Times New Roman. This
may be because the two chapters have been written by two different persons or have been
written at two different times. To avoid such inconsistencies, it is advisable to use a basic
©AV Page 16
template. Time spent in developing a template in the initial stages is time well spent and
may save significant time in the later stages.
Any documents sent to outside parties must be carefully checked and scrutinized for
internal inconsistencies and errors. As an example, the financials may have undergone
change and the project cost may have been revised from Rs. 50 crores to Rs. 55 crores. If
the schedule continues to show Rs. 50 crores as the project cost, the reader will view the
proposal unfavorably. A careful reading of the complete draft document checking for
inconsistencies would help minimize such issues.
The plan must give details that are necessary and sufficient to be self explanatory. Often
there is a temptation to disclose all that one knows, to demonstrate one’s knowledge and
experience of the business. There is a perception that pages and pages of text demonstrate
a great deal of thinking that has gone into planning the business. This is not necessarily
true, on the contrary, sometimes; excess information overload can reduce the reader’s
interest. Similarly using of excessive number of tables and graphs, just to fill up pages
may send negative signals that the plan has been prepared to impress the reader. One
must, as far as possible, avoid using tables just for the sake of using them; avoid using
graphs just to add substance to the plan.
A way that experienced writers use to minimize clutter and information overload in the
main report is by moving details of what is not essential to the flow of the main plan, to
an annexure. For example, in a manufacturing industry, the brief manufacturing process
could be in the main document, while the detailed process chart may be set out in an
annexure. Those who are interested and have an understanding of this aspect can read the
details in the annexure. At the same time, those who are not interested in these details or
those who do not understand these technical aspects can just read the summary process in
the main plan.
Prior to preparing the business plan one must think through the business idea and then
commit it to paper in a structured manner. The plan should be self-speaking, i.e. there
should be minimum requirement for clarification. Attention is to be paid to providing
explanations for the abbreviations and technical terms used, if any. Different aspects of
the business should be covered in different sections. Pages, graphs, tables and figures
used should be numbered. While these may sound like common sense, there are many
business plans which are prepared without attention to basic details such as numbering of
pages.
The chapters in the plan
Chapters and sections are to be organized with a logical flow. Illustrative sections are:
 Table of contents
 Executive summary
 Sections/chapters, giving information on
o Company and background information
o Management team and organization structure
©AV Page 17
o Business idea
o Sales and marketing plan
o Operating plan
o Financial details
o Other information, including assumptions made to be indicated where
applicable
 Annexures of key terms, references and other relevant information
The executive summary
An executive summary should convey the key information about the business in a
snapshot. Readers look at this summary and if interested in the idea, read the rest of the
document in detail. The summary should touch upon information such as the details of
the product or service being offered, the people behind the business, the potential market
and customers and the implementation plan. The business strategy and the financials
would be of interest to the reader and must be communicated clearly.
The business must demonstrate that it is sustainable in the long term. In the short term,
the majority of firms need surplus cash and need to be supported till they break even and
start generating surplus. The plan must demonstrate the ability to generate sufficient
profits to provide a financial return to the investors in the business, as well as to help
finance future growth in the enterprise. The executive summary could highlight how
value is being created.
Company and background information
A reader would like to understand which industry sector the enterprise operates in, such
as in the manufacturing sector, the pharma sector, the information technology (IT) sector
or other specific area. Further if the business is in the IT sector, the reader would like to
understand whether is it in a niche area or in IT products or in software services.
Experienced reviewers would have an understanding of the industry and would get into
these specific details. They would have a view on the expected industry and the growth
potential.
Other points to be covered in this section are the history of the company, with details of
when the business was set up and its evolution over a period of time. If this is a new
enterprise, the rationale for starting this business must be set out. One could be setting up
a new business for a variety of reasons, such as to fill a perceived gap in the market or
because of significant work experience and domain knowledge and the urge to start an
entrepreneurial venture or to take advantage of a market opportunity to name a few
reasons.
This section should give an overview of the general business environment, the existing or
perceived markets, a brief background about the key team and promoters of the business.
Other additional information may be provided, in brief, to make this initial section
complete.
©AV Page 18
Management team and organization structure
Readers are most interested in the background of the promoters. In fact, most often,
readers of the business plan first look at who is promoting the business and then look at
the business idea and financials.
The promoters can make all the difference to a business. If one studies successful
companies, one will find that, more often than not, that there are committed, qualified and
hardworking persons behind this. Some persons may be lucky and succeed once, but to
be consistently successful, one needs to be more than lucky.
Readers are interested in the quality of the team and will look for information about the
experience and qualification of the promoters and key team and the organization
structure. Key organization HR policies, such as a plan to reward performance with stock
options, or giving employees the option of flexible timings can also be mentioned in this
section.
Business idea
The core of the business plan is the idea. This section about the idea should demonstrate
the plan to convert the idea into a commercially successful business. This should address
issues such as business strategy and implementation plan, including inter-alia the vision
and mission statements, specifics of the product or service offerings, operational details,
any USP and barriers to competition. Other information to be included in this section
include items such as details of any in-house technology, process or idea. If some
technology is being sourced from a third party, this may be disclosed, including
information on any technology transfer through collaboration etc., with the details of
alliance partners, current as well as proposed, details of any intellectual property
associated with the business and other items which are important and give an idea of the
business model.
Sales and marketing plan
This section would set out the target market and market size, either existing or expected.
Information about the market research details, if any, profiles of customers, both existing
and potential (i.e. pipeline customers), the marketing strategy and pricing strategy should
also be detailed.
Many businesses fail in marketing their product(s) and/or service(s). While a product or
service may be good, if the target customers are not aware of this or are not addressed,
the product or service may not sell. The reader would be interested in understanding the
strategy and plan to capture customer interest. In fact these days, even in the case of
products, people are marketing an experience. An example is the sale of an apartment
which is marketed as a new lifestyle rather than a pure real estate transaction.
©AV Page 19
Financial details
The financial section should give summary information about the past financials and the
future forecast, including key financial statements, i.e. the balance sheet, the profit and
loss account and the cash flow statement. Details of contribution from the promoter
whether in cash or in kind, details of sources of funds and the plan to utilize them, the
breakeven point and the return on investment are other important parameters which will
be scrutinized.
There is one view taken by some persons that financial forecasting is a meaningless
exercise because the numbers are based on assumptions about the future, which cannot be
predicted. While the future is certainly uncertain, the exercise of forecasting is an
invaluable one. Going through one cycle of forecasting and then subsequently comparing
actual performance with the forecasts, helps one get an in-depth understanding of
business.
It is useful to prepare the financial forecast statements on a monthly basis, initially for the
first year. This can then be expanded for three to five years as required. If separate
divisions are planned, it is advisable to prepare separate statements for the different
divisions. For example, if there are two separate offices in India and one in UK, each
must have a separate forecast. These should then be consolidated to get overall company
statements, month-wise.
Forecasting sales may not be an easy exercise. Revenues depend on a variety of factors,
such as viability of product, acceptability of the service provided or product sold, market
demand and competitiveness. Sometimes sales are made to alliance partners. In such
cases, the sales will depend in turn, on the demand for the partner’s products.
Sometimes, it may be easier to start the forecast with the costs, as one would have some
idea of the costs involved. While sales are not predictable, costs are generally more
predictable. Some costs, such as rent, salary, etc. must be incurred. Other costs, while
they are not so predictable, are still to be incurred. These can generally be estimated. In
some situations therefore, particularly in new businesses, one can plan for the worst case
scenario and work out the expected costs, assuming that there may be no income for
some period in the future. This could be a period of one year, two years or even three
years. This of course depends on the nature of the product/service being marketed. Some
technology projects have a long gestation period, others have returns from year one.
Examples of these two extremes are biotechnology projects with very long time to market
and consulting companies, which may have sales from day one of the business.
Spreadsheets are useful tools to work with. To the extent possible, use features in the
spreadsheet such as formulas and functions - to automatically add, subtract and link
sheets. If you create a template of key items, then the numbers get automatically updated
in the final statements. For example if you want to check the impact of a salary increase
of 20% from 10%, you can have a cell with the salary increase percentage indicated. Just
©AV Page 20
by changing the number in the cell from 10 to 20, the impact on the salary cost gets
reflected. If this is linked to the profit and loss account and the cash flow, these
statements will also get automatically updated. The revised numbers can also be linked to
the balance sheet. Thus, just by making one change in a cell, a set of updated statements
are available for scrutiny.
It is therefore useful to spend some time in the initial stages, building an intelligent
spreadsheet. With adequate thought and planning, a good working document can help
reduce time spent on manual calculations and can also reduce the possibility of errors. A
point to note is that fancy spreadsheet generated numbers are of no use if the underlying
assumptions behind them have no foundation. Sometimes promoters do not give
sufficient thought as to how they can generate the sales projected and also as to whether
they have actually captured all elements of cost. In fact at this stage one should spend
time to ensure that, as far as possible, all revenue and expenditure heads are captured.
Numbers can then be plugged in and spreadsheets can generate the final statements.
Thought must also be given to the frequency and time frames for which the forecast is
being prepared. If possible, these may be on a monthly or quarterly basis for the
immediate following year. For later periods, the statements may be prepared on a half
yearly or annual basis. The statements may be prepared for three to ten years, depending
on the need and requirement.
Data from existing organizations may be analyzed to understand costs, cost structures and
to benchmark against. Industry information helps in validating assumptions made. It is
important to keep a record of explanations and assumptions made. This helps both for
future reference and to bring transparency to the forecasting procedure.
Some examples of data collated and analyzed would be comparable items of expenditure
in the industry such as salary, per diem cost on travel, rental costs, telephone, water and
electricity charges etc. Understanding the industry cost structures is important. If an
average company in the industry has a 20% margin and the business plan indicates a 25%
margin in the first year, then perhaps there is something wrong in the forecast. Perhaps
the costs have been underestimated; perhaps the revenue has been overstated. In such
cases, one needs to take another look at the financials and the assumptions to arrive at the
cause for such deviations from normal industry numbers and justify them.
Projections start with revenues, which can come from a variety of sources, such as from
services rendered, from products sold, from license fees earned, etc. In all cases, both the
volume of sales and the rates assumed will impact the earnings. Assumptions for these
along with the expected target customers (e.g. number and details of possible customers)
should also be set out.
It is good to have a fair understanding of the expected quality of revenues, in addition to
the quantity of revenues. This can be articulated by setting out data and information such
as the geography of the revenue, revenue from key customers, revenue from well-known
brands, repeat customers etc. As an exercise you can look at articulating the quantity and
©AV Page 21
quality of revenue of your business. For some additional information on this please refer
to the SlideShare page and the presentation made by the author for the Microsoft
Ventures Masterclass on Business Models: Growth and Value Creation, slide no. 13. The
details of the link are available in the reference section of this book.
Quality of revenue becomes important in a business valuation exercise. A company that
is perceived as having a better quality of revenue as compared to a peer, can command
higher multiples in valuation, i.e. better quality can command premiums. However this is
to be done with care. For more on valuation multiples, discounts and premiums, please
refer to Chapter 4 in this book.
Employee costs should be projected keeping in mind the number of employees and their
salaries, based not just on their qualifications, but also on their locations. Sometimes
employees may be located in different countries and their salaries may have to be
benchmarked with the salaries in those countries. This must be factored in and set out in
the assumptions along with the expected salary increments over the period of the forecast.
Some salary may be linked to equity, some to performance. These must be set out and
captured in the Plan document.
All items of cost and expenses in running a business must be captured. These may be
estimated based on past experiences and percentages or based on actual expected
amounts. In the initial months, these costs will be easier to estimate. As we get into the
medium term, trends may be used, based on past experiences and percentages adjusted
for expected future changes.
The items in the balance sheet are to be input based on the assumptions made in the profit
and loss account. Investment in fixed assets such as land and building owned if any, plant
and machinery, computers, furniture and fixtures etc. are based on requirement projected.
For example, capital expenditure (capex) is to be calculated based on the area of land
purchased, plant and machinery requirement, number of workstations, furniture, research
tools and equipment, vehicles etc. which are assumed to be required. Due care should be
taken in arriving at the capex as it is closely linked to various phases planned in the
project and the numbers must reflect basic assumptions made. For example in some cases
50% of the cost is required to be paid upfront in the form of an advance. This will be
reflected as an advance paid in the balance sheet, till such time the item is received and
commissioned, when it will move to an asset. Here also as far as possible, spreadsheet
links should be used. The debtors on hand, is based on revenues earned and average
credit period, which would need to be benchmarked with industry standards.
The cash flow statement should be carefully prepared, based on actual cash expected to
be received and paid out, from and to various accounts respectively. Much of these
calculations would be made based on industry standards and specific assumptions of the
way the business is expected to be run in the future.
Many firms incur product development costs, research costs and other IP (intellectual
property) related costs. As far as possible these may also be considered and captured.
©AV Page 22
There must be consistency across the different statements. For example deposits for
premises hired must appear in the balance sheet and the rent in the profit and loss
account. During a due diligence review some of these consistency checks are made.
These help the reviewer get an understanding of the quality of thought which has gone
into preparing the plan.
Other information
A final section in the plan should include information which may be relevant to the
business, and not included in the other sections. This may include project time lines,
implementation schedule, expected date of commercialization, regulatory environment
(for example environmental laws for a pharmaceutical company) etc. Other information
such as contact details, references, additional data and statistics, which may be
meaningful to a knowledgeable reader, may also be provided as an appendix or annexure.
Alternate scenarios
The future is uncertain. Whatever care one may take, it is difficult to forecast what will
happen. There are two common techniques to address such uncertainty. One is to prepare
financial forecasts in different scenarios, i.e. an optimistic scenario, a pessimistic scenario
and a normal expected scenario. The forecasts in these three situations help one think
through a range of possibilities and these get factored into the numbers. To take an
example, if an individual who is getting Rs.25 lakhs as salary per annum, has a sudden
salary cut to Rs.20 lakhs per annum, the individual will reduce the spending when the
income is reduced. Similarly in a business scenario, when revenue and growth is high, the
expenses will be higher than when revenue is low.
Financial forecasts are to be prepared to reflect possible scenarios and thinking through
these scenarios can help one look closely at the numbers and question assumptions. To
illustrate, a business dependent on agricultural produce will be impacted by the monsoon,
which is unpredictable. An optimistic scenario may consider a good monsoon while the
worst case scenario may assume that the agricultural produce has been impacted because
of poor monsoon. To get into the depth of this, one would actually have to consider the
impact of the monsoon on both the quality and quantity of the produce. Too much
monsoon or rains in the wrong season can also impact the business.
Another tool used to factor uncertainty in the business is to do a sensitivity analysis of
key parameters. These parameters include revenue and key items of cost. One example
could be studying the impact of a 15% fall in the capacity utilisation which would impact
production and therefore the sales of the business. Another example is to study the
business and financial impact of an increase in raw material cost due to foreign currency
fluctuation.
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Impact of changing scenarios
A business plan should specify the impact of changing scenarios. In an existing business
in particular, some of these changes can make a significant impact on the way the
business needs to be run in the future as compared to the past.
Thus the process of preparing a business plan has to have a logical flow, from idea
planning to writing a detailed document. The better the quality of the planning process,
the better will be the quality of the business plan.
Quick Reference Tool 1:
A quick guide to the business plan writing process
If you are preparing a business plan:
Spend some time on some analysis before you start
 What is the purpose of the business plan, is it for
o internal use of management
o Board member review
o Bankers and potential lenders
o Investors (VC/bank/angel investor)
o For other purpose, e.g. incubation
o What are the strengths brought to the business
 What are the constraints to either
o Address or
o Accept (and work keeping this in mind)
At the starting point
 Put yourself in the reader’s place; think about the reader and the message you are
trying to convey through the business plan
 Different persons may view the business plan differently, try to understand
background and experience of person/group to whom plan is shown
 You may prepare a detailed plan in sections, which may be stand alone and kept for
different purposes, i.e. sections for internal use, for investor and for banker
 Keep a track on versions to minimise confusion and possible errors
The business plan
 The document must be self speaking: i.e. minimum clarification must be required from
your end (particular attention to be paid to explaining abbreviations/short forms and
terms)
 The document must be reader friendly: key information that you want to convey
should not be hidden amongst too much details
 Plan on format of report and how data, information, analysis, comments etc. are to be
presented
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o Move what is not essential to flow of document to main report
o Think of content required to capture attention of reader; avoid excessive
information overload
 Avoid using graphs for the sake of using graphs; tables for the sake of using tables etc.
 Avoid temptation to disclose all you know and demonstrate your knowledge and
experience about the business
 Make attempts to protect your intellectual property if any
Illustrative contents
 Table of contents
 Executive summary
 Sections/chapters/paras
 Summary/conclusion
 Appendix of abbreviations, references, other annexures
 Graphs, tables, figures to be numbered and labeled
Illustrative list of chapters
 Company and background information
 Management team, Organization structure
 Business idea, strategy and implementation plan
 Sales and marketing plan
 Financial details
 Other information such as implementation schedule, statutory environment applicable
etc.
Illustrative contents in chapters
 Company and background information
o Background history if existing company; current status
o Rationale for existing business or new start up
o General industrial environment of business
o Brief background of promoters
o Vision and mission statement
o Goals and objectives
o Key business drivers and key constraints; SWOT and business strategy
o Other key information to make initial background information complete
 Management team, organization structure
o Experience and qualification of promoters and key team
o Organization structure
o Any key Organization/HR policies
 Business idea, strategy and implementation plan, including inter-alia:
o Vision, mission
o Product/service offered
o Operational details
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o USP(unique selling point); barriers to competition
o Details of any in-house technology/process or idea; or source of
technology, i.e. technology transfer through collaboration
o Details of alliance partners, current as well as proposed
o Details of any intellectual property associated with the business
 Sales and marketing plan
o Target market size
o Market research details
o Customer profiles; existing, potential/pipeline
o Marketing strategy, including social media marketing strategy if any
o Pricing strategy
 Financial details
o Past financials: Balance sheet, P&L account and cash flow summary for
five year period if available
o Future forecast – five years in summary (detailed schedules may be in
appendix)
o Details of contribution from promoters (cash/kind)
o Details of how funds will be raised and utilized
o Sensitivity analysis for key parameters, e.g. sales variations of + / - 10%
o Key ratios, break even, project IRR
o Other information such as quality of key parameters, i.e. revenue based on
geography
 Other information
o Time lines, implementation schedule, expected date of commercialization,
break even
o Regulatory environment if applicable, e.g. environmental laws for pharma
company
o Other information which may be relevant to the business
o Include required references, contact information, data and statistics
Preparing and presenting the business plan
 Presentation is the key
 Capture the reader’s interest
 Think through the format of report and how data, information, analysis, comments
etc. are to be presented
 Document should be neat and professional, with attention to details such as:
o format styles, font sizing, colours, header, footer, headings, para
alignment, spacing etc.
 Points to consider
o You must believe in the idea to sell it
o Homework is to be done before hand, adequate knowledge is required
©AV Page 26
o Credibility is important, i.e. if caught with one falsehood, nothing said
would be believed
 Updates and changes in business plan
o If there has been substantial change, update the plan
o The difficulty is when there are too many versions which are around
o If there is inconsistency between one plan and the other, this is to be
reconciled
o While the plan is to be updated to reflect reality and changes, too many
such changes give wrong signals
 Presentation of business plan in PowerPoint
o Think through the content and value to listener
o A master slide can be useful
o Include page numbers
o Use clear headers to demonstrate slide topic
o Avoid clutter (generally not more than 5 points per slide)
o Pay attention to details: colour combinations, business logo, legibility,
consistency of message, etc.
Quick Reference Tool 2:
A quick guide to business forecasting methodology
Financial forecasting summarizes future expectations of:
 Business strategy
 Accounting
 Financial analysis
 There should be a believable story about the future performance of the company. For
e.g. “Sales is expected to grow at more than average industry expected rate of growth
in this BPO company. This is because of the quality of the management team, the
investors and the past track record of the company in getting and retaining
customers.”
Strategic perspective
 The strategic rationale should be based on careful understanding of
o the company
o industry and
o general economic scenario
 Value is driven by the excess of return over cost of capital over a long period of time.
This comes out of competitive advantage, which could be due to:
o Superior product, service
o Lower costs
o Better utilization of assets and capital
©AV Page 27
SWOT analysis
 Strengths
 Weaknesses
 Opportunities
 Threats
Capture strategy into financial forecasts
 Initially start with profit and loss accounts and balance sheet
 Cash flow can be next derived from these
 Prepare by keeping key ratios and assumptions in mind
Forecasting methodology
 Understand business strategy
 Develop a complete picture
 Develop a complete financial forecast of the BS, P&L and CF statements
 In short term calculate detailed numbers, in the long term summaries trends expected
 Compute sensitivity analysis, for key drivers
 Compute probability scenarios, in the minimum, compute the following scenarios:
o Normal
o Optimistic
o Pessimistic
 Consistency checks
o key ratios and internal consistency
o industry parameters
 Cash flow and liquidity
o How will company raise funds
o How will funds be utilized
 Verify that the final numbers reflect the overall strategy of business
Starting point
 Make a start
 What are the key drivers of the business – now and in the future?
 What do you think are possible starting points?
Financial forecasts
 Starting point
o Demand and supply
o Market size and market share
o Break even point
o Growth trends
 In the case of early stage companies which have not yet turned profitable the
following are the key drivers of the business forecast for valuation purposes
o Cash burn
©AV Page 28
o Stake that the promoters are willing to offer to the private equity
investor/venture capitalist
 Often, demand is the starting point, based on which profit and loss statement is drawn
up - demand translates into sales
 Revenues forecast are dependent on industry and business, e.g.
o Retail industry: based on number of stores, online/offline sales mix
o ITES: based on number of seats
o Manufacturing: dependent on product mix
 Expenses are based on level of sales
 Revenue expenses are calculated based on trends as well as requirements
 Revenue expenses to be listed, item by item
o Key drivers to be identified (e.g. salary – driven by no. of people as well
as expected salary costs)
o Industry benchmarks may be used for cross referencing
(variations/deviations are to be justified)
 Capital expenditure (capex) depends on capacity required to generate revenues
projected as well as utilization of capacity
o Based on requirement to reach target revenues
o Also impacts depreciation & cash flow
 Balance sheet accounts based on expected sales and utilization of assets, company
policies (debtors collection period etc)
 Cash flow
o Based on forecast of balance sheet and profit and loss account
o Consistency check is important after getting the first set of numbers
In Summary
 Forecasting is the first step of prospective analysis
 It is the start for any valuation process
 The best way to forecast is to do it comprehensively and in detail including all key
financial statements
 The forecast must stand up to scrutiny and must be internally consistent
©AV Page 29
CASELET 3: VIRTUAL GAME: Writing a business plan
This article was originally published by the author on her blog, Entrepreneur's Corner in
www.citizenmatters.in
Are you interested in writing a business plan? Is it to show to an investor? If you are
planning to write a plan for your business or to help someone or are just curious about the
noise made about business plans, here is a game for you to play. A game, where you get
to be a virtual entrepreneur, without going into the pain of actually having a real company
out there to run. If you are game for this game, think of yourself as an entrepreneur
starting or running an existing business and...read on...
First: The background
Before thinking of preparing a business plan ... think through some of the points that are
relevant to the plan. List them down. These could be the idea/project that you have in
mind or are working on, the team, the potential or existing customers and the operational
plan, amongst other things. Pause for a while to understand:
 your strengths
 where you can improve and then
 where you want to go in a few years from today.
Once you have thought through this, please think about what an investor would like to
see. Again, if you have a specific investor in mind, understand what this person or
persons may be interested in funding. To illustrate, an investor in equity in a company,
would look for a multiple financial return, in the normal course of business.
So how is this multiple available? This would be possible if the investor puts money into
the company at say Rs.100 per share and is able to sell it in maybe 4-5 years at a multiple
of 5 times, 10 times or even more, i.e. at Rs.500 per share, or Rs.1000 or more. To get
this multiple, many other factors come into play. The company invested in has to have
super growth. To have super growth, the company must have customers who will pay to
buy the offerings, whether it is a manufacturing product, a service or anything else. You
can think about the other such factors which may enable the company to grow in value
over time. These factors may be internal to the company, such as a great team and good
idea, or external, such as growth in the economy.
In addition, the investor has to be able to sell the shares, i.e. there have to be buyers for
these shares. These buyers could come through the IPO route or as another company
buying this and so on. Please think of possible options of exit of the investor, and what
could be the possibilities in your case.
If you have a specific investor in mind, think through this carefully. What kind of
companies have they invested in? What do you think they will look for? Would they be
keen on funding companies in the industry sector in which you operate? Have you seen
their website/blog postings and checked with persons who are familiar with their style of
©AV Page 30
investing? Do your homework adequately and go in prepared for the questions they may
ask you.
Writing a business plan is somewhat like writing an exam paper. You prepare, work hard
and then commit all your knowledge and hard work to the answer paper. Do you
remember taking the 12th standard school leaving exam? While knowing the subject is
critical, it is also important to answer the questions well, so that the examiner understands
that you have understood the subject well.
Now for the Virtual Business Game...
Three different companies are discussed in brief below. Assume you are an entrepreneur
in each of these firms or you are an advisor to the companies. You can pick your role. If
you are writing business plans for them, here are some questions to trigger thinking:
 How would you proceed to write the business plan?
 Would the approach to writing the plan and questions asked by you be similar in
each of the above cases, or different?
 What are the key points in the business plan in each of these cases?
 In each case, identify what could be a key deal issue.
 Look for both key deal drivers and key deal breaker issues.
 Are they similar or identical in all the three cases?
 Does your business plan address these issues, directly or indirectly?
NOTE:
Deal issues are some key factors which may be the reason why someone may invest or
not invest in a company. For example, if there is only one person driving decisions in the
company, this could be a deal issue. Investors do not like to risk money in a business with
only one key person in the management team.
The three companies:
 Three friends established a company in Bangalore, to work in the areas of IT
services. Their company, ThreeForce, was started with Rs.30 lakhs invested in by
the promoters, who each had about 12 years of work experience, in India as well
as in Europe and US. Midway through the first year of operations, one of the key
customers also invested Rs.20 lakhs in the ThreeForce, for a minor stake in the
company. Towards the middle of the second year of operations, the promoters
decided to go in for a round of private equity investment. The initial funding and
the revenue generated was insufficient to achieve the ambitious growth targets
they had set for themselves. The promoters decided to approach a venture
capitalist or strategic investor for funding.
 Vijaya, Kannan, James and Rehana are good friends from school days. Vijaya,
who has completed her MBA and has 2 years of work experience in the IT
industry, is currently unemployed. She has two children of school going age.
©AV Page 31
Kannan is an engineer, who is working in a software company and now wants to
start his own business. His wife has a steady job in a multinational company and
he is willing to take a risk of losing his steady income. James, an architect is
currently managing his own architect's firm. He is interested in exploring the
opportunity to develop technology tools for the infrastructure industry. Rehana is
a graduate, who has been working in the BPO industry for five years now. She
has no family commitments and is comfortable with the job. She is excited at the
idea of starting a business with her friends. After a great deal of brainstorming,
the four have decided to create a company which will address the technology
needs of the infrastructure industry. They have heard that there is a lot of interest
in investment in this area and are keen to look for equity investment in the new
venture as they do not want to go to a bank and take a loan at this start up stage.
 GooDBuzz Technologies Private Limited was promoted by Amar Ramesh and
Rahul Gupta to offer services to the telecom industry. The customers were from
India, Europe and Asia. The company received two rounds of financing from a
VC in India, who appointed a Board Member to the company. In a Board
meeting, the nominee Director of the VC, expressed his view that GoodDBuzz
should expand its existing portfolio of offerings by providing services to other
industry verticals, as this would help the company grow at a faster pace. The
other Board members were also keen to explore this possible opportunity. This
however needed additional investment, which the existing promoters and
investors could not bring in. The Board members of GooDBuzz were now looking
at alternate options before them and how they should proceed. They decided to
look for private equity investment in the company.
END OF CASELET
©AV Page 32
CHAPTER 4
Valuation and Value Creation
Currently most businesses are trying to understand how value is to be created. If we are
trying to create sustainable value, we need to look at growth and value of the business
from a perspective that is beyond growth of the top-line and the bottom-line of the firm.
Value can be created in many ways. As an organization grows, there are many changes
and there needs to be an effective growth strategy to manage these transitions. The
business has to gear up for a future which is different, not just because the external
environment has changed, but because the firm itself may be radically different.
In this section, we first look at the different ways in which value is measured. Next we
look at the emerging aspects of intangible assets (IA) valuation. This is looking at
intangibles from the perspective of understanding and managing them in the current day
business environment. This chapter does not touch upon the accounting aspects of IA
measurement and recording in the financial statements. We also briefly touch upon value
creation in a business.
Valuation
Many factors impact valuation. These could be tangible or intangible, real or perceived,
internal or external to the firm. This includes the business strategy, business and
industrial environment, global economic environment, political environment etc. In the
case of a transaction between two or more parties, it may be as linked to the price the
buyer is willing to pay for the stake in the company contrasted to the price the seller is
willing to sell the stake in the company for.
Valuation is not something that is fixed and constant. It varies, from time to time,
depending on the transaction and the need of the buyer or seller. Much of the valuation is
because of assumptions about the future of the business, which itself is uncertain.
Aswath Damodaran, in his book, "Damodaran on Valuation - Security Analysis for
Investment and Corporate Finance", in fact talks of some myths in valuation.
Damodaran gives the reasons for these myths and goes on to explain why these are not
true. Three of these myths are listed below:
 Valuation is objective because valuation models are quantitative
 Well done valuation is timeless
 Good valuation provides a precise estimate of the value
Valuation models use data and quantitative information as inputs to arrive at the final
valuation numbers. There is, however, room for a subjectivity in these inputs. A variation
©AV Page 33
of one percent in the discount rate taken in the Discounted Cash Flow (DCF) model can
significantly change the valuation. In valuation using a relative method of valuation,
selection of different comparable companies, can lead to variation in the input
parameters, which in turn impacts the final value arrived at. Selection of comparables is a
subjective exercise. Comparables can be selected from companies in the same region,
having the same turnover, or similar cost structures. In the case of unlisted companies or
companies in an emerging, nascent industry, it is even more difficult to select
comparables.
Valuation of a company is undertaken with an eye on the future. We value a company
because of its tomorrow, in most cases. This estimate of the future carries its own risk.
The valuation models provide for the risk to be built into the numbers in different ways.
Some of this is by taking a higher discount factor, by having an appropriate risk premium
or by performing a sensitivity analysis by making slight variations in the key value
drivers of the enterprise being valued.
In brief, valuation is a perception of the value of a business at some point in time. It
depends on the purpose of the valuation; on whether one wants to buy or sell or is
looking for equity investors. Bankers value a company differently for lending as
compared to a venture capitalist (VC) who is willing to take a higher risk. Both the
banker and the VC are interested in financing future operations of the investee company.
Both the parties, want to get a financial return from such a transaction. However, both
will approach the project with different views. Both value the future of the enterprise
differently.
Planning for a valuation
You may be interested in valuing your business prior to an M&A transaction or for
investment. How would you plan for this valuation exercise? The practice followed by
most enterprises, is to get valuation done externally, by a third party. This is supposed to
bring an element of objectivity to the table. In fact third parties are also undertaking
valuation for venture capitalists (VCs). Earlier valuation used to be done by the VCs
internally, now increasingly some of them are getting third parties to value a potential
investee firm.
At the start of any business valuation exercise the business being valued would be studied
and industry and market reports obtained. The valuer would also try to select the method
that would be most suitable for the business being valued. The difficulty is that there are
multiple models to choose from. In addition, some methods can be modified and used
with slight variations, depending on the situation and requirement of the valuation. As a
result, valuation can often be a complex, time consuming exercise.
©AV Page 34
Environments impacting valuation
The value of an enterprise depends on a variety of factors, key among them being the
industry environment, both in the country or countries of operation, the socio-political
environment and the company specific environment.
It is not unusual to find two companies, in the same industry, operating in the same
region, with approximately the same number of people, having different values. The
difference in the value could be for a variety of reasons. No two businesses are alike, and
this is captured in the difference in the valuation. The differences in the two businesses
could be due to the experience of the key management team, it could be due to the
customers that one company has as compared to the other, or could be due to certain
patents or intangible assets held by one company and not held by the other.
Sometimes, this advantage which one company has over the other, maybe be perceived,
and may or may not exist in reality. This is because of the intangible "Brand-image,"
enjoyed by one company as compared to the other. A good valuation model should be
able to capture this intangible. For example if a discounted cash flow model is used, the
"Brand-image" may be captured by increased future revenues of one company as
compared to the other, which will in turn lead to increased cash flow.
To expand this further, let us take an example of two (hypothetical) companies in New
Delhi, Naveen Private Limited (Naveen) and Vijay (Vijay) Private Limited. Assume that
both are in the same segment of business, with almost identical current year revenues.
Further, assume that the key management team of Vijay as compared to Naveen, has
more experience and domain knowledge.
It is therefore, not surprising that, in the future, the performance of Vijay is expected to
be superior to the performance of Naveen. Of course, this is with the underlying
assumption that the two companies are quite similar in all other parameters of
measurement currently. These parameters include measurable assets and intangibles.
To sum up, though currently, if measured on current performance, the two companies
appear similar, in the future, it is expected that one company will outperform the other.
As a result, there will be a difference in the enterprise value, which is based on future
expectations, rather than current on performance.
Factors that impact valuation
Prior to an exercise in valuation, the enterprise being valued must be studied in depth. In
an existing company, historical data and other information would be reviewed. As
mentioned earlier, this would include company specific information, industry related
information in the context of the global environment for business.
In a new business, the future expectations from the company and industry would be used
as reference points. When a start up is set up to take advantage of emerging opportunities
©AV Page 35
in a new market, in the initial phase several assumptions and estimates are made
regarding the future. Often, in a nascent industry, the initial phase is very volatile.
Valuation can reach absurd heights and depths, in these situations. This is what happened
in the case of the valuation of the first few so called 'Dotcom' companies. Valuations
models were based on a variety of non-standard assumptions. Many companies were
valued based on page hits. A multiple was applied for every page hit. Currently,
ecommerce companies are commanding huge premiums compared to traditional
businesses, so much so that there is a worry about a valuation bubble.
A variety of valuation methods have been used for valuing companies in emerging
technology industries. It has been said that some biotech companies have been valued
based on the number of PhDs in the company. Many companies are valued at a multiple
of revenue, particularly when they are in a growth phase and there is little cash flow or
negative cash flow. The earnings based multiple can also be modified further as seen in
the example below. The revenue figure which is used as the base number could be the
historical average revenue, current year revenue or future expected revenue.
 Historic average of the previous three years: Rs. 80 crores ( revenue of preceding
three years Rs.55 crores, Rs.80 crores and Rs.105 crores respectively); multiple
three:
Value = Rs. 80*3 = Rs. 240 crores
(In a further modification, this could be based on the previous year or previous
two years‟ revenue and the multiple would accordingly be different in these
cases.)
 Current revenue (actual year to date and forecast for the balance period):
Expected to be Rs.125 crores; multiple two:
Value = Rs. 125*2 = Rs. 250 crores
 Revenue forecast for the following year: Rs. 155 crores; multiple 1.5:
Value = Rs. 155*1.5 = Rs. 232.5 crores
Thus we can see that the selection of the revenue period and the multiple impacts the
value range.
These multiples and revenue numbers would be selected based on review of similar
transactions that have taken place in the recent past and review of comparable companies.
Sometimes, instead of revenue multiples, earnings multiples may be used. Revenue
multiples would be preferred when the company has limited profits. Earnings and profit
multiples would be preferred in more established companies, where the earnings capture
the cost structure of the company being valued. Earnings could again be one of the
following:
 EBITDA: Earnings before interest, tax, depreciation and amortisation
 EBIT: Earnings before interest and tax
©AV Page 36
 PBT: Profit before tax
 PAT: Profit after tax
Each of the above has its own advantages and disadvantages. Interested readers can get
more information on the applicability of the above in books on valuation, some of which
have been mentioned in the reference section at the end of this book.
Valuation models can be broadly classified into three types:
Valuation methods
Cost based Income based Transaction multiple based
Figure 3: Broad classifications of valuation methods
Sometimes, hybrid models that are a combination of more than one of these methods are
used.
Cost based methods
In the cost based method for valuation, assets of a company form the basis for arriving at
a final number. Broadly, we can classify this into the following methods:
 Net asset value or book value method
 Replacement cost method
 Liquidation method or break up value method
Net asset value or Book value method
The book value method, takes the value of the assets as per the balance sheet of the
company on the date of valuation as the base value. A premium may be assigned to this
or the value may be discounted, based on the specific factors of the case in question.
Replacement cost method
In this case the cost of setting up an enterprise similar to the business being valued is
considered.
Liquidation method or Break up value method
In the liquidation value method, the value of a business is that amount which is realizable
on sale of the enterprise, either as a whole or in parts. Factors such as whether buyers
©AV Page 37
exist or whether the company is going to be sold piecemeal, are to be considered. Costs
of liquidation are to be deducted from the value of the enterprise.
Income based methods
Income based methods are the most widely used. These can be classified into the
earnings capitalization method, the discounted cash flow or net present value method and
the transactions multiple or the relative multiple method.
Earnings capitalization method or the profit earnings capacity method (PECM)
In this method, the earnings of the company being valued are capitalized at a rate which
is considered suitable.
For example assume that Prerana Limited is earning post tax profit of Rs. 30 crores and
we would like to capitalize this at 15%. The value of the Prerana Limited under this
method is equal to Rs. (30/15%) crores, i.e. Rs. 200 crores. This is a simple method of
calculation of the corporate value. The 15% rate here would be based on the standard rate
for similar companies in the industry and in the geographical region.
Discounted cash flow method (DCF)
The cash flow model assumes that the enterprise is a going concern and that the value
drivers of the company are also the drivers of the cash flow of the company. The business
is considered to have different phases in its life cycle. There is an initial growth phase,
followed by a steady phase.
The DCF model is a summation of the value of the company in the growth phase and the
steady phase. The value in the steady phase is captured as a residual value, based on a
mathematical formula. This growth phase, can in turn be further split into two or more
phases, with differing growth rates, based on the management perception of the
expectations of growth in the future. This is illustrated in the figure below.
Discounted
NPV of
Enterprise
Value: Phase 1
Value: Phase 2
Terminal Value
Discounted
Discounted
©AV Page 38
Figure 4: Net present value
Transaction multiples method or relative method
In the transactions multiples method (TMM) or relative method of valuation, the value of
a company is calculated based on the values of similar companies. The difficulty is in
identifying similar companies. Some common ways of selecting comparable enterprises
is by identifying companies by way of size, i.e. in terms of revenues, number of
employees etc. The other way is by looking at companies in the same industry,
irrespective of the size.
To illustrate this, let us take a company, Pure Services Private Limited (PSPL) with a
revenue of Rs. 70 crores in the current year. PSPL expects revenues of Rs. 100 crores in
the next year. Some investors are interested in valuing PSPL.
To arrive at the value of PSPL, comparable transactions that have taken place in the past
few months in the industry are reviewed. It is observed that the average value of these
companies, in the transactions, was between one to two times the forward revenue, i.e.
the revenue in the coming year.
PSPL can be valued using a multiple of 1.5, the average, which will lead to a value of Rs.
150 crores. If on the other hand, one feels that PSPL is superior to the other companies
being compared to, one could assign a premium to this and increase the multiple to 1.75
and value the company at Rs. 175 crores. The decision of the multiple to use, and the
comparable companies selected, alters the value of PSPL and can form the basis of the
negotiations in any potential transaction.
The valuation process
The following steps are followed in valuation:
 Data is collected, i.e.
o Historical information about the company, including financial and non
financial
o Industry specific information, both within the company of operation and the
global environment
 Data and information is validated
 Based on the data collected and preliminary analysis, the valuation models are
selected
 The business is valued based on the valuation models used and a value range is
arrived at, for different scenarios expected in the future (including based on a
sensitivity analysis and probable/expected scenarios – as applicable)
 Finally, the value of the enterprise arrived at is reviewed in the overall context of
the transaction proposed
©AV Page 39
The value arrived can become a deal breaker issue if the parties to the transaction have
widely differing value ranges. Hence valuation is to be done carefully and with due care
and cannot be just a number arrived at using a formula. These stages in the valuation
process have been highlighted in the diagram below in the book “Handbook on
Corporate Valuation,” by Pratap G Subramanyam and Anjana Vivek.
Figure 5: The valuation process
Collection of data
In this stage, one has to review market studies and research reports on the industry and
the business environment in which the company is operating. This includes data
collection about the future, expected growth in this line of business, expected market
share of the company, possible profit margins in the business and competition analysis.
The underlying business strategy is to be understood. Sometimes this strategy may be
articulated, sometimes not. Tom Copeland, Tim Koller and Jack Murrin, in their classic
book, "Valuation - Measuring and Managing the Value of Companies," explain the
importance of developing a strategic perspective and highlight some models for such
analysis.
No Yes
Data
Collection
Validation
of Data
Selection
of
Valuation
Model
Valuation
of the
Company
Validation
of the
Value
Does the
value stand
up to
scrutiny?
Relook at
the
valuation
exercise
starting
from data
collection
Finalize
the value
arrived at
©AV Page 40
Validation of data
The business forecast needs to be carefully scrutinized. The numbers in the forecast are
directly input into the valuation model and hence one needs to understand if these are
realistic and achievable.
To illustrate this, let us consider the case of Growth High Private Limited (GHPL), which
is expected to have an annual growth rate of 15% for the next 5 years, while the industry
growth rate is expected to be 10% in the same period. One needs to understand how and
why the rate of growth of GHPL can be so much above the expected industry growth
rate. The underlying drivers of superior growth need to be identified. This could be better
quality of products, cost efficiency or use of unique technology. In such a scenario, one
may also try the following exercise, what would happen to the value of GHPL if the
growth rate was reduced to that of the industry, i.e. 10%, or a slightly increased rate of
12%? In essence, deviations from industry average are to be scrutinized very carefully
and validated; otherwise, the valuation exercise will not hold credibility.
Selection of valuation model
Typically, one lists out some key approaches for valuation at the start of a valuation
exercise, such as the DCF model and market based model. Models which cannot apply in
the case under question are rejected. For example, it is difficult to value start ups based
on the profit multiple model, since there may be no profits in first few years. Such
companies are often valued, based on multiples of their revenue or some other such
parameter.
The methods selected must reflect the methods used in the industry, at that point in time.
It is preferable to use more than one valuation model. If the value of the company varies
with different models used, this may be an indication that the calculations are flawed or
that one of the models is not suitable for application in the case under consideration. In
such situations, one needs to reexamine the models used and the underlying assumptions
and inputs to the models used. The example that follows, illustrates this.
Example
Two companies are to be valued. We try to use the relative method in both cases. In Case
A, we find that we can use the relative method for calculating the value of the company,
Medcan Private Limited. In Case B, however, we find that the relative method is not
appropriate to value PencilPens Private Limited.
Case A
In this example we try to arrive at the value of Medcan Private Limited, based on the
enterprise value of three listed companies, Testman Limited, Medlink Limited and
CheXup Limited.
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Amounts in Rs. crores
Testman
Limited
Medlink
Limited
CheXup
Limited
Average
Enterprise value/sales 1.5 1.2 1.2 1.3
Enterprise value/EBIDTA 18.0 16.0 17.0 17.0
Enterprise value/book value 3.4 2.8 3.1 3.1
Medcan has sales of Rs. 180 crores, EBIDTA of Rs. 14 crores and book value of Rs. 74
crores. What could be its possible value?
Solution:
Application to Medcan Private Limited:
Medcan P Ltd.
Rs. crores
Average
of three
relative
companies
Enterprise
value of
Medcan
Rs. crores
Sales 180 1.3 234.0
EBIDTA 14 17.0 238.0
Book value 74 3.1 229.4
The value range of Medcan is from Rs. 229 crores to Rs. 238 crores, based on the above.
In this example, we could use a modified multiple. As an alternate, we could value the
company based on the average multiples of Medlink Limited and CheXup Limited only,
if we state that Testman Limited is different from the other three companies being
compared. Here the justification of the method used needs to be articulated.
Q. What is the alternate value range that you obtain if you do not consider Testman as a
comparable company?
Case B
Let us now value PencilPens Private Limited, based on the enterprise value of three listed
companies, Papers Limited, Documentation Limited and Printing Limited.
Amounts in
Rs. crores
Papers
Limited
Documentation
Limited
Printing
Limited
Average
Enterprise value/sales 1.5 1.8 0.9 1.4
Enterprise
value/EBIDTA
14.0 21.0 10.0 15.0
Enterprise value / book
value
2.1 3.0 1.8 2.3
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PencilPens has sales of Rs. 160 crores, EBIDTA of Rs. 10 crores and book value of Rs.
85 crores. What could be its possible value?
Solution:
Application to PencilPens Private Limited:
PencilPens P Ltd.
Rs. crores
Average of
three
relative
companies
Enterprise
value of
PencilPens
Rs. crores
Sales 160 1.4 224.0
EBIDTA 10 15.0 150.0
Book value 85 2.3 195.5
The value of PencilPens, using this method, ranges from a low of Rs. 150 crores to a high
of Rs. 224 crores. We cannot use the relative method for valuation in such a case and
have to look for an alternate method or at other comparable companies.
END OF EXAMPLE
The above example was illustrative. The use of the methods of valuation also depends on
the nature of the proposed transaction and requirement for this valuation exercise. In an
M&A transaction, valuation should reflect synergy expected from the proposed
transaction. The choice of valuation model and its application must be done with due care
and thought.
Different persons valuing the same company may therefore arrive at different values,
based on the models used and the assumptions regarding the possible future scenarios.
The differing values become a starting point for the negotiations and deal structuring.
Sometimes the value ranges are so different that these make the deal a non-starter.
Valuation of the company
Once the valuation models have been identified, data is input to obtain the value of the
company. To reduce the impact of subjectivity in the valuation exercise, different
scenarios may be reviewed. Typically, three scenarios are considered, an optimistic,
normal and a pessimistic scenario. In the optimistic scenario, both revenues and certain
expenses will be on the higher as compared to the other scenarios. In the pessimistic
scenario, revenues will be reduced and hence it is natural that some costs would be
controlled as the management tries to work with reduced cash flow. This exercise would
provide a value range of the company for different levels of performance.
Next, weights are assigned to the different scenarios. These reflect the expectation
regarding the probability of each scenario occurring in the future. For example it may be
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assumed that values in the three possible scenarios are Rs. 200 crores, Rs. 180 crores and
Rs. 150 crores respectively. It may further be assumed, after much deliberation that the
probability of each of these scenarios occurring may be 50%, 40% and 10% respectively.
The expected value of the company is then calculated as:
Value (expected) = (200*0.5) + (180*0.4) + (150*0.1)
= 100 + 72 + 15
= Rs. 187 crores
The valuation of the company, which is the key objective of this exercise, is to be done
carefully. The final valuation of the company or the valuation range has to effectively
capture the story behind the enterprise.
Validation of final value
Once we arrive at a value of the company, we need to again raise some questions such as:
 Does the value reflect the position of the company compared to others in the
industry and other competing companies?
 Does the value reflect the expected future performance of the company, based on
its strategy?
 Does the value reflect the price we want to negotiate for?
There are many factors that affect the value of a company and need to be kept in mind
while reviewing the enterprise value arrived at using valuation models. Some of these
are:
 Strategic requirements: These can override other considerations. For example, a
company in India may be willing to pay a premium to buy a small company in
Europe, because it wants quick access to the European markets.
 Demand vs. supply: If there are many bidders for one enterprise, the value of this
company will be higher because of the demand from multiple parties.
 Flavour of the season: Sometimes select industries are perceived to be on a
growth path. This will in lead to increased values for all companies in the
industry.
 Control premium: Investors sometimes want a controlling stake in the company,
for which they may be willing to pay a premium.
In addition to the above factors, in certain cases, valuation models may need
modification, these include valuations in:
 Mergers and acquisitions
 Investments by venture capitalists or private equity investors
 Valuations in restructuring exercises
 Valuation for Multi-business
 Cross border transactions
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 Valuation for an IPO
Illustrative example: Price banding in IPOs *
* Illustrative example contributed by Pratap Giri S. FCA, ACS
Unlike valuation of a share for an acquisition, merger or other strategic transaction based
purely on fundamentals, IPO pricing follows a mix of fundamental approach and market
mechanics. This is because IPOs have to keep in mind the current sentiments in the
market, the investors‟ risk appetite and return expectations and more importantly the
marketability of the share and the post-issue liquidity in the market. Therefore, merchant
bankers have to delicately balance the pricing with equal weightage to market aspects as
to the intrinsic value.
In price banding for a fixed price or a book built offer, merchant bankers rely heavily on
the Earning Per Share (EPS) and the Price to Earnings multiple (P/E). These are fine
tuned to the financial performance of the company in recent years, the performance to be
expected in the immediate future, the EPS and P/E multiple of comparable listed
companies and their stock performance and the industry averages. A lot would also
depend upon the timing of the public offer. Historically, in good market conditions, IPOs
have tended to be aggressively priced such as those of Jet Airways, TCS, ONGC and
others. In weak market conditions, generally IPOs are not opened but if they have to, the
pricing has to be investor friendly. In retrospect, one can conclude that the IPOs of
Maruti Udyog could have been priced higher if it had come in stronger market
conditions. It may be argued that in a bullish market, there is always scope for upward
movement and therefore the issuer can assume enough upside to the investor. However,
in IPO pricing, one cardinal principle is important. The investor should be allowed to
make money if the stock has to find sustained support. Therefore, some issues are
intentionally priced a bit lower than necessary to provide a psychological edge to the
investor. The IPO of Tech Mahindra is a case in point.
In book-built issues, the pricing is a collaborative effort by the issuer and the investor.
Therefore, it is believed that it leads to better price discovery, though it has been
experienced that in a strong market, even an aggressive floor price does not deter the
investor. The Reliance Power (IPO in 2008) is a case in point. Despite the fact that the
company does not have any track record, the issue received record subscription despite
aggressive pricing. However, the company was made to backtrack due to severe backlash
from the media on overpricing the issue. As a measure of recompense, the company
declared a bonus issue to all investors in the public offer.
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Quick Reference Tool 3:
Special case of valuation: Intangible assets
 Traditional accounting and business models do not readily allow for intangible assets
to be valued. However this is one area that cannot be ignored as intangible assets are
driving the value of many businesses today.
 In the current business environment, much worth resides in intangibles,
o Employees
o Brand value
o Intellectual property
o Software in laptops
o Customer satisfaction etc.
Intangible assets
 Identifiable non-monetary asset
 Without physical substance
 Held for use for production/supply of goods or services or for rental or for
administrative purposes
 Asset is a resource
o Controlled by enterprise
o Future economic benefits are expected to flow from it to enterprise
 Some assets can be a combination of tangible and intangible
o Software and hardware
o Legal document and patent
 Often the intangible asset value exceeds the tangible value in these cases
Intangible Asset (IA) value
 The value of the IA is from
o Economic benefit provided
o Specific to business or usage
 May have different aspects; such as
o Accounting value: value as per books of accounts
o Economic value: may have value to potential acquirer even though this
does not have any value in the financial statements and
o Technical value: even knowledge that a particular experiment has failed
may be useful to a researcher and so this would have technical value but no
economic or accounting value.
 Valuation differs for
o Liquidation
o Book value
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o Banks for lending
o Management control premium
o Partial use of IA
o M&A/LBO/LBI (management buyout, leveraged buyout/buyin)
Some Methods of Valuation:
Historical cost
 Historical and book costs associated can be identified with the IA; direct and
indirect costs
 There in subjectivity some areas, for example
o What is the period for costs should be calculated when the company is very
old, e.g. brand value of coca cola (dating to 1817)
o Which costs are to be considered, which are to be excluded, e.g.
advertisement partly relates to current sales and partly to future sales
Replacement cost
 Some IA can be replaced, some cannot
 How do you assign costs for different characteristics, e.g. for a brand – awareness,
image, quality of product, superior after sales service , leadership, distribution network
etc
 Further there are risk element in replacement of product, hence in practice,
uncertainty may lead one to purchase the IA instead of replacing it
Market price related
 It is difficult to get comparable transactions where one can understand the market
price (e.g. Used cars have a market price, but IA may not)
 Sometimes multiples may be used such as in M&A enterprise valuation
 It needs to be understood that market price may not necessarily be indicative of
value specific to requirement since this may have depended on some strategic rationale
 Market price may be linked to both tangible and intangible assets and it may be
difficult to separate and unbundle these values
Potential earnings
 Based on future expectations
 The difficulty is in separating the income associated with the IA on a standalone basis
 Discounts and multiples are difficult to estimate
Excess profits
 Profit from net tangible assets is separated out. For e.g. one may estimate that the
difference in price between a generic product and a branded product is indicative of value
of the brand. This would then assume that all excess profit is attributable to the brand and
not to any other IA, which may not necessarily be the case
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Relief from payment
 This assumes that if IA ownership was with another company, royalty would have to
be paid for usage of IA
 Value is assumed to be the capitalized value of relief to company
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CHAPTER 5
Mergers and acquisitions
Many businesses are looking at growth through the mergers and acquisition (M&A)
route. It is often assumed that if one grows through purchase of another business or
combines with another entity, the combined new entity will have a lot of advantages. In
reality such transactions are not so simple and a successful outcome is not guaranteed.
In this chapter we look at the process of the planning in an M&A exercise.
A merger is a combination of two or more enterprises into one company. In acquisitions,
one enterprise, or a division of a company is absorbed into another. From a legal
standpoint, there are many distinctions between types of mergers and acquisitions. Prior
to considering any M&A transaction, one needs to pay adequate attention to the statutory
regulations that need to be complied with.
The principal economic reason for a merger is that there is expectation of value creation
from the transaction. Historically, there have been many motivations for mergers and
acquisitions and many theories have been put forward. The new combined entity could be
formed for a variety of reasons, including for either one or more than one of the
following: operating synergy, financial synergy, diversification, strategic realignment, tax
considerations and market power as stated by Donald DePamphilis in his book,
“Mergers, Acquisitions and other Restructuring Activities.”
Different types of mergers and acquisitions
Mergers and acquisitions can be of different kinds. Horizontal mergers involve mergers
of two or more businesses that compete in the same kind of business activity. Vertical
mergers occur between businesses which are in different stages of production operation.
In their book, “Takeovers, Restructuring and Corporate Governance,” Weston, J Fred,
Juan A Siu and Brian A Johnson, state that conglomerate mergers are between firms that
are working in unrelated activities. Leveraged deals are a category of specialised
acquisitions. In leveraged buy outs (LBOs) the acquirers of the company borrow funds to
finance the transaction. The borrowed funds are secured against the assets of the
company. Typically these acquirers do not have sufficient funds to take over the target
company, hence the need for borrowing funds to finance such transactions. The types of
M&As detailed above are illustrative and not exhaustive.
The growth of the economy in India in the recent years, has led to many developments.
Indian businesses are now competing in a global environment. Many Indian firms are not
geared to face such competition. One of the ways to address this competition from firms
outside India and reduce imbalance due to sheer size, is by combining more than one
business by merging, or by larger businesses in India acquiring smaller businesses. Such
inorganic growth can help bring economics of scale to the newly formed entity. Further
the merging companies can bring different skill sets and competencies which
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complement and supplement each other, to give better returns and facilitate a better
growth rate in the merged entity, provided this is done with due thought, care and
planning.
Globally, M&A activity has been studied to understand whether the stakeholders have
benefited from such deals. A question, which is raised, is whether mergers pay off for the
target companies and the acquiring shareholders as well as for society. Many times,
M&As fail to meet expectations. Gerhard Picot in his book “Handbook of international
mergers and acquisitions,” states that in view of the economic significance of increasing
transaction numbers and volumes, it is regrettable that more than 50% of such
transactions do not bring in the desired increase in values and greater returns on
investments. In fact it has been observed that in most cases the shareholders of the selling
company benefit at the expense of the shareholders of the purchasing company.
Some of the reasons given for failure of mergers are:
 Overestimation of synergies
 Underestimation of expenses and costs of integration of the two or more different
firms
 Over valuing the business by the buyer
 Incomplete or inadequate due diligence
In view of such findings, it becomes important for persons involved in such transactions
to proceed with care. A detailed project review, or a due diligence review (DDR) could
help understand the finer points and deal issues.
The premise for M&A is to be carefully examined and questions raised not just on
financial parameters, but also on soft issues such as cultural fit, impact on customers, etc.
before proceeding with such deals.
Due diligence review (DDR) in M&A transactions
Companies merge because of perceived benefits to them, which is expected to lead to
increased valuation in the combined entity as compared to the individual separate standalone
companies. To put this simply, two companies A and B merge to form one
company A + B, with the expectation that:
Value (A + B) > Value (A) + Value (B)
The valuation in such transactions is dependent on a variety of factors. Prior to any M&A
transaction, each company projects a valuation, based on historical data, future forecasts,
current and expected business environment. The benefits of the deal proposed would also
be highlighted.
Each of the parties would review the data provided by the other party to the proposed
transaction. Such a review would bring out points, which may impact past historical data
or may highlight uncertainties in future forecasts. This can have an impact on the
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negotiation and provide a bargaining tool for the reviewer, if done with due care and
utilized well.
Valuation is dependent on a variety of aspects, such as technical skills, IT infrastructure,
physical infrastructure, financial and accounting and HR organization structure,
intangible assets and brand value. These cannot be taken at face value as stated by the
parties to the proposed deal, who have to provide variety of data and documents,
including inter-alia, historical financial statements, legal documents, records and manuals
maintained.
These details are to be reviewed and data to be matched and scrutinized for internal
consistency. Documents and manuals are to be studied along with procedures followed
by the company. This is to be done with a view to understanding whether what is laid
down in the manuals, is actually being practiced by the management. Every projection
and forecast made is to be carefully examined. For example, as the sales are projected
based on expected markets, the global markets may also need to be examined. The
reviewer must look at the total addressable markets (TAM) and study expected trends in
the industry to understand the demand for these products/services.
All elements in the projected forecast are to be examined, as the valuation of the business
is directly dependent on this. For example, if the promoters of a company being acquired
have projected an annual increase in turnover of 25% in the first year and 50% in the next
two years, the rationale behind these projections is to be understood. The customer
profile and turnover should be computed and examined. Reasons for loss of key
customer, if any, are to be looked into. Sales projections are to be cross-checked with
other figures such as corresponding increase in say raw material, in labour or salary costs
etc.
The impact of the M&A transaction, if it goes through as proposed, is to be factored in.
The ability of the proposed combined entity to capture some additional market should be
considered. Similarly expenses projected and savings expected because of the proposed
transaction are to be studied.
Statements made should be carefully weighed against historical available information.
Sales and expenditure should be reviewed against budget and forecasts made in the past.
Review of Management Information Statements (MIS) of different periods alongside
actual sales, expenses, capital expenditure (Capex) etc. should throw out any sudden
deviations from projections, in the past. This will help understand whether or not the
company has able to achieve revenues as forecast and the reasons for deviations if any.
Another key factor which must be examined is the historical capex and other expenses.
These are to be compared with industry standards, to understand whether the company
has been prudential in managing its day-to-day operations. This may also give some
insight into the cash management approach of the company.
Other elements which are to be considered are the details of compatibility of existing IT
systems in the two companies which would be merged, the HR policies, including ESOP
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schemes and the manpower skill sets in the two organizations. Employee turnover is to be
closely examined and reasons for any deviation from industry standards understood.
Many M&As fail due to poor post merger integration. Issues such as deciding the roles
and responsibilities for key individuals are to be carefully thought through. For example
two organizations, similar in size and turnover, may consider merging to become a large
powerful player. If both organizations have a COO, a CFO and CTO in place, it may be
difficult to decide and select the COO, CFO and CTO in the combined business. Further
the two organizations may have different structures to manage their day to day
administration. In such cases, these differences may come in the way of creating a
successful single merged entity which can go on to perform well in the market place. The
inherent differences may lead to internal conflict which may take time to be addressed
and hence the merged entity may lose out on the market opportunity.
The due diligence exercise therefore cannot just focus on financials and easily
measurable parameters, such as turnover and attrition in the two businesses. Some ways
of looking at soft issues such as cultural issues may also need to be addressed.
In one case, two companies in the IT Services industry, Timeon Private Limited (TPL)
and Pearle Private Limited (PPL) wanted to merge. About two years before the proposed
transaction, PPL wanted to close one of its divisions, due to a change in business strategy.
It had found a buyer in TPL and the entire division of PPL with 100 persons had been
sold to TPL. At the time of the proposed merger, an exercise was taken up to ask these
100 persons their experience in moving from TPL to PPL. On investigation, it was found
that within one year of the sale of the division of PPL to TPL, all these 100 persons had
left the services of the company. This was a worrying signal for the proposed transaction
and was taken up for additional review. On further investigation, it was observed that the
work culture in the two organizations were quite different. One organization had a lot of
structure and rules and regulations to be observed and the other had a very informal style
of working. These differences in working made the employees of the erstwhile division
of PPL, uncomfortable in TPL. Thus while prima facie, the two companies appeared to
be similar, a detailed review showed another side to the picture. As a result, the two
companies decided to partner and work together on assignments, rather than merging into
one entity.
Persons conducting the due diligence review therefore need to look into details and take
up leads which could help in taking a decision in whether the deal should go through or
not. Deal breaker and deal maker issues can come up at any stage of such a review.
Tax, legal and regulatory issues need to be factored into the due diligence review. Other
aspects which need to be looked into are the technical feasibility and the commercial
viability of the business, post the transaction. The findings of such reviews, keeping in
mind the proposed transaction also get factored into the valuation. The points raised
provide inputs for negotiation and deal structuring.
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M&A transactions and the regulatory environment *
* Sub-section contributed by Pratap Giri S. FCA, ACS
In India, the M&A activity has shown phenomenal growth in the liberalized era,
particularly after the deletion of the restrictive chapters under the MRTP Act. Mergers are
not very common as compared to substantial acquisitions, which almost serve the same
purpose. However, in India, both horizontal and vertical mergers have taken place.
Currently, M&A activity is still governed by Sections 391-395 of the Companies Act,
1956 since the relevant chapter of the Companies Act 2013 is yet to be notified pending
the constitution of the NCLT. The Supreme Court recently cleared the way for the NCLT
due to which the new provisions may be notified in due course. Besides the Companies
Act, the Competition Act, 2002 is also relevant in the context of larger M&A
transactions. Acquisitions in the case of listed companies are governed by the provisions
of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 as
applicable from time to time. Acquisitions in unlisted companies are largely an
unregulated area, except in the area of foreign investment. The current regulatory
environment is quite conducive for the M&A activity and one has not seen many
complications arising in court hearings under the Companies Act or with SEBI in the case
of substantial acquisitions and takeover of listed companies. There have been tax issues
arising from indirect acquisitions made by foreign companies in India and the most
notable among them is the Vodafone case. It led to a retrospective amendment of the
Income Tax Act that created further controversy. M&A is also governed by the relevant
provisions of the Foreign Exchange Management Act, 1999 in the matter of foreign
shareholding subsequent to the transaction. Similarly, sectoral regulation is also seen in
industries such as banking, insurance, telecom and others. The Income Tax Act 1961 also
promotes M&A activity providing for carry forward benefits on depreciation and
accumulated losses in the case of merger or demerger of companies. This has helped
corporate consolidation and restructuring in a big way. Last but not least, the provisions
of the new IND-AS 103 Accounting Standard on „Business Combinations‟ notified by the
MCA for applicability from financial year 2015-16 onwards in a graded way needs to be
followed. Therefore, in finding value in a M&A transaction, the regulatory framework in
the Indian context should be kept in mind.
The Companies Act connotation of M&A is quite wide and includes all such transactions
as would constitute an „arrangement‟ as defined in section 390(b). Merger tough not
defined specifically, is an arrangement that constitutes an „amalgamation‟ of companies
under section 394 of the Act. In approving a merger under the proceedings of Company
Law, the Courts look into the aspect of „public interest‟ which includes the relative
shareholder interests, especially if both the companies proposing to merge are listed. In
the Indian context, two mergers come to mind that were involved in controversies about
the relative valuation of both companies. In the first case which involved the merger of
the erstwhile TOMCO with Hindustan Lever Ltd., the merger was eventually put through
after the Hon‟ble Supreme Court upheld the merger. In the second case involving the
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failed merger of the erstwhile Global Trust Bank Ltd (GTB) with UTI Bank Ltd, the
merger had to be called off amidst allegations on the overvaluation of the GTB share.
On the aspect of acquisitions, the statutory framework acquired a definitive shape
following the introduction of the SEBI (Substantial Acquisition of Shares and Takeovers)
Regulations 2011, popularly known as the „Takeover Code‟. The 2011 Regulations
replaced the erstwhile Regulations that were introduced in 1994 and overhauled in 1997.
The 1997 amendments were based on the recommendations of the Justice Bhagwati
Committee that went into the aspect of acquisition of „control‟ as distinguished from
acquisition of shares. The new Regulations introduced in 2011 were a result of the
Achyutan Committee recommendations. The Code presently provides for a threshold
acquisition of shares or control of 25% as the trigger point for a mandatory public offer
by the acquirer. The mandatory offer shall be for a minimum of 20% of the issued capital.
The Takeover Code has made acquisitions serious business in India and only resourceful
and committed acquirers can hope to takeover management of companies and that too in
a transparent way.
Ind-AS 103 which is harmonized with the IFR Standards brings in a new era of
accounting for M&A transactions with a significant departure from the approach
advocated all these years under AS-14. The new standard does not differentiate the
accounting treatment for (a) amalgamation in the nature of merger and (b) amalgamation
in the nature of purchase. It also does not distinguish between transactions in the nature
of an amalgamation and those in the nature of an acquisition. Instead, it focuses on
„control‟ of a business acquired through by any means whatsoever and prescribes that
such business combinations shall be accounted for under the „acquisition method‟ as
prescribed under the standard.
The standard lays down the following process for such accounting:
 Identifying the acquirer
 Determining the acquisition date
 Recognising and measuring the identifiable assets acquired, the liabilities
assumed and any non-controlling interest in the acquire,
 Recognizing goodwill or a gain from a bargain purchase.
Quick Reference Tool 4:
A quick guide to M&A and alliance partnerships
Business growth
 Growth can be
o Organic and
o Inorganic
 Growth with alliance partners increasing being seen as the way to get ahead of the
competition
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Growth with alliance partners
 M&As and alliances can be
o Horizontal
o Vertical
 Alliances can be in many forms, e.g.
o Creation of new/different business entities (Through M&A activity,
restructuring, part purchase, JVs etc)
o Informal understandings
o Relationships with third parties
o Network associations
Growth with M&A
 Historically many M&As have not proved successful; this could be due to
o Overestimation of synergies
o Underestimation of integration issues
o Incomplete understanding of issues (includes financial, non financial)
o Incomplete or limited due diligence review
Initial Stage Planning
 Shared Vision and objectives to be set out
 Economic parameters to be factored, i.e. synergy vs. costs
 Legal and statutory issues to be factored
 Structuring issues to be set out
 Personal goals and aspirations of key management and stakeholders to be articulated
Implementation
 Due Diligence to bring out
o Inputs to deal issues
o Inputs to valuation
o Inputs to negotiations
o Inputs to deal structure
o Inputs to warranties
o Inputs to future action plan
 Valuation: to set the price and terms
 Regulatory clearances to be obtained
 Pre deal conditions to be set out and met
 Post deal and integration issues to be set out
Integration
 People issues to be carefully addressed, including but not limited to
o New appointments
o Redundancy
o Job transfers
o Cultural integration
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 Restructuring and divestment to be done with care
 Uniform business systems to be set out
 To manage internal and external communications to
o Avoid anxiety amongst employees,
o Keep customers informed
o Emphasise the positive
 Attempt to realise the synergy expected from transaction
CASELET 4: Value creation in an acquisition
KR Technologies Ltd. (KRTL) is an Indian Company established in 2000 by Karan
Kapur, Rita Kohli and Ramesh P. In the year 2013-14, the turnover of the company was
Rs. 2500 crores. KRTL also had one subsidiary company Process Experts Private Limited
(PEPL), established in April 2006.
In September 2013, the Board of KRTL met to review a proposal to purchase a British
BPO Company, John Lenox Ltd. (JLL) for US$25 million. The Board used the
opportunity to discuss the future growth plans of the company. The members decided on
a strategy to grow inorganically by purchase of some small and medium sized businesses
in Europe and USA. The first company to be purchased would be JLL.
KRTL acquired JLL in an all cash deal in April 2014. The expectation was that JLL had
many contracts which would now come to KRTL. One of the main customers for JLL
was Tristat Technologies and Services (TTS). JLL had a key contract from TTS and
expected revenue of US$ 100m from the contract over a three-year period. It was
presumed that this contract would be automatically renewed with KRTL.
Subsequent to the deal becoming made public, TTS cancelled its contract for US$ 100m,
quoting from a clause in its contract with JLL. The reason given by Rick Smith, COO,
TTS, to Karan Kapur, was that TTS was currently outsourcing to two other Indian
Companies and one European company. It did not want to have a 3rd Indian Company as
a partner. Once JLL was purchased by KRTL, it became viewed as an Indian Company.
KRTL made some changes in the management of JLL, on acquisition of the company.
They put a team from India in JLL. The CEO of JLL, William Woods was kept on.
William Woods was aware about the transaction, much before the rest of the employees
of JLL knew about it. He had indicated to KRTL review team that he did not expect any
employee related problem post the deal.
By July 2014, almost 20% of the employees who had been with JLL, left the company.
This included some of the senior management and the marketing head.
As a result of all these issues, the Board of KRTL felt that the deal value did not
materialize and decided to go slow on its strategy to acquire foreign companies.
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Q. Do you think these issues would have been identified if the due diligence had been more
carefully/thoroughly done?
Q. What are the key issues that should have been addressed in this DDR in which an Indian
company is tying to buy a foreign company?
Q. The Board members felt that the deal value did not immediately materialize. Does the
solution lie in avoiding such deals altogether? If not, how should KRTL proceed in the matter?
Q. What can still be done by KRTL to prevent further value loss from this deal?
END OF CASELET
CASELET 5: Proposal for M&A
Gyan Technologies Private Limited (GTPL) was incorporated in January 2013 in
Mumbai, India. The company was promoted by Anand Ramesh and Pronoy Bose. These
promoters had significant experience in the software industry, in India and in the US,
prior to setting up GTPL.
GTPL provided software services mainly in two sectors, BSFI (Banking Services,
Finance and Insurance) and telecom. The company targeted customers outside India
mainly in Europe and Asia and provided a combination of offshore and onshore services.
The company received two rounds of financing in February 2013 and August 2014,
respectively. The initial start up finance of Rs. 10 million was provided by Startups Fund
(SF). In August 2014, East Technology Venture Fund (ETVF) committed to invest
Rs.100 million in the company. GTPL received 70 million out of these committed funds
in August 2014. It was agreed by the interested parties in the deal (GTPL, SF and ETVF)
that the balance of Rs.30 million would be invested by ETVF in August 2015. Both SF
and ETVF appointed a nominee Director on the Board of GTPL.
At a Board meeting in April 2015, the nominee Director of ETVF expressed his view that
GTPL should expand its existing portfolio of offerings by providing services to other
industry verticals, such as health care and business automation. This would help the
company grow at a faster pace. The other Board members were also keen to explore this
possible opportunity and requested the management team of GTPL to examine various
options for growth.
In June 2015, ETVF indicated to the promoters of GTPL and to ST that it would not be
able to bring in additional committed funds of Rs. 30 million in August 2015. It however
would like to continue to keep its existing stake in the company.
The investors in the corpus of ETVF, East West Limited and Markus I Limited had not
brought in their contribution and ETVF did not have funds to invest in GTPL at this
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point. East West Limited and Markus I Limited had incurred losses in their investments
in a couple of portfolio companies in the second quarter of the calendar year 2015.
ETVF then placed a new option before the GTPL Board. ETVF had an existing
investment in Healthsoft Private Limited (HPL). HPL focused on providing a range of
services to the health care industry. HPL had initially started operations as a medical
transcriptions company and now was trying to expand into providing other software
services to this industry sector. The management of HPL was also exploring the option of
expanding their business and provide additional other IT enabled services.
The expected turnover of HPL for the calendar year 2015 was Rs. 200 million. The
projected turnover for the same period for GTPL was 250 million. In terms of number of
people, HPL had 140 employees as compared to 225 employees at GTPL.
ETVF proposed that GTPL could consider the option of merging with HPL. This would
be a strategic growth option that would lead to inorganic growth of the two companies.
The Board members of GTPL were now looking at alternate options before them and
how they should proceed.
Q. You are an advisor to Gyan. What would you advise them to do?
Q. How would you ask them to proceed?
Q. What are the challenges in the proposed transaction?
Q. What could be the possible synergies in such a deal?
Q. What are the preliminary questions that GTPL should put to ETVF and HPPL to get more
information about the advantages and disadvantages of this option to merge?
Q. In the situation above an investor has backed out from a commitment. What are the concerns
that need to be addressed by the different stakeholders? What are the red flags and signals that
the advisor needs to bring to the notice of the promoters?
END OF CASELET
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CHAPTER 6
The Due Diligence Review Process
The due diligence review process is a very important tool for planning. The findings from
such an exercise help in decision making, whether the due diligence review is for an
investment, a proposed transaction or just to get an understanding of an organization
status at a point in time. Currently, a great deal of attention is being paid to the due
diligence review process. In this chapter we take a look at this important process in
decision making and strategic business planning.
Illustrative example: Due diligence in public offers *
* Illustrative example contributed by Pratap Giri S. FCA, ACS
The three main areas where due diligence has acquired tremendous significance in recent
times are (a) Public Offers, (b) Mergers and Acquisitions and (c) Private Equity and
Venture Capital investments. In the case of public offers, due diligence is a statutory
requirement under the Issue of Capital and Disclosure Requirements Regulations (ICDR
Regulations) of SEBI. In the other two areas mentioned above, due diligence is
conducted voluntarily by the acquirers since there has to be a proper verification of the
business and financial affairs of the company in question.
Due diligence has now acquired the dimensions of a full blown audit of the company‟s
financial accounting records, a secretarial audit of compliances and an assessment of the
company‟s financial forecast all rolled into one. So it would not be correct to assume that
a due diligence review is a limited review. On the contrary, it has to throw up not only
issues that are in question as of date but issues for the future as well. There is a close
linkage between due diligence and valuation too as more often than not, the agreed
valuation goes through iterations based on the issues thrown up by the due diligence
review.
The responsibility of due diligence in public offers has been thrust upon the merchant
bankers managing the issue (known as lead managers). If there are multiple lead
managers, the lead manager in charge of preparation of the offer document has to file the
required due diligence certificates.
There is a four stage due diligence required to be performed by merchant bankers in
public offers. The first stage is extremely important. At this stage, the lead manager has
to conduct the due diligence and file a due diligence certificate with the SEBI along with
the draft prospectus (also known as a red herring prospectus in a book built issue). In the
case of a debenture issue, there is an additional due diligence certificate to be issued by
the debenture trustee appointed for the issue. The first stage is essentially to ensure that
there has been a proper verification of all facts and inspection of documentary evidence
by the lead manager of all the disclosures made in the offer document. It is also to ensure
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that the lead manager has taken adequate care to ensure statutory compliance by the
company and the lead manager with regard to the issue.
At the second stage, the lead manager has to certify the second due diligence certificate to
SEBI just before filing of the final offer document with the Registrar of Companies to
ensure inter alia, that the final offer document is in conformity with SEBI requirements if
any.
At the third stage, a due diligence certificate has to be filed before opening of the issue
certifying that no corrective action needs to be taken or that amendments have been
issued to the offer document after issue of the same. A fourth certificate is to be filed
after the opening of the issue but before its closure stating among others that adequate
disclosure requirements have been met.
Quick Reference Tool 5:
A summary of the due diligence review process
Due diligence is:
 A detailed review
 May or may not be a statutory requirement
 Conducted with a specific objective in mind
 Driven by the a transaction or proposed transaction
Undertaken for:
 M&A / demerger / reconstruction
 Private equity investment
 Lending by institution
 Completion of a deal
 Vendor side analysis
 Special/limited area review
 Fund utilization review
By whom is this undertaken
 By the „Buy side,”
o Prior to a proposed transaction for M&A
o Prior to a proposed transaction for VC/ private equity investment
o Post transaction
 By the “sell side,” prior to approaching a possible investor or attempting for a
strategic or private placement
Due diligence approach
 Investigative: to ascertain if data and facts presented reflect a true picture To “Trust
but verify”
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 Analysis of information provided
 To go to root of issue and not stop at the surface level
Due diligence helps to
 Take informed decisions as more information is available
 Understand possible risk elements in a transaction to minimise these risks by
addressing them
 Flag deal issues (deal breaker and deal maker issues)
 Provide inputs for valuation and negotiations
 Plan for the future course of action, from before the deal to post the deal
Due diligence depends on the
 Industry: the review for a manufacturing company is different from that for a
software services company
 Stage of the company: the review for an existing company is different from that for
an early stage company
 Nature of transaction: the issues for an M&A transaction will be different from the
issues in venture capital investment
 Scope of review: Sometimes the scope is defined and focused and may need only a
limited review
Areas of Due diligence: DDR can be for a variety of areas and could be financial as well
as non financial for example:
 Accounting and Financial
 Tax Issues
 Legal
 Business
 HR
 Technical
 Funding utilization
 IP and Intangible Assets related
Illustrative elements in a financial review
 Financial Statements and schedules
 Assets/liabilities/income/expenses/ cashflow
 Forecasts and financial models
 Auditors reports, internal (MIS) reports
 Shareholding pattern
 Financial strengths, weakness
 Funding plan and investment plan
 Inputs to valuation
 Inputs to negotiation
 Inputs to deal issues
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 Inputs to deal terms and conditions, for e.g. Representations, warranties etc. linked
to potential future liabilities
Illustrative elements in a legal review
 Contracts
 Agreements
 Impact of regulations on transactions
 Titled and deeds
 Warranties and indemnities
 IP issues
Illustrative elements in a business review
 Business and economic environment
 Business strategy
 Business model
 Marketing and sales strategy
 Business strengths, weakness
 Infrastructure
 SWOT
 Value drivers of business
 Key constraints
 Competitive advantages, USP
Due diligence methodology
 To consider the transaction drivers
 To focus on key issues
 To be timely
Due diligence output
 To address requirement of transaction
 To highlight the risks and possible deal issues
 To address issues that impact valuation
 To highlight concerns which need to be addressed, some prior to the proposed
transaction and others post transaction
Quick Reference Tool 6:
Illustrative list of information required during a due diligence review
During a due diligence review, the reviewer looks at various aspects of the project in
detail. In addition to looking at the business plan there is a great deal of information
required. The following list is a sample of some of the things that could be reviewed.
Executive Summary of project
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This should, typically not be more than 2-3 pages. This will highlight the following:
 Brief details of the promoters and the key management team.
 The product and/or service being offered by the company.
 The total addressable market (TAM) and the market barriers to the project.
 Financial details including the project cost, the funds tied up till the date of the plan
and the total funds requirement of the project including key financial forecasts.
Company and Background Information
This would give details of the company which requires finance including its various
business activities, general industry outlook, profiles of key persons and shareholders in
the company. The following list is indicative of the information which should be
provided:
 Memorandum and articles of association along with printed literature including
brochures about the company and its products and/or services.
 Company history and details of related companies, if any, achievements of the
company and its various business activities.
 Detailed profiles of promoters and key management team with their role in the
activities of the company.
 List of Board members, major shareholders, including institutional investors, angel
investors, NRIs, foreign investors. The promoters‟ contribution (both cash and kind to be
separately indicated) is also to be shown.
 General industry outlook and prospects for the business as perceived by the
management.
 Advantage and disadvantage of current location of business.
 Current status of the business.
 Name of bankers, auditors, legal advisors and key consultants of the company.
Human Resource
It is now widely being recognised that human resource is the key resource of any
Organizations. Investors are interested in looking at how the management has planned
to address the various issues in this area: They would generally like to see information on
the following:
 Organization chart with number of employees and future plans to hire more
employees.
 Details of skills required to manage and operate the business and whether such skills
are available in house or whether this would be outsourced.
 Deficiencies in the team existing and plan to overcome this deficiency.
 Details of salary levels for various employees.
 Details of employee stock option plans (ESOPs) and other schemes which are
existing or planned.
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 Details of any employee motivation schemes, cash and kind that are planned, if any.
This may be in the form of ongoing training programmes, bonus payments or could take
more innovative forms.
Product/service information and operational details
The product or process should be described in detail to help the potential investor
understand the business and the business environment. Some points which should be
covered are:
 Details of product range/process/service provided by company.
 Market and target customers, for each product.
 Features of the project which give it an edge over competition, including technology
edge, if any, may be highlighted, giving impact on the project, i.e. whether it makes the
product cost effective or solves existing problems or results in a superior product etc.
 Whether there are any market trends or changes which will affect the project, either
positively or negatively.
 Whether there are any barriers to prevent others from using or developing the project
technology.
 Details of any technology developed in-house, explaining how it has been developed
and stage of development, i.e. whether it is at the pilot stage or is ready to commercialise
and whether additional development cost is to be incurred.
 Information about any patentable technology. If any patent is held or is applied for,
details may be provided. If technology used is owned by others, it may be indicated
whether the company has the right to use the same.
 Details of any intellectual property rights associated with the project.
 If technology is sourced from outside with collaboration, details of any
Memorandum of Understanding (MoU) entered into or Agreement signed for the same.
Preferably copies of these documents may be provided. Further additional information
may be provided on
 information on the collaborators providing the technology may be provided, with
justification for their selection and information on others who could have supplied the
same or similar know-how.
 details of any buy back arrangement, i.e. whether there is a firm commitment to buy
back or whether any buy back is it conditional.
 whether upgrade of technology is automatically being provided, or whether additional
payments have to be made.
 whether the technology provider is at liberty to sell the technology to others
companies in India and/or globally and whether the same being sold to others.
 Details of any future development plans for the project.
 Details of major suppliers of raw material for the project.
 Whether key equipment will be bought or leased, and details of the suppliers.
Sales and marketing
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There is no use having the best product in the world, if there is no one willing or able to
buy it, whatever be the reason, whether it is related to price or requirement of the buyer
or anything else. Information about potential or existing customers is to be given in the
plan, including:
 Market survey details, if available, giving details of how market has been defined, in
terms of area, type of customers, price range, etc .
 List of customers, potential, existing and why they prefer or will prefer the
company‟s product to others.
 Details of other competitors, existing, potential or possibilities of others entering the
field and strategies to address competition from them, whether in terms of price, quality,
features, service etc.
 Projections for the next few years, preferably for five years, at least for three years.
 Sales and marketing strategy, will sales be through agents, direct, online sales,
licensed to others etc. Method followed for any overseas sales. Details of any firm tie-ups
may be indicated.
 Marketing Plan, advertisement plan whether hoardings, TV, print media or online
social media or a combination of various methods are to be used.
 Whether warranty is being provided and if this is built in with pricing and costs; how
post sales issues are to be handled.
 Details of how the product is being manufactured, in-house or contracted or a
combination.
Financial information
Financial information provided is reviewed very carefully during the due diligence
process. The investor will ultimately want a return on the investment and will therefore
look closely at the funds brought in, to be brought in; the funds spent and to be spent. The
following is a brief outline of the financial information to be provided by the promoter:
 Annual audited accounts for five years for existing companies (sometimes, investors
may just look at the previous three years statements or less), along with the cash flow
statements.
 Details of initial promoters contribution, whether cash or kind.
 Details of project cost proposed, sources and utilisation of funds.
 Firm commitments for finances at the time of preparing the business plan.
 Details of debt financiers and bankers providing any working capital.
 Projections for the next five years with justification for assumptions made.
 Sensitivity analysis to be done for key elements, such as drop in sales, increase in
raw material cost or salary cost. Worst case scenario is to be indicated.
 Key ratios, break-even details and IRR of the project
 Valuation, valuation methods and justification for inputs to valuation.
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Other information
Promoters may like to give some other information which is not included in the above
sections. Some of these other items which are to be included in a business plan are:
 The time schedule for completion of the project, estimated dates of
commercialisation and break-even.
 Project implementation schedule, preferably in the form of a chart such as a bar
chart.
 Details of any statutory compliances that have to be met and the status of clearances
to be obtained from Government Authorities. This may even be in the form of a checklist.
 Details of whether any promoter, shareholder or officer has been involved in any
legal or criminal proceeding.
 SWOT (Strength, Weakness, Opportunities, Threats) analysis of the project.
CASELET 6: Preparing for a due diligence review
Wave Tech Private Limited (WAVE) was established in April 2014, in Bangalore, India,
to work in the areas of embedded systems in wireless technologies. Wave was set up with
the objective to develop its own products for licensing to OEMs.
The company was promoted by three individuals, Mukund Desai, Venkatesh K and T
Isaac. Prior to starting Wave, these promoters, each had about 15 years of work
experience, in India as well as in the US. Their areas of expertise included software
development, embedded systems and design and development of electronic design
automation.
The promoters invested Rs.15 lakhs each of their personal funds in the company, for
equal stakes in the equity of the company. Mukund was appointed the CEO, Venkatesh
the COO and T Isaac, the CTO of Wave.
At the time of starting the company, the promoters envisaged that the product
development stage would take about 14 months, and that the prototype of their initial
product would be ready for sale in Q4 in the calendar year 2015. In the initial period,
Wave also intended to supplement its cash inflows with some revenues from services,
both offshore and onshore.
In July 2015, Wave received seed financing from Infotech Services Private Limited
(ISPL), an unlisted IT services company, which wanted to enter the IT products market.
ISPL committed Rs. 2 crores towards the initial product development costs for the first
two years of operations of Wave. This amount was committed to be paid in half yearly
installments of Rs.50 lakhs each. ISPL also committed to outsource some of its contracts
to Wave. Wave received Rs.50 lakhs in two installments from ISPL in July 2014 and
January 2015 respectively.
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By the end of the calendar year 2014, Wave had grown in size. The company had a full
time CFO, Amit Vyas, who was in charge of all financial operations and reported directly
to the CEO.
In April 2015, the company received an advance of USD 10,000, from Ramon Inc. Wave
was to supply its first prototype to Ramon for testing by December 2015. There was a
clause in the contract between Ramon and Wave, where Ramon had the option to convert
the advance paid by it into equity shares, in case Wave did not deliver the prototype on
schedule.
In May 2015, Wave was about 3 months behind schedule in product development. At the
same time, ISPL indicated to Wave that it would not be in a position to release Rs. 50
lakhs due in July 2015.
The CEO of ISPL, Karim Khan, explained that his company had suffered many setbacks
in its own business. Karim Khan also communicated to Wave that ISPL might not be able
to outsource any Software Service business to them.
Wave was now in a difficult financial position. The company urgently needed funds to
continue the product development activities. The promoters decided to approach a
venture capitalist or strategic investor for funding. At the same time, they were
approached by a leading wireless technology company WITEC who wanted to acquire
them and wanted to buy out the other investors.
Q. How should the promoters proceed in this matter?
Q. What are the advantages and disadvantages if they get acquired by WITEC?
Q. Is any preparation required from their side, prior to meeting the potential investors? If yes,
how should they get ready for this and the expected due diligence?
END OF CASELET
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CHAPTER 7
Negotiations
Negotiations are an important part of any business. What one gets out of a business
transaction, ultimately depends on negotiation skills, whether it is purchasing a company,
a machine, or stationery item. Negotiation skills and techniques therefore should be
carefully studied and worked upon. One needs to prepare and plan for this critical
element in creating and running a successful business.
In this chapter we look at some of the points to be considered when planning to negotiate.
At the end there is an exercise which forms the basis of a negotiating role play. To run
this role play, participants need to prepare for possible valuations on both sides of the
negotiating table, i.e. as potential sellers and buyers.
Prior to a negotiation, a detailed background check and planning is most helpful. It is
difficult to be „over prepared,‟ when it comes to negotiating for a business.
Often when one enters into a negotiation, price is the key and sometimes the only deal
driver. One may not pay heed to the fact that, if successful, the negotiation could be the
starting point of a relationship. For example, if a company is getting acquired by another,
the negotiations regarding the transaction price and deal structuring are just the initial
points in the expected relationship between the two parties involved. If one of the parties
perceives that they have not been fairly treated by the other, this will affect the long term
relationship after the transaction is completed. This perception of fairness is the key. So
not only must you try to be fair in negotiations, you must also convey and communicate
this to the party on the other side.
This may seem like a contradiction. After all, when one is negotiating, one wants to get
the best deal for oneself. So in such a situation, how can you consider giving in to certain
demands of the other side, in the interests of fairness? This is where the planning comes
in useful. In negotiations for an M&A transaction, it is expected that there will be
additional value creation due to the synergies in the proposed deal. This value creation
should be shared between the two parties. If all, or the majority, of value expected to be
created, is going to one of the parties alone, then this will not be a fair deal. This can lead
to conflict between the team members of the two firms in the future. In fact, this is almost
a sure recipe for distrust and discomfort between the parties on the opposite sides of the
negotiating table.
Example: Sample list of items to consider prior to negotiations in a proposed deal
Prior to negotiations, it is important to be prepared with the following:
o What you want from the deal
o Deal maker issues
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o Deal breaker issues
o What is the point where you are prepared to walk away from the deal
o The other party‟s interests in the proposed transaction, try to put yourself in the
other party‟s shoes
o The alternate ways in which the deal can be structured, i.e. in terms of a
combination of:
 Cash
 Stock
 Deferred and/or performance based
o Checklist of the factors you consider important, prior to the negotiations
o
o Consider factors which may be relevant to transaction, either in terms of the
valuation, deal structuring and/or which may need to be factored in the legal
documentation such as warranties and representations
o
o Decide on the team members who will negotiate
o Who will be the key negotiator
o Will you plan to have different persons handling specific questions
o Will you have your advisors with you to participate in the negotiations
o
o Decide on the negotiating strategy you want to adopt, thinking through the
following questions can help
 What are the questions you plan to ask, how will you formulate
questions, you need to mind your language
 What are the expected questions and how you can answer them
 How will you prepare to listen to the other team, listen to both the
articulated demands and the unarticulated ones
 How will you plan to handle potential breakdown situations if
negotiations are reaching a stalemate
 How will you pay attention to the deal motivation issues, which may
or may not be articulated
 Prepare with a role play, this is most useful.
The role play illustrated in the caselet below has translated into some successful
outcomes for the participants. In one case, a woman entrepreneur in a family business
played this game on a weekday and on the Saturday following she was at the negotiating
table to sell a division of the family business. Her target was to get Rs. X crores for this
unit sale. She realized Rs.2X crores as the sale price. She said that this role play had
helped her prepare and plan for the division sale and hence she was successful in the
negotiations.
CASELET 7: ROLE PLAY – An exercise in valuation and negotiation
The exercise below is an illustrative one which covers valuation, negotiations and deal
structuring. This is based on a case which has been successfully played out in the Indian
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Institute of Management Bangalore, by the author, in class room sessions in executive
education programmes.
1. Sheba, Gaurav and Khan are running a BPO, SGR Pvt. Ltd., started in
Year 1 (Y1), in Bangalore and are having discussions with a VC fund,
who is a potential investor in the company, to raise USD 2 million
funding.
2. The revenue expected in the calendar Year 4 , from 4 verticals is USD 4
million and the percentage share of revenue from these verticals is
expected to be as follows
 Finance - 30%
 Telecom - 30%
 Auto - 20%
 Health - 20%
3. In Year 5 and Year 6, it is expected that there will be growth at 100% in
all verticals. In Year 7 and Year 8, it is expected that there will be growth
of 50% in the finance vertical and the other verticals are expected to grow
at 20%
ASSIGNMENT:
 Prepare the revenue forecast for SGR Pvt. Ltd., based on the above information for
Year 4 – Year 8
 Consider a pessimistic and optimistic scenario for the forecast, to help you get a
better understanding of possibilities in the future
 Arrive at a value range for years 3 & 5
 You may use the following procedure to arrive at a valuation range for the company
and prepare for negotiations:
o Study companies in the industry, select your sample
companies for comparison
o Calculate expected typical margins and hence expected
EBIDTA, PAT, in the future, in the years under
consideration, in this industry
o Factor in the expected impact of the global market
scenario on this industry in general and on this company
in particular
o Arrive at expected PE ratios and price to sales ratios, in
the market expected in 3 years, in 5 years
o Arrive at a suitable multiples for SGR Pvt. Ltd.;
discounting for illiquidity, size and any other factor you
consider suitable
 Have a plan for structuring the deal
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ROLE PLAY: PREPARE TO NEGOTIATE
One group of persons can prepare as the key negotiating team for SGR and one team can
prepare as the VC fund, i.e. the potential investor in the business. The two sides can
negotiate and either close the deal or walk away from the deal. The deal can be structured
as a mix of initial payment or deferred payment or convertible instrument, if so desired.
ROLE PLAY LEARNINGS:
Negotiating Insights: From IIMB’s MPWE Programme
This is an extract from an article, originally published in the blog, Entrepreneur's Corner
in www.citizenmatters.in
Background: In the last week of sessions of the MPWE 2009 at IIMB (Management
Programme for Women Entrepreneurs) we had a negotiations role play for purchase/sale
of a business. The participants were divided into 8 teams, 4 representing the buy side and
4 the sell side. We therefore had 4 sets of negotiations. The learnings of this are shared
here.
Rules: The rules were simple; a one page sheet of the case was given to the participants
with a background of the company being sold as well as a sample set of companies. This
was to help them arrive at a valuation range, prior to the negotiations. The groups were
also given initial preparation time to plan and decide on their negotiation strategy. The 8
teams were instructed that they had to close the deal within the given time. They were
also told that they had to really feel the part of the buyer/seller side and had to get into the
role. The idea was to simulate a real life situation in a limited time period.
Analysis: It was interesting to see the different permutations and combinations that came
up regarding the sale price and deal structuring and the post deal plan. Three deals were
struck, and the fourth set could not agree to a deal price in the time available. There were
variations in the negotiating strategies and the deal price, however, some points were
common across the eight groups and below are the key takeaways:
 The fact that different persons negotiated differently came across very clearly. Some
teams were able to take leading positions early on in the game, because of the way
they took control over the whole process.
 Negotiations are the starting point, many times if the deal goes through; the two
sides have to work together in the future. It is therefore important to avoid getting
into personal traits and offensive or overly aggressive stances. It helps if the two
parties realize that they should not perceive this as a battle with two opposing sides,
but rather as a joint work to come to some agreement which is seen as fair to both.
 Ultimately, the teams are made up of individuals who may be sensitive to different
things. Negotiators need to be aware of the signals sent out by individuals.
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Negotiations is about understanding or attempting to understand the needs of
different people, in your team as well as in the team on the other side.
 If team members of one group disagree in the meeting or give conflicting views, this
can lead the other party to suppose that there is some problem to be addressed and
can directly impact valuation and deal structuring. Thus teams need to be careful
about what messages they are giving out, in their words as well as in their actions.
 Sometimes, giving the other party a few options helps. Some examples: taking a
certain percentage upfront for a certain value, taking some money now and some
later, an option of keeping a board position, or an option to change the management
of the company such as the CEO and CFO.
 Sometimes news flashes about the business and industry are received and can change
the whole tone of the negotiations. In the role play, there were two interruptions
which announced some changes in the business and environment. These influenced
the negotiators and the deal structuring changed as a result. For example, at one
point, the buyers were given a message about a rumour that there could be a
disagreement in the key team of the sellers. As a result, in one deal, the buyers
decided to bring in a change of management and a part of the deal money was
brought in as a severance package to the CEO of the selling company.
 The side that was more prepared came out of the deal stronger. They went prepared
not just with a valuation range, but also with a list of questions and answers to
questions that they could be asked. These related to the company, the business and
industry environment and the future plans post the deal, if it did go through.
 Despite this being a simulation, for a period of time, participants actually felt that
they were buying or selling a business and they felt pleased when the deal was
finalized. This is of course to the credit of all participants who went into this role
play with all seriousness and the outcome showed this. Many times, human emotion
influences us to work towards deal closure, even though the financial aspects may
not be very favorable. We need to be conscious of our emotions in addition to the
financial and business aspects.
 One of our participants summed up this set of sessions very nicely. She said, prior to
this exercise, I thought I could just value my company and go out and raise funding
for this, by offering an equity stake at a certain price. I now realize it is not like say
...one trying to sell something at a certain price point. There are many dimensions to
sale/purchase of a business and negotiations play a key role in the price we can get.
Summary and takeaway: The participants opined that these learnings and negotiating
insights could help them, not only in instances where they had to sell a stake in their
company or raise capital, but also in other negotiations such as transacting with a
customer or a buyer. Hence in real life also, practicing with a role play prior to a
negotiation would be helpful.
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Quick Reference Tool 7:
Valuation and negotiation: Five points to note
Here are some aspects on valuation and negotiation which can help you get a better deal
price, whether it is for M&A or VC or for strategic investment. This was originally
published in a LinkedIn post.
1. Valuation is
2. Art and Science
a. Subjective and Objective
There is a math to valuation, there are business models which are captured in
financial models and spread sheets. There is scenario analysis and sensitivity analysis.
There are premiums and discounts assigned to multiple factors. This objective math is
impacted by subjectivity of the person(s) doing the calculation, for example, if you are an
unlisted company, is the discount factor 50% or 80% or somewhere in-between? Should
you take a multiple of 9 times revenue or 10 times ... why 9, why not 10? The mistake
made sometimes is that it is assumed that because there is a calculation, the number is
correct.
3. Calculated value is discounted or goes at a premium, based on
a. Deal Rationale from sellers perspective
b. Deal Rationale from buyers perspective
Try to get the underlying rationale from the opposite side of the table. For example, if
you want to buy, try to understand why the seller wants to sell, the true reason, not just
the stated reason. This will help you in negotiating a better deal, in terms of price and
value ... And … may also get you more favourable deal terms.
Zane, CEO of Tan, a large company wants to buy out another large company, Zooz. On
the face of it, it appears that Zane wants this deal for professional reasons, such as the
fact that Zooz can be a great fit to Tan‟s line of business and can help Tan address a set of
international customers who are now not buying from Tan. However, the real motivator
for Zane to close this deal is quite different; he wants to show (off) to his alumni network
that he is heading one of the largest global companies. The acquisition is a means to
achieve this personal ambition of his. So sometimes the deal rationale is visible,
sometimes not.
4. Valuation is impacted by
a. Due diligence findings
Tainak wants to sell his house. While the house has been recently painted and is
reasonably well maintained, the front lawn has a tap that is leaking. The tap could be
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fixed by a washer at almost zero cost, but Tainak does not do this, thinking that this is
only a washer and that the rest of the house is fine. However, the potential buyer looks at
this differently and sees this as a possible signal that maybe… just maybe... the house is
not so well maintained. On the day the buyer visits, the water has been leaking and the
lawn is slushy in the corner near the tap. In the negotiations and price finalization this one
point helps the buyer push down the sale price by thousands. In business too due
diligence findings can be hooks, to negotiate with and lower the price.
5. Valuation can be impacted by
a. Deal structuring
Deals can be based on a mix of stock and cash, or linked to performance in the future.
Sometimes if the buyer and seller perceive the future growth plans differently, these
differences can be set out in a financial model and the deal can be structured based on
how the future plays out in reality.
6. Negotiations impact value, these include
a. Strength of position from which negotiation is done
b. Skill and talent of negotiator
c. Hard work and preparation
d. Unbundling of deal issues; i.e. setting out and contrasting between deal breaker
issues and other points
e. Role playing and scenario planning of alternate situations in advance
f. Negotiation style
Negotiations can significantly impact the deal value and the way the deal is structured. It
helps to analyse why the other party to the deal, wants the deal. It also helps to plan
through the negotiations strategy in advance.
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APPENDIX I
* CASE STUDY: Business Plan Preparation
* Case Study contributed by Ketoki Basu, FCA
Comp Xpert India Private Limited, a training institute was set up in Bangalore on
February 14, 2010. The promoters of the company, two brothers, Anil and Sunil are both
technocrats. Anil is an engineering graduate in Computer Science with nearly 2 decades
of experience in large corporate houses. Sunil the younger brother of Anil, graduated in
Electronics and Telecommunications 2 years after Anil. Sunil thereafter completed a
degree in Management before pursuing a career in management consultancy.
Anil and Sunil resigned from their respective jobs and started Comp Xpert in 2010. They
equally contributed to the initial share capital of Rs. 15 lakhs. The operations of the
company commenced from June 2010. The first academic year started from July 2010.
The institute offered courses in:
 Web development and design (WDD)
 Security and Networking and (S&N)
 Multimedia (MLT)
In the first year, the company operated from a residential house with about 5 students in
each of the above courses. They handpicked quality faculty for the courses. The course
was designed by Anil.
The school became popular in a short span of time and in about 5 years the company had
50 students in each of the courses. The company was willing to add new centres but
ensured the batch size was restricted to 10 per class. The centres were housed in about
2500 sq. ft. of space with a classroom each for the each of the 3 streams. In 5 years the
company was operating 5 centres with 15 classrooms; i.e. there were three class rooms
per centre.
Over the years, the company realized that there was a huge demand for the course, the
business was profitable but to expand strategically the company had to:
 Expand the number of centres to accommodate more students
 Update its course each year
 Purchase/build its own centres
During May 2015, the company was approached by an angel investor. The angel had
been following the company and was keen to take up a stake in the company. The angel
investor is from the IT education field and had operated a large institution pan India on a
franchise mode. He wanted to look at the business plan and financials to understand the
valuation of the company. Further if he did invest in the company, he wanted a fair idea
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of the prospects of exiting the company in terms of buy back of shares by promoters, sale
to strategic investor or initial public offering.
The Directors requested the Chief Financial Officer to prepare the business plan of the
company. As a starting point the financial plan was prepared. The sequence in which the
financial plan was prepared is explained below.
Financial Plan
Step 1
1. With a fair idea of the vision of the company, the market potential and demand for
the course, the number of students expected in future years was projected. A
summary of the students for the future years was projected as follows:
Year 1 Year 2 Year 3
No. of
students
No. of
students
No. of
students
WDD 200 350 500
S&N 200 350 500
MLT 200 350 500
Total 600 1,050 1,500
2. Having completed the student projections, classrooms and centres were projected
for the next 3 years as follows:
Year 1 Year 2 Year 3
Classroom
s Centres
Classroom
s Centres
Classroom
s
Centre
s
WD
D 20 20 35 35 50 50
S&N 20 20 35 35 50 50
MLT 20 20 35 35 50 50
Total 60 20 105 35 150 50
3. The annual fees per student in each course were expected to be Rs. 3 lakhs per
annum payable in 3 equal installments on specified dates in June, October and
February. With increase in costs was projected that such fees were to be escalated
by about 10% per annum.
Step 2
4. The Directors, the Chief Financial Officer (CFO), a Manager overseeing the
operations at the 5 centres and an office representative cum receptionist at each
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centre were the ones in the company‟s payroll. Besides this there were 3 trainers
at each centre.
5. With expansion it was envisaged that the number of managers had to be stepped
up. It was decided to keep the optimum number of centres under a manager at 5.
The revised salary for the different levels employees and the annual increment
were decided as follows:
Salary per month-INR Annual Increment
Director 1,00,000 12%
Trainer 60,000 12%
CFO 50,000 12%
Manager 35,000 12%
Office Representative 8,000 12%
Step 3
6. The capital expenditure requirement had to be estimated next. The addition of
assets were based on estimates that were as follows:
 Furniture- As per the current company practice, Rs. 7,000 worth of
furniture was purchase per student and Rs. 8,000 for each manager. Each
centre required additional furnishing amounting to Rs. 10,000. It was
decided to retain the practice. Furniture costs are expected to go up by
about 20% each year.
 Cost of equipment per classroom in each centre was estimated at Rs.
450,000. This was based on the current levels of equipment in each
classroom. Such equipment being subject to high degree of change in
technology, was estimated to be replaced every 2.5 years. Equipment costs
are expected to increase by about 10% each year.
7. The company‟s long term vision for expansion was to utilize surplus funds for
acquiring new premises for centres. During the previous year, the company had
from its surplus cash, purchased space to run a centre. This strategy of purchasing
space for centres would result in reduction of monthly rentals and rental deposit.
8. With the influx of new students, additional funding and generation of surplus the
company targeted purchasing 5 centres‟ space in Year 1, 20 centres in Year 2 and
another 24 in Year 3.
9. With 50 centres in place in Bangalore the company would then contemplate
expansion to other cities.
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10. Expansion to other cities could perhaps be considered at a later stage using the
franchise route. However, at this stage, expansion beyond 50 centres was not
being considered and did not form part of its current business plan.
Step 4
11. The other expenses were estimated as follows:
Type of expenses INR
Escalation
Course material 1,00,000 per student/yr. 8%
Rent 50,000 per centre 8%
Advertisement p.a. 12,00,000 100%
Electricity 3,000 per centre 10%
Water 1,500 per centre 10%
Repairs 1,000 per centre 10%
Housekeeping 2,500 per centre 10%
Security 10,000 per centre 10%
Printing & Stationery 2,000 per centre 10%
Postage & Courier 2,500 per centre 10%
Local Conveyance 3,000 per centre 5%
Travel 20,000 10%
Communication charges 5,000 per centre 5%
Website maintenance 30,000 5%
Legal p.a. 60,000 5%
Audit p.a. 3,00,000 10%
Office Expenses 3,000 per centre 10%
 For the rented premises a one-time refundable deposit amounting to Rs. 5
lakhs per centre would be payable. It was assumed that rental deposit will
not escalate and the company would negotiate to pay the same amount
each time. Rent is paid in advance at the beginning of the month for the
month.
 Insurance on assets were expected to be about 1% of the WDV of the
assets.
12. Though fees were payable on specified 3 installment dates, it was observed that
there was a considerable amount of delay in receipt of fees. Eventually however
all students paid up. This was ensured as pass certificates were not released to
defaulters. This aspect had to be factored in the financial plan. Based on this
information, the sundry debtors were estimated.
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13. Course material supplied to students would be at cost and purchased at the start of
the financial year.
Step 5
14. The CFO then constructed the monthly Balance Sheet, Profit & Loss account and
Cash flow statement for the 3 years.
Step 6
15. These statements were then consolidated on an annual basis. The annual Balance
Sheet appeared as follows:
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Balance Sheet
Period Year 1 Year 2 Year 3
EQUITY & LIABILITIES
Shareholders' Funds
Share Capital 590.0 1,740.0 3,590.0
Reserves & Surplus 279.0 816.9 1,691.1
Money Received against Share Warrants
869.0 2,556.9 5,281.1
Share Application Money pending allotment
Non Current Liabilities
Current Liabilities
Short-Term Borrowings
Accounts Payables 3.4 6.5 10.3
Short-Term Provisions
3.4 6.5 10.3
TOTAL 872.4 2,563.4 5,291.4
ASSETS
Non Current Assets
FIXED ASSETS
Tangible Assets 596.3 1,927.2 3,693.9
Intangible Assets
596.3 1,927.2 3,693.9
Non Current Investments
Other Non-Current Assets-Rent Deposit 95.0 145.0 120.0
95.0 145.0 120.0
Current Assets
Current Investments
Inventories
Accounts Receivables 150.0 462.0 1,452.0
Cash and Cash Equivalents 31.1 29.2 25.5
Other Current Assets
181.1 491.2 1,477.5
TOTAL 872.4 2,563.4 5,291.4
INR In lakhs
16. From the estimates the company was expected to record a turnover of INR 18
crores in Year 1. This was expected to touch INR 34.65 crores in the second year
and INR 54.45 crores thereafter. The projected Statement of Profit & Loss for 3
years:
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Statement of Profit and Loss
Period Year 1 Year 2 Year 3
INCOME
WDD 600.0 1,155.0 1,815.0
S&N 600.0 1,155.0 1,815.0
MLT 600.0 1,155.0 1,815.0
Revenue from operations 1,800.0 3,465.0 5,445.0
Other Income
Total Revenue 1,800.0 3,465.0 5,445.0
EXPENSES
Cost of Materials Consumed 600.0 1,134.0 1,749.6
Purchases of Stock-in-Trade
Changes in Inventories of Finished Goods, Work-in-
Progress & Stock-in-Trade
Employee Benefits Expense 498.0 950.9 1,505.3
Finance Costs
Depreciation & Amortization Expense 97.0 181.7 352.9
Other Expenses 222.0 394.8 500.4
Total Expenses 1,416.9 2,661.4 4,108.1
PROFIT BEFORE EXCEPTIONAL &
EXTRAORDINARY ITEMS AND TAX 383.1 803.6 1,336.9
Exceptional Items
PROFIT BEFORE EXTRAORDINARY ITEMS AND
TAX 383.1 803.6 1,336.9
Extraordinary Items
PROFIT BEFORE TAX 383.1 803.6 1,336.9
Tax Expense 126.6 265.7 462.7
PROFIT/ (LOSS) FOR THE PERIOD FROM
CONTINUING OPERATIONS 256.4 537.9 874.2
PROFIT/ (LOSS) FOR THE PERIOD FROM
DISCONTINUING OPERATIONS
Tax Expense of Discontinuing Operations
PROFIT/ (LOSS) FOR THE PERIOD FROM
DISCONTINUING OPERATIONS (After Tax)
PROFIT/ (LOSS) FOR THE PERIOD 256.4 537.9 874.2
INR In lakhs
17. The Cash flow statement was prepared for 3 years. While the business was
profitable, funding was envisaged from the perspective of the company building
its own centres. The angel investor was looking at the initial funding requirement
at this point. It was envisaged that depending on the growth, the company could
also look at approaching a Venture Capital Fund at the next stage. Further, there
could also be an option of taking a franchise route. However the projections
initially prepared did not consider any franchise option
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Cash Flow Statement
Period Year 1 Year 2 Year 3
Net Profit before exceptional items and tax 383.1 803.6 1,336.9
Adjustment for:
Depreciation & amortization expense 97.0 181.7 352.9
Finance costs
Operating profit before working capital changes 480.0 985.3 1,689.8
Adjustment for:
Inventories
Accounts receivables -112.5 -312.0 -990.0
Short term loans & advances, Other current assets
Accounts payables, Other current liabilities 2.6 3.1 3.7
Short term provisions
Cash generated from operations 370.1 676.5 703.5
Income tax paid (net of refunds) -126.6 -265.7 -462.7
Cash flow before exceptional items 243.4 410.8 240.8
Exceptional items
Net cash from operating activities (A) 243.4 410.8 240.8
Cash Flow from Investing activities
Purchase/sale of fixed assets -626.2 -1,512.6 -2,119.6
Other Non-Current Assets-Rent Deposit -70.0 -50.0 25.0
Investments made
Sale of investments
Interest received
Dividend received
Net cash used in investing activities (B) -696.2 -1,562.6 -2,094.6
Cash Flow from financing activities
Issue of share capital 475.0 1,150.0 1,850.0
Proceeds/(Repayment) of loans
Finance costs
Payment of dividend
Net cash from/ used in financing activities (C) 475.0 1,150.0 1,850.0
Net (decrease)/increasein cash & cash equivalents (A+B+C) 22.2 -1.9 -3.8
Cash & cash equivalents as at the beginning of the year 8.9 31.1 29.2
Cash & cash equivalents as at the end of the year 31.1 29.2 25.5
INR In lakhs
The Directors and the CFO finalized the financial plan which was to be shown to any
potential investor.
Business Plan
Having finalized the projections, the CFO had to put together the plans of the founders in
terms of vision, mission and other business parameters as a narrative report. The
procedure followed was to break up the report into relevant chapters which were to focus
on key areas of interest to a prospective investor.
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Executive Summary
A summary of Comp Xperts in a few sentences was mentioned. The chapter was written
to give the investor an idea of the business. The presentation and choice of words was
such as to increase his appetite for further information about Comp Xperts.
Company and background information
The details of the structure of the company and when it was set up was stated. The history
of Comp Xpert and how it had evolved over the years was briefly mentioned here,
keeping in mind that an investor would like to understand and have information about the
industry sector, why the company was founded any anything else that was special about
the company.
Management and organization
Investors are keen to know the background of the promoters. This gives them an idea as
to whether the company has the right people behind it to make it successful. The detailed
resumes of Anil and Sunil were given in this Chapter. The resumes were projected in
such a way so as to show the value such promoters were bringing to the company.
Comp Xperts has a large pool of technical advisors. These consist of both industry
experts as well as those with a good track record in academics. The background of such
experts was brought out. The organization structure was explained in detail. Under this
chapter Comp Xperts‟ SWOT analysis was also presented.
Products and services
The offerings of a business have to be set out. The details of the courses offered and the
duration of the course was explained. It was also explained why such courses were
popular.
The aspect of the Directors getting personally involved in the course design and
handpicking the faculty was an important issue to be highlighted. The special features of
these courses offered by Comp Xperts and what makes it different from others offered in
the country was also pointed out.
Marketing plan
The Directors provided the data on the market survey carried out by a professional
agency for the company. The report clearly explained the market gap and Comp Xperts
potential share in future. It was explained that in the next 3 years the company had plans
to expand to 50 centres in Bangalore only. The potential to expand to other cities was
highlighted from the market survey data but it was mentioned that the same would be
taken up after 3 years.
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Location
The flagship centre and the location of future centres in the next 3 years were mentioned
here. The logic behind choosing such locations was also explained.
Competition
The competition in the market both domestic and global is of importance to an investor.
This helps them to determine the entry barriers. Comp Xperts‟ competitors both in India
and overseas were pointed out in this chapter. The features of each competitor were also
explained clearly. The differentiator in terms of each course was highlighted.
Strategy
Here, the following were explained in detail:
 Value proposition of Comp Xperts
 Comp Xperts‟ competitive edge over others
 Sales strategy and
 Pricing strategy
 Financials
The annual Balance Sheet, Profit & Loss account and Cash flow statements were
explained. The CFO added some graphs to explain sales increase and expense trends. The
salient ratios were also calculated and explained here.
Summary
Having completed the Business Plan, Sunil was able to translate the same into a crisp
presentation for the investor pitch. Further, the exercise of preparing the business plan
with detailed financials, paved the way to work out the valuation of the company. This
would help the company when it came to negotiating with the any potential investor.
While the company did realize that it had the potential to grow, it had not actively tried to
plan this expansion. The directors decided that while the angel investor had proactively
approached them, they would seriously consider approaching other investors should there
be a shortfall in their fund requirement.
The directors also decided to approach an expert to advise them on the proposed
transaction.
Questions for case analysis:
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I. Assume the company has approached you for assistance in this matter. The
questions below would need to be addressed by you so that you can provide quality
inputs to the founders.
 What would be your recommendations regarding the Business Plan that has
been prepared?
 How would you advise the directors to prepare for the negotiations with the
potential investor?
 How should they prepare for due diligence that the investor is likely to
suggest?
 It appears that the company can also go to VCs and other early stage
investors. Can you do your homework on the requirement, review the
projections with care and suggest any alternate funding strategy? Do you think
that debt funding is a better option for the company at this stage?
 What are the other options that you can suggest for growth and value
creation?
II. Assume the investor has approached you for assistance in this matter. The company
has provided you the Business Plan and the Financial Plan as prepared above.
 Would you accept the Business Plan that has been prepared? Would you
accept the financials as they are or would you like to make any
adjustments/modifications? Why? Are these modifications related to
assumptions made or in the financial model or strategy related?
 Would the nature of the modification/adjustments made by you if any in the
Business and Financial Plan, impact the approach taken to negotiate?
 What are the deal issues that you would flag off, i.e. reasons for the deal to go
through and not go through?
 Is there any other suggestion that you would like to give to a potential investor
in this company?
 What are the ways in which an investor can add value and protect this
investment if made?
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APPENDIX II
* CASE STUDY: Business Plan Review
* Case Study contributed by Rajnish Singh, Director, VentureBean Consulting Pvt. Ltd.
Executive summary
Ripple Industries Pvt. Ltd. (RIPL), incorporated in 2001, promoted by K Govind and
family, is a leading manufacturer of coolant pumps in India. These pumps are used in the
manufacture of machine tools. For most of the pumps manufactured by the company, it
also manufactures the paired motors in-house. In addition to coolant pumps, RIPL also
manufactures refueling pumps and electric motors. The Company also manufactures
alternators stator windings (auto-electrical) for KRENT, a multi-national company based
on designs provided by KRENT.
The Company has also set up exclusive facilities for assembly of windings to a couple of
companies on contract basis. The Company currently operated out of 4 facilities in
Bangalore.
The company is an ISO 9001:2008 certified entity and the products are CE Marked,
making the pumps acceptable in the worldwide market. RIPL has a well-established
quality system to ensure that each pump is tested with a computerized system to ensure
that every product is quality certified. RIPL maintains the data of 10 years of products
manufactured, which establishes a good traceability of custom-made products.
For the year ended March 31, 20X5, the Company achieved a Total Income (TI) of Rs.
3340.2 lacs, on which it made an Earning Before Interest and Depreciation (EBIDA) of
Rs. 304.6 lacs, a profit before tax (PBT) of Rs. 174.0 lacs and a profit after tax (PAT) of
Rs. 116.4 lacs. For the same year ended March 31, 20X5, the net cash accruals of the
company was Rs. 181.4 lacs.
For the year ending March 31, Y1, the Company is expected to achieve a Total Income
(TI) of Rs. 3400.0 lacs, on which it is expected to generate an EBIDA of Rs. 243.0 lacs,
a profit before tax (PBT) of Rs. 130.7 lacs and a profit after tax (PAT) of Rs. 87.6 lacs.
For the same year ending March 31, Y1, the net cash accruals of the company is expected
to be Rs. 152.4 lacs.
The Company is facing severe space constraints at its facilities and is unable to increase
its production. The Company has taken possession of about 85,000 sq. ft. of land 80 kms
from its current facilities and proposes to expand its manufacturing facilities by setting up
a machine shop and shift its existing machine shop to this new facility during Y2.
Subsequently, RIPL proposes to shift the pump assembly operations to the new facility in
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the coming years. The total cost of construction of the necessary infrastructure to shift the
Machine Shop, shift the existing machines and purchase a new CNC machine, is
estimated at Rs. 420.0 lacs. The Company proposes to complete the relocation activities
by March 31, Y2.
The Company has been approached by Zimmer Technocast Pvt Ltd (ZTPL), which has
facilities for manufacture of 100 MT of Ferrous castings to takeover of its foundry. ZTPL
is promoted by four first generation entrepreneurs, and the foundry has been in operation
since 2008. For the year ending March 31, Y1, ZTPL is expected to achieve a Total
Income (TI) of Rs. 805.0 lacs, on which it is expected to generate an EBIDA of Rs. 74.3
lacs, a profit before tax (PBT) of Rs. 18.8 lacs and a profit after tax (PAT) of Rs. 12.6
lacs. For the same year ending March 31, Y1, the net cash accruals of ZTPL is expected
to be Rs. 37.6 lacs. RIPL is keen to buy the foundry business of ZTPL, together with all
the associated assets, as it would be able to source its entire casting requirements onhouse,
thereby reducing the risk of quality, price and timely delivery as compared to the
current purchase structure where it has to depend on a large number of suppliers to
purchase the required castings for its pumps and motor assemblies. The total cost of the
transaction is estimated at Rs. 500.0 lacs. This transaction is expected to be completed by
June 30, Y2. In addition, the Company would incur costs for refurbishment of certain
machines and buildings to the extent of Rs. 30.0 lacs during Y2. After stabilizing the
operations of the foundry, the Company plans to install an additional line at ZTPL
facilities during Y3, which will enable it to increase its sales by about Rs. 1000.0 lacs in a
couple of years.
With the addition of new facilities and purchase of the foundry business from ZTPL, the
Company is expected to achieve a turnover of Rs. 7509.5 lacs by Y7, on which it is
expected to generate an EBIDA of Rs. 765.8 lacs, a PAT of Rs. 321.1 lacs and net cash
accruals of Rs. 482.0 lacs.
To meet a part of the cost of the expansion project and purchase of the assets of ZTPL,
the Company is planning to raise a term loan of Rs. 715.0 lacs from banks. In addition,
the Company plans to increase its bank borrowing for working capital by another Rs.
300.0 lacs to meet its increased working capital requirements.
Company profile
The company has been in the production of coolant pumps and electric motors since
incorporation. Today the Company is a market leader in this segment with a dominant
70% market share in the coolant pump market. Almost 90% of the coolant pumps are
supplied with electric motors manufactured by the Company in-house. In addition to
coolant pumps, RIPL also manufactures oil skimmers, refueling pumps and electric
motors. The Company is currently developing solar pumps. In the year 2005, the
Company introduced high-pressure pumps in India. The Company also entered into an
agreement with ZAND to sell its pumps in India. In 2007, the Company introduced the
high-pressure screw pumps. Today, the Company has the entire range of coolant pumps
in the market.
©AV Page 87
The Company currently operates out of 1 owned premise of about 30,000 sq. ft. land area
and about 15,000 sq. ft. of built-up area. In addition, the Company has taken 3 premises
on lease, close to its owned premise, with 20000 sq. ft. of built-up area.
The Company had facilities for machining castings, motor windings, winding varnishing,
assembly of pumps and motors. During 20X5, the Company set up a 30 MT non-ferrous
foundry to develop non-ferrous parts required for the pumps being developed for exports
market. The Company has been successful in developing the heat exchange pump in
collaboration with ZAND. The first batch of these pumps have been supplied to ZAND
for overseas and Indian users, who are getting the same tested by their customers. Over
the next few years, these pumps are expected to generate significant exports volumes.
Company was awarded the Best Vendor by KRENT and appreciated for continuous and
timely delivery by its largest customer of coolant pumps.
Shareholding and organization structure
RIPL is currently managed by Mr. Kumar (son of Mr. K Govind), who is the Managing
Director of the Company. Other Directors are Mr. K. Govind, Mrs. Vidya and Mrs.
Veena. RIPL is currently 100% owned by the family. The details of current shareholding
pattern of RIPL are given in Annexure A.
Organization Structure
RIPL has a well-defined and lean Organization structure as given below.
Mr. Kumar is supported by an experienced team in each of the roles above.
©AV Page 88
Financial Performance of RIPL
The financial performance of RIPL for the 5-year period ended March 31, 20X5, was as
given below.
(Rs. in lacs)
Year ended March 31, 20X1 20X2 20X3 20X4 20X5
INCOME
Sales
- Domestic 1450.6 1483.4 2366 3118.4 3278.7
- Exports 2.1 2.9 7.4
Other Operating Rev 34 39.3 36.1
Total Sales 1450.6 1483.4 2402.1 3160.6 3322.2
Packing and Forwarding 5.4 5.2 8.9 11.4 12.2
Other Income 5.0 1.1 4.6 9.1 5.8
Total Other Income 10.4 6.3 13.5 20.5 18.0
Total Income (TI) 1461.0 1489.7 2415.6 3181.1 3340.2
EXPENDITURE
Material Consumed 909.0 984.1 1588.7 2213.0 2232.0
Changes In Inventory 5.7 -2.2 0.2 -3.7 5.6
Employee Cost 158.4 170.7 283.2 351.6 402.3
Manufacturing Expenses 55.9 65.2 101.0 138.9 132.7
Sales & Marketing Expenses 62.0 63.1 97.2 111.9 114.4
Admin Expenses 74.6 71.9 80.6 80.4 83.6
Repairs & Maintenance 25.8 17.9 36.4 44.4 65.0
Total Expenses 1291.4 1370.7 2187.3 2936.5 3035.6
EBIDA 169.6 119.0 228.3 244.6 304.6
% EBIDA to TI 12% 8% 9% 8% 9%
Interest on Loan 19.5 31.3 39.5 53.2 55.4
Depreciation 35.4 39.8 41.6 60.7 75.2
Profit Before Tax (PBT) 114.7 47.9 147.2 130.7 174.0
Tax 41.9 11.5 49 43.3 57.6
Profit After Tax (PAT) 72.8 36.4 98.2 87.4 116.4
Dividend 1.5 5.9 5.9 8.8
Tax on proposed dividend 0.2 1 1 1.4
Net cash accruals 106.7 70.3 133.9 142.2 181.4
Return on Equity 24% 10% 22% 17% 19%
Return on Total Cap.
Employed 22% 13% 21% 17% 21%
©AV Page 89
The Company‟s turnover has more than doubled during the 5-year period ended March
31, 20X5. However, the TI of the Company has been relatively flat during the last year,
on account of slow down in the automotive industry and hence resultant impact on the
machine tools industry. Although, the sales of coolant pumps declined during the last
year, the Company has been able to maintain its TI on account of increase of sales to
some key suppliers. The EBIDA of the Company has been varying between 8% and 9%
during the 4-year period ended March 31, 20X5.
During the year ended March 31, 20X5, the Company earned a PAT of Rs. 116.4 lacs.
During the same year the Company declared a dividend on its equity share capital of Rs.
8.8 lacs (60%) and earned a net cash accruals of Rs. 181.4 lacs.
The Balance Sheet Statement of the Company for the 5-year period ended March 31,
20X5, was as given below.
(Rs. in lacs)
Year ended March 31, 20X1 20X2 20X3 20X4 20X5
LIABILITIES
Equity Share Capital 4.7 14.7 14.7 14.7 14.7
Reserves & Surplus 301.3 332.6 424.3 504.8 610.9
Net Worth 306.0 347.3 439.0 519.5 625.6
Long Term Borrowings-Banks 35.3 126.4 108.8 128.5 112.6
Working Capital Borrowings-
Banks 16.7 -12.6 -22 38.7 14.8
Loans From Directors 120.5 123.4 148.8 174.4 156.6
Deferred Tax Liability 5.9 9.6 13.2 17.2 24.8
Current Liabilities
Trade Payables 162 253.6 339 494.8 436.1
Statutory Dues 7.4 12.5 16.8 23.0 21.4
Advance from Customers 6.4 5.4 10 13.7 5.6
Others 4.7 6.8 1.7 3.1 4.9
Provisions 92.3 12.8 52.3 46.1 61.2
Total Current Liabilities 272.8 291.1 419.8 580.7 529.2
Total Liabilities 757.2 885.2 1107.6 1459.0 1463.6
ASSETS
Fixed Assets
Gross Block 391.1 441.6 671.2 862.3 990.6
Less : Depreciation 176.9 216.4 257.5 308.8 384.0
Net Block 214.2 225.2 413.7 553.5 606.6
Current Assets
Inventory 31.8 42.2 44.7 50.0 38.5
Receivables 350.6 382.4 557.0 662.9 628.3
Advances to Suppliers 4.1 3.7 11.2 13.3 9.1
©AV Page 90
Staff Advances 4.6 1.8
Balance with Statutory
Authorities 18.8 142.3 41.7 43.2 44.3
Cash & Bank Balance 16.7 40.5 23.6 101.6 97.8
Deposits 28.5 28.9 15.1 29.0 31.8
Others 92.5 20 0.6 0.9 5.4
Total Current Assets 543 660 693.9 905.5 857.0
Total Assets 757.2 885.2 1107.6 1459.0 1463.6
Year ended March 31, 2009 2010 2011 2012 2013
CR 1.99 2.27 1.65 1.56 1.62
TD/E Ratio 0.56 0.68 0.54 0.66 0.45
LTD/E Ratio 0.1 0.4 0.2 0.2 0.2
FAC ratio 6.1 1.8 3.8 4.3 5.4
During the year ended March 31, 20X5, the Company added Rs. 128.3 lacs to its gross
block by adding CNC machine and stator winding machine and the Net Worth of the
Company was Rs. 625.6 lacs. As on the same date, the Company had outstanding Term
Loans of Rs. 112.6 lacs and Bank Borrowings of Rs. 14.8 lacs (against sanctioned limits
of Rs. 75.0 lacs). RIPL had inventory of Rs. 38.5 lacs (6 days of annual raw material
consumption), outstanding receivables of Rs. 628.4 lacs (70 days of annual sales) and
trade payables of Rs. 436.1 lacs (71 days of annual raw material consumption).
As on March 31, 20X5, the Company has relatively low debt outstanding from Bank. As
on the same date, the Company had unsecured loans from promoters of Rs. 156.6 lacs.
The unsecured loans from promoters carry interest rate of 14% and are repayable as
required by the promoter. However, the Promoters are willing to sub-ordinate their loans
if required. The Current Ratio, Total Debt to Equity Ratio, Long Term Debt to Equity
Ratio and Fixed Asset Coverage Ratio were all within acceptable limits.
Current performance
Performance of RIPL for the 10-month period following March 31st, 20X5 and for
estimated performance for the full Y1 is given below:
(Rs. in lacs)
10 months Y1
Sales 2731.2 3430.0
Other Income 7.5 20.0
Total Income (TI) 2738.7 3450.0
Change in Inventory -6.9
Raw Material 1826.2 2298.1
Employee Cost 354.9 428.8
©AV Page 91
Manufacturing Expns 87.1 137.2
Selling Expns 84.2 102.9
Admin 188.2 171.5
Repairs 40 68.6
Total 2573.8 3207.1
EBIDTA 164.9 243.0
% EBIDA to TI 6% 7%
Interest 12.8 37.3
Depreciation 0 75.0
PBT 152.1 130.7
Tax 0 43.1
PAT 152.1 87.6
Net Cash Accruals 152.6
The %EBIDA to TI for the 10-month period is lower at 6% on account of increase in
Employee costs and cost of Raw Materials. However, for the full year the margin is
expected to marginally improve to 7% on account of better absorption of costs on over a
larger turnover.
During Y1, the dependence on coolant pumps has reduced by 2%, which has been taken
up by sales to other leading suppliers.
Proposal Details
A. Expansion Scheme
RIPL currently operates out of 4 premises in Bangalore. The Company has no space in its
current premises to increase production beyond the current levels. The Company has not
been able to take on new works from KRENT on account of this. In view of the above,
the Company proposes to expand its manufacturing facilities by setting up another unit,
about 80 kms from the current facilities.
The company has already purchased about 85,000 sq. ft. of land for Rs. 124.0 lacs. As per
the Agreement with of purchase from the State Body, once about 40 % of the land is
covered by facilities by the Company, the Sale Deed will be executed in favour of the
Company.
RIPL proposes to immediately construct a building of 20,000 sq. ft. to house its machine
shop and an office block of 3500 sq. ft. at the new premise. On completion of the
buildings, the entire machine shop would be relocated to the new facility. In addition, the
Company proposes to purchase a new CNC machine to be installed here. The building
construction is expected to commence from Y2 and the buildings are expected to be
ready and the machine shop is expected to be relocated by end Y2 itself. The operations
are expected to commence from April 1, Y3.
©AV Page 92
The total cost of the expansion scheme is expected to be Rs. 420.0 lacs as detailed below:
Cost of the Expansion Scheme
(Rs. in lacs)
Area (Sq. Ft.) Y2
Buildings
- Machine Shop 20,000 260.0
- Office Block 3,500 60.0
Plant & Machinery
- CNC M/c 1 No. 100.0
Total 420.0
Means of Financing
The above cost of the Expansion Scheme is proposed to be financed as below:
(Rs. In lacs)
Term Loans 315.0
Internal Accruals 105.0
Total 420.0
B. Purchase of Assets of Zimmer Technocast Pvt Ltd
Zimmer Technocast Pvt Ltd (ZTPL) is in the manufacture of ferrous castings. ZTPL has
a foundry of 100 MT capacity, together with allied facilities in Karnataka.
ZTPL is promoted by the Partners of Zimmer Foundry and Proprietor of Sri Lakshmi
Foundry. The promoters hold almost 75% of the paid-up capital of ZTPL. The details of
the promoters of ZTPL is below:
Name Age Qualification
Mr. Rama Rao 69 Yrs Metallurgical Engineer
Mr. Venkatesh 64 Yrs Mechanical Engineer
Mr. Ganesh 57 Yrs Commerce Graduate
Mr. Mangalam 74 Yrs Mechanical Engineer and
Foundry Technologist
The Promoters of ZTPL are in the field of castings manufacture from 1960s and have an
excellent reputation in developing and manufacturing ferrous castings used in the general
©AV Page 93
engineering, machine building, earth moving, construction and mining and mineral
dressing industries.
ZTPL started commercial production in the year 2008 and started making profits from the
very first year of operations. During the last few years the foundry has established a good
reputation for itself and earned “Best Vendor”, “Green Channel supply partners‟ award”
as well as Self Certification status from almost all its customers‟. The unit is also
accredited with ISO 9000:2008.
At present, the foundry, after standardising its operation, is ready to expand the
production capacity with additional balancing facilities. This requires infusion of further
funding. But the current promoters are not in a position to bring in the additional
investment. Also, in consideration of their age and health conditions they are unable to
devote their full time for managing the unit. Their children are also are not willing to take
over the company as they are employed in good positions and few have settled abroad.
Some of them are also requesting their parents to come and stay with them and or join
them abroad.
In view of the above situation, the current promoters of ZTPL are exploring opportunities
to sell ZTPL. RIPL has been approached by ZTPL to take of the foundry of ZTPL.
Considering that about 30% of ZTPL‟s production can be consumed in-house by RIPL
and also that ZTPL has established a good base of customers that account for nearly 70%
of its capacity, RIPL is keen to buy the foundry business of ZTPL together with all its
assets.
RIPL has already entered into an MOU with ZTPL for this transaction. It is expected that
the transaction will be completed in Y2.
Financial Performance of ZTPL
The financial performance of ZTPL for the 5-year period ended March 31, 2013, is
below.
(Rs. in lacs)
Year ended March 31, 20X1 20X2 20X3 20X4 20X5
INCOME
Sales
- Domestic 180.0 433.9 642.9 777.5 685.9
- Exports 0.0 0.0 0.0 0.0 0.0
Other Operating Rev 21.9 21.3 4.6 15.1 13.8
Total Sales 201.9 455.2 647.5 792.6 699.7
Total Other Income 0.4 0.5 1.0 1.3 1.4
Total Income (TI) 202.3 455.7 648.5 793.9 701.1
EXPENDITURE
©AV Page 94
Material Consumed 129.4 258.8 385.6 475.2 394.8
Changes In Inventory -2.4 -5.7 0.0 -5.4 -13.5
Employee Cost 10.9 22.3 37.9 59.3 61.9
Manufacturing Expenses 30.1 71.9 109.5 122.1 123.0
Sales & Marketing
Expenses 1.8 5.5 8.8 12.9 13.9
Admin Expenses 6.8 26.9 27.4 31.4 37.1
Repairs & Maintenance 2.6 7.0 16.5 16.3 14.4
Total Expenses 179.2 386.7 585.7 711.8 631.6
EBIDA 23.1 69.0 62.8 82.1 69.5
% EBIDA to TI 11% 15% 10% 10% 10%
Interest on Loan 21.9 28.4 32.9 36.8 36.1
Depreciation 24.0 28.8 28.7 27.5 25.9
PBT -22.8 11.8 1.2 17.8 7.5
Tax 6.5 -1.9 -1.4 1.1 4.8
PAT -29.3 13.7 2.6 16.7 2.7
Dividend 0 0 0 0 0
Tax on proposed dividend 0 0 0 0 0
Net cash accruals -5.3 42.5 31.3 44.2 28.6
Return on Equity -151% 41% 7% 30% 4%
Return on Total Cap.
Employed 8% 20% 15% 20% 15%
ZTPL saw a reduction in its sales during FY 20X4-X5, on account of Slow down in the
market and also due to the stoppage in off-take by a leading customer. The EBIDA
margin of ZTPL has been consistent around 10% for the 3-year period ended March 31,
2013. The Balance Sheet Statements of ZTPL for the 5-year period ended March 31,
20X5, are below:
(Rs. in lacs)
20X1 20X2 20X3 20X4 20X5
LIABILITIES
Equity Share Capital 49 49 49 49.0 49.0
Reserves & Surplus -29.6 -15.9 -13.3 5.8 16.0
Net Worth 19.4 33.1 35.7 54.8 65.0
Long Term Borrowings-Banks 113.6 103.1 91 43.5 19.5
Working Cap. Borrowings-
Banks 62.2 52.5 91.1 89.7 97.3
Loans From Directors 49 75.5 81.5 83.5 83.5
Deferred Tax Liability 6.5 4.5 3 2.7 3.1
Current Liabilities
Trade Payables 43.8 57.8 102.6 111.2 143.9
©AV Page 95
Statutory Dues 0.8 1.1 1.8 2.0 5.9
Others 10.9 5.7 12.4 31.0 34.8
Provisions 3.5 0.2
Total Current Liabilities 55.5 68.1 117 144.2 184.6
Total Liabilities 306.2 336.8 419.3 418.4 453.0
ASSETS
Fixed Assets
Gross Block 203.8 222.6 238.4 274.6 284.5
Less : Depreciation 24 52.8 81.6 109.1 135.0
Net Block 179.8 169.8 163.3 165.5 149.5
Current Assets
Inventory 36.4 56 75.5 82.8 110.3
Receivables 74.0 90.1 138.2 146.9 149.7
Cash & Bank Balance 0.3 6.4 26.1 0.4 25.0
Loans and Advances 14.2 13.1 15.2 22.2 15.1
Others 1.8 1.4 1 1.0 3.4
Total Current Assets 126.4 167 256 252.9 303.5
Total Assets 306.2 336.8 419.3 418.4 453.0
CR 2.28 2.45 2.19 1.75 1.64
TD/E Ratio 11.59 6.98 7.38 3.95 3.08
LTD/E Ratio 5.9 3.1 2.5 0.8 0.3
FAC ratio 1.6 1.6 1.8 3.8 7.7
As on March 31, 20X5, ZTPL had inventory of Rs. 110.3 lacs (106 days of annual raw
material consumption), outstanding receivables of Rs. 149.7 lacs (78 days of annual
sales) and trade payables of Rs. 143.9 lacs (138 days of annual raw material
consumption).
The performance of ZTPL for the 9-month period in Y1 and for estimated performance
for the full Y1 is given below:
(Rs. in lacs)
9 month
period in Y1 Y1
Sales 589.8 803.0
Other Income 0 2.0
Total Income (TI) 589.8 805.0
Change in Inventory 5.4
RM 320.9 441.7
Employee Cost 94 72.3
©AV Page 96
Manufacturing Expn 81.9 144.5
Selling Expns 1.0 16.1
Admin 36.6 40.2
Repairs 1.3 16.1
Total 541.1 730.7
EBIDA 48.7 74.3
% EBIDA to TI 8.3% 9%
Interest 24.1 30.5
Depreciation 14.0 25.0
PBT 10.6 18.8
Tax 0.8 6.2
PAT 9.9 12.6
Net Cash Accruals 37.6
Performance Improvement Plan for ZTPL
Subsequent to the take over of the business of ZTPL, RIPL proposed to take the
following steps to improve the performance of ZTPL:
1. Currently, ZTPL is able to utilize about 60-70% of its casting capacity. RIPL
requires about 40T of ferrous casting every year and by shifting this business to
ZTPL, the capacity utilization of ZTPL would go up to nearly 100%, thereby
enabling ZTPL to better absorb its fixed cost and hence result in improved
margins.
2. Many processes like mould handling, sand handling and scrap handling are done
manually in ZTPL. By incorporating some basic modification handling processes
for these can be made easier, resulting in less fatigue to workmen, who can be
used for other process works.
3. ZTPL gets much of the fettling activities done through contract work, which
results in high labour and transportation cost. RIPL plans to reduce some of this.
4. ZTPL‟s rejection rates are currently between 8-12%. RIPL proposes to reduce the
rejection rates to 5-7% by close monitoring of process and quality control.
5. At present, ZTPL manufactures only large castings. RIPL plans to effectively
utilize the molding machines and increase production by about 5-10%, with some
minor modifications.
In addition to the improvement in performance of ZTPL, RIPL believes that it can reengineer
some processes and design, thereby reducing its raw material requirements and
costs by about 3-5%, which will improve RIPL margins.
In the coming years, as ZTPL has sufficient land and other support facilities, RIPL plans
to install additional production lines and increase the capacity of ZTPL.
©AV Page 97
Cost of Transaction
The total cost of the assets purchase of ZTPL, together with the cost of refurbishment, is
estimated at Rs. 530.0 lacs, as detailed below.
(Rs. in lacs)
Asset Purchase
Land 120.0
Building 180.0
Plant & Machinery 100.0
Others 100.0
Total 500.0
Refurbishment
- Building 15.0
- Machinery 15.0
Total refurbishment 30.0
Total 530.0
Means of Finance
The above cost of the purchase of ZTPL assets is proposed to be financed as below:
(Rs. In lacs)
Term Loans 400.0
Internal Accruals 80.0
Unsecured loans - Promoters 50.0
Total 530.0
Sales and Marketing Arrangements
RIPL has a large network of customers for coolant pumps. Some of its largest customers
for coolant pumps and their share of the total sales are given below:
Anz Designers Group 6%
Barb Grz 4%
Kane Automation 4%
Fabricators & Traders 4%
Designer Engineers 1%
The client base for coolant pumps are well diversified and RIPL is not heavily depended
on any single customer. RIPL normally works on an order base manufacturing process
©AV Page 98
for every customer. However, as a part of its inventory, it does carry certain inventory for
standard coolant pumps.
The largest component in any coolant pump is copper (for motor winding). RIPL has a
method of revising its prices every month in case the price of copper fluctuates
significantly.
Financial Projections of RIPL
A summary of the financial projections for RIPL, for the 7-year period ending is given
below.
(Rs. in lacs)
Year ending March 31, Y1 Y2 Y3 Y4 Y5 Y6 Y7
INCOME
Sales 3400.0 4251.4 5023.9 6023.9 6752.4 7090.0 7444.5
Other Operating Rev 30.0 39.8 43.0 43.0 43.0 43.0 43.0
Total Sales 3430.0 4291.1 5066.9 6066.9 6795.4 7133.0 7487.5
Total Other Income 20.0 21.5 22.0 22.0 22.0 22.0 22.0
Total Income (TI) 3450.0 4312.6 5088.9 6088.9 6817.4 7155.0 7509.5
EXPENDITURE
Material Consumed 2298.1 2792.1 3237.8 3842.8 4268.6 4480.7 4703.4
Employee Cost 428.8 512.2 599.5 707.0 780.6 819.4 860.1
Manufacturing Expenses 137.2 268.4 338.0 448.0 547.2 574.4 602.9
Sales & Marketing
Expenses 102.9 121.8 142.3 167.3 184.2 193.3 203.0
Admin Expenses 171.5 135.6 152.0 182.0 203.9 214.0 224.6
Repairs & Maintenance 68.6 85.8 101.3 121.3 135.9 142.7 149.8
Total Expenses 3207.1 3916.0 4571.1 5468.6 6120.4 6424.4 6743.7
EBIDA 243.0 396.6 517.9 620.4 697.1 730.6 765.8
% EBIDA to TI 7% 9% 10% 10% 10% 10% 10%
Interest on Loan 37.3 114.7 203.4 192.6 164.6 136.6 108.6
Depreciation 75.0 148.0 178.0 178.0 178.0 178.0 178.0
PBT 130.7 134.0 136.4 249.7 354.4 416.0 479.2
Tax 43.1 44.2 45.0 82.4 117.0 137.3 158.1
PAT 87.6 89.8 91.4 167.3 237.5 278.7 321.1
Dividend 8.8 8.8 8.8 14.7 14.7 14.7 14.7
Tax on proposed dividend 1.4 1.4 1.4 2.4 2.4 2.4 2.4
Retained Earnings 77.4 79.6 81.2 150.3 220.4 261.7 304.0
Net cash accruals 152.4 227.6 259.2 328.3 398.4 439.7 482.0
Return on Equity 12% 11% 10% 16% 19% 19% 18%
©AV Page 99
Return on Total Cap.
Employed 17% 14% 17% 19% 21% 21% 20%
DSCR 2.3 2.5 2.5 1.7 2.1 2.3 2.7
By Y7, the Total Income (TI) of RIPL is expected to reach about Rs.7509.5 lacs, on
which it is expected to make an EBIDA of Rs. 765.8 lacs, PAT of Rs. 321.1 lacs and net
cash accruals of Rs. 482.0 lacs. RIPL is expected to improve its ROE to 18% by Y7 and
ROCE to 20%. The Company is expected to main very healthy Debt-Equity Ratio and
Debt Service Coverage Ratio during this period. The Balance Sheet Statements are
projected to be as below:
(Rs. in lacs)
Year ending March 31, Y1 Y2 Y3 Y4 Y5 Y6 Y7
Liabilities
Equity Share Capital 14.7 14.7 14.7 14.7 14.7 14.7 14.7
Reserves & Surplus 698.5 778.0 859.2 1009.5 1229.9 1491.6 1795.6
Bank - Term Loans
Existing 45.4
Bank-Term Loan ZTPL
Assets 400.0 400.0 300.0 200.0 100.0
Bank-Term Loans-New
Facility 315.0 315.0 240.0 165.0 90.0 15.0
Bank - Working Capital
Loans 4.8 304.8 344.8 344.8 344.8 344.8 344.8
Unsecured Loanspromoters
131.6 231.6 231.6 231.6 231.6 231.6 231.6
Deferred Tax Liability 24.8 24.8 24.8 24.8 24.8 24.8 24.8
Trade Payables 440.7 654.2 720.1 887.2 1020.2 1070.8 1124.1
Other Current Liabilities 31.9 31.9 31.9 31.9 31.9 31.9 31.9
Provisions 43.1 54.4 55.2 99.5 134.0 154.3 175.2
Total 1435.5 2809.4 2997.3 3184.0 3396.9 3554.5 3757.7
Assets
Gross Fixed Assets 990.6 1940.6 2240.6 2240.6 2240.6 2240.6 2240.6
Less : depreciation 459 607.0 785.0 963.0 1141.0 1319.0 1497.0
Net Fixed Assets 531.6 1333.6 1455.6 1277.6 1099.6 921.6 743.6
Investments 190.0 190.0 190.0 190.0 190.0 190.0
Inventory 44.1 193.5 206.3 292.5 375.3 394.0 413.5
Receivables 652.1 883.8 989.6 1195.1 1348.6 1416.0 1486.8
Loans and Advances 142.4 142.4 142.4 142.4 142.4 142.4 142.4
Cash and Bank Balances 65.286 66.1 13.4 86.4 241.0 490.5 781.4
Total 1435.5 2809.4 2997.3 3184.0 3396.9 3554.5 3757.7
CR 1.8 1.7 1.7 1.7 1.8 1.9 2.1
©AV Page 100
TD/E Ratio 0.1 1.3 1.2 0.9 0.6 0.4 0.2
LTD/E Ratio 0.1 0.9 0.8 0.5 0.3 0.1 0.0
FAC ratio 11.7 1.9 2.0 2.4 3.0 4.9 49.6
The Net Worth of RIPL is expected to increase to Rs. 1810.3 lacs by Y7. The term loans
of Rs. 715.0 lacs that RIPL proposes to borrow to meet a part of the Expansion Scheme
and Purchase of Assets of ZTPL, is scheduled to be fully repaid by then.
During Y2, RIPL is expected to increase its bank borrowings for working capital by an
additional Rs. 300.0 lacs, to meet its increase working capital requirements.
The Current Ratio and Fixed Asset Coverage Ratio of RIPL are expected to be within
acceptable norms during this period.
ANNEXURE I
Ripple Industries Private Limited
Company profile
Date of Incorporation :
Location
: 1. ----- Bangalore
2. ----- Bangalore Rural District.
Products : Coolant Pumps and motors
Oil Skimmers
Re-fuelling Pumps
Auto-electrical
Contract manufacturing
Board of Directors
Name Age (Yrs)
Mr. K Govind 78 Director
Mrs. Vidya 67 Director
Mr. Kumar 45 Managing Director
Mrs. Veena 40 Director
Shareholding pattern
Name % Holding
Mr. K Govind 3.03
Mrs. Vidya 3.34
Mr. Kumar 46.63
Mrs. Veena 46.37
Ms. Deepa 0.61
Mr. Krishna 0.03
©AV Page 101
Assumptions for Financial Projections for RIPL
1. The sales estimates for RIPL for Y1 are based on the sales achieved for the first
ten months in this year and expected business for the two months of February and
March Y1.
2. Annual growth of 5% is assumed in the sales for RIPL every year, except for Y3
and Y4, where incremental sales of Rs. 500.0 lacs is assumed every year on
account of new business from KRENT.
3. Raw Material for RIPL has been assumed at 67% of Sales for Y1 and Y2, and
66% thereafter, on account of better management of cost of raw material with
ZTPL supplying castings.
4. Manpower cost for RIPL has been assumed at 12.5% of Sales based on historical
data.
5. Manufacturing expenses for RIPL has been assumed at 4% of Sales based on
historical data.
6. Sales and Marketing expenses for RIPL has been assumed at 3% of Sales based
on historical data.
7. Administrative expenses for RIPL have been assumed at 5% of Sales based on
historical data.
8. Repairs and Maintenance expenses for RIPL has been assumed at 2% of Sales
based on historical data.
9. The sales estimates for ZTPL for Y1 are based on the sales achieved for the first 9
months of the year and expected business for next 3 months.
10. Annual growth of 15% is assumed in the sales for ZTPL from Y2 for every year
and 5% thereafter, except for Y4 and Y5, where incremental sales of Rs. 500.0
lacs is assumed every year on account of additional business with increase in
production.
11. Raw Material for ZTPL has been assumed at 55% of Sales based on historical
performance.
12. Manpower cost for ZTPL has been assumed at 9% of Sales based on historical
data.
13. Manufacturing expenses for ZTPL has been assumed at 18% of Sales based on
historical data.
14. Sales and Marketing expenses for ZTPL has been assumed at 2% of Sales based
on historical data.
15. Administrative expenses for ZTPL have been assumed at 5% of Sales for Y1,
thereby reducing to 4% of Sales for Y215 and 3% of Sales thereafter, on account
of better absorption of fixed coast over increased sales.
16. Repairs and Maintenance expenses for ZTPL has been assumed at 2% of Sales
based on historical data.
17. Depreciation on fixed assets are assumed on SLM based on the depreciation rates
provided by Company‟s Act.
18. Income Tax has been assumed at 33% of the PBT.
19. New term loan of Rs. 715.0 lacs proposed to be borrowed by RIPL is scheduled to
be repaid in 48 monthly installments, the last one in March Y7.
©AV Page 102
Questions for case analysis:
I. Mr. Kumar, MD, RIPL has had some second thoughts about the plan to takeover
ZTPL. He has approached you, a Chartered Accountant, for advice and assistance
in this matter, He has shared this business plan extract with you.
 How would you proceed in this matter? What are the key questions you would
ask Mr. Kumar?
 What would be your recommendations regarding the Business Plan that has
been prepared?
 How would you advise the directors to prepare for the negotiations with the
Zimmer Technocast Pvt Ltd., whether they decide to go ahead with this deal
or not? Prepare a list of key due diligence questions to be asked.
 What are the other options that you can suggest for growth and value creation
of this company, after looking at their plans for the next 7 years?
II. You are an equity investor, interested in funding growth companies in the
manufacturing sector in India.
 How will you view this business plan, particularly when there are two aspects
to it, an acquisition as well as an organic expansion plan?
 What are the key questions that you will have for the two companies? Prepare
a list of Preliminary Due Diligence questions to ask.
II. You are bank manager who has been approached by Mr. Kumar for funding the
growth plans.
 Will you view this proposal favorably? If yes, why, if no why not?
 What are the key questions that you will have? Prepare a list of initial
questions that you will need answers to.
 Set out a list of information that is to be provided by Mr. Kumar for your
review.
©AV Page 103
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