 This is Sonali. Thank you all for carving out some time for attending today's webinar on the episode 6 of the Business X learning series, which is all about creating value in your business. To all the attendees out there, please type in any questions you might have in the Q&A section and we'll try to answer as many as possible at the end of the session. Request you to keep the questions within the scope of today's discussion and not to your personal business queries. I would now like to welcome our speaker, Mr. Gaurav Mariah, Chairman and Founder of the Franchise India Group. A very warm welcome to you sir. Thank you, thank you Sonali and welcome friends and welcome to another edition of Business X series. We talk about three things in different episodes. One is investing, second is scaling and third how do you value your businesses. And we do it every week. One topic on investing, one topic on scaling up and one value. This is now the sixth episode and last time we talked about value and today also I think we're talking about the value. It's a value series. Building value in your business is very, very important and our perspective at Business X and at Franchise India Group has historically been especially for small and medium enterprises because we understand the community very closely. We worked last 23 years in that community and I understand that how different is the mindset when it comes to small and medium enterprise versus large companies. Large companies always thrive to build value in their enterprises and that's where the organizations behave and do and design. And when it comes to small and medium enterprises is absolutely different in their mindset is very income centric so they're driving incomes. But things are changing faster than you know because a lot of external pressures are coming on companies. Businesses are changing for various reasons. People have to look at their businesses for from a different perspective now. And also I think in this changing times a lot of people want to move out of their businesses. They want to resell their businesses. Some are looking to really come out of their businesses and get some value out of it. A lot of reasons are coming in where there is a need for you to really discover a value in your business. And also I always say that even if you run your small and medium enterprise continue to assess your value. And continue to assess your value because when you start assessing your value you will actually start knowing where the business is going and how business is inherently designed. And sometimes we run our businesses which are not so efficient and there is no inherent value in build but we keep running and we just keep managing our cash flows. We get into this kind of a life cycle where we're just managing the business for sake of it and have a little bit of residual incomes which survive us. And I think that becomes your practice of life and then you continue to run that practice. I've seen in my lot of my businesses why I start asking myself why I'm doing it. You know end of the day you don't run businesses to just pay checks or pay your rentals, pay your things and just have small income on that. Incidentally you are building businesses which can tomorrow create value for you and that's where the real problem comes in. So today's next 30 odd minutes are designed to really discuss about that. So let's go backward in terms of what we discussed last episode on value because a lot of people are joining new so they would have not come in. So last time we were trying to put a foundation of what is the value and how you really discover value in your business. And one of the simple answers you know I don't want to look at confusion in terms of how value is being looked at. To me a firm can have a value only if ultimately it delivers earnings. You know so one of the key reasons for enterprise to really look at value is eventually where is earnings going to come from. It is eventually going to be the profitability of the enterprise not necessarily at the given time now. It can be in a future cycle, it can be 3 years, 5 years, 7 years but eventually the earnings potential of that business model over the time for the stakeholders that would create the inherent value. And how it is consistent, how it is dependable, how it is predictable all these measures would really define how this business is doing value. So we also understood that a valuation is just not about the scientific practices. A lot of you know professional valuation professionals are very scientific in their approach in terms of picking up your bottom line and doing some multiple and some finding of some some comparatives and so on so forth. And they come up with some kind of value. To me a valuation is a combination of an art and a science. Relatively sometimes the art is more dominant in some sense than rather than the science part of it. Especially look at now you know at this stage if I have to look at a business from a valuation viewpoint I always look from a perspective of a buyer. Because a buyer at this stage has many choices and why would he look at your businesses and why would he give you a valuation that could become a very very important. This is a buyer's market. At this stage everything could change. Another thing which changes is also the valuation cycles. What times of economy we are living in. Now if you look at the current times where there's a lot of pressure for people to sell their businesses or exit their businesses or sell the entire thing. But there are not many buyers out there, not many liquidity out there. So this is a I would also say a depressed cycle. At a depressed cycle the valuations would also change. So eventually I would look at valuation as a structure of how you really want to. So we went last week on the value front in terms of how people should look at when they are thinking about valuation, how they should really look at it. Then we also talked about basic things on your valuation. How to define your asset. How do you really go deep down in your asset and define that. What is your tangible assets in the system? What are your intangible assets in the system? What is your liabilities currently sitting in the system? What is your financial matrix? So all these are a combination. I call these four different pillars and how do you really bring those together and try to understand what the where is the inherent value. Another very important method is I have realized that whenever you approach a valuation professional, they always reach your objective. I always call the valuation more quantitative where valuation itself becomes an objective. Fundamentally is that you set in a mind that this is the value which I see for my business and then all the numbers you try to stack it up to that. Which means that you put the projections, you put the earning levels, all that needs to be done. So sometimes especially the future valuation are more objectively driven than really historic performance driven. So we set an objective and try to do that and that's where it changes. And a lot of when we read especially when I have been approached by a lot of especially these startups when they come in and present their valuations and present their business models. I don't get it sometimes. And I feel that these are always designed for certain objective already set in the mind and they've designed their financial modeling according to that. So this more quantitative in nature rather than going by the depth of historic performance. And it's right because a lot of startups don't have a historic performance. So they put some lot of assumptions in their business models and on that they based on their. But my principle of valuation, which I use in a very simple manner, I divide the entire business. I look at a business from three perspectives. These three perspectives to me are very clearly three different inherited value in sitting in the business. One is the subscriber value, which is me. I call the SAS principle, SAS principle. The subscriber value is that what is your current customer base and what is the life of that customer continue to purchase with you. So that to me is a very important value and especially the consumer business is what is your subscriber value where it is coming from. Second is more reasonable to understand from a balance sheet is your asset value. What is an asset deployed in the business model and third is the what is the strategic value? What is your, I mean, if I have to look at an asset to acquire or buy that out, what is it giving me? It's giving me some kind of a market share, go-to-market capability, some talent being available there or any other strategic location which is there or some licenses, some contracts, which are sitting as a strategic value in that. So between these three things, I would place my valuation. So I will, assets are more definitive in nature, which means that I would know the real value in terms of what is an asset value. But the other two, one has to do judgment and today's discussion, we will talk about these two more than the asset because asset is very clearly seeing the balance sheet and you can read it out. But you are not able to find a real genuine subscriber value. What is the subscriber telling you and what is the current status and what is the future status of that subscriber value and also from the strategic value in terms of how do you really find the strategic value. And most of the time the strategic value is lying in the, when I got non-paying assets and what kind of intangible assets particularly, they put a lot of constitute more of the strategic value in the business. But few questions one has to really answer and I will put across these questions. How predictable is your cash flows in the future? What is the predictability of that cash flow? Second, how do you improve your margins, hence profitability? One of the areas I've seen that companies discount their future performance and their profitability doesn't increase because the margins are not capable to increase going forward. So I will feel that a lot of people actually have done mistakes in raising capital and defining these future cash flows. And most of the time disappointed they are not able to meet the revenue guidelines or the projected guidelines purely because they never had real answers on how their profitability or margins will continue to increase. So fundamentally the problem in India is the big inflation keeps hitting you, your margins don't increase and the performance which you predicted on a bottom line three, four, five years rather becomes more bleak. So how do you really have a structure where you were able to demonstrate to investor that there is a larger, there is a predictability in your improvement on the margins? What is your sustenance and stability in the performance? Another big reason is that when you predict three to four years, five years and most of the young companies are small and medium enterprises actually have to do a future valuation structure. How do they really predict the stability of their business model? Because next three to four years, five years the business would not only grow but would be very, very stable and sustainable. How do you do that? What is your founding team? Who is the team brand running on that team and how stable that team is and it's not only the founders but the key management team and how do you lock them in? And that's very important. Currently I've seen most of the investments especially in the early stage or a small to medium enterprises people would only do when they see a very strong management team. What is your competition inside and outside their influence and threat to your business? When I say inside, I've seen a lot of companies have failed because the key guys have left the company and created another competition. Is there any risk of internal combination? Is there a risk of external competition? There is a new competition which is now called the invisible competition. These are called the destructors and destructors come from changing the way consumer actually bought anything. So sometimes that competition to me is invisible competition. This is becoming even bigger now that you have to really see through is there a product or a service you own which can be destructed. There can be in three to five, ten years something can be done which can absolutely change the way people consume and so on. So all these areas are very, very important for us to understand. So today I think we will go into a little depth of couple of things and I will take you through some of the areas which are very important for us to understand. So apart from the economic value of the businesses there, we have to really see that what other things an investor would always look at. I always believe that whenever people look at, they always look at the current status of the business and the current status is largely around what the brand stands for. What the brand is talking at this stage and brand is just not about the logo or the symbol. It has to stand for something much larger. So what is the brand stands for? What is your customer goodwill today? How many customers you have? What kind of goodwill you enjoy? What kind of loyalty they give it to you and so on. Second, is your internal resource structure, which is your employees, their satisfaction, their commitment level, they continue to be excited about the growth of the organization. Sometimes you have a lot of vintage in the team and they are running there but they are not so committed in the growth of the organization. So these are two very different things these days. Fundamentally it's not about the aging of people with you and rather if you really see people, teams which have performed for four or five years committed to each other, but they were very clearly committed on the growth and the vision of the founder. Just having people doesn't make any sense rather a lot of companies have actually eroded value because their employees have aged and they have no commitment to the growth of the organization. So employee satisfaction is one aspect of the business but overall their commitment to growth is much bigger aspect of the business. So one has to really see where it is coming from. Your supplier relationships, how locked they are, I mean a lot of companies invest into like look at McDonald's. McDonald's, any market they go, they have three or four or five key suppliers and they actually go with McDonald's everywhere. And they're so committed, they have large part of the 60, 70% of their dependability comes on McDonald's. How dependent your suppliers are on you. So they could really put the best to the entire thing. All good organizations, all good companies would have a very strong supplier commitments. How they are, you know if you're not in the first five priorities of your supplier then might be, they might change, they might change the pricing, they not take you in a priority and things like that. And that's exactly what happened in this crisis in last four or five months because the production levels went down because of labor issues, other issues, lockdown issues. So people actually serviced only three or four top clients of theirs. And I would see that would change a big change in that. So the companies like Mother Dairy, Nestle and likes of them really continue to support and a lot of these micro companies which are also buying what destructed because their supplier commitment was not there. They were buying from the same suppliers, this product but they were not able to get that because the commitment to them was very, very poor. Your overall operational capability, how seamless is your operations today and how defined it is and how especially when you are looking at an M&A kind of an opportunity. I think integration plays a very important role, how this gets integrated and integration is not only the culture but operational capabilities and how simple your operations is to be taken over. That also sets an value. If I see something which is very complex to take over, then there is also a difficulty in that. Then there is a commitment levels for the current entire thing, your operational capabilities today and what is your social and community value for your enterprise. And that's also very important these days how do you really do that. But apart from that, there is also a future value. Future value, how do you really see three, five years from now? What is the future going to look like? How diversified your consumer base is going to be? How you really spread that? People like this diversified consumer base. Companies like Mahindra, if you really see how diversified their consumer base is, look at their portfolio on the automobile side. They are one of the largest suppliers to defense. They are the largest suppliers to government. They are suppliers to a lot of these specialized vehicles which are more utility state, urban development and likes of them. They are big time invested now on public transport and they are also passenger car manufacturers and they are also commercial vehicle manufacturers. So they were diverse in their portfolio. Even if for that matter, a disruption comes from one thing, they might get defense going up. They might get their own. So how diverse your consumer base is? How recurring revenue that is sustainable and resistance to commoditization? Which means your product continues to have certain amount of premium and advantage. So they are able to intact your margins rather than getting the risk of commoditization. How good your improving cash flows are? How we can really see that your cash flows are continued to do that? How do you demonstrate your scalability in the business model? How do you demonstrate to new markets, new products and new channel? These are three things which I have to be demonstrated in every, if anything which needs to be scaled, you need to really think from three levels of growth. What I call new markets, new products and new channel. So if you are able to define in your business that these three things would continue to happen. One company which is Maruti has demonstrated at one time all three and that's where they disrupted the entire automobile share in the country. So they got new market which means that they brought a new product absolutely. Nexa was a new brand and they went to a new market and then new target groups, new products they launched, multiple products. And then created a new channel also which means that Nexa dealerships were next to Maruti dealership and they stood next to each other. And they created another full channel base of Nexa. Because they impacted all three growths, there was an absolute big change in their market share and Maruti overnight revived their market share rather than gained before what they were. And because they demonstrated all three growth platforms and finally what is your financial forecast and controls? How you are able to forecast your financials and your controls over the business because sometimes the business goes out of your control. Now let's go into why people value businesses and why they want to really value businesses and what is the larger purpose of valuation? And these days there can be multiple purposes and purpose has to be understood before we even begin the process of valuation. Because unless and until we know the purpose, we will not be able to understand. Purpose and urgency are two very important aspects in the thinking process of your valuation. So business valuations can be used for different purposes, largely market consolidation, market consolidation or market share consolidation does it. Overall financial and retirement planning, you might be looking to exit the business because you don't want to continue. It can be because of taxation purposes, a lot of consolidation people do or acquisitions happen because of taxation. There can be now huge valuations are happening because of the bankrupt series, structuring, litigation, a lot of these issues. But a lot of people are also especially small and medium in price because of the reasons of devastation, looking at people moving into some other businesses. They are all valuing their businesses and they are looking for exiting their businesses. And one of the areas which business X really works on is helping companies to value and then find the right buyer. So whenever you really look at business valuation, you always look at a three different approach and one what I call the market approach. Second is a very income approach and third is a cost approach. And these are only three approaches which is used by any form of valuations when you look at. Now let's understand what is a market approach. Market approach is very simple. It's normally very comparative kind of a structure where you would set up say a private business and you map it with the publicly traded company. So you essentially would do a comparative and comparative market pricing. And sometimes you will also see the last transactions happen and then I think so if I was selling a food business, I would one compare it with Domino being a listed company and what kind of earning levels they are running on, what kind of a valuation they are sitting on. Their public companies are definitely valued but I can still get some comparatives on that. But I can also value in the last acquisition happened by a comparative brand in the market. So these are very clearly driven from market approach. How do you, how markets have approached and what kind of a structure they have. The second methodology is always about income approach methods. Income approach methods are, they are various methods but the most common method is obviously discounted cash flow mechanism. How do you really do that but there are other methods also what is what capitalization of access income method. There is a capitalized income, economic income method. So there are different methods but most of them especially on the smaller bit and I think it's based on discounted cash flow method where you will forecast your earnings for next three five years and then discount that earning levels. And create a valuation for the business and this is most commonly used in all the valuations especially for a small to medium enterprises and they would always use this kind of a method. The third approach is very clearly what I call the cost approach model. Now the cost approach model is essentially to really understand what it was cost to build this up. You know it's very cost plus model is very asset centric what it took to build this up and if I say invested into a factory which costed me to build three crores and if it is depreciated in structure level I will come with the cost plus model in terms of doing it. It is also can be done from a replacement model which means that if I have to do the same thing today what it cost me right and that's also comes in. These are more fair value to be right for more asset based businesses where you would take this kind of approach. This approach is also done a lot of time in smaller industrial units, smaller industries where people would look at this from a perspective of that if I have to do this again what would it cost me and if I'm getting this a little cheaper than what market would offer and then there is a bargain on that. So this is very conventional approach people would do that a lot of transaction where even the valuation professional is not there but now we still require to get any transaction done on a many because it's required by the regulator but a lot of transaction in the market happen on this approach. So there are three approaches in the business just to give you clarification one is what I call the market approach, the income approach and the cost approach. Depending on that most of the startups and early stage companies would always look at the discounted cash flow approach that's a more income approach how do you really define your incomes over over the years and try to see what kind of valuation needs to be done and most difficulties to really assess that because most of the times there is a lot of variance in that and how do you really capture that variance both from a buyer and a seller people. Now let's understand you know because a lot of our clients are franchise companies and businesses which don't have too much of tangible assets they have a lot of intangible assets and and they come to us and and look at a valuation a lot of time people ask me also that if I'm running a franchise network. Is it good to run a franchise net broadly very hypothetical question I always say that how your business is performing would give you the valuation. People don't want to know how much you invested in the stores and so on so they want to know how your your bottom line is and how you run your own stores or you run franchise stores. So but let's talk about a little bit on the intangible assets power over intangible assets or franchisee it can be your trademarks patents good copyrights any kind of goodwill you sit in the business any kind of a contract which you have signed any kind of securities you have so anything which which has been a part of your business. It's not a very important you know asset which is which is not physical but it is important you say maybe a contract you have which which has a five year earning potential or 10 year. You have a software which has been developed which is that which is very important for the company so all these become very strongly the intangible assets. Especially in the knowledge space in the knowledge economy or the information economy these assets would become much more and most difficult to really assess and put a valuation to it. There are different methodologies people use one is a what I call the double RRM method which is a relief from royalty method. This RRM calculates value which is based on hypothetical royalties that you would be saved by owning the asset and rather than licensing it say for example you had a software. Now you want to value it so you need to really value if I would have to take this software on license what kind of monies I would have to pay for next five years or seven years and there can be some kind of an intuitive value which would come out of this. There always would be an intuitive value you need to then compare that this is this is worth for you or not worth for you and so on. There is another method which you use is called what I call WM which is with or without method which means you do both projections of the discounted cash flows over three five years one with this assets which you want to really value and one without it and then see how does it really reflect on and then you can take a call. There is also a lot of optional rights which means that you can put option which means that you want to really take that asset at a certain stage you would have you can exercise that. So a lot of people don't take all this pieces and some companies have not taken I mean they have acquired businesses and they have not even taken the brand you know in same in cases like hutch acquisition. Hutch acquisition would have never acquired hutch as a brand and they created their own brand called the good upon all of these cases companies would not acquire some kind of intelligence and intelligence. And the third method is also which is called the replacement cost method which is the method requires an assessment of replacement cost of the intangible asset with a new one which means that if you have to replace this with a new thing which means rather than your old software if you have to buy a new software what is the cost of that. Depending on these methods you will be able to find what is the value of the your intangible asset value. So these are so today idea was to cover really to go in the foundation of valuation and then pick up a little bit on the tools of valuation three different approaches which we talked about and also talked about how the intangible valuation it needs to be. So this is for today I have to keep it short because I have to run for another was planned at 330 so so thank you very much I thanks for continue to joining us on business x series next week we have an income series how investing series. So how do you invest into businesses or new assets will continue to do every week either on invest scale or value and if you have a questions you can reach out to me directly or Sonali. And I will give my email ID borrow maria gm at borrow maria.com I apologize for a little rush today because I had something which is planned for a couple of weeks and it happens to be 330 so so I have to rush for this entirely but next week we'll do a full one hour session on invest and we'll also do a little recap on on what we have done in the last six episodes.