You've finally reached the Promised Land of entrepreneurship: a business that is small enough to manage without too many headaches, but large enough to churn out healthy profits like clockwork. So what's the best way to extract all of that surplus cash and reward yourself for years of blood, sweat and tears?

There are three obvious options: remuneration, dividends, and shareholder loans. Many owners will be primarily concerned with their respective tax implications, which will vary depending on your particular circumstances (e.g. whether your business qualifies for the Small Business Corporation tax structure or not).

As a rough rule of thumb, increasing your salary will probably be more tax efficient than paying a dividend until you approach the highest income tax bracket (i.e. 45%). Yes, the dividends tax rate is only 20%, but they're paid from after-tax profits, so the effective tax rate can actually end up over 42%.

Increasing your remuneration has the added benefit of reducing your company's taxable income, but bear in mind that SARS can disallow salary deductions if they're deemed excessive relative to market benchmarks.

Loans are usually not a good idea. Interest-free or low-interest loans are deemed to be dividends and will be taxed accordingly. However, unlike actual dividends, they'll continue to be taxed as deemed dividends until they're repaid. Loans can also expose your personal assets to risk in the event of business creditor claims.

Tax aside, there are some other important factors to consider. Increasing your remuneration has the advantage of putting cash in your pocket immediately. Dividends, by contrast, tend to be declared at the end of the financial year, so you'll have to wait for your payout.

That said, the cash flow advantage of a salary increase can be a double-edged sword. We tend to adjust our lifestyle according to our earnings, so salary increases often get treated as disposable income instead of invested for long-term financial freedom. Dividends can just as easily be splurged on a new car or overseas holiday, but the delayed gratification fosters sobriety.

Finally, dividends don’t impact the value of your business in the same way that salaries do. As an expense, salaries reduce your profitability, whereas dividends come out of your retained earnings. If your salary goes up, then your profits and retained earnings will come down, eroding business value in the process.

Look at it from an investor’s perspective: would you rather buy a business that generates surplus earnings for its owner, or one that operates on thin profit margins due to bloated management salaries?

Most entrepreneurs know that profitability matters, but there's more to your bottom line than meets the eye.

Your accounting profit reflects how well you're pricing your goods or services and controlling your costs. It's a measure of business sustainability as well as management competence.

However, accounting profit is strictly limited to business line items and excludes an owner's investment circumstances. Therefore, it's a reasonable indicator of business performance, but not a reliable measure of investment performance.

Your economic profit, on the other hand, includes your required rate of return (i.e. the return that you need to justify your investment risk). Many entrepreneurs under-estimate their required rate of return, and it's not unusual for an owner-run business to make an accounting profit but an economic loss.

For example, consider a business that makes a net profit of R1 million and pays a dividend of R500,000. Many owners would be delighted with these results.

But what if you had to invest 10 years and R10 million to get your business to this point? If you had allocated that same capital over the same timeframe somewhere else, you could have enjoyed a better return with less risk (e.g. you would have more than tripled your capital by simply investing in the S&P 500).

The distinction between accounting profit and economic profit is critical, because your business isn't just a place to work. It's also an asset that can (and should) create wealth for you.

Accounting profit tells you whether your business is making enough money for itself. Economic profit tells you whether it's making enough money for you.

Few topics are more provocative among investors than Bitcoin.

Advocates highlight its history of outsized year-on-year returns and argue that, much like gold, the limited supply serves as a hedge against inflation. Critics point to its volatility, absent cash flows, abundant scams, and lack of any ubiquitous real world application at scale.

Clearly much hinges on your particular investment philosophy and objectives. However, from a strictly financial perspective, an investment ought to yield an income stream, capital appreciation, or both. If it can't, then one has to question whether it can be considered an investment in the first place.

So how does your business compare?

Most SMEs don't generate ownership income streams. Any compensation their owners receive is contingent on their employment, so they really own a job instead of a business.

Furthermore, most SMEs don't appreciate in value. Even those generating accounting profits usually incur economic losses because of their high risk profile (i.e. they're not profitable enough to compensate their owners for their investment risk).

Of course, speculation is inherent to any investment. Just because your business hasn't generated any ownership income or appreciated in value doesn't mean that it can't do so in the future. Nonetheless, at some point it either has to make good on its investment potential, or languish as a place to work.

As for Bitcoin, its price may have skyrocketed exponentially, but it's a lot harder to quantify whether its value has appreciated. Regardless, it's stuck around for more than a decade. That's longer than most SMEs.

“After everything I’ve put into this project, I can’t give up on it now.” Ever heard yourself say this? Or replace “project” with “business” or even “relationship” and I’m sure you’ll easily answer “yes”.

Being sentimental about things or relationships we’ve invested in – money, time, or effort – can be endearing. Imagine how cold and meaningless life would be if we didn’t value what we put into our projects, whether it’s our business, staff, clients or even personal relationships. Maybe the symbolic value of that old family heirloom outweighs its high maintenance costs?

But there’s a place where sentimentality or loss aversion gets us into trouble. Especially for business owners and other decision-makers.

If ever you’re facing a major decision, whatever you’ve invested to date is irrelevant.

In the business case for a big disinvestment – ending a major project or operation – only future costs must be factored in green-lighting the decision.

Sunk costs – expenses incurred and which cannot be recovered – have no place in your cost-benefit analysis. In deciding to end an investment, we must compare only the future costs of keeping it going against the benefits it’s expected to yield. What we’ve spent is water under the bridge – it’s never coming back.

The only time a cost that’s already spent could be a factor is if you’re certain you can recover it. But our assessment of certainty is usually clouded by our irrational emotions:

- In taking steps to recover a bad debt, at what point do you realise you’re throwing good money after bad?

- You’ve invested thousands in a marketing campaign for a product launch, but it’s not gaining traction – when do you cut your losses?

- When you’ve paid for a big-ticket conference, but you've fallen ill on the day, how sick must you be to convince yourself that your debilitated attendance is not worth it?

- Do you over-eat at the fixed-price buffet because you have to get your money’s worth?

The most common dilemma I’ve seen business owners grapple with is when an existing project or operation is challenged by a replacement. It’s even harder to kill a project if it’s already produced some assets, like useable software or production machinery. But despite whatever has been produced, assuming projects A and B will yield identical benefits, the time and money already spent on project A are irrelevant.

To choose between finishing project A and starting project B, only project A’s remaining costs are relevant. If project B’s total costs are less than project A’s completion costs, the decision is simple: switch to project B.

When you’re deciding to switch from one investment to another – a project, a business, a key relationship – the only costs relevant in your business case are the future costs.

COVID has forced many business owners and their employees to work from home on a partial or full time basis. If you've been similarly affected, don't forget to claim any eligible home office expenses when submitting your income tax return for the 2021 year of assessment.

To qualify as tax deductible, home office expenditure must satisfy both a positive and negative test: the positive test (i.e. permissible deductions) falls under section 11 of the Income Tax Act, while the negative test (i.e. restrictions and prohibitions) is covered under section 23.

As far as section 11 is concerned, any non-capital expenses and losses incurred while generating an income may be tax deductible. Common home office expenditure that may qualify include rates and taxes, office equipment wear-and-tear, phone and internet, as well as repairs and maintenance.

In terms of section 23, deductions aren't permissible unless they involve a section of your home that:

1. You're occupying for the purposes of trade.

"Trade" includes "every profession, trade, business, employment, calling, occupation or venture", so any work you're performing from home in the ordinary course of your business ought to qualify.

2. You've specifically equipped for the purposes of trade.

This will obviously vary from one profession to the next, but a workstation with a computer will probably be sufficient for most deskbound owner-managers.

3. You're using regularly and exclusively for the purposes of trade.

"Regularly" is open to interpretation, but occasional work from home (e.g. every now and then over the weekend) probably won't cut it. "Exclusively" is far less ambiguous: your home office space can't be used for anything other than work, and will probably need to be a separate room.

Note that qualifying expenses may also be subject to apportionment using the ratio between the space dedicated to work and the total premises. This calculation must be based on the entire area of all buildings (not just the main residence) as well as exact floor area measurements (i.e. don't rely on estimates).

As always, check with your accountant for any additional provisions that may affect your particular circumstances. For example, section 23 also differentiates between variable and fixed income-earners, so your compensation structure may also impact which home office expenses you can claim.

Valuing your business can be a lot of fun when negotiating an equity investment to springboard growth or structuring a lucrative exit strategy that will assure your financial freedom. However, there are many scenarios (e.g. forced buyouts due to owner deadlocks) where getting your business valued may be decidedly less glamorous but no less necessary.

Many conventional valuation practices are based on large companies, so applying them to a small enterprise is challenging. SMEs are risky, volatile and unpredictable. Their valuation can vary by an order of magnitude depending on your methodology: valuations based on historical performance tend to be overly-conservative, while those based on future potential risk excessive optimism.

So what's the solution?

#1 Clarify the context

The purpose of a valuation ought to inform its calculation. Equity investors are motivated by a share of the upside, so it's reasonable to prioritise future returns. By contrast, if a disgruntled partner wants to sever ties as quickly as possible, it makes more sense to focus on current financial position and recent trends.

#2 Normalise the data

SMEs tend to be highly dependent on owners who don't come from strong management backgrounds, which is reflected in their financials. Irregular income and discretionary expenditure are common, particularly when personal and business affairs get conflated. Adjustments must be made to account for these otherwise any valuation will be biased towards the owners' personal idiosyncrasies.

#3 Establish a range

Relying on a single number is foolhardy because every valuation methodology has its own pros and cons. Performing multiple valuations will confirm over-arching trends and provide a range for framing negotiations. For example, if liquidation, net asset and normalised EBITDA valuations all yield a range of R1.2m - R2.4m, then it's hard to defend a value of R200k or R20m.

The saying goes, “The only constant in life is change.” Except change is not constant.

As you’ve grown your business, have you noticed how the uncertainties and assumptions around each decision have increased, both in their number and their degree of uncertainty?

For example, if you offer a discount of 10%, how many more units must you sell to at least make the same profit. If you replace ageing, inefficient machines with new assets that contribute more to gross profit, what volumes are needed to compensate for the finance costs? Or in seeking to improve turnover, should you concentrate your capital on generating more leads, improving conversion ratios, managing margins, or reducing customer churn – for each additional rand spent, which area would yield the best return?

To cope with these complex decisions, a critical skill every entrepreneur needs is to be able to conduct at least a basic sensitivity analysis. In fact, if you’re a seasoned business owner, you’ve surely done some what-if analyses for your bigger, higher-impact decisions.

The basic model is to identify the key variables or inputs affecting your decision, identify the relevant outputs, then  build an algorithm that converts the inputs to outputs. With your model created, you simply assume your input values and calculate the expected output.

The value of the what-if analysis is in both validating your model and, ultimately, understanding how the variables influence the outcomes.

For example, if you operate an airline, 2 of the biggest costs affecting profits are fleet repayments or rental payments and the cost of fuel. Newer jets are significantly more fuel-efficient than older planes. But replacing a tired fleet would incur higher rental costs. So what would you do?

After modelling the key inputs, like volumes (passenger load factor (capacity utilisation), flights per day etc.), ticket prices, fixed and variable operating costs, a sensitivity analysis would help us see which input factors should be managed closely and which can be accepted and merely monitored.

The starting point we typically take to solve this conundrum is to first set a baseline for our assumptions of the most likely input values, then apply a basic what-if analysis of adjusting each input up or down by 10% and measuring the effect on the output value(s).

The input variable that causes the biggest change in output tells us which variable our business is most sensitive to.

There is much more available in doing sensitivity analyses, like multi-variable analyses and integrating the model with industry indicators or employee and customer behaviour changes. E.g. how might not investing in a new fleet of jets increase customer attrition when competitors’ shiny new models entice your customers away from you?

The greater the impact of your entrepreneurial decisions and the more ambiguities and assumptions involved, the more valuable a sensitivity analysis will be in managing change in your business.

For any entrepreneur building a business that feeds their wealth, a basic sensitivity analysis should be a frequently-used tool in the toolbox.

Infection rates in the second wave of COVID-19 are not only bigger, but the virus is spreading at a much faster rate than in wave 1. If you think the jump back to stricter lockdowns is bad, I’m sorry to warn, worse is still to come.

Much worse.

Countering the health and economic risks must be a communal, collective effort. Unfortunately, it’s obvious we can’t count on government much.

The minister of Small Business Development issued a press release on 14 Jan. 2021 proudly announcing that R316 million of the R513 million available to the Debt Relief Scheme has been disbursed.

To any small business, the average pay-out of R211,000 is not insignificant. But in the context of there being 35,865 applications to the Debt Relief Scheme, 14,451 were completed correctly and only 1,497 were approved.

Apparently, this will help retain an estimated 23,254 jobs for a few months. (The scheme allows for up to 6 months’ forecast costs to be supported.)

In October, Stats SA reported that SA had already lost over 600,000 formal-sector jobs. Of the informal sector, who knows how many more jobs we’re losing? So although saving 20,000+ thousand jobs (for a short while) is invaluable to each worker, the effect is barely a token in the greater scheme.

The numbers get worse: of the balance of the fully completed 14,451 applications for debt relief, the financial support needed totals R4.4 billion, of which R3.6 b is purely for salaries (again, for a very limited period).

A similar picture shows up in other places. For example, as at 7 Dec. 2020, banks had approved only 27% of the 47,000 applications for the COVID-19 Loan Guarantee Scheme. (Fin24)

Can government help?

Effectively, no.

The mounting unemployment, adding to an already extreme unemployment rate, reduces government’s tax base. BusinessTech reported that from “2017 to June 2020, the [tax base] declined from 6,100,000 to 2,700,000 individuals . . . a large chunk of that reduction occurred after February 2020.”

At least Ramaphosa isn’t lying too much, as reported by Business Day in its 15 January headline: “No money for Covid-19 relief, says Ramaphosa”.

The writing is on the wall: as small business owners, surviving and recovering from the COVID-19 effects is pretty much up to us.

Get help where you can, but as usual, don’t expect much help from government.

Instead, we must do what good entrepreneurs do best: rely on our own ingenuity.

When launching a business or new product, a penetration pricing strategy of super-low prices can successfully build a customer base very quickly. After grabbing a foothold in the market, you can then raise prices to more sustainable levels.

Except, you don’t want to be too successful in the low-price land-grab. The absurd case of MoviePass’ failure in September 2019 highlights the risks.

MoviePass’ value proposition was for members to be able to visit a movie theatre once a day for a monthly fee of only $14.95. When regular ticket prices ranged from $16 to $19, it was a compelling offer.

What’s in it for the cinemas? In case you didn’t notice, cinemas make their money from their (exorbitant) margins on snack bar sales.

For a while, membership grew steadily. But then new owners of MoviePass decided they wanted to rapidly grow the few thousand members to 100,000. They dropped the monthly membership fee to about $10.

Within 3 days, membership exploded to 150,000.  The rapid rise overloaded the servers and users were unable to book and redeem their tickets.

Further up the supply chain, the credit card company issuing the membership cards couldn’t churn out more than 30,000 cards per month. Some members waited months for their cards. A cornucopia of related maladies ensued.

Surprisingly, despite the negative publicity, MoviePass managed to keep most members and limped along for several months.

The business model was built on the typical model of discounted gym membership. If most members under-utilise the service, their revenues would cover the costs of the few high-utilisation members.

But fun fact: most people like going to movies much, much more than they like going to gym. There weren’t enough low-use members and the gym model didn’t apply.

Ultimately, MoviePass was under-resourced and out of cash. With a plethora of other questionable decisions, it closed abruptly. (The Verge, 19 Sep. 2019)

The key lesson is to test your strategies with a limited segment of your market to validate your models.

Penetration pricing is a well-proven strategy, but you need more than hopes and dreams to turn it into long-term success.

In 2011, Microsoft paid $8.56b for Skype. And then Microsoft blew it.

The popularity of Zoom is proof enough – if COVID-19 happened 10 years ago, we’d all have been Skyping, not Zooming.

At the time of the deal, questions were already being asked about the strategic fit and the premium price tag (Wired, 2011). Skype had reported a turnover of $860m, but a net loss of $7m. The economics of the deal didn’t justify the price. Nor were there any strong enough integration prospects with Microsoft’s existing apps. In fact, Skype was likely to kill Windows Phone.

Then things got worse.

So, what happened and what are the lessons for the business owner?

1. Poor user experience: Skype’s business model involved peer-to-peer contact, which is a good model in reducing operating costs – no heavy investment in servers to host each call. But it’s a terrible architecture when relying on user’s devices for quality, which were often under-resourced and, hence, often failed. (Slidebean: Startups 101, 5 June 2020)

2. Poor user expectation: to address the quality issues, Microsoft tried implementing a series of fixes. Unfortunately, fixes that were promised within months took years. And, like smacking water drops on a counter top, while one problem was eliminated, more problems splashed out of other places.

3. Too many projects: Microsoft prioritised developing Skype for Business, which distracted from definitively and rapidly resolving the user experience issues with regular Skype. Capital and talent were stretched and results suffered.

4. Multiple overlapping products: funding and R&D for MS Teams took a much higher priority than Skype in the boardroom, leaving Skype as the poor cousin languishing and exacerbating the other problems. It didn’t make sense to have multiple products competing not only for management attention, but diluting each product’s position in the market.

For an app that so successfully disrupted the telecoms industry (to the point where Skype was banned in some countries to protect national phone networks), it’s a sad demise.

An upside from this tragedy, though, is that MS Teams took many good elements from Skype and Skype for Business. This contributed to Teams being a robust product (even though it’s nowhere near as user-friendly as Zoom).

There's little else worth celebrating, meaning that the only real value Microsoft earned from acquiring Skype was extending Skype technology into Teams. There could be an argument for the economic value of removing a competitor from the market, but then why invest anything at all in not only maintaining Skype, but building Skype for Business?

The bottom line, literally, is that Microsoft’s return on investment is dwarfed by the cost of its investment in Skype.

Something we advise our clients wanting to hit the acquisition trail is to be clear on how any acquired company will strengthen their growth strategy, their market position, and their product suite, and that there’s a viable plan for integrating the acquisition that preserves its value.

In this case, Microsoft got all four of those criteria very wrong.

If a person dies with COVID-19 present, it’s convenient to blame it all on COVID-19. Not just human deaths, but companies, too.

It’s been widely and reliably reported that many of the deaths attributed to COVID-19, sad as each one may be, were of patients who already had one or more morbid conditions. For these patients, medical professionals say COVID-19 merely brought the day of reckoning forward a few years or months; the “real” killer had done most of the damage already.

The same is true for business. Seeing many companies scale down or close down, it’s easy to point the finger at the current whipping boy, the so-called pandemic. Although it might well be true that the last straw for most closures was the lockdown effect, it would be inaccurate to apportion all the blame to this one factor.

A good example of this is Hertz in USA, which filed for bankruptcy in May. The proximal cause of failure appears to be the decimation of travel and related car hire volumes, but the rot started years earlier. (Hertz SA says local operations are not affected. (fin24, 25 May 2020))

After buying out Hertz USA in 2005, the new owners sucked out a $1b dividend payment, loading its debt obligations in the process. They also invested heavily in sedans when the American rental market was clearly favouring SUVs.

Among many similar strategic errors, this set up Hertz USA with a weakened “immune system” – marginal free cash flow from operations (coupled with high debt repayments) – that had it crumble under the COVID-19-induced lockdown shock.

In the triage to save the company, Hertz has laid off thousands of workers. It’s also offloading assets like smaller business holdings and 180,000 of its over-500,000 rental car fleet. Except, “volumes in the new and used passenger market have dropped by 71% year-on-year from Q2 2019.” (BusinessTech, 1 Aug. 2020) So, flooding the market pushed down prices further, making it even harder to satisfy creditors and stay the executioner’s blade.

Blaming the economic downturn and not examining internal factors implies an external locus of control by management. When success depends on only external causes, there can be no collective learning by management. Those same leaders are destined to repeat their mistakes.

The biggest mistake at Hertz was to prioritise wealth extraction for shareholders when the business couldn’t afford it. Don’t pay dividends if it increases your debt burden. Not all debt is a problem – “good” debt is debt that grows the business and generates wealth. Increasing debt to pay dividends is clearly not a good type of debt.

Pulling value from your business might be due to greed, vanity or, in the current trying times, desperation. Whatever the reason, if it doesn’t support your overall strategy, expect problems down the line.

One day in the shower, a eureka moment inspires you with a novel idea that can solve a real problem for real people. You build a prototype, test it with potential customers, and your cursory one-page business plan looks bullet proof. You’re all set to start the new venture!

One problem: you’re don’t have cash to set up shop.

Sweat equity is often the best form of start-up capital. But selling ephemeral riches to your first hire seldom works. And for some ventures, getting the simplest minimum viable product working costs millions.

Time to find investors for seed capital.

This is usually the one problem every entrepreneur hits when starting out. Fortunately, finding investors is not the hardest problem to solve. There’s a lot of capital looking for places to invest, despite a global pandemic and locked down economies. (In fact, especially due to a pandemic, investors are struggling to find viable investments.)

The real problem is negotiating how much equity to exchange for capital. If your start-up is pre-revenue or there’s no market traction, your first investor will want a big chunk of equity. Makes sense, right? After all, they’d be putting a big chunk of capital at risk.

Practically and logically, giving away a 100% equity stake for 100% of the capital is not unreasonable. But then you’d no longer be the entrepreneur, merely an employee. That leaves little reason for you to drive growth – you know the sacrifices needed to make a new venture work!

That’s why most savvy early-stage investors and venture capitalists will want the founders to retain a controlling stake. In exchange for investors “giving up” equity, they might negotiate other terms, like guaranteed chairman or director positions to influence decisions at board level, or a convertible loan portion instead of pure equity.

So giving away 30%, or 40% or even 49% for seed capital sounds OK, eh? As founder, you would still be running the show, right?

Yes. In the short term.

We recently helped a client in their negotiations with a prospective investor. In exchange for several million in seed money, the investor asked for a 40% stake, leaving the founders with 60%. On the surface, it wasn’t an unreasonable offer. But we advised our client to leave the money on the table.

Given the growth plans we co-developed with our client, we knew that seed funding was not the only funding we’d need. Even with pessimistic growth projections, we’d forecast needing a series A funding round for market expansion within 3 years. With the forecast value of the business at that stage, combined with the growth capital needed, the equity dilution would have easily pushed the founding owners to be jointly minority shareholders.

Of course, the next funding round didn’t have to be through selling equity; debt- and asset financing could have worked. But why limit future options before you’ve left the starting gates?

While the best investments are where everyone gets along, we can’t count on relations not getting fractious and parties relying on their legal rights to enforce their interests. Maybe the best example of a founder getting voted out was when Apple fired Steve Jobs. It happens.

So you want to leave room to “sell” a little more equity later.

You also want to leave room for employee share options.

That being said, after a few funding rounds and rewarding employee equity, it’s normal for the founders to be minority shareholders in a growth-oriented business. (This is different for founders building a legacy business or family-run business.)

Either way, a rough rule of thumb is for founding entrepreneurs to exit a growth business with at least 25%. Two factors inform the exit equity proportion: 1. to make the sweat, family and emotional sacrifices worthwhile, and 2. to assure retirement funding and financial freedom.

Regardless of your reasons and timelines for being in business, plan your end-game scenarios before your first investment negotiations.

Regardless of whether you’re building a growth business to exit soon or a family legacy, you don’t want to give away too much equity too early.

Two key lessons for business owners emerge from the Western Cape High Court’s recent judgment on the Guardrisk insurance case. Although the story is about insurance, the learning is about any agency or advisory service.

In the case, a restaurant claimed for lost revenue during the COVID-19 lockdown against its business interruption insurance policy with Guardrisk. As reported in the court judgment by SAFLII (26 June 2020), Guardrisk repudiated the claim because the proximal cause of loss was the lockdown and not the disease. However, judge Le Grange ruled that the claim should be honoured.

The court also issued a costs order against Guardrisk to pay the restaurant’s legal costs. Although a costs order is usually given when the case or decision is relatively obvious, to deduce that this case was “cut and dried” against the insurer would be grossly inept.

The case report was lengthy and it referenced many legal facets and precedent case law. What’s more, the judge explicitly stated that this case does not set a clear precedent for similar cases and that each insurance claim must be assessed against the specific wording in the policy.

One of the factors in the restaurant’s success was getting good advice in taking the right actions and arguments to enforce their claim. But could the whole debacle have been avoidable if they got that advice earlier at the inception of the insurance policy?

When insuring against a risk event, a good insurance broker will reduce the risk (ironically!) of getting the wrong insurance. Aside from matching the right product to the client’s needs, this should at least entail deciphering the fine print, exceptions to exceptions, and other legalese. The “right” insurance is where the insured event the policyholder has in mind is, in fact, the same thing the insurer intends covering.

That good advice probably won’t happen in the burgeoning market of cheap insurance products. To attract more clients, many insurers offer direct sales of ever-simpler products that cut out the agent and the value they offer. Some insurance brands are  built on just this appeal, purportedly saving the customer “unnecessary” costs.

While some of these policies have their place, there are plenty of disgruntled people whose insurance claims were correctly rejected. Had they bothered to check the fine print of excluded risk events – with a broker’s help – the pain could have been averted.

The lessons are twofold: 1. you get what you pay for and, 2. if a risk is worth insuring against, don’t skimp on a cheap agent.

Beyond insurance, this parable is relevant to any agency, advisory or brokerage business. Think beyond the obvious financial services like retirement planning, life assurance or funeral schemes. Are you pinching pennies with a budget doctor, architect, or management consultant?

Although a high price doesn’t guarantee expertise, a cheap price almost always promises high costs later.

A client hired me to help improve her firm’s cash flow and profitability. A key point in our coaching revolved around how to price their services and our ensuing conversation had her settle on higher rates that put her old price list to shame. Here’s how we got there…

I started by asking how she came to her current prices, whereupon she referenced various cost inputs, like salaries and other typical business overheads. We talked through the billable hours and the rates for each service, break-even points and other good ol’ accounting principles. It was easily apparent why she wasn’t making much profit. (Hence investing in the coaching!)

Having modelled the operations and financials, we played a game of “What if?” We experimented with operational factors, like billable hours, staff unavailability, and the price points of each input. This pseudo sensitivity analysis was eye-opening: the business was – by her own metaphor – skirting the precipice leaning over the abyss of business failure.

We’d already explored that there was very little wriggle room to cut costs – they’d already done a great job with that. (Why would anyone hire a coach to help do the easy stuff, eh?)

So we took a new approach: instead of what-iffing marginal increases to the rates card, we explored a single fee to cover all services. (A related discussion later helped us streamline services to reduce the menu of choices. This not only eliminated the infrequent services, reducing the internal complexity and skills needed to fulfil the remaining services, but the reduced palette also reinforced the new brand as a specialist service for just her target client.)

Back to raising her fees, her first suggestion still looked like a marginal increase from the current rates. When I probed into the reasoning for this marginally better price point, her feeling was that, putting herself in her customers’ shoes, it felt reasonable, safe, and unlikely to frighten away her client base.

That’s when the coach stepped in to challenge “safe” and “reasonable”. (Because you don’t get coaching to be even more comfortable in your comfort zone, right?)

I suggested she double the rate.

She took several seconds to process that.

Then we doubled the rate again.

And again.

Now we were well out of her comfort zone. What was initially scary turned to a near-catatonic mood of OMG-I’ll-lose-all-my-clients.

While we worked through the mini trauma, the principle for everyone wanting to raise prices is that the benefits to her clients could still be argued, rationalised and bought into by her clients.

Specifically, we explored the value to her clients in terms of their gain. As a corporate attorney crafting commercial agreements, negotiating and giving strategic advice on big deals for her clients, what she’d be charging would usually be less than 1% of the reward her clients would enjoy from those deals. She needed to sell the business case – the return on investment ratio of benefits over costs.

Also, she had decades of specialist expertise and a track record that put her streaks ahead of her competitors. Her sales slant had to focus on her years of know-how and not a consulting rate per hour.

With all of this, her paradigm mutated from one of, “How can I charge so much?” to be replaced with, “How can my clients afford to not hire our service?”

So that’s what she did.

In a follow-up conversation months later, my client confirmed that by positioning their services using a business case approach, she eliminated many of their high-maintenance clients and replaced them with far more valuable clients.

But the real gem from their new sales approach was this: not only were her clients valuable to her business, but her services were also valued and appreciated by her clients even more than the old ones.

As a small-business owner, your job is never “done”. There’s always a carry-over of tasks from one day to the next. But not only the daily operational tasks, also the strategic tasks in building your business to support your financial needs.

While operational tasks produce value for your customers, strategic tasks are about creating owner value. The latter inherently implies change.

So, if change is mandated, how often and how much must our business change?

A recent article by McKinsey & Company describes its decade-long research into how mergers and acquisitions affected the performance of the global top 1,000 companies. The findings show how re-positioning the portfolio of markets and products, through small M&A deals, drove above-average returns to shareholders. Conversely, companies that made infrequent or “big-deal” transactions, or relied mostly on organic growth, not only performed poorly, but some even lost value.

Although many of our clients are working on acquisition-based growth, the majority of small businesses are not in the M&A space, so, how exactly is this McKinsey research relevant to entrepreneurs?

Many of the research findings speak to fundamental principles that apply to both big and small companies, like moving with the market. But the questions remain, when and how big to change?

First, the timing of change. The article shows that there’s an optimal rate of change of 2 or more small deals per year. Over the 2007-2017 period, the top-performing companies changed by a total of between 10% and 30%.

Importantly, companies that changed to little, too much, or too infrequently often lost significant value, whereas companies that adapted their positioning with frequent, small changes, came out tops.

In other words, for small business, the key is to programmatically and proactively implement small changes that keep you relevant to your market. If you wait until you’re forced to change, your change is already too late.

Next, how big should each change be? The study discusses 2 factors: M&A deal size, and the acquired company’s market position relative to the buyer’s.

The optimal deal size was around 2% of the acquiring company’s value. The ideal “closeness” was for the acquired business to match an existing but non-core business unit in the buyer’s group.

For most small businesses, this translates to diversifying with a new but similar product line, or expanding an existing line with a few new features. These changes could lead to either expanding to new types of customers or capturing more value from your existing client base.

Combining the “when” and “how big” questions, I’d apply this as making a rapid series of small, iterative changes that rely on frequent and early market validation.

How else would you keep your business relevant?