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On Your Mark, Get Set, Sell!

8/28/17 – Keith Carlson

When and why to start preparing

The most significant financial transaction in a private business owner’s life is likely to be the sale of his or her business. Although many sales are premeditated, others result from unplanned events, which is why every owner should have an exit strategy. Professionals who are well versed in mergers and acquisitions, succession planning, capital markets, and valuations can help entrepreneurs develop exit strategies, whether sale is imminent, unexpected, or a long-term goal.

Operate to sell

Most business owners seem to assume they’ll run their businesses until they retire. But priorities and interests can change, or be forced to change by unforeseen circumstances such as illness and disability.

As a result, even owners who have no intention of selling should generally operate their business to maximize its value. This means developing and understanding key value drivers, such as consistent financial performance, free cash-flow generation, management quality and continuity, and knowledge of the typical risks investigated by buyers. It is important to note that value drivers aren’t one-size-fits all: they can change with a company’s industry, geography, and size.

A quick note on operating to maximize value

Many owners intentionally minimize their taxable income, run personal expenses through the business, or overpay relatives. This typically leads to lower reported profits and can adversely affect the business’s theoretical value, as valuation is mostly based on earnings. However, buyers usually base their offers on multiples of historic earnings before interest, taxes, depreciation, and amortization (EBITDA), with special consideration for “owner’s expenses” that would be eliminated if the company were purchased by an independent third party. In short, owner’s expenses are added back for the purposes of calculating a business’s value. It’s best to consult professionals with M&A transaction and valuation experience for assistance in accurately adjusting your earnings. 

Timing of a sale is very important

If an owner is contemplating a sale in the next five years, it’s important to consider various non-business factors that will affect the company’s value in the marketplace:

  • Market conditions. The supply and demand of businesses vary over time and between industries. This is conveyed in the last bullet of this section.
  • Availability of capital: Institutions that provide capital to would-be buyers expand and contract their offerings in accordance with their overall appetite for putting money in M&A deals. When markets are flush with capital at ideal costs, purchasers are better able to pay premiums.
  • Comparable transactions. Evaluating comparable transactions over time makes it easier to set the asking price for a business, and even the ideal time to sell. Professionals with M&A and valuation experience have access to databases with useful transaction data that can guide this advice. 

Prepare for sale

It’s important for sellers to look at their businesses through the eyes of a prospective buyer and identify its strengths and weaknesses. Companies should continually evaluate and revise their understanding of their strengths and weaknesses to know which characteristics to emphasize and which to correct or mitigate. Some threats and weaknesses are simply inherent in certain companies or industries, but you should still do things before a sale to soften the perception.

Financial record keeping. One common area of weakness that is entirely in the business owner’s control, regardless of industry or size, is financial record keeping. One of the quickest ways to damage a buyer’s perception of your business is to keep inadequate or low-quality financial records (internal statements and externally prepared statements). When a buyer requests financial information to review your company, the perfect response is to provide reviewed or audited financial statements from an independent CPA firm, and to have the internal or interim statements mostly reflect the same content of the third party reports. You should be continually striving to improve your financial record keeping: it is good practice for managing your business in addition to enhancing its value. It is also important to remember that good record keeping is much like regular personal exercise: it takes time, patience, and discipline.

Address risk. Excessive risk lowers the market value of a business. With effective planning, you can minimize or eliminate risk. The following are several risks that can be mitigated with time and effort:

  • Customer concentration: Diversify your customers or reduce reliance on critical and larger customers as much as possible. If this isn’t possible, find ways to reduce the relationship risk (contracts, for example).
  • Consistent financial performance: Buyers enjoy growth, but they also enjoy knowing that a business’s financial performance is consistent. So don’t grow just for growth’s sake. Grow wisely and consistently.
  • Employee turnover: One area buyers can analyze quickly to assess company culture is employee turnover. If your turnover ratios are high, you should make efforts to reduce or stabilize or them.
  • Adding systems and infrastructure: Spend wisely, but don’t foolishly under-invest in your business. Let others help you assess your business and judge whether adding overhead-related infrastructure, systems, or software could improve its ability to scale.

Archiving and saving information. Owners can expedite eventual due diligence from advisors and potential buyers by saving and archiving past reports and other information about the business. People won’t need just recent information: they’ll want to examine data over time to see how the business has changed and improved. Items you should save and archive in an orderly fashion include

  • Monthly and annual financial statements: balance sheet, income statements, cash flow statements, and tax returns;
  • Property, plant, and equipment listings and appraisals;
  • Customer contracts;
  • Forecasts and budgets;
  • Backlog and pipeline reports;
  • Schedules of discretionary adjustments (excess owners’ compensation, perks, and quasi-business expenses). 

Planning pays

Selling a business is exciting and stressful. Professionals who specialize in mergers and acquisitions can ease the process. In fact, their early and continued involvement can dramatically increase the eventual sale proceeds. 

Sidebar: Don’t let complacency compromise the value you’ve worked hard to build

Some business owners scale down operations as they approach retirement or a planned sale date. For instance, they might take more vacations, forgo advertising and equipment purchases, neglect research and development, or let long-term contracts lapse. Revenues can decline as a result, and the business may look dilapidated to a would-be buyer.

Buyers typically base their offers on a company’s historic financial results and their own perception of its ability to generate similar or better results in the future. So owners who let revenues slide and assets deteriorate are less likely to receive top dollar — especially if competing businesses are available in the marketplace. If top-dollar is what you want, keep running the business as though you intend to keep it forever. 

Consider personal mitigation efforts. A professional with M&A transactional experience, in conjunction with your tax advisor or accountant, can help you minimize the taxes that result from a sale if given enough time in advance. He or she can work with your tax and wealth advisors—even help you select qualified ones—to devise plans tailored to your situation.