HOW TO PREPARE YOUR BUSINESS FOR SALE

(Used with permission of the author, C. Peter Smith)
 
 

PREPARE YOURSELF
 

Have a personal financial plan prepared that projects your financial future after business is sold.  Qualified financial planners can assist in projecting retirement needs, college education expenses, life insurance requirements, etc.  In order to project a realistic personal financial plan, project a conservative price for your company and do not forget the tax consequences.  The price of a business to a Buyer is not influenced by the personal financial needs of the Seller, however, if the conservative price of your business plus your other savings and investments does not give you the financial resources to meet your personal needs, you may need to change or defer your decision to sell your business.

 

DEFINE CLEARLY WHAT IS BEING SOLD
 

Will the sale be a stock or an asset deal?  Is the land and building included?  Who will pay off current creditors?  Is your business car included in the deal?  What about the cash value of your life insurance?

 

I have encountered numerous situations where the definition of what was included in the deal was not clear.  In some situations the deals have fallen apart.  One seller assumed her company owned a luxury car, which was not included in the asset sale of the business, but she did not specifically exclude this asset from the equipment list.  The deal collapsed at the last moment because the Buyer assumed the car was in the deal and had his heart set on driving that car.  Specify exactly what is being offered for sale then set the asking price and terms based on those specific items.  Later negotiations can add or delete items as needed to meet both parties requirements.

 

SELL YOUR BUSINESS ON THE UPSWING
 

You may consider the basis of the deal to be the sale of certain assets or the stock, however, from the Buyer’s viewpoint, potential future profits are the key reason for purchasing your company.  To project these potential profits, the primary factor that a Buyer considers is the most recent trend in the Company’s sales and profits.

 

Consider two companies with the same level of earnings last year.  The first company had four years of decreasing earnings and an increase in earnings in the last year.  The second company had four years of increasing earnings and a decrease in earnings in the last year.  If further analysis indicates real trend changes in these companies and not a one-time pick-up or loss, then the first company will be valued significantly higher than the second.

 

You should sell your business when you are making the most money, having the most fun operating the business and realistically seeing the biggest and brightest future for the business.  Buyers are smart people.  Generally they are more attracted to good businesses that are not going to get better, than to marginal or declining business that may (or may not) get turned around under new ownership.

 

CHANGE YOUR FINANCIAL OBJECTIVES
 

Maximizing your living expenses out of pre-tax company earnings and minimizing tax liabilities is a common financial objective for most small business owners.  But, for at least the two years prior to selling your business, you should maximize short-term profits and readily accept the possible related tax effects.

 

Often family-related expenses and assets that would be eliminated under a new owner are kept in the business until it is sold.  If you find this necessary, then spend the extra accounting time to create at least two years of pro forma financial statements adjusting out the family perks.

 

Also, make plausible to a prospective Buyer the reasons for the adjustments.  Adjusting out the salary expense of a “phantom employee” such as a semi-retired mother-in-law is usually plausible.  Adjusting out the expenses for the owner’s business car would be questionable since a new owner might consider this a necessary expense of the business.

 

In those same two years, expenses with only long-term profit should be minimized.  For example, this would not be a time to invest in a new computer system or extensive research and development.  Excess inventory and fixed assets may be sold to improve earnings.  Minimize expenses to stationery supplies and other disposables.  These can often be timed to run out shortly after the targeted date to close a sale.

 

DO NOT EXPECT TO SELL FUTURE POTENTIAL FOR HARD CASH TODAY
 

Most industries have standard rules-of-thumb to calculate the value, tangible and intangible, of a business in that industry.  These rules-of-thumb may be expressed as a multiple of earnings, a multiple of book value, a percentage of sales or another measure that is unique to an industry.  These rules-of-thumb will vary depending on general economic conditions or trends in a particular industry at a particular time.  They take into account both past performance and what is expected for future potential profits in that industry.

 

Frequently, the future potential of a company will be grossly over-estimated by the current owner.  Intangibles such as goodwill, customer lists, good reputation, excellent location and prospect lists usually will not significantly affect the value of a specific business by more than plus or minus 25% from a rule-of-thumb price.  Many of these intangibles exist in small businesses because of the presence and personality of the owner and as this, they are apt to disappear when the owner sells the business.

 

Additionally, whatever increases exist in future profit potential, are usually achieved only by taking additional financial risks such as adding equipment or injecting working capital.  The reward for taking the risk belongs to the risk taker – usually the Buyer.  However, if you believe the potential future profits of your business are unique and the value of your business is significantly more than the rules-of-thumb for your industry indicate, then be prepared to share with a new owner the risk of attaining those potential earnings.  For instance, you might ask a price equal to the book value of your company plus a mark-up that adjusts for the used, fair market value of your equipment.  Then negotiate a percentage royalty on the company’s sales or profits for the next three years as the future potential of the business materializes.

 

SEPARATE THE LAND AND BUILDING FROM THE BUSINESS
 

The real estate in a small business is often its most valuable asset.  But, this asset can also distort the company’s Income Statement and Balance Sheet.  If the land and building are owned inside the corporation, it is often best to create a separate pro forma set of statements as though the premises were rented at an arms length, fair market rate.

 

Many small corporations lease their premises from their owners.  Whether the premises are owned by the corporation or separately by you, plan to have an independent real estate appraisal made of the land and building as part of the overall evaluation of your company.  Do this even if you intend to lease the building to a new owner in order to develop comparable leasing rates.

 

IDENTIFY AND GROOM AN EMPLOYEE AS YOUR REPLACEMENT
 

Contrary to most Sellers’ expectations, most Buyers do not have a cadre of management ready to move into the purchased company.  Regardless of contractual obligations, between 60% and 70% of all owners are gone from their businesses within one year of sale.  Hence, before the deal is done, most Buyers need to identify and feel comfortable with the person you choose as your successor.

 

CLEAN UP CONTINGENT LIABILITIES
 

Buyers, especially larger companies, are very concerned with contingent liabilities.  For example, suppose your company was the defendant in a $500,000 lawsuit which you expect will eventually be settled for a small fraction of the original amount.  It may be better to negotiate the settlement now.  A Buyer taking over the liabilities of a company can better evaluate a firm $10,000 or $20,000 final liability against your company than a possible $500,000 liability that may or may not be settled for something less.

 

IDENTIFY POTENTIAL BUYERS
 

You should begin early to identify prospective Buyers.  Trade journals and local newspapers often have business announcements concerning deals made in your industry or geographic area.  You should start a scrapbook or log and find out as much as possible about the type of deals done and the prices paid.  Many deals are done between owners of companies that know each other from prior business or social activities.

 

Except for direct competitors, contacting a prospective Buyer early in the selling process is usually not detrimental.  Often this may be disguised as an informal discussion perhaps during a fishing trip or on the nineteenth hole.  Many reputable Buyers will respect your need for confidentiality.  They, in turn, can give you valuable feedback about the stability for your company and often provide an estimated range of the value.

 

Many deals take a year or two to culminate.  Buyers that decline on a particular candidate often reverse their position later as businesses and/or economic conditions change.

 

One note of caution:  Do not become a “Phantom” seller!  I know of one owner who has been showing his business to prospective Buyers for over five years.  Most of the prospective Buyers in the particular industry no longer take this owner seriously.  He will have a creditability problem to overcome when he really decides to sell.

 

MAKE YOUR BUSINESS SHOW WELL
 

You would not show your car to a prospective Buyer without washing it or your home without mowing the lawn.  The same kind of aesthetics also appeal to a prospective business Buyer.  A coat of paint, a general house-cleaning and some minor repairs and maintenance to fix cracked windows, etc. will make a difference.

 

The same kind of housekeeping should be done to the corporate books and records.  For example, you might have some miscellaneous employee receivables that are from a terminated employee you hope to find some day, or there might be some obsolete inventory or some equipment on the books that you moved into your home workshop years ago.  These items should be cleared.  They tend to distract a prospective Buyer’s auditors from the real issue of finding out the value of the company.

 

Similarly, the corporate minute book should be brought up to date.  Review leases, contracts and other long-term commitments to be sure they are current and accurate.  Check if any restrictions exist to prevent assigning these agreements to a new owner.

 

FIND YOURSELF AN EXPERIENCED CONFIDANT AND UNDERSTAND HIS BIAS
 

In addition to being the largest business transaction, the sale of your business is often the loneliest transaction that you will ever undertake.  Owners tend to look at their own companies, especially long time, family owned business through “rose-colored glasses”.  I highly recommend that early in the process you find someone, a confident, to give you deal-making advice, to help you through the sale of the business and, in many cases, to handle the actual negotiations with the Buyer.  This confidant should be objective, honest and experienced in deal making.  Even some old fashioned hand-holding is often needed to bring you through what can be a very emotional time.

If you plan to stay on and work for the Buyer, the role of the confidant as a negotiator becomes very important.  During the negotiations, you and the Buyer are adversaries.  After the deal is done, you are then playing on the same team.  The confidant, as a negotiator, can act as the “bad guy”, enabling you and the Buyer to avoid any hard feelings from the negotiations.

 

Lawyers, bankers or accountants are likely candidates.  Other candidates include management consultants or professional merger and acquisitions intermediaries.  Regardless of whom you consider, three things should be evaluated.  First, is this person someone who is experienced in deal making?  This major transaction is not a time to break in a junior partner in a firm.  Second, if potential Buyers are not readily identifiable, does this person have the contacts and abilities to find potentially interested Buyers who are financially capable of doing your deal? Third, what is the basis of the person considered?  If a deal is done, will your confidant be losing a good client or company?  Or if the confidant is hired on a contingency basis, would he or she be tempted to suggest a lower price for the business in order to make a deal quicker?  No outsider will be totally unbiased toward your transaction.  It is simply good business for you to understand the bias of your confidant at the outset.

 

The price paid for this kind of advice is not cheap, whether on an hourly, daily or contingency basis.  However, when considering the total value of the deal, if the confidant’s advice moves the deal only a few percentage points, speeds up the process a few months, or saves the deal because the Buyer balks at the last moment, the price is worthwhile.

 

As a deal begins to come together, you should look for good technical advice from your attorney, accountant, and/or tax professional.  Any good deal-making confidant will insist on this.  Again, this technical advice is not cheap, but, any professional merger and acquisition intermediary can relate numerous “horror stories” regarding Sellers, especially first-time Sellers, who have gotten into serious trouble making a deal without help.

 

BE REALISTIC AND HONEST WITH YOURSELF AND OTHERS
 

In the process of selling your business, you will have numerous opportunities to fool yourself and others.  Keep asking questions such as “Would I really buy this business for as much as I am asking for it?” or “If I were an employee, would I accept that reason for wanting to sell this business?”

 

This point is not made to suggest that you should set an asking price too low or advertise to your employees two years too early that you are preparing to sell the company.  Keeping your plans confidential gives you negotiating room and helps maintain good employee relations.  However, when you are in the final stages of negotiations or when confronted with questions from employees, customers, etc., you will see the need for realism and honesty.

 

SUMMARY
 

Perhaps the one single thing that frustrates owners most about selling their businesses is the amount of time that lapses between the decision to sell and the final closing.  Small deals are often harder and more time consuming to put together than larger deals.  Since most decisions to sell are made when finances are getting tight, that passage of time becomes a disadvantage to the Seller and advantage to the Buyer.

 

Good preparation can often turn the passage of time to your advantage.  By taking actions to prepare your business for sale you can both improve the salability of your business and reduce the pressure to sell.  As a result, you can get a higher price for your business and affect a smoother transition of ownership.

For more information visit our website here Business Acquisitions Ltd.