“Give me six hours to chop down a tree and I will spend the first four sharpening the axe.” – Abraham Lincoln
Prepare Business to Sell
Preparation is the key to many aspects in life, and never more so than when it comes time to selling a business. In order to plan their best exit strategy, business owners should gradually but surely prepare their business so it sells for the best possible purchase price and terms. Three preparatory steps to a successful business sale are:
- Reducing one’s role as the owner of the business.
- Keeping track of one’s company’s records in an organized way.
- Having a ‘clean’ set of financials available for potential buyers.
Reducing the Owner’s Role
Businesses that are run by an absentee owner have higher valuations than businesses that are run by active owners who are involved in the day to day operations of the business. When a buyer is faced with the daunting task of replacing an active owner who has personal relationships with employees, customers, and suppliers, then the valuation of the business may suffer. This is because the buyer will have to absorb the costs to replace the owner after the sale either with their own labor or from having to hire increased staff. If it is possible for an owner to reduce their role in the business, then doing so will greatly enhance the value of the business when it comes to sell.
Owner Should Not be ‘Irreplaceable’
When an active owner has a personal relationship with key customers, employees, or suppliers, then buyers become frightened that they (as the new owner) will possibly lose customers or business after the sale when the old owner is no longer around. Additionally, buyers will calculate the cost of having to replace a working owner (and/or their spouse if he or she is also active in the business) when deriving their valuation of a business. As a result, they will either be afraid to purchase the business at all or will give an offer that is not satisfactory. By slowly delegating responsibility and tasks to a managerial staff, the owner may prepare their business to receive a much higher purchase price when it comes time to sell.
Organize Company Records
A key way to prepare one’s business is for sale is by organizing important company records. Such company records may consist of the original incorporation documents, shareholder certificates, W2 payroll records, customer invoices, and insurance certificates. If the records are tracked by date then that is even more helpful. Keeping company’s records in an organized way comes easy to some business owners. For others, not so much. But when it comes time to sell, a buyer will typically require a thorough due diligence process before closing. The due diligence process will ask for all these records, so having them organized and in place greatly facilitates the sales process.
Transparent Financials Improve Valuation
Having a clean set of financial records is by far the most important preparatory step one can make before selling a business. Financial records primarily include historical tax returns, profit and loss statements, and balance sheets. The goal of the financial records is to prove the adjusted owner benefit of the business. The adjusted owner benefit is the true economic profits derived by a working owner of the business (including personal expenses that flow through the financial statement, unrecorded cash, and the owner’s salary). If the financials are transparent and organized enough to show the true adjusted owner benefit, then the buyer of the business is likely to pay a higher price with more favorable terms. Moreover, transparent financials are also necessary for the business to qualify for external funding backed by the SBA or Small Business Administration.
- Are all your sales reported on your tax returns (and sales tax returns)?
- Are your business expenses all reflected in your tax returns?
- Are all of your employees paid appropriately and legally?
- If you run personal expenses through your business, do you have appropriate evidence of this so that such personal expenses can be ‘added back’ to your owner benefit?
- If the financials and records of the business are not transparent, the business valuation may suffer but due diligence may still be conducted by other means.
- This is especially the case in some industries such as laundromats where traditional due diligence is not the industry norm.
- Also, some buyers may not want to perform traditional due diligence since they are so familiar with the industry.
- For most buyers and for most industries, however, having a clean set of books is a must for a buyer to pay a fair price for a business.
- Moreover, a buyer seeking SBA financing will not be able to get funding unless they are given a coherent set of financial records.
If you’re thinking about selling your business, give Martin a call today to learn how you specifically can start preparing your business so it sells at the highest price possible.