Quality of Seller’s Documents Affects Purchase Price
In the initial business evaluation between the seller and the business broker, the seller should provide certain documents or items that enables the business broker to price and list the business properly. A well prepared seller who has accurate and up to date documents generally leads to a higher purchase price. This is because buyers trust the represented cash flow and advertised merits of a businesses when backed up with clear and transparent documentation. Moreover, having the right documents will make it far easier for a buyer to obtain SBA financing on the business purchase. In general, needed documents that business owners should generally have available are their financials (three years of tax returns or profit and loss reports), lease, physical asset list, and an itemized list of personal ‘add-backs’. Other documents requested during the formal due diligence phase includes employee and payroll records, bank statements, insurance certificates, and financial data showing key metrics of the business such as the level of customer concentration.
Financials of Business
The financials of a business are generally the historical tax returns or profit and loss statements. It is best to have the three most recent years available (preferably in PDF format for tax returns which is easier to view and send). The tax returns and profit and loss statements should both tell the same tale as far as the sales and profits (or ‘adjusted owner benefit’) of the business. Often times, sellers have their own Quickbooks-generated profit and loss reports, which are fine to use so long as they are accurate and generally match the provided tax returns.
Include Most Recent Financials
- The intelligent buyer knows that the most important attribute when buying a business is the future cash flow of the business.
- While historical financials are very important (especially for the purpose of obtaining external financing), the current performance and future trajectory of the business is even more important.
- If the selling process takes place mid-year or later, sellers should thus have an interim profit and loss report for that same year (the tax return for that year will not be available since the year will not have been completed yet).
- Moreover, if obtaining historical financials is problematic, then the seller should do everything possible to still compile or obtain a set of financials for the most recent 12 month time period.
- This is referred to as the TTM or Trailing Twelve Month time period.
Businesses May Not Have Traditional Financials
In some industries, it is generally accepted that tax returns or even profit and loss statements do not describe the true nature of the business’s sales or profits. When selling laundromats for example, buyers often rely on utility bills to gauge the sales levels. This is simply because of the cash nature of laundromats. As long as the buyer understands what is available and otherwise receives sufficient information to make a well informed offer, then a successful sale may still take place. Likewise, when selling restaurants, some buyers may be comfortable proceeding with the purchase without typical financials. Such buyers are comfortable with viewing the foot traffic and sales activity of the restaurant without needing to look at the tax returns or profit and loss statements.
Itemized List of Personal Add-Backs
- It is quite common for many owners of businesses to expense their personal or family bills (such as auto, healthcare, or cell phone costs) through the business.
- This means that the tax return or profit and loss statement uses personal costs as business expenses.
- In reality, such costs are considered ‘add-backs’ to the adjusted owner benefit because the costs would not be borne by the buyer and are not legitimate business expenses.
- Business owners should compile an itemized list of any personal add-backs that flowed through their historical financial statements.
- The seller should identify the expense category within the tax return or profit and loss statement in which the personal expense was taken.
- The seller’s salary (or spouse’s salary) should also be identified and is generally considered to be an add-back.
- These and other hidden assets of a business – if known and properly disclosed – will increase the advertised profits of the business and hence the purchase price of the business.
Lease
Assuming the business owner is renting their premises, the seller should make their lease available for review in order for a business broker to properly evaluate their business. With retail business in particular the lease is of paramount importance and should be thoroughly analyzed. Key factors in a commercial length are its length, the annual rent increases, options to renew, and any exclusivity provided to the tenant within the commercial plaza. While it is not typical to give buyers a lease until the formal due diligence phase begins, the major terms of the lease must be known and disclosed in the initial stages of the selling process.
Asset List
- A business owner should compile an asset value with the current approximate valuations of equipment, inventory, and leasehold improvements.
- Equipment refers to any movable items (such as vehicles or machinery).
- Equipment is different from inventory which are items of resale value.
- Equipment is also different from leasehold improvements which are attached to the property and not movable.
- The equipment list should describe the major items of company owned equipment (industry jargon is fine) along with the year of service and currently depreciated value.
- The inventory list should value inventory at cost, while a list of leasehold improvements should approximate its current depreciated value.
- Having an equipment list is necessary for any buyer to obtain external financing and informs the buyer of what physical assets are included in the asking price.
Retail Businesses Should Have Inventory Report
For retail businesses such as clothing stores, convenience stores, or furniture stores, an inventory report is also a necessary document needed in most instances to sell a business. The inventory report will separately itemize the value of the current inventory in the store ‘at cost’, at retail value, and by age. Inventory can make up a major component of the final purchase price for retail businesses, and thus should be disclosed with as much transparency as possible.
Less surprises and more transparency in a business sale generally leads to a smoother transaction and satisfied buyers and sellers. A business owner with an organized and prepared set of financial and company documents will generally receive a higher purchase price for their business.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.