Careful preparation and advanced planning can significantly increase the likelihood of a successful business sale and have a positive effect on valuation. The following are proactive steps a business owner should take prior to beginning the business sale process:
Recasting Financial Statements. Financial statements of privately held companies are typically prepared for tax purposes, not for business sale purposes, and do not accurately reflect the true profitability and potential earnings capability of a business. Acquirers must be able to “read between the lines” of the financial statements and tax returns to appreciate the cash flow being generated for the owner(s). Recasting financial statements involves identifying the owner and certain family member salaries, one-time or extraordinary expenses, current expenses for future expansion that have not impacted historical sales, interest expense, non-cash expenses such as depreciation and amortization and other expense items not likely to recur or be applicable to future ownership. Failure to properly present true “recast earnings” reduces the perceived value of a company.
Growth Plan. A well thought out and realistic growth plan can greatly enhance the value of a company. It serves as a road map to expansion opportunities that a new owner could attain with additional capital or other resources that it may bring to the table. Whether it is time constraints, burnout, or lack of capital resources holding the business back, it is critical to develop a well-defined plan that identifies the most realistic expansion opportunities. The more untapped expansion potential the greater perceived value the business will have to an acquirer.
Tackling “Deal Killers” Early On. If there are issues that could potentially jeopardize a deal, a seller is ill served by trying to conceal these issues and hope that they are not uncovered. Eventually these items will surface, and it is far better to proactively address them rather than have to take a defensive posture when they are independently discovered. Such “deal killers” may include a lease that needs to be negotiated, property to be cleaned up, equipment to be replaced, financials to be revised, pending litigation, key employee retention, customer retention or concentration, etc. Addressing these issues in a timely and straightforward manner can avoid spending months identifying qualified acquirers only to have the deal get derailed due to undisclosed information. There are a variety of ways to disclose, present and/or remedy these issues prior to or during the initial marketing phase. Buyers have a greater willingness to proceed if they feel the seller has been honest in disclosing the “skeletons in the closet” from the outset.
Addressing Key Dependencies. Reducing key dependencies in a business will serve to increase the marketability and value of a company. Three key areas include customers, vendors and employees. Customer dependency exists when a high percentage of the company’s revenue is derived from a few large customers. Vendor dependency results from difficulty finding comparable vendor replacements, if needed. Employee dependency exists when the business is highly dependent or held hostage by key employees or the existing owner, whose departure could severely impair the business. These dependencies create significant risks for an acquirer and can have a negative impact on valuation. With advanced planning and focus the negatives associated with these dependencies can generally be mitigated.
Carve Out Excess Assets. One method of increasing a seller’s total financial yield from a transaction is to identify excess assets that can be converted into cash prior to a transaction, without adversely impacting the business. For example, assuming a company has accumulated $450,000 of inventory but only requires a $250,000 level, the seller can generate an additional $200,000 by converting the “excess” inventory to cash prior to beginning the sale process.
Likely Acquirers. Advanced research within an industry can determine if it makes sense to approach companies in a related business seeking additional sales, territories, capabilities or complementary revenue centers. These “strategic buyers” may have a strong desire to acquire a similar or related business as a means of growing through acquisition, or because they may recognize the synergies that will result from the combination of the two companies. By identifying likely prospects, the search for an acquirer can be more tightly focused in a direction that can maximize the overall transaction value.
Independent Valuation. An independent valuation enables a business owner to get a sense of a realistically achievable value and confirm in advance whether or not it makes financial sense to sell the business given current market conditions. This step can eliminate time wasted in the business sale process that detracts focus from the business. Properly understanding valuation at the outset will also prevent leaving money on the table by undervaluing the company, or losing qualified acquirers by seeking an unrealistic price.
Tax. It is also crucial to understand the tax implications of a sale in advance. This will provide a realistic picture of the net after-tax yield and help to determine the most advantageous way to structure the sale for tax purposes.
Current Sales Performance. An often overlooked area that has a major impact on marketability of the business is the company’s current year-to-date financial performance. The 12-month period during which the sales process is taking place is a decisive one. If sales performance deteriorates during this period, marketability and value will be negatively impacted. Current performance often has greater significance to a potential acquirer than the past several years track record. The business owner must focus his or her efforts on whatever can be done to maintain consistent (or improved) sales, margins and profits during this period. Working with a qualified M&A intermediary is a vital component of managing the sale process, as it allows the business owner to maintain focus on running the business. An experienced intermediary will handle the time consuming intricacies involved in the proper packaging, presentation and negotiation of a business sale transaction, as well as carefully vetting potential acquirers so as not to impair the owners focus on driving the growth of the business.
Although this list is not all-inclusive, we hope it raises your awareness of things that can be done in advance to prepare your business for sale.