If you are seriously considering exiting your business by selling to a third party, there are several steps you should take before you begin actively marketing your company.
The more time you allow for advance preparation, the better, though most of the following steps can be taken during the few months leading up to a sale process. The following checklist can help position your business to attract the right buyer and get maximum value.
Recast Financial Statements
Financial statements of private companies are typically prepared with a view towards using all available accepted accounting methods to minimize a company’s taxable net income. This tends to be at odds with what a business owner wants to show to a potential buyer in the context of a business sale. The goal when presenting financial information to a potential acquirer is to maximize the presentation of net income and cash flow.
Since the primary factor influencing a company’s value is its earnings, it is key to maximize the presentation of the financials. It is imperative that potential buyers are able to read between the lines and appreciate the actual cash flow or income-generating capability. By recasting or adjusting the financial statements, you can help potential acquirers recognize the financial capability of the business.
The financial statements should be recast or adjusted to reflect the discretionary cash flow available to a new owner. This recasting involves identifying shareholder and family member salaries, perquisites or fringe benefits that shareholders of privately held businesses customarily make available to themselves, extraordinary expenses, current expenses for future expansion that have not impacted historical sales, non-cash expenses, and other expense items not likely to recur or be applicable to future ownership. This higher earnings presentation, when combined with the negotiated adjusted earnings multiple, will significantly increase value.
Develop a Growth Plan
A well thought out and realistic plan for growth can greatly enhance the value of a company. It serves as a road map to expansion opportunities that a new owner could exploit, assuming additional resources were available. The plan should assume that significant capital resources will be available after the sale and should identify areas where historic sales were constrained due to capital limitations. Whether it is limited desire, burn out, or lack of capital resources that may have held the business back, it is critical to develop a well-defined plan that identifies realistic expansion opportunities. If acquirers perceive untapped expansion potential, it will generally translate to greater perceived value for the business.
Tackle Deal-Killers Early On
If there are issues that may potentially jeopardize a transaction, a seller is ill-served by hiding his or her head in the sand. Since these issues will eventually surface, it is far better to address them proactively, rather than have to take a defensive posture when they are uncovered. Such deal-killers may include a lease that needs to be negotiated, property that requires environmental clean up, equipment to be replaced, financials to be revised, pending litigation, or key employee retention.
Addressing these issues in a timely and forthright manner avoids spending months identifying qualified acquirers only to have the deal fall through because certain issues were not anticipated. Buyers have a greater willingness to proceed when they feel the seller has been honest in disclosing the skeletons in the closet from the outset.
Address 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. 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 thus negatively impact value.
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 inventory level, the seller can generate an additional $200,000 by converting the excess inventory to cash. By reducing excess inventory or selling off any excess equipment in advance, it provides time to verify that the reduction of these assets will not have a negative impact on earnings. This is important to do prior to a transaction, since a buyer will likely value the company primarily based on earnings and will not be interested in paying for excess inventory.
Advance research within an industry can determine if it makes sense to approach companies in a related business seeking additional sales, territories, capabilities, or complimentary 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 deal value.
An independent business valuation enables a business owner to get a sense of a realistically achievable value and enable the shareholders to confirm in advance whether it makes financial sense to sell the business at that likely value range. This step can eliminate time wasted in the business sale process that detracts focus from the business. It enables everyone to confirm they are on the same page prior to beginning the sale process. Properly understanding valuation at the outset will prevent leaving money on the table by undervaluing the company or losing qualified acquirers by seeking an unrealistic price.
In addition to having an independent business valuation completed on the company, in certain circumstances it could be beneficial for equipment-intensive businesses, or in transactions in which real property may be included in the transaction, to obtain independent appraisals of the equipment and/or the real estate prior to beginning the sale process. Appraising these assets will help in the valuation and planning process prior to going to market. The buyer will likely need to have these assets appraised and being prepared will insure integrity by presenting these assets with accurate valuations.
Current Sales Performance
The 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 potential acquirers than the previous 10-year 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.
Selling a business is a once-in-a-lifetime event for many business owners. Proper planning and advanced preparation is critical in order to maximize the value of the business and the probability of closing a transaction. Business owners tend to be so focused on the day-to-day challenges of the business that the above areas often get overlooked. Preparation today results in more options and value tomorrow.
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