Put your business’ house in order before searching for a buyer
Statistically, 61% of business owners spend either no time or less than one year planning for their exit. As a result, many owners settle for less than they could receive in a sale.
If you have two to three years to prepare for a sale, it can be time well spent. Here are 10 steps in the succession planning process that may help improve your business value and ensure a smooth transition.
How much is enough?
Model out how much money you need from the sale of the business to retire and achieve your goals comfortably. It can be very difficult, especially for entrepreneurs, to stop working, and particularly difficult if you do not know how much is enough. Conversely, if you stop working too early and without proper planning, you might wind up not having enough money. Consult with a qualified financial adviser if you do not have one.
Show clean, strong financials
If possible, show strong profitability in the two years leading up to the planned sale. Most buyers will want to examine at least three years of financial statements. If the seller shows one strong year, buyers might chalk it up to a one-time anomaly. With two back-to-back years of strong profits, buyers will be more confident and they won’t have an argument that the business is trying to sell after one year of exceptional strength.
As you get closer to a sale, particularly in the year leading up to it, show strong profits on your tax return. Yes, you will pay more taxes, but showing strong profits increases buyer confidence in the earning power of your business — which should increase the price. Lenders also are more likely to get excited about financing the transaction.
Clean up the company’s financials — eliminate as many extraordinary expenses as possible. Examine the profit and loss and balance sheet statements for line items that are vague or inconsistent year-to-year. Work with your CPA to try to consolidate income and expense line items to show financials that are as clean and simple as possible.
Keep track of all personal discretionary expenses through the company’s profit and loss statement. If the expenses can be substantiated, your business valuation could improve.
Obtain a business valuation
Think about a business valuation, the estimate of fair market value of a business, as simply information to make decisions. In fact, it is often beneficial to obtain a business valuation two to three years before your desired window to sell, so that you know where you are and what the valuation metrics are.
Small business owners often are dismayed to learn that their businesses will sell for two-to-five times adjusted earnings (depending on a variety of factors). While a properly run limited auction business sale process will yield the highest price and terms, often this range is reality for business owners. It is better to know sooner rather than later so that you can adjust your time frame accordingly.
Consider your transition period
Ask yourself what the ideal transition period would look like and the role you would play in it. If you were purchasing your business, what transition period would make you feel comfortable as a buyer?
Owners tend to work until they are burned out or close to it, not realizing that their transition post-sale may require another year or two of working, particularly in an economy where it is difficult to find and retain upper-level management.
Furthermore, if you go to market communicating that you are “done” working or will not participate substantively in a transition period, you may significantly reduce the marketability of your business — and thus likely the value — and turn numerous buyers off.
Make the business less reliant on you, if possible. For example, work fewer hours by transferring your responsibilities to a recently hired or current manager. This is directly related to the last topic: your ability to transition quickly out of your business is directly tied to your level of involvement in the day-to-day operations and oversight of the business. Additionally, businesses that are less reliant on their owners are generally more marketable.
Align key staff
Identify the most valuable employees outside of you and make sure they are properly vested in the business. Is any manager a linchpin of the company? Consider ways — for example, bonuses, phantom stock, compensation based on recurring customer revenue — to motivate that key person to stay with the business. Furthermore, if you can identify a key staff member that has the aptitude and attitude to take over the owner’s role, that can ease a buyer’s mind greatly.
Given the endemic labor shortage, buyers are very concerned about staff morale, employee tenure and employee loyalty. The more you can demonstrate that your team is stable, the more marketable your business will be.
If you are considering an Employee Stock Ownership Plan, make sure that you talk to an expert to understand what that entails.
What is your employee base’s skillset and age? Hiring a diversified mix of employees is vital to the longevity of your business. Now, there might not be much you can do about this, but some buyers might frown on a business where the employees are largely close to retirement.
Diversify customer base
Consider how diversified your customer base is. While it might not be possible to shift this mix much before a sale, it’s important to understand how customer concentration affects deal structure.
For example, if one customer consistently accounts for 30%-plus of your sales, it is reasonable to assume that a buyer will include an earn-out as part of the deal structure related to that customer. The earn-out is contingent payment over time based on that customer’s sales with your business. The earn-out serves as a hedge against the larger customer leaving and significantly impacting the business.
Document processes and roles
Create a written business continuity plan. This protects the current value of the business if something were to happen to you or key employees.
Document key roles and responsibilities and critical business processes in writing or video so that a buyer can quickly understand what makes the business tick.
Establish the value of the company’s equipment and real estate through a certified machinery and equipment appraiser and real estate appraiser. This evaluation should be done just before a sale — especially for manufacturing or other equipment-intensive businesses.
While the “asset value” may not be the proper way to value your business, showing buyers and lenders the present value of your equipment and real estate makes the business generally more marketable.
Physically clean up the company’s equipment and facility to make it as presentable as possible to buyers. Keep up on regular maintenance and capital improvements, so your equipment is always in good operating condition. If you have unused equipment, consider selling it off before the sale. Buyers assume that any equipment on the balance sheet/depreciation schedule will be theirs in an acquisition, and selling off unused equipment before marketing the business gives you the opportunity to take more from the sale.
Identify growth opportunities
While your career might be winding down, the buyer will want to grow the business. Consider how you would grow the company if you were 20 years younger. Explain precisely what could be done and what types of investment are needed. Document this, even if it’s just bullet points.
Finally, the sale process can become more grueling when owners are not prepared operationally or financially for the intense scrutiny that will come from potential buyers and lenders. These tips offer some guidance but remember to seek professional advice. Make sure you establish your team of advisers beyond simply a mergers and acquisitions expert, including a CPA, financial adviser, attorney and lender, among others. Your team is critical to a smooth acquisition and transition process.
Click here to read more from the April-May 2023 issue of Northwest Indiana Business Magazine.