The number one mistake business owners make in selling their company is not preparing soon enough. Whether you want to sell your company today or in the next five years, these are 8 critical steps in maximizing your company’s value. Proper preparation will enhance the value of your company, make the transaction flow smoothly, and avoid pitfalls that often terminate transactions midstream. Timing is very important to maximize the selling price of your business and the amount you get at the closing table. Ideally when you sell your business, you will receive all the money at the closing table. Here are 8 things you can do to prepare your company for sale:
1. Strive to Increase Profits and Cash Flow
The single most important factor in determining the value of a business is “The company’s profits”. The buyer of your business will likely secure a loan for the purchase, and they will be using the business profits to make their monthly payments. That is why maximum profitability, as well as healthy cash flow, is so important to the value of your business. Increasing sales and profits for the last three years make a company more valuable than one with a recent downturn. If you can create recurring revenue, you enjoy increased profits, and leads buyers to pay more for the company. If you are unable or not willing to grow the business in revenue and profit, it may be time to sell now.
2. Clean Up the Financial Statements
If you are planning to sell your company in the next few years, it is time to start keeping “clean” financial statements. Instead of running personal expenses through the company, it is acceptable to have the company pay you a salary, pay for insurance (health, life, and disability), retirement plans (401k or IRA) or even pay rent for the building you own personally.
However, expenses like personal cell phones, personal cars, family members that are overpaid for their positions, and any other nonbusiness expenses paid through the company will decrease the purchase price.
It is also important if you have other businesses that have shared expenses, that these expenses are actually separated on the financial statements. If you do not have clean financials that accurately reflect the true profitability of the business you will be forced to sell the business for a discount and it is more likely that the buyer is going to ask for a large portion to be seller financed. Clean financials make smooth transactions.
3. Remove Owner and Key Employee Dependency
If the business cannot run without you, you do not have anything to sell. You should start cross training your employees to have at least one backup person for each position. It may be a good time to talk to your attorney about having employees sign a non-interference, non-circumvent or even a non-compete agreement. This is not required for all employees but it is a good idea for any key employees. If you’re going to have an agreement, make sure it is transferable over to a new owner.
This would also be a good time to update or create an operation manual. This can be as simple as the employees documenting what they do. It will make it easier to hire and train new employees if needed. If you have family members working in the business that will not be available after the sale, it is time to start transitioning them out of the business. When a buyer purchases the business, they generally want to keep all the employees.
4. Diversify Your Customer Base
Do not put all your eggs in one basket. If 20% or more of your revenue comes from one customer, the buyers and banks will be concerned by this. In some industries, it is common to have higher customer concentrations, but try to diversify as much as possible by adding new customers.
5. Sell Obsolete Equipment and Inventory
If you have equipment or inventory that is obsolete or not contributing to the profits then sell it. If you have equipment that is only occasionally used and is not vital to your operations or you can rent it, think about doing that.
A general rule is that every piece of equipment needs to generate enough profit to pay for itself every three years. The same thing goes for inventory — does it make economical sense to keep an item in stock? Every business is different and you need to evaluate your inventory levels and availability of restocking.
6. Review Your Corporate Structure
We see many companies that are not properly set up for a clean business transaction due to their corporate structure. The two major concerns are the corporate entity type and multiple businesses ran through the same company tax returns.
If you are set up as a C-Corporation and you file an 1120 tax return, you face the possibility of double taxation because you will be taxed at the corporate level and again at the personal level. This could result in up to 50% of the sale proceeds being paid in taxes. If you sell the business as a stock transaction, the issue is stock transactions typically sell for less money than equivalent asset transactions. If you change your entity type to a Subchapter S filling an 1120s tax return this will save you the corporate taxation and most of the sales proceeds will be taxed at the capital gains rate which is 15-20%. You will need to talk with your CPA to discuss these options and see if it’s a good fit for you.
The second issue is having multiple businesses run income and expenses through a single company tax return. The issue is that buyers are depending on the business’ tax returns to be clean and accurate for the business they are purchasing. If you have multiple businesses on the same tax return and only selling one of them, it makes it more difficult for them to get financing to purchase your business. It would be best to have each business on a separate tax return.
7. Hire Younger Staff
As we get older, we see a tendency of not replacing employees as they retire. This can be a huge issue for the future buyer. If you and your key managers are all approaching retirement age, it may be likely that when the business sells, the buyer will have to replace the entire leadership team within a few months or years. This will definitely affect the value that someone is willing to pay for your business. It is always better to have a wide age range of employees so there is a progression plan for each of the key positions in the company. If this is something you are unable or unwilling to do, you may consider selling your business earlier to avoid this issue.
8. Review Your Facility Requirements
Sometimes, business facility requirements change. Your facility may be too large, too expensive, too small for the current operation. Or, it simply may not work for a buyer. Business models have changed in the last few years for some businesses that no longer have employees coming into the office every day and no longer have the need for the same size facility. With the increase in real estate values in the last few years it may make it prohibitively expensive for a buyer to afford the current facility. If that is the case you need to consider relocating the business now to make sure the business is in a proper sized facility and the future buyer is not burdened with an expensive piece of real estate with expenses consuming the profits of the business.
The same thing can be true for undersized cramped facilities. You may need to move to a larger facility to more efficiently run the business. The last issue is if you’re running the business from your house. Home-based businesses are acceptable for small businesses. However, as your business grows and you have multiple employees, it is most likely better to relocate the business. If you don’t, the buyer will relocate when they purchase the business. Effectively, this can reduce what a buyer is willing to pay for your business.
Why Are These Things Important?
When you are thinking about selling your business, you will need to put yourself in the buyer’s shoes. The typical buyer makes a down payment of 10-15% of the purchase price plus working capital. Business transactions are financed for a maximum term of 10 years and business transactions including real estate for a maximum term of 25 years, with current interest rates at over 9%. This means they are going to have a huge loan payment and little issues that could happen to the business become much more prominent. These are just a few things that we can do to help minimize the risk to buyers to maximize what you will receive from the sale of your business.
Thinking of selling your business?
Call Gateway Mergers & Acquisitions now for a free, no-obligation pricing analysis at (972) 219-6961!