It can be a difficult thing for a business owner to plan for the sale of their business. They have nurtured and grown the business over many years, and the thought of selling it is not something they want to contemplate, much less create a plan for. For many people this is like meeting with a lawyer to create a family Trust for when you pass away.
Here are some recommendations for what it takes to get an optimal price for the sale of your business, and why to start now.
When Is It Time To Start Planning For Your Business Exit?
You will leave a lot of money on the table if you try to rush the process through at the last minute. If you have an illness or some other catalyst that forces you to sell your business without an exit plan already in place, there will undoubtedly be weaknesses that either significantly lower the purchase price, or worse, results in no sale at all. Since most owners have never sold a business before, they don’t realize that it takes time and strategic planning to optimize the business value drivers to get the best purchase price. As a result, you try to sell your business before the enterprise value has been maximized.
Know What Your Buyer’s Are Looking For
Critical to increasing business value is to understanding how a potential buyer views your business. When buyers look at your business to determine what they think it is worth, they will probably start by reviewing your earnings and more importantly cash flow. Having $5 million in sales and $500K in earnings is much more valuable than having $10 million in sales and $500K in earnings. If there is revenue derived from products or services that don’t make a profit it will actually hurt the value of your business. This additional revenue increases the number of headaches that go along with additional employees and overhead and reduces your business profit margins.
It is important to work with a brokerage firm familiar with current market values to obtain a realistic value for your business. The next step is to work with the business broker to conduct a business audit and assessment that highlight the strengths and weaknesses of the business. The broker can target the most important value drivers. We’ve found with our clients it is not uncommon that improving these value drivers can significantly increase and sometimes even double the market value. More importantly, a thorough business assessment greatly increases your chances for a successful sale of your business. If the business valuation and assessment has been performed carefully, it should withstand the most rigorous buyer due diligence.
The time to develop a plan to sell your business is now. Exit strategies are a critical element of every business plan regardless of when you plan to exit. The time, money, and effort to perform a business valuation and assessment is small compared to the increased sale price that results from allowing time to improve business value drivers. A rushed sale of your business can greatly erode the price you could have received for your business.
Improve Business Value Drivers
There are dozens of value drivers, with some only applicable to industry specific businesses. However, there are universal value drivers and a few of the most important ones are presented below:
- Diversified and growing customer base
- Financial performance (e.g. increasing sales growth trend, strength of sales backlog, growth in profitability, liabilities)
- Strong products and services (e.g. product/service differentiation and innovation)
- Barriers to competitive entry
- Solid vendor relationships
- Marketing strategy to link customer’s needs to the business products/services
- Current technology and work-flow systems and processes
- Strong and efficient management information systems
- Strong company culture with a skilled and loyal workforce
- Market environment (strength of the market niche and management understanding of how the industry is structured to minimize impact of the macro trends on the business)
- Solid management team that can transition to the new owner
- Strategic plan (a long term financial forecast that can be passed along to the future owner to provide an assurance of continuity and preferably increase of sales).
Diversify Your Business
One of the most common concerns raised for small businesses is diversification. But what does this mean? Diversification is the idea that you can reduce risk by increasing the number of customers you have. Buyers typically look for a customer base in which no single customer accounts for more than 8-10% of total sales. They are concerned if you have a few customers that represent a large percentage of your sales, that one or more leaving for any reason will harm the business and its profitability.
It also means sourcing products from multiple vendors, so you are not overly reliant on prices or the supply chain one vendor provides. Diversification also means providing multiple lines of service to more customers, which reduces the risk and impact of losing any individual customer. It can also mean training multiple people to perform the same key tasks. Also, don’t forget to include yourself as the business owner in this cross training. The more work and client relations that only you perform, the higher risk you become to a buyer.
Business owners should attempt to diversify their products and business lines, suppliers, customers, and even their human capital. Reliance on a single product line is risky because that product could become obsolete. Reliance on a single supplier reduces the company's bargaining power, which could lead to higher prices. It can also threaten availability of supplies if the supplier went out of business. Possibly the greatest risk is being overly reliant on any individual customer. If the loss of any single customer could threaten the viability of your business, diversification should be your top priority.
Predictable Revenue Streams
Buyers don’t like surprises and prefer predictability since they tend to be risk adverse by nature. In particular they like predictable revenue streams and don’t want to find skeletons in the closet. It is also helpful to have recurring and sustainable products and services that are resistant to commodization. If buyers see a downward drift in profit margins even as revenue grows the past few years, it will raise a concern.
It is difficult to create any useful service or product that can’t be knocked off by competitors. This is especially true if you create a very profitable product or service, since your strongest competitors are keeping close watch on new developments in their niche. You need to develop strategies that enhance recurring revenue and mitigate commodification. This may require hiring a business consultant who specializes in your business niche to perform a review and provide ideas to maintain the profit margins on your products and services.
Get Your Records In Order
It is important to have clean books for the last few years, to provide buyers assurance they can trust the numbers. For most small business sales, reviewed or audited financials are unnecessary.
We recommend preparing and organizing key documents that are typically requested by potential buyers. These documents include: financial statements, tax returns, accounts receivable and payable aging reports, worker’s compensation claims, past or pending litigation, procedure manuals and employee handbooks, articles of incorporation and company bylaws among many others.
Beyond organizing and keeping records of necessary documents, we recommend cleaning up your financial statements. It is recommended to organize your financial statements for consistency and comparability across years as this is often what buyers want to review. If you make their task easier to review yearly financial statements and everything lines up, it shows a level of integrity that fosters confidence in a buyer’s mind.
Transition360 specializes in Exit Strategy that maximizes your value and compliments your CPA’s tax planning strategies. When we have the opportunity to partner with a business owner through one or two tax cycles before going to market, history has proven that we can sometimes help double the market value from the initial valuation. This is exemplified by a large Puget Sound based Traffic Safety Company where the owner first met with us over 3 years before selling. We performed a business valuation and pointed out the key business drivers to improve. The owner worked consistently over 2 tax cycles to improve these areas, resulting in a steady increase in sales, processes and efficiencies. The company was sold for double the initial valuation and the tax planning netted the owners an additional unexpected $300K. This is a good example of how an early start and working over a number of years can result in a big improvement.
You can review our newest business listing here, and take a look at how the financials improved year by year. This is a good example of how an early start and working over a number of years can results in a big improvement.
"In my view Transition360 is “IT” when it comes to helping companies understand their value and creating a plan to sell for the highest multiple possible. You will find their process a professional, well defined, action-oriented partnership that takes the burden off of the owner by shouldering almost all the work associated with a business sale." Eric Fry – Advantage Development Consulting