Prepare Business for Sale

How a Potential Buyer Will Value your Business!

Dominantly, most Buyers are buying a business based on the net cash flow of the business. The common industry term is E B I T D A.

In addition to E B I T D A, most buyers will include in net cash flow owners prerequisites such as Owner / Family Compensation, owner benefits such as extraordinarily rich life insurance, pensions plans, and other fringe benefits. Also, any personal use assets paid for by the business such as vehicles, apartments/condos, boats, airplanes, etc.

Once a net cash flow number is derived, most buyers will pay in a range of three (3) to five (5) times that number.

The Main Goal

The main goal of every business owner trying to sell their business is to increase E B I T D A. Every dollar ($1) increase will increase the value of the business by three (3) to five (5) dollars.

What about the Value of the Business Assets?

Assets of a business such as land, buildings, equipment, furniture, fixtures and inventory all support the value of the purchase price and may slightly increase the multiple offered on E B I T D A. However, buyers are buying Cash Flow!!! If the assets are not producing sufficient cash flow, then they only represent value in a liquidation or near liquidation scenario.

The Main Goal for the Assets of the Business

For every business owner planning to sell their business, the main goal pertaining to the assets should be to sell unproductive assets such as:

  • Machinery
  • Land, Buildings
  • “Dead” Inventory / Excess Inventory
  • “Dead” Raw Materials / Excess Raw Materials
  • Fleet Vehicles
  • Company Cars (All)
  • Recreational Vehicles, Boats, Airplanes, 4 x 4’s

These assets add no value to the business, so any money received from their sale are a direct benefit to the business owner.

What Else Can A Business Owner do to Increase the Value of Their Business

1) Poor Performing Units
Shut down or sell off poor performing, zero or negative cash flowing units, locations and product lines, etc. unless they are crucial to the operation of the business. Any money received here will be a direct benefit to the business owner as a buyer will view them as having little or no value.

2) Personnel
Eliminate any personnel that a new owner would terminate. Many business owners have strong personal relationships (or obligations) to long term employees. The new owners could care less. They will be looking for increased productivity / profitability. If these employees are to be terminated, the current business owner will likely treat these employees with more compassion and in a more financially equitable manner than the new owner who has no loyalty to them.

At this point, you should also seriously look at other personnel reductions.

3) Receivables
Sell off all receivables, in particular delinquent receivables that have been written off. In most cases, the receivables of a business stay with the current owner. Selling the receivables will make the balance sheet and income statements look much better.

4) Lawsuits
Settle all legal suits outstanding where possible. This includes both plaintiff and defendant suits. Outstanding suits project poor management at best and a lot of problems for the new owner at worst.

5) Margins
When buyers evaluate the cash flow value of a business, they pay particular attention to gross profit margins (gross profit divided by sales) and pretax net profit (or free cash flow) margins (net profit divided by sales). The higher the margins the greater the perceived value. A sophisticated buyer will almost always compare a company’s margins against industry standards. Margins are strong indicators of the pricing flexibility of the company.

The two best ways of improving margins are to raise prices and reduce operating expenses. A concentrated effort here will yield big benefits when selling the business.

6) Raise Prices
Where competitive conditions allow, raise prices 5% to 20% across the board or selectively. Many business owners become passive or conservative over time with their pricing. With a solid product and/or customer base, most modest price increases can be implemented with negligible impact. Virtually all of this revenue increase goes directly to the bottom line as net income.

7) Unproductive Marketing
Eliminate any unproductive marketing expenditures such as charitable giving and charitable advertising placements. As a business grows and prospers, most hometown American businessmen give back to the community through charitable giving and charitable advertising placements for church, school functions, etc. Large national companies buying a local business will immediately end these types of expenditures as will most new individual business owners – so you might as well do it. Drive up net income and the sales price for the business. Then give some of the sale proceeds to charity.

8) Clean Up / Clean Out
Physically clean up the appearance of the business. Things that sparkle and shine sell faster and for a higher price than things that do not – it’s just human nature. You don’t get a second chance to make a good first impression. Start with a thorough cleanup and “throw it out” campaign. If it is not going to be used, sell it or throw it away. Then give the physical location a thorough scrubbing: walls, windows, floors, cabinets, etc. Where practical paint, clean or replace carpet and upgrade landscaping. In particular, upgrade the office suite of the owner. Remember this will be the “home” away from home for the new owner or his executive.

9) Fringe Benefits
Reduce employee fringe benefits that are out of the “norm” with your industry. You can bet that a new owner will. If it is a corporate buyer, the existing and retained employees will be added to the corporate buyers existing fringe benefit plan. So make the cuts and reap the benefits.

10) Sales Trends
Take definitive action to reverse any stagnant or declining sales trends. Nothing will negatively impact the value of a business or kill a potential sale more than declining sales trends. Buyers are making a financial investment in a future stream of income. A declining stream is viewed very negatively.

11) Grow by Acquisition
Many business owners know of attractive acquisition opportunities, but pass on them because they are thinking of selling their business. If the company has the financial resources available, it may be in their best interest to pursue good acquisitions. Acquisitions can help in several ways.

        1. The most important is that the larger the company, the better visibility it has in the eyes of the bigger and better buyers.
        2. Acquisitions in a majority of the cases add value to a business greater than the cost of the acquisition. Acquisitions can bring increased market share, more diverse pool of customers, larger geographic trade area, economies of scale, key people or larger talent pool, wider range of products or services, intellectual property, etc. All of which can increase value in the eyes of the buyer.

12) Joint Venture Opportunities
Joint venture opportunities have long been used to increase market presence and corresponding sales growth; this is particularly true when the venture partner has high market visibility and presence. Joint ventures can also be used for product/service diversification or to reduce the costs associated with new product/service development. Buyers like quality joint ventures. They see lots of future value in being teamed with a quality venture partner. They also see management acuity in the market place and a sign of quality management that is appealing to the venture partner. Where practical, management should pursue any joint venture opportunity of quality. Even if not consummated, just having talks with a venture partner or being in a feasibility study stage or planning stage adds good value to the company.

13) Overtime
Eliminate or reduce as much as possible, overtime pay. Buyers view overtime (paying a premium for labor) as very poor management. Workers get used to the extra income that overtime produces. A tendency can develop for workers to create situations to continue that income. If this tendency to create overtime becomes entrenched, new owners quite often feel it will be very difficult if not impossible to correct. Damaged labor relations may result if new management has to implement corrective action.

14) Long Term Contracts
Lengthen and firm up all long term contracts with customers, critical suppliers, and labor unions. The last thing you want to happen in the middle of delicate negotiations on the sale of the business is a labor union strike, loss of a major customer or critical supplier.

15) Long Term Commitments
Conversely, avoid entering into any long term commitments not critical to the business operation. For example, building leases, purchase of expensive computer systems, fleet leases, purchasing high tech / high cost equipment. It is likely that a new buyer will want to do his own purchasing and negotiating when upgrading a computer system or creating leases.

16) Long Term / Short Term Debt
The business owner should review with his lenders if his debt structure can be assumed by a buyer. If so, this can be very valuable in negotiations and in structuring a purchase offer / agreement. With fluctuating interest rates, the business owner should do a review of all outstanding long and short term debt to determine if it can be refinanced under more favorable terms or if better alternatives of funding are available.

17) Processing Receivables / Payables
You should make a concentrated effort to speed up the processing of receivables and slow down the payment of payables while not incurring late charges or losing prompt payment discounts. This will definitely improve your income statement if you are on a “cash” accounting basis versus “accrual”.

18) Key Man
Protect the new buyer against the loss of a “Key Man” during the sales negotiations or after the sale where the Key Man will be instrumental in the transition to the new owner. Often, the existing business owner is required in the sales transaction agreement to perform certain duties for a specified period of time after the sale. This can be training the new owners, introductions to key business relationships, advice and guidance on running the business.

The best strategy is to develop a #2 Key Employee so that the owner is not critical to the survival of the business. A second, highly regarded strategy is the acquisition of an assignable “Key Man” life insurance policy. This policy could be payable to the buyer after the sale, used to payoff debt and improve liquidity prior to sale, or to payoff heirs so they will not hinder the sale.

19) Tax Returns
During the due diligence process, the prospective buyer and/or his agents (CPA’s, Business Advisors, Acquisition Team, Lawyers) are going to request the three (3) most current Federal Tax Returns. Usually they will want to see monthly or quarterly profit and loss statements (P & L’s ) from the last filed tax return to the present date. Nothing will send up “Red Flag” more than not having current tax returns. A substantial number of businesses consistently file for extensions on filing their taxes – usually for very good business reasons. In preparing a business for sale, it is imperative that all tax returns be filed promptly without extensions. Also, P & L statements should be prepared promptly and accurately no later than 30 days after the close of the period that they are being run for.

20) Get a Second Opinion on the Company’s Financials and Tax Liability
Most businessmen, when starting a business, use an individual practitioner or small accounting / CPA firm to keep their books and prepare their taxes. Usually they stay with that entity even as they grow large. Unfortunately, many of these firms are very conservative in their accounting and do not keep up with the latest and most advantageous tax law changes. The big boys, most likely to be the buyer, hire the biggest and the best accounting firms. Their own financial people also stay on top. In particular, on those changes that are industry specific to their industry. If in due diligence, they find a business doing poorly here, it is to their advantage and they won’t tell you. It is not unusual for a buyer in a stock sale to file an amended tax return to recoup past tax overpayments. On both asset and stock sales they will immediately implement any advantageous tax strategies to increase cash flow, that had the business captured prior to the sale, would have increased the value of the business. Business owners should strongly consider hiring a notable outside accounting firm to audit their financials and tax returns for their accuracy and appropriateness.

21) Licensing
Registrations, licenses, permits, patents, franchise agreements, distributorship agreements, corporate charter, etc. are items that a buyer will have a keen interest in. These items can be critical to the viability of a business. Some in particular, such as environmental permits, banking, insurance, gaming licenses can have very significant value. Be sure to check on a regular basis to see that all of these items are current with all associated fees paid. It can be quite embarrassing or even disastrous if a potential buyer finds that one of these items has lapsed – particularly if someone forgot to renew or pay the associated fees. A particular positive for a buyer would be that the seller has made inquiries and gotten all the necessary information, including costs on what it would take to transfer these items to the buyer.

22) Insurance
Having insurance coverage in place or having coverage at particularly good rates can be a distinct competitive advantage that will be highly valued by buyers. This is particularly true for some insurance coverages that are hard to obtain (or obtain at a reasonable cost). Check to make sure that all of the insurance coverages are current and that the policy limits are appropriate to current exposures. It is a big plus for the buyer when the seller has met with his insurance agent or company and has all the information on the transferability of insurance coverage: time frames, costs, limitations / exclusions, etc.

23) Corporate Business Plan / Marketing Plan / Sales Forecast
As mentioned previously, buyers of businesses are dominantly buying a future stream of net income. Of vital importance to them is the current owner and his management team’s perception of the future of the company. This is best presented in the format of a corporate business plan. The business plan should have as an integral part a marketing plan with a sales forecast showing sales predictions for at least the next three (3) years, preferably the next five (5) years. The marketing plan should also address management’s perception of the strengths and weaknesses of the company’s competition.

This document is particularly important because it will show a buyer, in particular a corporate buyer, the current owner and his management team’s grasp of the future outlook for the company and the industry. In addition, it will help the potential buyer accurately gauge the future of the company.

24) Development of a New Service / Product from Existing Capabilities
Having new service / product development projects in progress is viewed extremely positively by buyers. Its major contribution is that it shows a strong commitment and belief in the future of the company. Also, it is very indicative of management’s awareness of the direction and desires of the market place.

25) Financeability
Financeability is the ability of a potential buyer to acquire borrowed funds to facilitate a purchase. Funds can come from commercial lenders, private equity groups, mezzanine lenders, etc. The first and most critical decision factor in the eyes of the lenders is a strong past financial performance AS SHOWN ON THE COMPANY’S TAX RETURNS. The lenders are going to want to see 3 years of past tax returns along with the most current P&L (profit and loss) statement. The historical financial performance must show that the company has more than sufficient cash flow to meet debt service.

Some business owners are tempted to not declare all the company’s income on their tax returns to save on taxes. This not only hurts the financeability of the business, but it also hurts the value a buyer is willing to pay for a company. A seller is much better off to declare the income and pay the taxes.

The next most important consideration to lenders is the value of assets that can be pledged to secure a loan. Assets of high value to lenders would be real estate, account receivables, titled equipment such as cars, trucks, etc., high value machinery and equipment whose value can easily be established and which can be easily sold, and high value inventory, etc. Having a current, accurate value of these items, even if it means getting a current appraisal, is very valuable in both the eyes of the buyer and the lender.

26) Diverse Customer Base
If one or more of a company’s customers accounts for more than 5% of sales, this hurts the value of the company. The higher the percentage, the greater the loss in value. Where this situation exists, the company should put a strong emphasis in its marketing activities to generating new customers and diversifying its customer base.

In summary, the existing business owner planning to sell his business should be very aggressive in cutting costs to maximize net cash flow, while simultaneously improving revenue streams that will also maximize net cash flows and in general, improving the overall physical appearance of the business.

Business Brokers
of Louisiana