Don’t wait until you want to sell your business to find out you could have done more to make it more attractive to buyers.
Tim McDaniel, CPA/ABV, ASA, CBA, principal at Rea & Associates, says there are eight key factors that determine the salability of a company. Knowing how your business stacks up in these areas provides benefits even if you’re not thinking about selling.
“The more you make your business sellable, the more fun it is. Your business is sellable when it’s less reliant on you, there’s less risk, more cash flow and higher growth. You might work on all of those things and decide it’s so much fun you wouldn’t want to sell,” says McDaniel.
Smart Business spoke with McDaniel about salability factors and what buyers are looking for when considering an acquisition.
What are the key factors that determine whether a business is sellable?
There are eight main buyer considerations:
- Financial performance. The better and more consistent recent performance is, the more assurance it gives a buyer.
- Growth potential. Whereas financial performance is more about history, growth potential looks at the future. A future income stream with a lot of potential is very attractive. There are times when past performance might not have been great, but there appears to be a growth opportunity on the horizon.
- Switzerland structure. The business does not overly depend on any single customer, employee or supplier — they remain neutral if there is a loss in any of those areas. For example, one business owner had 80 percent of its business with one customer and went bankrupt when it lost that business. Things like that make the business less sellable.
- Valuation teeter-totter. Essentially, this is about having up-to-date equipment. If your equipment is old, you either have to invest in new equipment or a buyer will pay you less because they’ll have to buy new.
- Hierarchy of reoccurring revenue. Alarm systems sell for a premium because they have monthly reoccurring business, which lowers the risk. Reoccurring income is very important to buyers, and it’s particularly attractive if it’s under contract.
- Monopoly control. Future cash flow is important, and the higher the barriers to entry, the harder it is for a competitor to take away market share. Few people can start a business to compete with the iPhone. However, if you want to compete against a painter, you just have to hire people who are skilled at it and advertise.
- Customer satisfaction. High customer turnover will create ill will in the marketplace at some point and certainly makes a business more difficult to sell.
- Hub and spoke. This addresses how well the business can survive without you. Many small businesses are dependent on one person and will fall apart the day they leave. That makes the business less valuable and difficult to sell. A buyer might have some of the purchase price based on you staying, and have you sign an employment contract. That’s why it’s important to start building a good management team and relying on other people.
How can a business improve its salability?
Not all businesses excel in each of the eight areas above. However, an owner needs to work toward improving those areas where it is weak in order to make the company more sellable. Start by identifying what drivers need attention, and then develop specific action plans to positively impact them. You will watch the value of your business increase dramatically. It’s not something you want to start working on two weeks before you sell. It’s a process that takes time and focus.
Often, business owners are too busy running day-to-day operations to sit back and consider their business’ value. Yet, there is benefit in looking at the business through the eyes of someone who might be interested in buying it.
Tim McDaniel, CPA/ABV, ASA, CBA, is a Principal at Rea & Associates. Reach him at (614) 923-6532 or firstname.lastname@example.org.
Determine your business’ sellability score at www.reacpa.com/my-sellability-score.
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Identifying the intrinsic value of your company is an extraordinarily beneficial exercise, especially when business owners are looking to maximize the sale of their company, says Joshua Geffon, a shareholder at Stradling Yocca Carlson & Rauth.
“The crown jewel of an enterprise may be intellectual property (IP), the management team, key customers or brand recognition, and/or any combination of these ingredients. The key for an entrepreneur is to recognize, exploit and promote these attributes to gain maximum value for the enterprise during the acquisition process,” Geffon says.
Smart Business spoke with Geffon about what business owners should know before engaging in the acquisition process.
What are some mistakes owners make that jeopardize the sale of their companies?
A fairly common mistake is not doing enough to secure the company’s IP. Confidentiality and IP assignment agreements, patent filings and related IP protection should be in place to have clear and strong IP ownership and title.
Broad indemnification by the seller on contracts creates risk that buyers of companies don’t like. Material contracts that allow customers, suppliers, service providers or other partners to easily terminate can significantly undermine a seller’s value proposition.
Also, tax and planning is critical. Overlooking tax-related filings often leads to significant turmoil and financial hardship. Inversely, proactive corporate and personal tax planning for founders and executives also can create real economic benefits.
What’s important to have in order before initiating the acquisition process?
Be sure you are prepared to provide copies of well-organized and complete corporate, capitalization and financial records, as well as material contracts, as part of a due diligence review by the buyer. Being well organized on these matters ahead of time will buy a lot of credibility with the buyer. Messy or inaccurate records will cast doubt on the value of your company.
What legal pitfalls often trip up the sale?
Buyers are always concerned about risk. Risk comes from inside your company in the form of personnel — employees, consultants and others — and outside from lawsuits, warranty and return claims, supplier terminations and limits on business operations.
Employees are often the company’s greatest asset and typically a company’s largest expense. Sellers usually engage in pre-emptive measures to entice employees to stay by offering equity, cash and other incentives that require personnel to work as diligently for the buyer as they did prior to the transaction.
Your company’s value proposition may be significantly weakened, and deals have died, if buyers identify agreements that limit rights to develop, manufacture, assemble, distribute, market or sell products.
How do you determine a realistic price?
Depending on the stage of your business and the industry, there are a few methodologies available. The most common are discounted cash flows and price to sales, but this relies upon a history of revenues and costs and/or sales. Early stage companies have a harder time utilizing these valuation methods.
When traditional valuation models are inapplicable, recent transactions in the sector or the valuation of similar public companies can be used. Gauging your value proposition with board members, advisers and strategic partners can help you solidify an approximate value.
Remember that buyers are valuing your business on your financial statements, projections, business plan and opportunities in your industry, along with synergistic opportunities with the buyer.
Who should help a business owner in a sale?
Secure competent, experienced service providers. These people will help you get a better sense of the market, your company’s value and your risk exposures. Get them involved well before the sale to ensure the process runs as efficiently as possible.
A good merger and acquisitions attorney will lead you through the process, identify and mitigate risks, and explore potential resolutions to issues ahead of the transaction. An independent accountant who can review and audit your financial statements also may be needed.
Joshua Geffon is a shareholder at Stradling Yocca Carlson & Rauth. Reach him at (424) 214-7000 or email@example.com.
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Selling a business is challenging. From vetting potential buyers to preparing financial statements to keeping negotiations on track — all while running your company — there’s a lot that can go wrong. In fact, almost no detail is too big or too small to affect the eventual outcome of merger and acquisition (M&A) deals. However, you can reduce the odds of a mistake by knowing where similar transactions have gone astray.
“It’s important to talk to owners who have successfully completed sale transactions and to work with experienced M&A advisers,” says Brian Reed, partner in Transaction Advisory Services at Weaver.
Smart Business spoke with Reed about common M&A mistakes and key items to resolve before closing a deal.
How might sellers hurt their chances before putting their business on the market?
You risk a letdown when you make overly optimistic future earnings projections or put too much weight on variable measurements, such as the sale prices of similar companies in stronger M&A markets. If you won’t budge from an unrealistic sale price, you could drive away an appealing buyer.
Work with a professional adviser to assess your company’s value as well as estimate an offering price the market can support. The two may not match because the price depends on contemporary economic, M&A market and sector conditions.
Where does timing factor into this?
Other critical seller mistakes revolve around timing, whether internal or external. For example, selling at the wrong time, at the end of a market cycle, could mean fewer buyers and possibly lower offers. If your sector has experienced a recent wave of M&A deals, the buyer base could be depleted, and you may want to hold off.
Sometimes sales are spurred by internal circumstances, such as the retirement of a founding owner, but these situations shouldn’t rush the sale. If your company is not ready for the market, consider appointing an interim head to make preparations and screen potential buyers.
Sellers, particularly those selling for the first time, often greatly underestimate the amount of work and hours it takes to prepare for sale. Have you allocated enough time to implement strategies to maximize your sale’s value? Is your company ready to promptly and accurately respond to hundreds of specific buyer requests? If you haven’t assembled a team with the time and resources to handle these requests, it could bring your potential deal to a standstill and deter otherwise interested buyers.
How might housekeeping impact deals?
Housekeeping issues aren’t trivial. They include essential tasks such as ensuring that contracts and legal obligations are in order. Some items that can trip companies up are:
• Poor accounting. If your financial statements and records are not properly organized and presented, it reflects poorly on your management, and the due diligence process will likely take longer. Sloppy accounting errors could mean tax or legal issues after the deal closes.
• Neglecting key players. Buyers want to know that key employees will stay onboard once the sale is completed. Make sure your top performers are offered financial and other incentives to stay.
• Locking in contracts. Don’t renew an expensive vendor contract as you’re about to transfer ownership. Buyers don’t like long-term contracts they didn’t negotiate, particularly if they’ll be penalized for breaking them. Negotiate short-term contracts or push for favorable terms.
What are some common loose ends to watch for and resolve?
Leaving loose ends hanging won’t endear you to your buyer, as they could hinder integration and future profitability. Some common unresolved internal issues involve:
• Minority interests. Buying out minority investors or shareholders before a sale means the buyer won’t need to deal with their demands later.
• Employee controversies. An integration team doesn’t want to deal with open legal issues, for example, while trying to build a new culture.
• Copyright confusion. Make sure all patents, copyrights, trademarks and other intellectual property holdings are in order. If you’ve failed to verify and document ownership, you may risk the deal’s value.
Brian Reed is a partner in Transaction Advisory Services at Weaver. Reach him at (972) 448-6936 or firstname.lastname@example.org.
Blog: To stay current on audit, tax and advisory issues that may impact your business, visit Weaver’s blog.
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Many of us have heard the saying, “By failing to prepare, you are preparing to fail.” While most business owners meticulously plan the ongoing management of their organization, far fewer prepare for a successful sale. If the sale of the company is a part of your exit plan, it quite literally pays to be prepared.
With merger and acquisition activity heating up, Smart Business sat down with Kevin Strain, Audit Partner at Sensiba San Filippo LLP to discuss what specifically businesses can do to ensure they are ready.
Why is it critical that businesses be prepared for an acquisition?
The current climate for acquisitions makes it more likely than ever that you’ll find yourself talking to a potential buyer. Acquisition activity has been ramping up since 2010, and is only expected to increase. Low interest rates and resurgent equity markets have left corporations flush with cash, and looking for opportunities.
Yet even in the current environment, the majority of deals still fail. More than 85 percent of prospective deals are never completed. Suitors come calling, but the process breaks down prior to execution, often because sellers are unprepared.
What is the first step a company should take to prepare?
It is critical to identify and document the areas that drive organizational value. Every organization is different, and what makes you an attractive candidate for an acquisition depends on the nature of your business. Some acquisitions are technology buys, driven by intellectual property. Others are organizational or revenue buys, driven by the desire to add personnel or future earnings.
Regardless of what drives the marketability of your company, it is important to recognize the value drivers and document them. For example, if you hold technology patents, it’s essential that these are defended and documented.
What financial preparations should be made?
A detailed examination of financial records and projections should be expected during the negotiation process. If you haven’t had an audit completed recently, that should be the first step. If you have been through an audit, you need to be ready to provide the same information on relatively short notice. Make sure to keep the information that your auditors ask for current.
The focus of the financial review may also be driven by the type of acquisition. If a suitor is seeking to buy a future revenue stream, you need to be sure your projections are tight and defensible.
What pitfalls can derail the sale of a business?
Areas of potential risk can provide bargaining power to a buyer or stop the process in its tracks. Whether it’s an uncertain tax position, legal exposure or patent dispute, exposure can damage or kill a deal. Ideally, you’d like to resolve these issues. But if that’s not possible, put them on the table as soon as possible. It’s best for buyers to know where you stand sooner rather than later so the investment in the process is not wasted.
What else should business owners keep in mind?
Understand your own expectations and limits. You don’t want to be deciding where you are willing to bend during negotiations. That will weaken your ability to negotiate the best deal. Are you comfortable with an earn-out? How much guaranteed cash do you need? Are you willing to indemnify the buyer against any contingent liabilities?
Finally, it’s wise to find an experienced adviser to help you navigate through the process. The majority of business owners only sell a business once, so it’s important to get it right the first time.
Kevin Strain is an audit partner at Sensiba San Filippo LLP. Reach him at (650) 358-9000 or email@example.com.
Blog: Visit www.ssfllp.com/blog for more insights on merger and acquisition best practices.
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There are a number of reasons why you might want to sell or transfer your business. Some serial entrepreneurs find they like to start businesses but don’t really like to run them. Others have been around for a long time and are just getting tired or too old to stay in their role.
Some owners may have maximized the value of their company. Perhaps your personal balance sheet needs more diversification because 95 percent of your value comes from the business, so you bring in partners or sell a portion to employees, giving yourself more options and downside protection.
Whatever the reason, Norman M. Boone, founder and president of Mosaic Financial Partners Inc., says there are a number of questions to answer if you’re a business owner moving through the transition process.
“It’s really important to focus on your personal needs, both financially and emotionally,” he says.
Smart Business spoke with Boone about asking the right questions prior to a sale and how to deal with the financial and emotional issues.
What are some key factors business owners need to understand about selling or transitioning from a business?
There are six key things that they have to be thinking about and understand:
• What’s the business worth?
• Do you have a plan of who is going to come in and operate the business successfully when you are gone?
• Have you been too busy running the company to consider personal issues like your own estate plan, will and insurance?
• What do you want in terms of lifestyle? Do you want to keep running this business until you drop dead, or do you want to sell it and go onto the next business? What are your criteria and where do those triggers happen? Do you want to be working full time or part time? Do you need control of the business or not?
• If your personal finances are completely reliant on the business, what’s your extra exposure of not having diversification? If something were to happen to the business, would you and your family be OK going forward?
• What are some tax issues you could face with a sale or transition?
Why is it so important to ‘know your number’?
One of the key issues when it comes to selling a business is that people don’t know how much money they need to be able to live their life comfortably and successfully for as long as they and their spouse might live, factoring things in like medical care and Social Security. For example, if somebody spends $100,000 a year, maybe they need $2.5 million in assets to support that. If your lifestyle is more expensive, then you need more dollars, and knowing what that number is, whether it’s $2.5 million, $5 million or $15 million, is pretty important before you start to negotiate a sale.
If you sold your business for $6 million and after taxes you’re left with $4 million, you’re going to be frustrated if that’s not enough to support your lifestyle for as long as you might live. You may not be able to continue living as comfortably as you were before.
Is there a disconnect between what people need to live on and what their company will actually sell for?
As a general rule, people overestimate what a company could sell for, particularly on an after-tax basis, and underestimate how much capital they need to support their current expenses. That combination means that often people are really frustrated. They might get right to the edge of the deal, and suddenly realize, ‘Oh gee, I can’t do it on this. I need 2 million extra dollars to sell the business.’ You see deals fall through reasonably frequently because of that.
Once you know your number, you can do things to make the company more valuable. Get your accounting in good order. Minimize expenses in order to raise profitability. Grow the business in terms of sales. Have a brand that is as well known as possible. In addition, the less dependent the business is on you as an individual, the more it’s worth to somebody else, because if you’re critical and are replaced, then it’s very possible that operation could fall apart. Therefore, build in systems, processes and procedures to bring along key employees so they can continue to manage the business without skipping a heartbeat.
Why is it important to focus on what comes before selling?
If you’ve been running a business for 25 years and you’re being asked to let go, it’s not easy. You get emotionally attached to it and, as important, your identity is tied up in being the owner of that business. If you sell the business, what is your identity? What are you getting up for in the morning? This issue comes up all of the time. It’s one of the reasons why people don’t have a succession plan and why they don’t sell when they need to.
Owners need to try to think about what other things they want their life to involve, and then prepare and practice doing that before the sale. It could be getting involved in nonprofit organizations or sitting on the board of a couple of your friends’ companies. Business owners should retire to something, rather than from something. In the ideal world, the person who is selling the business is inevitably sad, but ideally, they are excited about what it is that they are going to do once they have more free time.
Norman M. Boone is founder and president of Mosaic Financial Partners Inc., which is celebrating, this year, its 25th anniversary. Reach him at (415) 788-1952 or firstname.lastname@example.org.
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