Business Brokerage Blog
Selling and buying businesses can be a hard decision, so take a look at some of these informative blogs that might help you make the right decision. When you are ready to buy or sell, give the professionals at Astra a call to get started!
7 Questions Business Owners Ask Me and the Answers I Give Them
- How much is my business worth?
The correct answer is the price a Buyer offers you that you are willing to accept. It makes no difference whether you are making money or losing money. It makes no difference whether sales are increasing, declining or flat.
It makes no difference how much blood, sweat and tears you have put into your business. It makes no difference how much money you have invested in the business. It makes no difference how much money you owe to the bank or to yourself.
It makes no difference what a business valuation or appraisal says. It makes no difference what your hard assets are. It makes no difference what your customer list or client list contains. It makes no difference what your patents or service marks cost you. It makes no difference whether you are a Franchiser, Franchisee, Licensor, Licensee, Distributor or Independent Contractor. The bottom line is that what you finally accept is what your business is worth.
2. How long will it take to sell my business?
The correct answer is no one knows for sure. But I tell my clients that the average time is seven months from listing to closing. For companies that sell for $1 million or more, the average is nine to twelve months. But I also explain that the quickest I ever sold a business was one week, and the longest it ever took me to sell a business was six years. Additionally, I explain that price and terms sell a business. The lower the price the more affordable the business will be. The lower the down payment, the more people will be able to consider it. The greater the amount of owner financing, the easier the business will be to sell.
3. Is there anything I can do to make my business more desirable?
The answer is yes. The most important thing you can do is to put your ego aside and not make the business dependent upon you. Ideally, the goodwill of the business should be at the lowest level that interfaces with customers or clients. This means that you want to hire and keep employees that make your customers happy with high quality work and excellent customer service.
4. Is there anything I should not due during the listing period?
The answer is that you should not slack off in any way. You need to stay focused and operate your business as if it will never sell. You need to work as hard or harder no matter how burned out you feel. Do not make any major changes during the listing period. Try to retain all good and excellent employees and remove those that are not contributing as they should. Try to keep your inventory fresh and eliminate any obsolete items. Keep your equipment and machinery well maintained and properly functioning.
5. What is due diligence?
It is the process where the Buyer examines all your books and records, gets approved by the Landlord, gets approved (if applicable) by the Franchiser, Licenser, Distributor, bank, etc. Your books and records need to be current and “bullet proof.” Your tax returns for payroll taxes, sales tax, state income tax, federal income tax, county income tax, city income tax and any other municipality taxes are 100% current. Your various licenses need to be current whether or not the buyer will have to apply for their own. You want to fully disclose everything and not leave any skeletons in the closet.
6. What else do you suggest I do to impress a Buyer?
Have a job description for each employee. Put together a Policies and Procedures Manual. This will make the corporate buyer feel more comfortable about taking over the reins. Make sure all your employee reviews are current. The last thing a new owner wants to do is to sit down in a vacuum with an employee who is expecting a raise. Make sure you clean everything that is dirty. Make sure you fix anything that is broken. You do not want the Buyer to wonder what else might be a potential problem. Prepare a business plan and/or marketing plan to show the Buyer how he or she can grow the business. Put together a transition plan that shows the Buyer how you will assist them daily for a period of 28 days. The Buyer may not want you for the full transition period, but at least you are showing that you have thought it through and are willing to make yourself available.
7. What happens if I agree to do some owner financing and the Buyer misses a payment?
The way the closing attorney prepares the paperwork, if a Buyer misses a rent payment or a note payment, it is considered an event of default under the note. This will allow you to take back the business in a worst-case scenario or enter into serious discussions to protect your financial interests. While the best outcome is a Seller getting paid all their money and a Buyer being successful, you must plan for the worst and hope for the best. But I also tell my clients that they should never sell their business to a person they feel will not treat their employees, customers, clients or vendors properly. If you ever get a knot in your stomach during the negotiation that is the time to throw in the towel and let me gently explain to the Buyer that you do not feel it is a good fit.
Alternate Programs to Create and Maximize Your Retirement Income - Tax Free
Astra, with their associates, have developed exit strategies using major banks and insurance companies to transfer ownership of your company in a manner similar to a department store ‘lay-a-way’ plan. There are two programs to choose from – MiniMax and SuperMax.
These programs offer a customized succession plans, which enable business owners to hand the reins of their business to a new generation or investor, while securing a TAX FREE retirement income stream, reducing risk, eliminating volatility and creating an estate legacy.
This is a strategy that has a stated time frame to transition the operation, and eventually, the ownership of the business. This succession plan maximizes the net cash flows for the remaining lives of the owner and spouse and if possible, creates a legacy for the surviving family members or investors.
Whereas you are looking to obtain a sale price of up to 4 to 5 times multiple, buyers have been reluctant to provide you with an acceptable purchase price with terms satisfactory to you. These alternate programs will provide you with an acceptable exit strategy with a financial benefit of many times over what you had originally wanted and while you are young enough to enjoy your retirement income.
I trust this is of interest. If so please advise and we will introduce you to our associate and start the process with a conference call where an in-depth detailed discussion will reveal how this program works.
Looking forward to working with you.
Time Bomb Tax Announcement With Major Implications (July 18, 2017 ) By Jonathan Funk, 23 Aug, 2017
Finance Minister Announces Major Tax Changes For Business Owners
On July 18th 2017, The Federal Government announced major tax changes on business owners – triple taxation.
Previously you would have received much more on the sale of the share or assets of your company.
The new legislation taxes could be as high as 75%.
Astra has a proven program that will mitigate this new onerous tax legislation. We would like to have the opportunity to show you how we can do that. To avoid “triple taxation” you must plan your exit strategy through a proven program. Our SuperMax and MiniMax programs will abate these new punishing tax changes. Our financial consultant will review your situation and demonstrate how Astra’s Super or Mini Max programs will work for you to save you many, many thousands. Please contact us at info@abc-astra.com or bhughes@abc-astra.com.
SUMMARY
This note is a summary and clarification of the 27 page announcement by the Minister of Finance on July 18 which has major implications for private business owners in Canada. Please take the time to review this note and give yourself time for reflection. We suggest you read this more than once.
The tax consequences of the NEW Rules could cost you millions of dollars without putting smart tax planning in place.
Scenario A – Under the old rules, you could sell your company’s shares and after it paid the capital gains taxes due, the net cash proceeds could be put into your hands personally with no additional tax to pay on the transaction. Not anymore.
The proposed new rules should not impact your company ‘s ability to pay capital dividends (net after tax proceeds from the sale) to you as a shareholder unless the buyer and the seller are not dealing at arm’s length (for example, between family members). With a non arm’s length transaction, the net proceeds are taxed again in your hands as an ineligible dividend at an effective tax rate of between 42 to 57% depending on your province of residence.
Scenario B – Under the old rules, you could sell your company’s assets and after it paid the capital gains taxes due (if any), the net cash proceeds could sent to your Holdco as an after tax intercorporate dividend with no additional tax to pay on the transaction. This would have allowed yo to redeploy cash for other investments. Not any more.
The proposed new NEW Rules will disallow the inter-corporate dividend as a tax free transfer to your holdco and instead tax it as an ineligible dividend at highest possible tax rates.
Scenario C – Old rules: Shareholder dies, creating a deemed disposition of shares. No tax paid liquidity is in hands of estate to pay tax. Estate uses a capital loss maneuver in combination with “stop-loss” rules and acceptance of a promissory note from a corporation to mitigate the amount of actual tax due as a result of deemed disposition of shares when the shareholder dies.
The proposed new NEW Rules will disallow the estate from transferring shares with a high-cost base to a parent company in exchange for a tax-free promissory note.
NEW Rules: Shareholder dies, creating a deemed disposition (CRA considers shares and other personal property to be disposed/sold) of shares. No tax paid liquidity (ready cash (on hand) is in hands of estate to pay tax. Estate raises cash to pay this tax by selling corporate assets with attending cap gains tax “A”. Net proceeds are paid off of the balance sheet to pay the cap gains tax on the deemed disposition caused by shareholder’s death. This is Tax “B”. However, since it all came off the balance sheet, CRA wants additional tax as they regard this as a non-eligible dividend or Tax “C”. This is “triple taxation”. A+B+C=CRA The total tax bill could be as much as 75%!!!
Scenario D- Old and New rules are the same: Shareholder dies, creating a deemed disposition of shares. No tax paid liquidity is in hands of estate to pay tax. However, life insurance proceeds come into and out of the corporation tax free by way of capital dividend account (CDA. Sec. 89) to pay required taxes. Estate now transfers shares to whomever it is directed by the Will of the deceased shareholder. No corp assets were sold, no taxable cash came off the balance sheet’s current assets yet the cap gains tax were paid. The new shareholder’s capital is still on the balance sheet but it is now tax paid or paid-up capital (PUC). Dividend income paid at say 8-10% of the tax paid PUC are within CRA’s “safe income” rules but taxed at the attending marginal rate.
Here are the main reasons tax practitioner’s advocate the use of life insurance in corporate-estate situations: A) it’s a lot cheaper than paying ANY amount of tax and B) it is already pre-approved by CRA and does not cause any tax burdens.
In summary: either from action or inaction when large blocks of capital are moved into the hands of a shareholder or an estate, the transactions are on CRA’s maximum tax radar. On the other hand if dividend income on capital is employed as a source of income, the tax rates are far less than taxes on salary or high amounts of capital treated as ineligible dividends.
In Brief, CRA does not want you to take capital off a balance sheet, but keep it employed ON the balance sheet, and CRA is satisfied.
Therefore smart planning will open doors for tax efficient succession planning for your family and provides options to negate asset sales triggering double or even triple taxation.
And, smart planning utilizes the Income Tax Act’s rules to get your hard earned capital into shareholders hands while you’re alive either tax free or with a lot less tax paid during your lifetime and after death.
Bottom Line: Smart Planning will get you:
a strong balance sheet
a company that will not be hurt or destroyed because of tax
happy shareholders
a happy estate
satisfied CRA
Everybody wins!Smart planning starts with us. Contact us now.
TIME IS NOT YOUR FRIEND – WE HAVE WAYS TO HELP
The Valuation of Non-Compete Agreements
A non-compete agreement is a covenant to the purchase and sale agreement that restricts the seller of a business from competing with that business in the future. Such covenants usually last for a specified period of time and may apply to a specific geographic area (generally the area currently being served by the subject company).
Non-compete agreements provide buyers with a measure of comfort in that the expected stream of earnings from the business being acquired will not be disrupted by competition from the former owner. The seller benefits because the buyer has confidence that the anticipated earnings will materialize and therefore the seller can maximize the purchase price.
In some cases, they receive an annual payment for a specified number of years. In others, the amount the seller receives is included as part of the total purchase price. In either case, the seller is granting a promise to the buyer that may have considerable value in terms of preserving the future earnings potential of the acquired business. Thus, a non-compete agreement represents an important (though intangible) asset for the buyer, quite apart from the operating assets.
Why put a value on non-compete agreements?
If the consideration paid to the seller for entering into a non-compete agreement is included as part of the total purchase price paid for the acquisition, there are three good reasons to assign a separate value to it.
Accounting Standards and Reporting Requirements
If the purchaser is a corporation, generally accepted accounting principles (GAAP) require the parent company’s financial statements to be consolidated with those of its subsidiary. Depending on the jurisdiction, these accounting rules have specific standards that require a purchaser to allocate the total purchase price paid in a business combination to the fair market value of all the tangible and identifiable intangible assets acquired (which would include the non-compete agreement). This provides stakeholders with more information on the true nature and cost of the acquisition.
Compliance with Income Tax Rules
Proposed changes to the Income Tax Act mean that any amount the seller receives for granting a restrictive covenant will be treated as ordinary income for income tax purposes. The buyer will generally treat the expense as the seller treats the income; in this case, it would be a deductible business expense. There are some exceptions to this general income inclusion rule. One exception is where the grantor and grantee jointly elect, in prescribed form with their tax return for the year, that the amount is an eligible capital expenditure to the buyer and an eligible capital amount to the grantor. Therefore, it is necessary for the parties to determine the value of the non-compete to ensure there are no unintended tax consequences.
Possible Future Damage Claim
In the event the seller breaches the covenant not to compete, the purchaser may have a claim for economic damages. The fact that a valuation was prepared at the time of the transaction demonstrates that the parties contemplated that real damages would arise if the seller was allowed to compete. This helps support the purchaser’s legal claim against the seller.
How should a non-compete agreement be valued?
There are two generally accepted approaches used to determine the value of a non-compete agreement:
Differential Valuation Approach
The differential approach involves valuing the business under two different scenarios. The first valuation assumes the non-compete agreement is in place and the second valuation assumes that it is not. The difference in the value of the business under each approach is attributed to the non-compete agreement. Because the differential approach involves a rigorous business valuation analysis under two scenarios, it allows for more flexibility in determining the net impact on future cash flows arising from potential competition from the seller. The downside is that this approach is more complex and time consuming.
Direct Valuation of Economic Damages Approach
The direct approach involves determining the present value of the potential future economic damages that would occur as a direct result of not implementing a non-compete agreement. The direct approach is somewhat simpler since it involves estimating the direct damages from competition, usually in the form of a percentage of income lost. This method is more widely used because of the need for only one estimate of future operating results, which makes the analysis less time consuming. Both methods, if properly applied, should arrive at a similar conclusion of value.
A Framework for Using the Direct Damages Approach
When using the direct damages approach, the first step involves a risk analysis to determine the maximum potential damages that could arise if the seller competes with the acquired business.
The second step is to determine the “expected value” of the losses based on a probability assessment that considers the likelihood that the seller would compete with the acquired business.
The third step involves determining the present value of the economic damages avoided over the term of the non-compete agreement.
Step 1: Estimate annual economic losses, assuming competition from the seller.
This step involves the following stages:
1. Estimate future earnings or cash flow, assuming a non-compete agreement is in place. This will generally incorporate the same set of assumptions that a hypothetical market participant would use in estimating future operating results for the purpose of pricing the acquisition.
2. Quantify the potential damages (in the form of reduced earnings or cash flow) if the vendor(s) were free to compete with the business post sale.
This generally involves a two-step process:
1. Perform a risk assessment that considers the key factors that could negatively influence the business projections determined in Stage 1. Depending on the nature of the business, the following questions should be asked:
Does the former owner have significant personal contact with customers?
If so, are these customers loyal to the former owner? How many customers could the former owner take to a new business and what is the profit related to these accounts?
Are the other employees loyal to this person and do those employees have strong relationships with customers?
Does the former owner have access to trade secrets that are critical to the company’s success?
Depending on the circumstances, financial damages may take the form of one or more of the following:
Lost sales to existing customers recruited by the former owner
Lost sales to new customers through the use of trade secrets taken by the former owner to provide a similar product or service
Lower gross profit margins due to reducing selling prices to compete with the former owner
Higher marketing expenses incurred in an attempt to mitigate damages (i.e., recoup the lost sales)
2. Based on the above risk analysis, estimate the percentage of projected earnings or cash flow that would be lost due to seller competition. We have seen estimates ranging from 10% to 50%, depending on the nature of the business and the industry in which it operates.
3. Apply this percentage to the annual projected cash flow determined in Stage 1. This represents your estimate of how much of the future earnings the former owner could take from the company if he or she decided to compete after the sale.
Step 2: Adjust the losses determined in Step 1 based on the probability that the seller would compete in the absence of a non-compete agreement.
This step involves performing a probability assessment to determine the likelihood that the former owner would compete in the absence of agreeing not to. It is likely to be the most difficult and subjective part of the analysis. Some of the factors that affect the probability of the former owner competing include:
The age of the former owner. Is the individual near retirement age or is she too young to retire and physically able to compete?
The former owner’s employment status. Has he entered into a management contract to stay on with the existing business? If so, this reduces the likelihood of competing with the purchased business, particularly if a significant part of the purchase price is held back and paid out over time, or is contingent upon business performance. Does the individual have other skills in a different industry in which he could find work that is unrelated to the purchased company’s industry?
The former owner’s financial resources. Is the individual wealthy or does she need to work?
Competitive entry barriers. Are there significant barriers to entry in this industry? If the business is capital intensive, does the individual have access to sufficient capital resources? If not, is it likely that the individual would be hired by a competitor?
The former owner’s track record. Has the seller sold a business in the past and subsequently started up a similar competing business?
The strength of legal agreements. Is the protection term and market area defined in the non-compete agreement reasonable and enforceable in a court of law? Are there other pre-existing legal obligations in place to help prevent the seller from competing?
Based on the above factors, estimate the probability that the former owner would compete with the purchased business if there were no restrictive covenants. The estimated probability factor is then applied to the losses calculated in Step 1(c) to determine the “expected value” of the losses.
Step 3: Determine the present value of the expected annual losses.
This step involves determining an appropriate discount rate with which to calculate the present value of the expected losses. Consider using, as a starting point, the weighted average cost of the capital (WACC) used to finance the acquisition. Generally speaking, the cash flows associated with intangible assets have greater risk than those associated with tangible assets. This additional risk would generally support a higher rate of return to compensate the investor. However, since much of the risk in the cash flows was already removed through the probability adjustment (in Step 2), a significant risk premium (applied to the WACC) would likely not be appropriate.
Once a discount rate is determined, apply the appropriate present value factors to the expected losses (determined in Step 2) to quantify the value of the non-compete agreement. For accounting purposes, the value of this intangible asset would be amortized over the term of the agreement.
A simplified example of the valuation analysis described above is provided in the following table:
Note 1: Based on a market participant’s
estimate of the post-acquisition operating results expected at the date of
acquisition (assuming the seller does not compete with the purchased business)
Note 2: Based on an assessment of the risk factors described above
(typically between 10% and 50%)
Note 3: Based on a probability assessment described above (between 0% and
100%)
Note 4: Represents the estimated annual economic loss likely to occur if a
non-compete agreement was not in place
Note 5: Discount factor is based the company’s weighted average cost of
capital (in this case 15%). Formula = 1 / (1+i)(n)
Note 6: The NPV of expected damages represents the estimated fair value of
the non-compete agreement. A tax amortization benefit would normally be added
to this amount to reflect the present value of the tax shield. The amount of
the tax shield would depend on how the parties elect to treat transaction value
for tax purposes.
7 Pitfalls to Avoid Between LOI and Deal Close
When selling your business, reaching the letter of intent (LOI) stage is a great indicator of success. But, the process is far from over. There are many steps that still lay ahead that can derail or ruin the transaction. Below are 7 pitfalls to be aware of between the LOI and the closing of the transaction:
1. First, get the
letter of intent done well, and read all the legal details.
The first step to
moving from letter of intent to closing is to make sure that everyone
understands all elements of the letter of intent, and that the letter of intent
has a reasonable amount of detail. Misunderstandings and miscommunications
will blow-up a deal very quickly if the parties have different interpretations
of the terms.
In the midst of
negotiation, it may be tempting to leave a detail for later, or hope the other
party didn’t notice some important detail, or leave an open item to later.
There is no one way to do things, but if you truly want the deal to
happen, I have had much more success taking the extra time to explain a term or
go over something again to make sure that everyone is on the same page. The
LOI sets the pace for the rest of the process, so it is important to do it
well.
2. Keep the
business on budget and performing well.
Ensuring that the
business remains on track is critical during the process from LOI to closing.
Although it may take a great deal of focus to close the deal, keeping the
business running according to plan is necessary for the transaction. This is the
most important, of many things, to balance during the closing process. Among
private equity buyers, you will hear wisdom shared from investor to investor
with things such as, “95% of all bad deals were off budget during the closing
process.” The buyer will be watching every twitch of the business with extreme
scrutiny. To a buyer, there is nothing more comforting than seeing the
financial results comes in as expected. Even better for everyone is
having the financial results come in ahead of budget. Yes, this is true
even when you are the seller wondering if you could have gotten more for your
business because it makes the buyer want to close the transaction even more and
maybe some small horse trade will go your way in the end (and, there is always
one more horse trade).
When the
financial results are not on target, it forces the buyer to spend time and
energy trying to figure out if the miss is a short-term blip or something more
fundamental. Better to avoid having the buyer to think twice about
anything.
Most deals require
the seller to operate the business as usual during the closing process.
This should be obvious and intuitive to all involved. However, I
have seen sellers try to be clever and change some aspect of the business
during the last months or weeks to try and tweak the deal to be more favorable
to them. This never works. First, it is counter to the spirit of
the deal to keep operating the business as normal, and it’s very difficult to
change any reasonable size organization from their normal operations without
creating problems, both intended and unintended. Furthermore, it is in
the seller’s interest to keep the business operating normally just in case the
transaction does not close. It is a fact
of life that not all deals close after a signed letter of intent. The
seller needs to be aware of this and not make any adjustments that they would
not make if they were not selling the business. In particular, do not
change a strategy to fit the buyer until after the close.
3. If something
bad happens, inform the buyer immediately.
Business results
are rarely perfect and on budget. If something happens, the best policy
is to be up-front and inform the buyer immediately, just as you would want to
be informed if your roles were reversed. If done well, this can increase
the buyer’s confidence in the seller and the business. If done poorly, it can
torpedo the transaction in a heart beat. In one recent situation where I
was not directly involved, the seller lost several clients in late November
that was going to reduce their revenue by >20% (probably only for a few
months, but it wasn’t totally clear). The seller did not tell the buyer until
the December and January financial statements were ready, and it cratered the
deal. They may have had a chance to save the deal if they had been up-front
immediately. More importantly, they should have done everything in their power
to keep those clients and keep the business on track (or presented more
conservative financial forecasts that accounted for some potential lost
clients).
4. Have scrubbed
and analyzed your previously presented financial statements.
Most serious
buyers will perform a “Quality of
Earnings” accounting due diligence on your company. This means
that they will review, in detail, the financial statements that you have
previously presented to make sure the earnings presented are high quality. It
is inevitable that they will find various adjustments that make the earnings a
bit better and a bit worse than expected — that are normal. However, it will
save sellers a ton of time if they have performed their own analysis to find
the unusual items or the items that the buyer may ask about. It is much more
efficient to be prepared up-front than to scramble around trying to understand
the questions yourself and to explain what the buyer may be finding.
5. Be organized.
The buyer will
need all sorts of information about the financial results, legal, insurance,
human resources, major contracts, etc. Of course, the seller wants the
information to be strong and supportive of the picture that was painted during
the sale process. Almost equally as important is how the information is
organized and presented. Buyers appreciate indications that the company is well
managed and organized — such indications provide more confidence to the buyer.
6. Manage the
lawyers — don’t let them manage you.
The lawyers view
their job as doing everything they can to protect you, so they will always take
the most conservative path and recommend the most protected, conservative
position. There is nothing wrong with that, but if both parties take that
same stance, there is no room to find a middle ground that makes sense. The lawyers
work for you — you should have the confidence to tell them what
you want, make the final business decisions around the deal, and not let the
lawyers manage you. Finishing the Letter of Intent does not mean that all the
deal decisions are done. There are many more small details and decisions in the
final documents, and both parties need to continue compromising and negotiating
the details that are not covered in the Letter of Intent.
7. Communicate
well with everyone involved.
Special effort
needs to be made to communicate (probably more than you think) among all the
parties. And, special effort should be made to think about the best methods to
communicate everything. Never take a shortcut by firing off an email when a
phone call would be better. Everyone is on edge and making sure to communicate
enough— and via the best method possible — pays off big time.
5 To Dos for a Successful Exit Strategy
You pick up the phone, and BAM! You’re blindsided. The person on the other end of the line wants to buy your business. You freeze. You don’t want to say the wrong thing. Your mind races. What am I supposed to do now?
Are my ducks in a row? Am I prepared to get what I think this is worth? What is this business worth? Is it worth anything?
Although this is the dream scenario for many entrepreneurs, most business owners won’t be able to sell their companies. According to Business Reference Guide, 70 to 80 percent of businesses put on the market don’t sell.
Here are five things you need to do now—before you get that phone call—to build a strong business and prepare for a successful exit.
1. Hire and Develop Leaders in Your Organization
Avoid falling back on the old business maxim, “If you want something done right, you’ve got to do it yourself.”
The problem with handling the most important tasks and decisions yourself is that it doesn’t prepare the rest of your staff to takeover when you leave. Any new owner will be hesitant to take the reins of a business that depends solely on you.
Insisting on doing everything yourself also stifles your business growth because one person has limited bandwidth. Identify team members with leadership potential, and invest in their development early on.
2. Keep Your Business in Growth Mode
Don’t get distracted by one potential buyer. The odds of selling your business to anyone buyer range from 15 percent to 40 percent, depending on the study.
Your odds with this interested buyer are worse than 50/50, so it’s best to keep your business growth a top priority.
Making headway with new markets, new products, and new opportunities also makes your business more attractive to investors. Buyers like to see growth opportunity, so don’t plateau right before closing. Make some significant, measurable progress on growth before an exit opportunity arises.
Remember: Talk is cheap. Execution is valuable.
3.Build Systems
Building systems in your business is important for three main reasons: Systems help you hire and train good employees, they help you build a scalable business, and they create opportunities for you to explore recurring revenue models. All three are appealing to potential buyers.
4. Avoid Heavy Customer Concentration
It goes without saying that taking care of your biggest customers is important. But if a vast majority of your business comes from one customer, you may have too much of a good thing.
Businesses with poor customer concentration are risky to buyers. Ideally, no single customer should account for more than 20 percent of your revenue. If this is the case for your business, try to acquire more customers to minimize that risk.
5. Keep Great Records
“Due diligence” is the term used when potential buyers peek behind the curtain to make sure what you’ve said about your business is true. If all the information is in your head and they have to take your word for it, this can be painful for you.
Make sure you keep accurate records. Procrastinating on your bookkeeping can make it all but impossible to catch up when potential buyers need to quickly access current information.
These five areas are all critical to your business, but juggling them all at once can feel overwhelming. Make a plan this week to execute on just one of these things, and you’ll avoid the crunch-time panic that’s familiar to business owners who don’t prepare an exit strategy. Of course, you should always seek advice from a mergers and acquisitions professional that has sold businesses and knows what to expect from the process.
In short, you need to focus on building a business, not just a job. This means keeping a potential buyer’s perspective in mind and growing a company that will be an attractive investment.
If you have a strong business, you can exit at a premium. It just takes careful preparation before the opportunity to sell arises. If you wait too long, you may not exit at all.
5 Key Value Drivers When Selling a Company
Accessing the private capital markets can be tricky — especially for first time visitors. Whether you are considering a recapitalization, a management buy-in or buy-out, or a family transfer, there are key considerations that should be discussed and understood before any company is brought to market.
To identify the best buyer and maximize purchase price, the business owner and the investment banker should both be able to articulate the value drivers for the company. Clearly articulating these points can help a potential investor see the value of your business.
Below are 5 key value drivers that must be discussed with your business broker as early as possible in the process so that all parties are on the same page:
- Customers
One of the most important value drivers to discuss is your customer base. An understanding of how a business makes money and who its customers are is essential for any Private Equity (PE) firm and deal negotiation. Too often, I see write-ups or pitch books of a business that do not explain how the business makes money. You must be able to answer that question; you have to succinctly be able to tell someone how the company makes money.
You also have to be able to speak to how you acquire customers. What is the profile and size of your customer base? How do you engage with them? Having a more organized Customer Relationship Management (CRM) and legitimate salesforce, can help demonstrate to an interested PE firm that you are working with regular, sustainable customers.
Last, but not least, you also have to be able to speak to how you lose customers. If your customers are able to abandon your business overnight with little to no switching costs, it will be a red flag for many private equity firms. If you have customers that can leave next week without pain and heartburn, that’s not a good thing. While it is not an insurmountable challenge, the deeper entrenched your business is in the customer’s life and business, the better.
- Industry & End Markets
In addition to your customers, it is imperative to be able to comment on the size of addressable market. There is no need for detailed reports, but you must have a sense of the number of potential customers and trends in that space. Is your industry growing or shrinking? Is there heavy regulation? These types of extra-company factors can make realizing a successful investment difficult for most PE shops.
PE investors are also concerned about businesses that are highly discretionary. For example, if your business offers a completely discretionary item, that means the purchase can be put off during downturns and economic uncertainty. That is a big risk in future cash flows and, unsurprisingly, a red flag for many PE investors. Similarly, if a business is very cyclical, it can be challenging for an investor. Most PE firms use some form of leverage during an acquisition, and leverage and cyclicality is a very risky cocktail. It can go sideways on you very quickly.
To help appease an investor’s concerns, you should demonstrate that your business tracks along with the general economy. If you can show solid financials for the past five years, that is a great sign that your business is not particularly subject to cyclicality or customer discretion.
- Suppliers
We already discussed the addressable market and your customers, but now it is time to consider your suppliers. The two questions you need to address are:
Are there any supplier concentrations? If your business is being influenced by your supplier because of their consolidation or control of the market, that is not a deal killer, but it is something that must be disclosed to the PE firm as soon as possible. It is important to understand the costs and risks of switching suppliers.
Can a supplier go straight to your customer? If that is the case, it makes investors very nervous. Most PE investors want to see a fundamental, tangible reason why your business exists. If you are relying on opportunistic inefficiencies, there is a great deal of risk that your business will be squeezed out by larger competitors or those with vertical integration capabilities. You need to demonstrate that your firm will be around for a long time because it is addressing a clear need — and one that no one else can easily replicate.
- Competition
As the interested investor gets the lay of the land, he will also need to know about the level and type of competition surrounding your company. You will need to effectively be able to address the presence of any competitors and how you differ from them. What are the variables? Price? Service? Location?
If there is no competition, then you still need to explain why the customer is buying from you. Are they buying from your firm because of the salesperson? Or, because of the right price? It may sound like a silly question, but it is fundamental to why a company exists. The more and better you can answer the question, the more value you can demonstrate in your business.
- Management & Financials
Only after understanding the full ecosystem in which you company exists will the investor begin to look into the company itself. Understanding the key stakeholders and management of the business is absolutely crucial to a successful deal.
Getting deals done in the lower middle market is so much more about the psychology of the stakeholders than actual financials. You need to make sure everybody is happy. This is why most PE firms will spend so much time getting to know the management team and making sure there is a fit. If you try and fit everyone into a predetermined box or equation, the deal will fail.
When it comes to financials, the numbers will be what they will be. At this stage of the process, the investor is probably most interested in seeing how organized your business is. The numbers need to be reliable. We don’t want to be in a situation where we’ve made a deal, then did some diligence only to discover that we were misled. In those situations we have to break the deal, which is disappointing for everyone involved. The more confident we feel in your ability to track numbers, the more confident we will feel about the deal. However, don’t worry about too many add-backs or no CFO — just be systematic with the process.
Lost opportunities
It is unfortunate some buyers are not willing to work with us and agree to pay our “Finder’s Fee.” Buyers who cooperate with us are exposed to many more opportunities.
To those buyers not willing to pay our finder’s fee, we say – you have passed by when opportunity was knocking.
We have a buy side team and a sell side team and the value of our buy side engagements is that we can find a much larger pool of sellers than you can find on your own. If we can find better deals, even considering our fees, then you have an obligation to your shareholders to take the best deal and pay our fee. The gut question for you is – “Is this deal, including the Astra’s fee, a better deal than any others you can find?”
There should be no problem for you to investigate. You are under no obligation to buy when you sign our agreement. We will even do searches for you at no cost or obligation.
You do your due diligence and if the price is right, including our finder’s fee, and your offer is accepted, that’s the only time you are obliged to pay our finder’s fee. This sounds simple to me. How about you?
Should we be able to obtain a fee agreement with the owner, then you will not be obligated to pay a buy side fee. “We do not double dip.”
Why You Should Use CBI to Sell Your Business
CBI is a Certified Business Intermediary – Astra is a IBBA member with a CBI designate.
Do thoughts of selling your business ever cross your mind? As a business owner you certainly know that the day will come when you will walk away from your company’s operations. Selling your business will likely be one of the biggest decisions of your business life.
No doubt you have a good idea of what your business is worth. But there are many factors to consider when putting your company on the market. Is now the best time to sell? Should I look for a cash deal or should I consider certain terms? What about confidentiality?
Working with a professional business intermediary will provide the expertise to help you make those decisions. Consider teaming with a Certified Business Intermediary (CBI), a professional who fully understands what it takes to successfully sell a business. A CBI can bring significant value to the complex process and help you complete a sale that will include the best possible value and some peace of mind.
A Certified Business Intermediary, or CBI, is the designation awarded by the International Business Brokers Association (IBBA) to members that have met certain educational requirements and ethical standards. IBBA, with 1,500 members worldwide, is the largest international, non-profit association operating exclusively for the benefit of
people and firms engaged in the various aspects of business brokerage and mergers and acquisitions.
A CBI is an experienced, proven professional whose claim of competence is supported and documented. With the skills necessary to handle the marketing, negotiations and complex details involved, a CBI can successfully complete the purchase or sale of your business.
To earn the CBI designation, an IBBA intermediary must meet the following requirements:
Education – A CBI must complete a minimum of 68 class hours of business brokerage courses offered through IBBA and must demonstrate an ongoing commitment to professional development through continuing education and recertification.
Experience – A CBI must demonstrate competence in the application of knowledge gained through practical experience with a combined minimum of three years’ experience and education in business brokerage.
Knowledge – A CBI has to demonstrate a high degree of knowledge garnered through the completion of required courses and the passing of the comprehensive CBI examination.
Ethics – A CBI must thoroughly understand the IBBA’s Code of Ethics and apply the code to his or her business practices.
A higher level of education and training means that a CBI will have more access to people and information than other business brokers. A CBI has professional affiliations with hundreds of other intermediaries in addition to the most current industry information regarding taxes, government and legislation.
A CBI’s experience and knowledge of current marketplace conditions is critically important for anyone looking to sell a business. If you are considering the sale of your business, you need every advantage you can garner, primarily preparation, experience and knowledge.
Valuing Your Business
As a business owner considers placing his or her company on the market, ascertaining the proper value for the company is critical. Too often the owner assigns an unrealistic and unachievable arbitrary value then proceeds into the sale process only to be disappointed with the market’s response. As a result, the asking price is reduced several times. During this unfortunate period buyer prospects and valuable time is lost.
A company’s value is determined by a compilation of factors such as the company’s sales, earnings, performance, market outlook, personnel, net book value, and fair market replacement value of equivalent operating assets. But it can also be influenced by intangible assets like the company’s image, reputation and goodwill.
To maximize the fair market value of your business, it’s vital that you capitalize on those intangible assets.
Develop key employees. Buyers generally aren’t interested in paying a premium if the business relies on you for its success. Remember to delegate responsibility to key employees and involve your key staff members in the decision making process. Demonstrating that your company’s success is reliant on your capable, well-trained employees – not just you – will pay off at the time of sale.
Document what you do. Be sure that job descriptions, operation processes, and strategic plans are documented. Documented records and plans give a buyer greater comfort that he or she will be able to emulate your successful growth and will help your buyer obtain financing. Also, be sure to keep business records like sales and expense reports, internal profit and loss statements/balance sheet, and tax returns clean and well-organized.
Build relationships. Name recognition, customer awareness and your reputation are all part of your business value. Even if your company doesn’t have many hard assets, your relationships are key. Consider diversifying both supplier and customer accounts.
Improve cash flows. A potential buyer wants to see the “true cash flow.” And, of course, in the business world cash is king. Be sure you are driving all income to the bottom line.
Review your assets. Sell off or dispose of unproductive assets or unsalable inventory. Remove or buy off any assets that are primarily for your personal use.
Find and build your niche. You don’t have to be everything to everyone. Buyers will pay a premium for a niche that has barriers to competitive entry.
Remodel, clean, and organize. What’s the first thing anyone does when they put their home on the market? They spruce things up and make sure everything is in its right place. Yet, in business, that’s rarely considered. A well-maintained facility will get the best price. Even businesses that lease space can benefit from a thorough cleaning and organization to convey a feeling of quality and efficiency.
There are several approaches to valuing your business.
Balance Sheet Value
There are several balance sheet valuation methods, including adjusted book value, book value and liquidation value. The adjusted book value is determined by revising the asset’s book value to reflect the cost it would take to replace the assets in their current condition. This method requires the total values to be offset against the sum of the liabilities.
The book value considers the figures from the company’s financial records, as depreciated at the time of the sale. The book value can pose some difficulties for sellers, particularly if the seller has depreciated the assets too much to gain prior tax advantages.
The liquidation value is the amount that could be realized if all assets – equipment, furnishings and inventory – were sold separately. This value is typically much lower since it doesn’t consider a company’s intrinsic value.
Income Approach
The income approach takes into consideration the company’s level of earnings using a capitalization rate, discount rate or multiplier. Several income approach methods are frequently used. Each method requires a level of earnings and a conversion factor to translate the earnings into a company value. Selecting the proper level of earnings – after-tax, pretax, discretionary or cash flow – and matching it with the proper conversion factor – discount rate, cap rate or a multiplier – is critical to calculating a reasonable value.
Market Approach
The market approach sets a value based on the values of other businesses that have been sold. Setting the market value involves researching the sale prices for similar businesses in a geographic area. In some cases, however, finding a company that is similar in many ways to your company may be difficult.
Whatever your goal, you want a good advisor to help you assess the value of your company. Question your advisor on the effects of deal structure and how multiples are used. A business owner should never accept a computer-generated valuation or a one-size-fits-all approach when selling the business. And don’t be impressed by the person who presents the highest value – you may only be setting yourself up for failure during the sale process.
The Benefits of Buying vs. Starting a Business
So you want to be your own boss. There are certainly pros and cons to both buying and starting a business. If you do a careful analysis, you’ll learn what many seasoned entrepreneurs have discovered…the risk-to-reward ratio is tipped in your favor when you purchase an existing business.
Starting a business of your own can pay great dividends, but it’s important to understand that the risks are significant. Most start-up businesses will falter and eventually die. According to Michael Gerber, author of The E-Myth Revisited, 40 percent of new businesses fail in the first year and 80 percent fail within five years.
On the other hand, purchasing an existing business reduces an entrepreneur’s risk while creating opportunities for tremendous profit. There are a number of reasons to consider the purchase of an existing business rather that starting one:
Proven Concept. Buying an established business is less risky – as a buyer you already know the process or concept works. Financing a purchase is often easier than securing funding for a start-up business for that very reason—the business has a track record.
Brand. You’re buying a brand name. The on-going benefits of any marketing or networking the prior owner has done will transfer to you. When you have an established name in the business community, it’s easier to place cold calls and attract new business than with an unproven start up.
Relationships. With the purchase of an existing business, you will also be buying an existing customer base and vendor base that took years to build. It’s very common for the seller to stay on and transition with the business for a short time to transfer those relationships to the buyer.
Focus. When you buy a business, you can start working immediately and focus on improving and growing the business immediately. The seller has already laid the foundation and taken care of the time-consuming, tedious start up work. Starting a new business means spending a lot of time and money on basic items like computers, telephones, furniture and policies that don’t directly generate cash flow.
People. In an acquisition, one of the most valuable and important assets you’re buying is the people. It took the seller time to find those employees, develop them and assimilate them into the company culture. With the right team in place, just about anything is possible and you will have an easier time implementing growth strategies. Plus, with trained people in place you will have more liberty to take vacation, spend time with family, or work on other business ventures. When start-up owners and independent contractors go on vacation, the business goes too.
Cash Flow. Typically, a sale is structured so you can cover the debt service, take a reasonable salary, and have some left over to take the business to the next level. Start-up owners, on the other hand, often “starve” at first. Some experts say start-ups aren’t expected to make money for the first three years.
Risk. Even with all these advantages, some entrepreneurs believe it is cheaper, and therefore less risky, to start a business than to buy one. But risk is relative. A buyer may pay $1 million, for example, for an established business with strong cash flows of approximately $200,000 to $300,000. A lending institution funds the transaction because historical revenues show the cash flow can support the purchase price. For many people, however, that is far less risky than taking out a $300,000 loan with an unproven concept and projections that may or may not be realized.
Becoming your own boss always involves a risk. When you buy a business, you take a calculated risk that eliminates a lot of the pitfalls and potential for failure that come with a start-up.
Earnout or Seller Financing: Which is better for your business sale?
When structuring a business sale, a common problem that arises is a difference in opinion on the value of the business. It’s important to recognize that the two parties are motivated by different information. Buyers are focused on past earnings and the operational risk in the business that will affect future earnings. Sellers typically focus on the company’s recent historical performance, hoping to maximize their profit from the sale
This difference in focus can make it difficult for either side to find balance between the amount that a buyer is willing to pay and the amount a seller is willing to accept. An earnout or seller financing can bridge the value gap, yet each has its own pitfalls and advantages.
Of course, an all cash deal at full market price would be a dream for any seller, but the reality is that these two innovative financing solutions are often the magic that makes many business acquisitions happen. Read on to determine which financing solution is best suited for you and your business.
Seller financing
Seller financing is when the seller agrees to finance a portion of the purchase price over a set period of time. The amount due in the future is defined and capped, limiting the upside, but protecting the seller’s interests by establishing a repayment schedule.
This option is best suited for a departing owner that wants the security of a guaranteed repayment schedule.
Businesses with steady sales and operating profits are a good fit for this type of acquisition financing solution. By offering this repayment option to a buyer, it widens the buyer market, increasing the chances of multiple offers and a higher selling price.
When there is a shortage of bank financing or the need for multiple financing options, this is when seller financing is vital. Buyers are increasingly asking sellers to finance a portion of the purchase price as a means of bridging the value gap. The buyer has to come up with a portion of the total price up front and the remainder over time. It is typical for a seller to finance one-third to two-thirds of the sale price within a three to five year term.
Here is a look at some of the benefits and risks associated with seller financing.
Benefits:
A seller has access to the full purchase price, which might otherwise not be possible.
Businesses typically sell for 15% more when seller financing is provided.
Sellers can earn 8-15% interest over a five to seven year period, resulting in increased compensation from the sale.
Security over non-business assets can be requested to guarantee repayment.
Bank financing options are more likely with an increased amount of equity in the deal.
Risks:
Success under new ownership is not guaranteed and the seller will have money at risk.
Finding the right buyer that has the appropriate skills to take over the business is important.
A buyer may be unable to make the scheduled payments. A carefully crafted agreement can protect the seller’s interests in this worst-case scenario.
The bottom line:
This creative financing solution may be the best fit for you and your business if you wish to successfully sell your business and its goodwill. Acquiring lender financing for goodwill can be tricky, but if designed correctly, this option increases the probability of lender financing.
Earnouts
An earnout is where a portion of the purchase price is paid after the closing, contingent in whole or in part on the target company’s financial performance over a specified period of time. Earnouts are common in about 80% of acquisitions and typically represent about one-third of the total transaction value. They are typically based on the projections that the seller prepares as part of the sale and/or due diligence process. Earnouts are structured as a percentage of a mutually agreed upon financial metric.
Earnouts are typically suited for high growth businesses where future financial results are difficult to model.
Despite having a compelling reason to sell the high growth business (which is key), the owner has a firm belief in the company’s future potential. As such, they are willing to take on the risk that it will perform to its expectations, even under new ownership. Earnouts make the buyer believe in the future of the business.
Benefits:
No limit to seller profit.
No increase in buyer risk.
Helps protect a buyer from overpaying for a business. If a milestone is missed, the additional consideration is not paid.
Protects a seller from selling too cheaply. If the business continues to perform well and milestones are achieved, the seller gets additional compensation over time.
Risks:
Earn outs are often more complicated and risky to the seller than seller financing, as future payments are not guaranteed or collateralized.
Earnout negotiation points:
Unique to the structure of each earnout is the selection of a target metric, which is typically revenue, EBITDA, or gross profit. Each represents varying levels of risk to each party in the transaction and as such, this determining metric must be wholeheartedly agreed to by both seller and buyer.
Revenue is the easiest metric to measure and the most difficult to manipulate from a seller point of view. Buyers are hesitant to offer this metric, as it doesn’t account for whether the revenues are non-recurring or if margins are acceptable. This option is best suited to a buyer who is in complete control of operations after the transition; that way they can control the margin and overhead costs of the business. Sellers typically prefer this metric as it removes the risk of poor management by the buyer.
EBITDA is a commonly used metric for earn outs. A buyer may prefer this metric because it shares remaining profit and corresponds closely to real world cash flow success. On the other hand, a seller may be focused on growing the sales and therefore have preference for a revenue or gross profit threshold. The potential risk associated with this metric is that it is the easiest to manipulate. The “E” (earnings) could be padded with expenses that the seller may not have incurred while running the business. To reduce this risk, unique clauses can be devised to protect a client from expense manipulation.
Gross Profit is often referred to as the “compromise” metric because it’s not as easy to manipulate with general expenses. This approach is more appropriate for businesses with stable overhead levels. As long as it is the accurate gross profit of the operation, both parties’ interests should be protected.
The bottom line:
The most important takeaway is that precise and careful drafting of the earnout clause is key to minimizing and eliminating disputes. With the right guidance from experienced advisors, the earnout should be viewed as a powerful tool in price negotiation.
Selling Your Business
When selling your business, you don’t want just any buyer, you want the best buyer. With the market we’re now experiencing, many sellers are getting multiple offers, but the buyers they choose aren’t always the ones offering the most money.
Would you consider a lower price for a buyer that fits the company’s culture? Would you consider an offer that’s a million dollars lower if it meant the difference between years of seller financing and cash at close?
It’s common for deal structures to include a variety of options which must be carefully considered and evaluated, long before you get to the negotiating table.
You may not realize it, but you’re positioning and negotiating from day one of a sale. Be sure your priorities are well thought out or you might give a buyer the wrong impression which can have serious consequences. There aren’t any wrong answers – your priorities should be what you feel is important.
A prospective buyer may ask how long you’ll stick around after the sale and you may casually respond that you’ll be around as long as needed. Then you find out that the buyer is thinking about a two year transition when you and your wife had been discussing a potential move to Florida.
Something like that could blow up a deal. Had your initial response been that you would be around three to six months and then could provide consulting services from Florida, the buyer would not be counting on long-term support. Remember, it’s always easier to give the buyer more than expected than take something away.
As a seller, there are some common decisions you may have to make:
Financing – Do you prefer a higher offer with some seller financing or a lower offer with cash at close?
Transition – Are you looking for a quick exit? Does the buyer expect a lengthy transition?
Employees – Sellers are often very protective of their employees. Will the buyer relocate or replace staff?
Ownership – Are you looking to maintain a minority stake for yourself or your family?
Legacy – Most sellers don’t want to cash out and watch the company erode. Ten years from now they want to look at a successful business that they had a hand in building.
Real Estate – Is the buyer interested in your building? If the buyer doesn’t want your facility, how soon can you fill it?
Trust – Do you trust the buyer? Some sellers will pass up higher offers to work with a buyer they feel better about.
Even if you know your preferences, you may not get everything you want when making a deal. A reputable business broker or intermediary will be sure that the right questions are asked to help you organize your thoughts, review your priorities and understand what the market will bear. In the end, you’ll find yourself in a better position to negotiate and close the deal—without sacrificing your goals.
Benefits of using a broker to sell your business:
Confidentiality.
A business broker will protect the identity of the company and contact only owner approved buyers through a blind profile – a document describing the company without revealing its identity.
Business Continuity.
Selling a business is time-consuming for an owner, and with a business broker, the owner can maintain a focus on running the business when a broker is working on the sale.
Reaching potential buyers.
Business brokers have the tools and resources to reach the largest possible base of buyers.
Marketing.
A business broker can help present your company in the best light to maximize the sale price. He or she has an understanding of the key values that buyers are looking for and can assist in identifying changes that can lead to a better selling price.
Valuing your Business.
Putting a value on a business is far more difficult and complex than valuing a house. Every business is different, with hundreds of variables that have an impact on the value. Business brokers have access to business transaction databases that can be used as guidelines or reference points. But the best way for a business owner to truly feel comfortable that he got the best deal is to have several financially viable parties bidding for his business, which is much more likely using the resources of a professional business broker.
Balance of Experience.
Most corporate buyers have acquired multiple businesses while sellers usually have only one sale. An experience business broker can level the playing field for a business owner making his one and only business sale.
Closing a Deal.
Since the business broker’s sole function is to sell the business, there’s a much better chance that a deal will be closed in less time. The faster the sale, the lower the risk of employee problems, customer defection and predatory competition.
Due Diligence
Merriam-Webster Dictionary defines due diligence as “research and analysis of a company or organization done in preparation for a business transaction.” Ultimately, due diligence is the process of being sure that things are as they appear before a deal is sealed. For someone considering a merger or the purchase of an existing business, the review of documentation and the answers to your due diligence questions are critical.
There’s no doubt it is a complex process that can be time-consuming, but with so much on the line with any merger or acquisition, you don’t want to make a decision without all of the information. You want to be sure everything is reviewed and all questions are answered to your satisfaction.
During the due diligence process, an often lengthy list of documents should be provided. The list of documents should cover a range of areas, including:
Legal structure and incorporation of the company
Internal Revenue Service (IRS) records
Insurance policy information
Organizational structure
Personnel policies
Operations
Capital and real estate
Contracts, licenses, agreements and affiliations
Technology and Intellectual Property
Current or potential legal liabilities
Marketing materials
Today more than ever, buyers are putting more emphasis on the due diligence process, and while the financial aspect is a key component, the due diligence process should also consider organizational items. Be sure to seek documentation and ask important questions about the company’s culture, strategy, leadership and competencies.
Although the due diligence process may take considerable time, it’s a critical part of any transaction and should be considered the foundation of the entire deal.
Determining Your Company’s Value: Multiples and Rules of Thumb
My firm recently met with a business owner who told us right up front that he had started his business six years ago with the intention of selling it. He came to our meeting prepared with tax returns and financial statements and also informed us that he would be willing to stay on in a sales role with a new owner for up to three years.
The business — a specialty subcontractor to the commercial building industry — did about $7 million in annual gross sales in 2009, had been growing rapidly every year since its inception, and showed $725,000 in Ebitda and $900,000 in seller’s discretionary earnings (S.D.E.). Everything about the business looked great.
The meeting continued to hum along nicely as the seller recounted the history of his company and listed its biggest customers and possible buyer candidates. We listened carefully, impressed by how thoroughly he had prepared for this day. Then we asked if he had a particular asking price in mind. His number, he said, was $8 million. If I had sound effects in my conference room, I would have cued the needle scratching across the surface of a vinyl LP.
So, what’s the problem with an asking price of $8 million for this business? The primary issue is that the price would be a multiple of 11 times Ebitda, or almost nine times S.D.E. according to the seller’s financial statements. Given the industry and the asking prices for similar businesses for sale across the country, those multiples are far beyond what most buyers would consider reasonable in today’s market.
While there are many factors that help determine an appropriate asking price — including competitive advantages, opportunities for growth and historic financial performance — multiples and rules of thumb can be a good place to start. Several resources are available for obtaining data on pricing businesses for sale, including Business Valuation Resources and BizBuySell.com. A business broker, intermediary or transaction adviser will have access to a number of resources for small-business deal flow data, as well.
Business Brokerage Press publishes an annual guide to pricing small businesses for sale in both a print and online version. Here are some multiples and rules of thumb for a handful of businesses from the latest version:
Manufacturing (annual sales of $1 million to $5 million): three to four times S.D.E. plus inventory.
Retail auto parts: 40 percent of annual sales plus inventory.
Commercial printers (annual sales under $2 million): two and a half to three times recast Ebitda.
Retail apparel: one and a half times S.D.E. plus inventory.
Wind farms: 10 times Ebitda.
Some industries have their own rules of thumb. For example, an authorized reseller of wireless phones and service is sometimes valued at 30 times monthly residuals. While there is no such thing as a “comp” (comparable) when it comes to selling a small business, looking at multiples for similar businesses in the same industry — and preferably in a similar geographic area or market — can be the next best thing.
One of the keys to a successful sale is to have a clear understanding of how buyers will value your business, whether it’s an individual or a strategic acquirer. More often than not, that value will come down to a multiple of the business’s earnings.
“We recently completed a survey of a broad cross-section of business brokers and merger-and-acquisition professionals,” said Dave Kauppi, a mergers-and-acquisition adviser and president of Midmarket Capital, in a recent blog post. “One of the questions we posed was, ‘What is the biggest challenge you face in your practice?’ We gave them eight choices including lack of financing, sell side deal flow, not enough buyers, etc. The top answer was seller value expectations.”
And so it was with the seller mentioned above. Multiples for a business like his are around three to four times S.D.E., resulting in an asking price that is barely half of his current expectations. He returned to our office about a week after our initial meeting to pick up his financial statements and tax returns. Something tells me he won’t be back as long as his needle remains stuck on a multiple that is simply too high.
Barbara Taylor is co-owner of a business brokerage, Synergy Business Services, in Bentonville, Ark.
The Best Business Deals Die Three Times: Wisdom from Buying & Selling Businesses
All business deals are complex, especially purchase and sale agreements. The best business deals often die several times!
Business Deal Reality Check
“The best business deals die three times,” is sometimes said with the reverence of having been spoken by a person of great wisdom. This week, I spent days in full-time discussions with a company where we are far along in the due diligence process and it is unclear if we will get over the finish line to make the final deal work for them and for me. It is a difficult, frustrating, and time intensive process. Furthermore, it usually isn’t a glamorous business. For several sessions, we were squatting in a hotel banquet / storage room with laundry bins, uncleared tables, and minimal air conditioning in a hot, humid part of the country. Other times, we were at a business owner’s home with the plumber drilling holes in the wall and interrupting our conversation. My world is not one of plush, fancy hotels and catered lunches in white-shoe law firms.
Some observations from the front-lines this week:
Something in human nature isn’t satisfied with a big decision until everyone is convinced they got the most they could. This becomes even truer when selling a business with a lot of money involved and the owners are at the end of their career with no more deals on the horizon. Most deals have to have people walk away at some point for the participants to become convinced they got the most they could get. That is unfortunate, in my book, and wastes a tremendous amount of energy and time. It really bums me out, actually. I would prefer much less posturing and more straightforward conversation, but that is very difficult for people who do not have a long-term relationship and the stakes are high.
It is important to negotiate with someone who has confidence to make decisions. This week, I became convinced that one participant didn’t have confidence to make the decision — the negotiation could go on forever because the person was too nervous to make a decision.
Rational decision-making does not rule the day. A perfectly rational decision becomes unattractive when surrounded by emotion, expectations, and other less rational factors.
Finding common ground is difficult with different backgrounds. People often have different depths of knowledge on accounting, business valuation, and the business deal process that makes finding common ground and a common view of the world very difficult.
Value creation in a deal process is vital; and can only happen when everyone considers new and different ideas. The key to many business deals is to find the trade-offs that create value for each party. To do that, you need to have an open dialogue about what is most important and what is not important to each participant. And, you need to consider creative ideas that you may not have considered before (see the point above about someone having confidence to make a different decision than what they may have thought about for months and years previously).
Business owners need to understand how intensive the selling process is — it is basically a full-time job. It is so important for business owners to pick a time to sell when they can dedicate the time to sell. And, they need to realize that their business needs to be able to run without them while the sale process is happening. This adds an unbelievable amount of stress to business owners because the selling process is stressful and then they have the stress of keeping their business on track.
There is wisdom in the phrase “the best business deals die three times” because both parties will keep coming back together to make a great deal work, even after the business deal dies once or twice. For bad business deals, it just isn’t worth it to come back together. This week, a business deal I liked died — time will tell whether it comes back together.
COMMENT
The owner’s time is too valuable to keep their company on track. Engage a broker to market the sale of the business.
Business Buying Process
Buying a business is a process that takes time. It can sometimes take years to find the right opportunity.
There are some key steps to follow in the business search process:
Start with a self-assessment: Ask yourself why you want to buy a business. What types of work activities do you like and what kind of lifestyle do you want to pursue? It’s important to understand that there may be more work and longer hours for an owner in some industries. Be sure to include your family in the assessment.
Establish financial expectations: Determine how much money you need and want to earn. Make sure your expectations are in line with the types of businesses you are targeting and the return they can produce.
Put together a personal financial statement: Outline your assets and liabilities. Identify what you can use for your initial investment. The personal financial statement serves as proof of your financial wherewithal, so be prepared to share this document with a seller’s intermediary.
Update your résumé: Sellers want to be sure that their business will continue to be a success. They’re looking for someone with the experience necessary to continue their legacy and take care of the staff. Ultimately, you’re selling yourself to the current owner(s), the lender, and the professionals representing them.
Outline your acquisition criteria: Define the parameters of your search. Ideally it should include your targeted industries, geographic area, and transaction size. Your motivation, lifestyle, expectations, financial statement and résumé will help you develop your acquisition criteria.
Search multiple sources and enlist help: Let your professional advisors (e.g. attorney, accountant, financial planner) know you are looking for a business. Most importantly, contact business intermediaries who represent businesses within your targeted market. They will notify you of available companies that meet your criteria and qualifications. Most business brokers or intermediaries work for the seller and are paid by the seller. That means you can enjoy the luxury of their services at no cost. The intermediary is looking out for the seller’s best interests, so you should have experienced council to represent you in any transaction.
M&A Advisers Proven to Improve Valuations
“Do I really need an M&A adviser?” This is a question thousands of business owners ask themselves every year when they embark on the process of selling their company. Although there are many benefits to an adviser, some business owners still choose to bypass the intermediary, thinking the value is overstated.
In an effort to definitively answer this question, several academics “analyzed a sample of 4,468 acquisitions of private sellers during the period of 1980 – 2012 to examine the decision and the consequences of hiring sell-side M&A advisers.” The results bode well for intermediaries.
In the study, entitled Does Hiring M&A Advisers Matter for Private Sellers?, Agrawal et al. discovered that “private sellers receive significantly higher acquisition premiums when they retain M&A advisers.” Although “top-tier” intermediaries offered the highest acquisition premium, the benefit of the M&A adviser held true across all deal sizes
M&A Advisers Create Competition
The higher acquisition price derives from an M&A adviser’s ability to run smoother processes with better buyer lists. As Agrawal et al. learned, financial intermediaries have “greater economies of specialization and information acquisition, and have lower search costs than their clients.” A smooth process means that the M&A adviser are particularly adept at keeping multiple, relevant bidders engaged simultaneously. This concurrent interest from several interested parties is critical to obtaining the best sale price.
“Previous studies find that bargaining power is a significant determinant of the magnitude of private company valuations,” wrote the professors. “A key determinant of the seller’s bargaining power is the number of competing bids it receives.” Like supply and demand, “a seller has more negotiating leverage when a prospective buyer believes that it is competing with other bidders.” An M&A adviser helps drive acquisition premium by driving competition.
Best of all, the competition doesn’t even need to be real. According to Agrawal et al., the mere presence of an M&A adviser can induce a sense of competition. “An M&A adviser can influence the attitudes and assumptions of bidders. If a seller only has one strategic buyer interested in purchasing the company, using an M&A adviser can give the prospective buyer the impression that there are competing strategic buyers against which it must compete to acquire the seller.”
M&A Advisers Are Most Important in Private Transactions
This competition thesis is particularly vital for private companies because of the opacity of the private capital markets and the information asymmetry between first-time sellers and investors.
“Public companies receive more bids than comparable private sellers for several reasons,” write Agrawal et al. “First, regular SEC filings allow potential bidders to obtain information about public companies that they may be interested in acquiring without incurring significant costs. Second, public companies tend to have greater visibility and media exposure relative to private firms, increasing the probability that they would attract the attention of potential bidders. Third, a public company receiving an initial takeover bid via a tender offer is required to publicly disclose it. The disclosure is followed by a waiting period imposed by the Williams Act of 1968 to provide opportunities for potential buyers to submit competing bids.”
Without these same factors in the private markets, private sellers often benefit from a sense of competition.
Extra-Valuation Benefits
Overall, Agrawal et al. explained, “A sell-side adviser can identify strategic buyers, evaluate the reasonableness of a bidder’s offer, manage and pace concurrent negotiations with multiple bidders, reduce the information advantage that a seasoned acquirer has over a private seller regarding the M&A process, and represent a private seller in negotiations with potential buyers.”
Although these are extremely compelling reasons to retain an M&A adviser, an effective intermediary can offer benefits beyond price — a good M&A adviser can help a business owner identify the best process for exiting the business. Since many closely-held businesses often experience intense family or shareholder dynamics, which may complicate the transaction, having a full understanding of the available options is essential. For example, if you want to sell the business to family or friends, a management buyout (MBO) or an Employee Stock Ownership Plan (ESOP) may be most appropriate. For transactions involving highly complex family or shareholder dynamics, your adviser can also serve as objective, third-party counsel that helps your business make decisions that maximizes a successful outcome for all stakeholders.
Additionally, advisers help keep you focused on running your business — a vital part of any sales process. They do not let the transaction become a distraction that negatively impacts business performance during such a critical period.
What are Realistic Expectations when Buying or Selling a Business?
The number of businesses sold in the market has reportedly grown significantly in the last quarter. Although this may be considered a positive development, this has yet to reverse the slump experienced in the past three years. Buying a business or selling a business in these times where the economic conditions are still volatile demands from all parties concerned (the buyer, the seller and the business broker) to re-think their expectations.
. Everyone must have a firm grip of the market trends during this current unpredictable economic environment.
With many sellers wanting to sell their businesses so they can enjoy the financial rewards of their work and sacrifices or due to their desire to move on to a new venture or challenge, and the new breed of buyers caused by the high unemployment rate (as laid-off employees are now looking to buy a business as an alternative to traditional employment), one would think that the market is more liquid with many businesses sold and bought. But such is not the case.
Seeking and getting approval for capital is tough these days. Traditional lending institutions are cautious in committing to financing small and medium business acquisitions. There are people out there who want to buy a business but their dreams are not realized because of lack of capital due to difficulties in borrowing.
Those selling a business who hopes to get paid full in cash are overly optimistic. Getting paid in full at once rarely happens. Usually, buyers make a down payment and pay the remainder in installments for years. The seller should be patient, flexible and creative with the terms of the transaction. He or she must weigh and study the consequences of the various financing deals offered before deciding. Buyers who hope to have full third-party financial backing in buying a business are also in for a surprise. Banks are more discriminating with the prevalence of fraud and mismanagement. They want to go over the deals with a fine-toothed comb. It is seldom that buyers acquire a business with no participation at all. Business brokers also have to contend with more careful and educated buyers who are knowledgeable about the businesses they are eyeing. They should provide detailed accurate financial information sought by these clients. Ramming the deal down their clients’ throats no longer works.
Despite the confluence of factors favourable to buying or selling a business in these times, we have to examine why there are not many transactions or closed deals. The high unemployment rate drives more people into business, be it buying a solid business or starting a new one. Borrowing interest rates are now lower. There are more buyers for the many businesses for sale offered by retiring entrepreneurs. Sellers who want to enjoy the fruits of their many years of work and sacrifice must be willing to negotiate and consider seller financing. With hard-up capital, they have to consider alternatives.
All parties want to get the deal done. Neither the seller nor the buyer will get everything they want, but it is possible for all to end up satisfied with the price and agreement. All parties need to adjust their expectations, and work together to find solutions for a win-win business sale transaction.
The Astra team of intermediaries has hundreds of buyers looking for opportunities. We also have access to several data bases of buyers. We would like to help you with your exit strategy. Please call us to discuss how we can help you.
Avoid Common Business Sales Myths
The typical business owner will only sell a business once. Understanding the complex process involved, will help produce the best results, but don’t fall prey to the myths that can derail or seriously affect a potential sale.
Myth #1 – I Can Sell It Myself
Many owners believe they’re qualified to sell their business without professional assistance, but selling a business is not like selling a product or service.
If you’re looking to sell on your own, confidentiality is lost. If word of a potential sale gets out, there are definite risks of losing clients, employees and favorable credit terms.
Do you really have the time to run your business and compile marketing materials, advertise, screen buyers, give tours and facilitate due diligence? When you’re looking to sell, you want to put even greater emphasis on running your business, boosting your sales, and not taking on new challenges.
Myth #2 – I’ll Sell When I’m Ready
Certainly, an owner wants to be sure he or she is mentally and emotionally prepared to sell. But personal readiness is just one factor. Economic factors can have a significant impact on the sale of a business.
Sale prices can be affected by industry consolidation, interest rates, unemployment and many other economic measures. Talk with a professional and aim to sell when your personal goals and market conditions align.
Myth #3 – I Know What it is Worth
Some owners will base the company value on what they need for retirement. Others will tell you they want $100,000/year for “sweat equity.”
A third party valuation is a good idea for anyone seriously considering the sale of their business. An outside valuation will include a thorough analysis of the business and the market it operates in. This will provide a solid understanding of the company’s growth potential, not some vague industry average.
Myth #4 – It’s Like Selling a House
Selling a company is much more complex than selling a house. A successful business sale usually requires a great deal of pre-planning, at least a year and maybe as long as three years to drive sales, develop key staff, document the operations and control expenses.
The average house will sell in less than four months, while the average business sale is nine months to a year.
Even after the business is sold, the seller can be expected to put in at least a few months, and possibly years of transition time, helping to make the new owner a success.
Let us help you to value and conduct a professional business offering. Contact us.
Build Your Team Of Advisors Like an Olympic Team
Selecting the right players is crucial for success
Chances are you are not the best person to sell your business. Could you do it? Probably. You could also take out your own appendix, but that is not recommended either. The difference between selling your business “well” and “not so well” could add up to millions of dollars. Why risk the difference at this stage?
In my interviews with individuals who sold their businesses, I asked each one, “Who did you turn to for advice when it came time to sell your business?” Some reported they had acted alone; but, in retrospect, they believed that might have been a foolish decision. Some relied primarily on a lawyer, or business coach, some their accountant, and a number turned to other CEOs for advice. About half used a business broker or investment banker.
There are two broad categories of advisors in a business sale; the technical experts, who work on the taxation, legal, financial, and transactional aspects; and the leadership or strategic experts, whose specialties include setting the vision, managing growth, and dealing with people and family issues. Generally speaking, you save money on the technical side and make money on the leadership side.
Accountant
You can probably continue to use your existing accountant if you are satisfied with their ability to meet your business needs. But, be careful that your accountant is not financially motivated to kill or defer your sale. If your business represents a significant portion of the accountant’s revenue, a sale may mean your company will no longer be using their services. If you are concerned about this, address it directly with your accountant or consider using someone else when preparing to sell your business.
Let us help you to value and conduct a professional business offering. Contact us.
How to Sell Your Business
You only sell your business once.
That thought alone may be enough to keep you up at night when you decide it’s time to cash in on your years of hard work — as if there isn’t enough pressure associated with every step of the sale of a business. But there’s much you can do to prepare for the sale, and it’s not a bad idea to start thinking about it long before the day arrives.
While every transfer of business ownership is unique, there are some important questions that sellers should ask themselves and there is a common process that is used for the sale of most small businesses. The more you prepare, the more successful the outcome is likely to be. What follows is a brief outline of the process for small, closely held companies. Many of these principles apply to larger transactions as well. First, ask yourself three questions:
Can Your Business Be Sold?
Many elements of a business make it attractive to buyers. For example, does it have a solid history of profitability, a large and loyal base of customers, a competitive advantage (intellectual property rights, long-term contracts with clients, exclusive distributorships), opportunities for growth, a desirable location and a skilled work force?
Are You Ready to Sell?
Make sure you are ready, both financially and emotionally. Think about what life will be like after the sale. What will you do — not just for money but also with your time? Many business owners suffer real remorse after handing over their business to a new owner.
Here are a few indicators that it may be time to move on:
It’s not fun anymore. Burnout is a very real issue for business owners, and an entirely legitimate reason to sell.
You’re not inclined to invest in growth. You may be comfortable with the current size and profitability of your business and have no desire to make the capital expenditures necessary to take it to the next level.
You feel your management skills are overmatched. It is not uncommon for business owners to build their business to a certain point and then realize they lack the skill set required to go further.
What’s Your Business Worth?
Many owners have no idea. On one end of the spectrum, for example, was a client who owned a professional services firm. She felt the firm was worth more than $1 million. After a lengthy search, a buyer paid her less than half that amount. Then there was a client who was about to sell his I.T. company to an employee for $200,000. After advertising the business for sale nationwide, he sold it for one dollar shy of $1 million.
Selling a business is both art and science, and in no other area is this more evident than the valuation. While every seller wants to achieve maximum value, setting an asking price that is too high signals to buyers that you may not be serious about selling.
While there are a number of methods used to value a business, the most common formula for smaller transactions is a multiple of seller’s discretionary earnings (S.D.E.). This type of market-based valuation involves recasting profit-and-loss statements — adding back owner’s salary, perks and nonrecurring expenses — to find the S.D.E. of the business and then using comparable data for similar businesses to arrive at an appropriate multiple.
Prepare Your Business for Sale (Now!)
Another client owned a popular sports bar and grill. He’d made repairs to some of his kitchen equipment, brought his books current and determined a reasonable asking price. He got an inquiry from a serious buyer — an industry veteran on a nationwide buying spree with his partner. The buyer liked everything about the business, and asked for data from his point-of-sale system, which my client was unable to produce quickly. By the time he assembled the information, the buyer had made an offer on a similar business in another state.
There is no way to overstate the intensity with which buyers will scrutinize your business. But here are things you can do to put your best foot forward.
First, get your books in order. Not being able to provide accurate financial statements in a timely manner can cause a deal to unravel in short order. Be sure to have the following on hand before you go to market:
Last three years’ profit-and-loss statements.
Last three years’ balance sheets.
Year-to-date profit-and-loss statement.
Current balance sheet.
Last three years’ full tax returns.
List of furniture, fixtures and equipment.
List of inventories.
Commercial property appraisal or lease agreement.
Be ready to furnish other documentation — particularly during the due diligence phase — when you will probably be asked to produce insurance policies, employment agreements, customer contracts, lists of patents issued, equipment leases and bank statements.
Spread the Word
Not surprisingly, most savvy buyers use the Internet to research available businesses for sale. Some sites specialize in selling certain kinds of businesses like manufacturing, distribution, wholesale, franchises, Internet properties, retail, service businesses or restaurants. Most of these sites charge a monthly subscription fee to advertise your business for sale.
There are two primary marketing materials that are typically used to describe your business to potential buyers. The first is a one-page document that offers highlights of the business without revealing its identity and is sometimes referred to as a “blind profile.” The second is a comprehensive selling memorandum or prospectus to be sent to serious buyers who have signed a confidentiality agreement.
Make Sure Potential Buyers Are Qualified
There’s no bigger waste of time than working with a buyer who will not be able to complete a transaction. Ideally, you will want all interested buyers to sign a confidentiality agreement before sending out anything other than the “blind profile” for your business. In addition, you should require buyers to submit some basic information:
Name and all contact information.
Previous employment and business ownership.
Educational background.
Funds available to invest and sources of financing.
Minimum monthly income requirement.
Intended timeframe for completing a transaction.
Reason for interest in your business.
Negotiating the Deal
You will also want to spruce up your business to make it attractive to buyers. Make any needed cosmetic improvements to the premises, get rid of outdated inventory and make sure that equipment is in good working order
After you’ve found a qualified buyer, provided a selling memorandum and had an initial meeting, it will be time to stop the flow of information and ask that an offer be presented. This can take the form of a nonbinding letter of intent (LOI) or a term sheet. It should spell out the primary terms of a deal so that all parties can move forward in good faith.
My client ended up receiving three offers on her professional services firm. One was from a competitor, one was from an industry expert residing out of the country and one was from a regional firm looking to extend its geographic footprint. While that last offer was the weakest from a financial standpoint, we knew that this buyer would be able to complete a seamless transition and build her business. We decided to negotiate with the regional firm.
The asking price was $500,000. The regional firm offered a disappointing $400,000, with $50,000 down and the balance financed by the seller over five years at 6 percent interest. My client planned to stay with the firm under new ownership and was relatively certain that gross sales would increase substantially when her company became part of a regional brand. She offered a counter proposal: In lieu of financing the balance of $350,000, she asked to receive 10 percent of gross monthly sales for five years. She conservatively estimated that she would realize an additional $108,000 — over and above the selling price of $400,000 — at the end of the five-year period using this deal
structure. Both parties accepted.
All sellers hope to get a full-price cash offer for their business. But in the real world this rarely happens. More often buyers will make a down payment and then pay some or all of the remainder in installments to either you or a lender. Don’t be dismayed by an offer that doesn’t meet your original expectations. As this case illustrates, a willingness to be creative with the terms of a transaction can go a long way toward a successful sale. Be sure to enlist an accountant and a lawyer to help you assess the tax consequences of the terms you suggest or accept. Be sure the accountant and you agree to the “market value” of the business. You can obtain a valuation through a professional consultant.
Selling a business is largely about setting realistic expectations, avoiding surprises and just plain hanging in there. It can be an arduous journey, but one with a very tangible (and rewarding) light at the end of the tunnel. Once you’ve successfully sold your business, savor an accomplishment that not every entrepreneur gets to enjoy. Whether you’re lying on the beach, retiring by the lake or starting your next venture, you did it!
Quick Tips:
Put yourself in the buyer’s shoes.
Don’t go it alone. Assemble a team of professionals, most importantly a business broker, a legal advisor and an accountant that you trust.
Get a professional valuation of your business.
Make sure your financial house is in order prior to sale.
Let us help you to value and conduct a professional business offering. Contact us.
Determining Your Company’s Value: Recasting the P.&L.
Does your business sponsor a Little League team? That’s an add-back.
Transitioning
One of the first steps in the process of valuing your business is to recast, or normalize, your most recent profit and loss statements. At the heart of this process is a subject that is familiar here – You’re the Boss — it’s another example of the importance of cash flow.
Small-business owners are accustomed to thinking about revenue and expenses in terms of minimizing taxable income. While that may be a good strategy for tax time, it is not necessarily a fair representation of the financial performance of your company. If you try to place a value on your business without recasting profit and loss statements, you may understate the cash flow from operations, which could in turn result in an asking price for your business that is too low.
As I mentioned, most valuations are based on a multiple of earnings. For a smaller, owner-operated business, the most common earnings metric used to value the business is called seller discretionary earnings, or S.D.E. You may also see it referred to as owner’s benefit, cash flow to owner, seller discretionary cash flow or simply cash flow. Whatever the term, the goal is to provide potential buyers with an accurate picture of all of the available cash flow from your operations.
When combing through expense accounts looking for add-backs, keep some questions in mind: Were these expenses necessary for the operation of the business? Will a new owner incur these same amounts? Here are some examples of typical add-backs for each category:
Discretionary: One of the primary discretionary expenses of the business is how much the owner pays himself or herself in salary. Others are what might be called perks: personal use of a car or mobile phone, a life insurance policy or even sponsoring your child’s Little League team.
I recently met a florist who traveled to Amsterdam for an international floral design workshop every year. Not surprisingly, the associated travel expenses were significant. Was this a legitimate business expense? Sure. Would it be necessary for a new owner to attend the same workshop in order to continue operating the business successfully? I doubt it. Another discretionary add-back I encountered not long ago was a $40,000 aviation expense. The owner of the business had a private pilot’s license and liked to use his personal aircraft to travel to industry trade shows and expos a dozen times a year. While some travel expenses would be associated with attending these shows, aviation expense hardly seemed necessary for operation of the business.
Extraordinary: In Ozark Metal Fabrication, the salary paid to a family member may be extraordinary. It’s not unusual for business owners to pay excessive (i.e. well above market rate) salaries to both family members and long-time employees. A larger than usual lawyer bill might also be considered extraordinary. The amounts for these expenses should be adjusted to fair market or normal levels.
Nonrecurring: These are one-time expenses, like moving expenses, or cleanup and repairs from storm damage. It’s reasonable to assume that these expenses would not be incurred by a new owner.
Noncash: The most common noncash expense is depreciation.
It’s important to look at the S.D.E. of your business from a buyer’s point of view. This is the amount of money that a new owner will have left over after operating expenses to pay himself or herself a salary, service any debt incurred to buy your business, and build or reinvest in the business.
Remember that your profit and loss statement is an example of internal reporting — not to be confused with either financial or tax reporting, which are intended for different endusers. Buyers will ask for both internal financial statements like the P & L. and balance sheet, as well as corresponding tax returns.
Last, be prepared to defend any add-backs that you include in your S.D.E. analysis: a savvy buyer will expect you to be able to justify each add-back and explain it in detail. Not surprisingly, discussions about add-backs and S.D.E. with a buyer can become contentious. One listing we had last summer attracted a veteran buyer who questioned every addback associated with the business. We never did agree on whether a theft at the establishment — an upscale sports bar and grill — counted as an add-back. A general manager had spent the better part of six months stealing almost $50,000 in cash and inventory (liquor) from the first-time owner. I argued that it was unfair to count this as a strike against the profitability of the business, especially under more seasoned ownership. The buyer said it was unfortunate but chalked it up to poor management and eliminated it from S.D.E. What do you think?
Trying to do this yourself can be very daunting. A professional business consultant or business broker will be able to assist you. They are less expensive than an accountant.
Let us help you to value and conduct a professional business offering. Contact us.