So you have decided to sell your business? Congratulations! Hopefully this is the culmination of a very carefully planned out process. If not, you will undoubtedly be leaving some value on the table. From a buyer’s perspective, here are some items to consider before hitting the market.
[There are a variety of ways to sell a business, including a Share Sale or an Asset Sale. This article is focused on a Share Sale of a profitable business]
You have heard the analogy before, but it fits: if you want to maximize value on the sale of your car, its best to give it a wash, remove the pile of newspapers from the back seat and put some air in the tires. Running a business is a detail oriented venture. Before selling, make sure you bring everything up-to-date and have the business structured for sale, including:
- Updating the Minute Book (director’s resolutions, share transfers, unanimous shareholders agreement)
- Collapsing funky share structures/corporate structures
- Documenting processes, operating manuals, and safety manuals etc.
- Paying taxes and keeping them current
- Getting corporate documents in place (supplier agreements, employee contracts, confidentiality agreements).
Some of these details may not seem that critical, but ignoring small details sends the buyer a clear message on how you run your business.
FORTIFY BARRIERS TO ENTRY:
In a highly competitive environment, buyers will look to the strength of barriers to entry. If the business has intellectual property – useful trademarks, patents, industrial designs – try to secure it. Additionally, you may be able to tie the hands of suppliers through exclusive rights, licenses, joint ventures or non-disclosure agreements etc. Some of these items are an easy way to reduce the level of perceived risk that the buyers see, and perceived risk will erode the purchase price.
Customer concentration is also seen as risk. If you have few customers, start to diversify your customer base to show that the business appeals to a wider audience. I would also suggest creating redundancy in key suppliers and key employees so that you can show the buyer that you have taken the steps to minimize potential disruption. If you are an owner that is planning on exiting the business, make yourself redundant as well by grooming managers to take over the leading roles.
PREPARE TAX WISE:
Canada has a Lifetime Capital Gains Exemption on the sale of qualified small business shares that now exceeds $800,000. Prior to selling your business, it is prudent to talk to a tax professional to ensure you have a tax friendly structure. It’s common for sellers to get tripped up on certain rules (i.e. holding real estate in the operating company may put you offside with the 90% active assets rule, or if you haven’t held the shares for the preceding two years they will not be qualified shares etc.). Keep in mind that you may be able to structure the business to utilize the exemption limits of other family members.
ANALYZE YOUR LEVEL OF ACCOUNTING:
Consider increasing the level of accounting reporting in your business. If your business does yearly revenues of less than $5 million, Notice to Reader may suffice, but Review Engagement Statements may give the buyer more comfort. On businesses with over $15 million in revenues, investing in Audited Statement may be worthwhile. Consider the fact that many of the Representations and Warranties in a Share Purchase Agreement will refer back to your financial statements and the statements become an integral part of the agreement. Obviously the buyer is heavily reliant on the statements, but the seller should be quite comfortable with them as well.
START PLANNING AND FORECASTING:
If you don’t already operate with one, create a business plan and financial model to start tracking current progress and predicted future growth. Not only is this a useful tool in itself, the exercise of planning will help all managers to understand how the business operates. This becomes even more critical when you have to articulate your business and its future growth prospects to potential buyers. I would suggest that the leaders of business should dig deep here. You can hire an outside advisor to assist in the process, but if the team does not fully grasp how the business operates as a whole, this will become readily apparent in due diligence.
PULL ALL SKELETONS FROM THE CLOSET:
If you know there are some contentious issues with your business, face them and start working on them prior to the sales process. You may not find a solution, but at least make the buyer aware of them and what you have done to address them. One of the quickest deal killers is discoveries of hidden issues during due diligence as it breaks down trust and increases the perceived risk. Also, I would recommend being upfront on what you see are the weaknesses or gaps in your business. Value added buyers often see weaknesses as areas that they can fix, which would result in improved returns once they own the business.
FRONT END LOAD DUE DILIGENCE INFO:
Do not underestimate the amount of time and focus the sales process takes away from your day-to-day operations. The request for information comes at a time when you really need to be hitting full stride and any weakness in Revenues/Earnings will give the buyers an excuse to revise the offer. It is prudent to understand the items typically needed and get these in place (in electronic format) before the sales process.
FOCUS ON WORKING CAPITAL:
Try to get the working capital in line with the actual needs of the business. In typical sales agreements, it is expected that the business is delivered with enough working capital to allow for continued operations. One of the mistakes I have made in the past is leaving too much cash on the balance sheet, making it look like the working capital target should be higher than is actually required. Other items that will provide immediate value is focusing attention on shortening the collection time on your Accounts Receivable and cleaning up the balance sheet (i.e. stagnant inventory).
CONCENTRATE ON EARNINGS:
It seems intuitive that a company should focus on growth of revenues at all costs to maximize future value. However, share sales of profitable companies are typically based on a multiple of earnings. I would suggest focusing on Earnings, not Revenues at all points of a business’s growth cycle, but definitely for the couple of years leading up to a sale. Remember, if you are selling your business for a 4 x multiple, every additional $100k earned will translate into $400k extra into your jeans! This formula does not necessarily hold true for revenues.
You will notice that several of the points listed, while not overly onerous, will take some time to put in place. As a final point, if you know you would like to sell your business and would like to maximize the value of the sale, it is never too early to start on these tasks!
Article by Nicholas Donohoe.
You can read more about Nicholas Donohoe here.