10 steps for how to value a business, sell a business, or buy a business.
Originally published: 1/1/10 by Kevin R. Yeanoplos
Part 2 of 3 on how to value a business, sell your business, or buy a business.
Beauty is in the eye of the beholder. And according to a certain porcine female that’s been known to hog the Muppet’s spotlight from time to time, “It may be necessary from time to time to give a stupid or misinformed beholder a black eye.”
That may sound a bit extreme. But as we learned in Part 1 of this three-part series, “beauty” (otherwise known as “value”) can be defined as “something intrinsically desirable.” And maximizing the value of a business often revolves around positively impacting another’s perception of the business, so that they find it intrinsically desirable. Sort of sounds like that black eye, doesn’t it?
The reality is that business owners enjoy a number of different benefits that go along with operating a successful business. One benefit might be coasting along contentedly with little or no earnings, thanks to aggressive “tax planning.”
The “no-earnings-no-taxes” scenario is appealing to the current owners, but it isn’t very tempting to potential new owners who are primarily focused on historical economic performance and estimated future cash flows.
Unfortunately, you may not be one of those rare business
But even if you’re not, it’s never too late to make changes. And the sooner the better — a potential buyer isn’t very impressed with last-minute housekeeping!
An owner must put himself in the shoes of a prospective buyer and be willing to make any changes necessary to maximize the business’ “curb appeal.” In this article, I discuss some of those changes, building on the concepts I wrote about in Part 1.
There are a number of areas that a business owner should examine closely, including:
1. Potential for sales growth. Most buyers prefer businesses with room for sales growth. To that end, the current owner should at the very least prepare a sales forecast or budget, indicative of future revenue plans. The current owner should consider new products, new markets, and geographic expansion. Even in times of economic uncertainty, opportunities for expansion can present themselves.
2. Financial strength. The current owner may have historically stripped the cash out of the business, hurting its “liquidity” or ability to cover its short-term expenses. While it may seem distasteful, leaving a larger amount of working capital in a business can make it more appealing to a potential buyer.
3. Discretionary expenses. It’s common for a privately held business to minimize profit and taxes by paying for expenses that aren’t necessary to run the business. Temporarily setting aside any issues of appropriateness from an income-tax point of view, if this is the case, the owners should “recast” or “normalized” the profit of the business so that it is representative of the earnings that a new owner could expect from the business.
As such, expenses such as personal travel, real estate rent that is more than fair-market rent, personal automobile use, and similar items should be minimized, thereby ensuring clean financial statements. This will present a truer picture of operations in addition to instilling confidence in the potential buyer as to a lack of risks associated with the business’ financial picture.
4. Management depth. Owners tend to think that they are indispensible to the future of a business. That may be true, but dependence on a key individual can reduce the value of a business. Although counterintuitive, an owner should do everything possible to reduce the business’ dependence on him. One of the most important things an owner can do is to train their replacement and build a broader management team.
5. Market and market strategy. The owner should also consider strengthening the sales and marketing efforts to drive growth. Unlike capital expenditures, these investments will have a near-term positive effect on the top and bottom lines. As part of this process, the owner should also consider discontinuing unprofitable lines in order to increase the bottom line, even though in the short term it might hurt sales.
6. Quality of financial information. A potential buyer will expect that the current owner has important and necessary business documents in appropriate order. Among other things, this includes accounts receivable and accounts payable agings, lists of customers and vendors, financial data available in electronic format (QuickBooks, for example), income-tax returns, corporate documents, leases, and similar information.
Generally speaking, audited financials are preferred, but buyers also will accept reviewed and compiled financial statements. The owner may want to get an audit of the business’ financials in preparation for a sale.
7. Additional unnecessary expenses. The owner should attempt to eliminate any expenditures that don’t directly contribute to the growth of sales and profits or are unnecessary to the operation of the business, such as capital expenditures that create excess capacity. Along those lines, the owner should determine whether or not the capacity of existing assets is being effectively utilized. It may make sense to sell some of the equipment, keeping in mind that some capacity will be necessary for future growth. The owner should however, make sure that any past-due maintenance on any of existing equipment is brought up to date.
8. Hidden liability issues. Obviously, this is a more important issue if the owner is contemplating a stock sale as opposed to an asset sale, as generally these types of liabilities only “follow” as part of a stock sale. The owner should resolve any pending lawsuits, human resource troubles, insurance claims, leases renewals, permits renewals, open regulatory complaints, and similar items.
Don’t expect that these issues won’t be uncovered, as a careful level of due diligence by the buyer will uncover them — and maybe even some that the owner is unaware of.
The owner should identify any remaining contingent liabilities. Further, the owner should disclose plans to deal with any pending changes in safety or environmental regulations that affect the industry, particularly if building changes will be necessary.
9. Plans for the future. Related to the sales discussion above, the owner should plan on presenting potential buyers with a business plan that lays out the future strategy, including consideration of new products, new markets, new distribution plans, cost cutting, acquisitions, and similar items.
10. Optimize workforce. While it may be distasteful, the owner should examine the existing workforce level for excess capacity. It is common with privately held businesses to encounter situations where two employees are performing duties that one could do, for instance, particularly where family members are involved. The owner should reduce (or increase in some instances) the employee count to a suitable level by performing an analysis of job duties and respective hours spent doing them.
By understanding how each of these factors can increase the value of a business and taking the steps to clean up their business, an owner can maximize the sales price.
Now that we’ve explored considerations in selling a business in Part 2, Part 3 will focus on considerations in buying a business.
Articles by Kevin R. Yeanoplos
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10 steps for how to value a business, sell a business, or buy a business.
In part 2 of a 3-part series, Kevin R. Yeanoplos discusses how an owner must put himself in the shoes of a prospective buyer and be willing to make any changes necessary to maximize the business’ “curb appeal.” He discusses key areas that a business owner should examine closely, including potential sales growth, financial strength, discretionary expenses, management depth, market and market strategy, quality of financial information, additional unnecessary expenses, hidden liability issues, plans for the future, and workforce.