Whether you’re considering selling today or in five years, if you want to maximize what you receive, the time to start preparing is now. While some things can be done shortly before a sale, many should be done years in advance.
Buyers will be skeptical of profitability improvements implemented shortly before sale and might even view them as short-term fixes that could damage the value of the business. For example, a staff reduction can improve profitability immediately. It can also lead to lost customers and reduced sales if customer service or quality suffer. However, if changes are implemented two or three years in advance, it will be clear to a buyer that they aren’t short-term fixes, but true improvements to the viability and bottom line of the business.
Reduce Working Capital to Increase Value
Cash flow drives the value of a business. It is impacted by the capital required to fund operations. As a business grows, its capital requirements grow. Decreasing the amount of capital required to fund operations decreases the amount of additional capital required to grow the business.
Start with components of net working capital, which include cash, accounts receivable, and inventory less accounts payable. The lower the net working capital required, the better. Managing your receivables better not only reduces working capital requirements and increases the value of your business, but reduces your exposure to your customers’ financial problems.
Reduce inventory to necessary levels and get rid of dead inventory. A buyer might factor your current inventory levels into net working capital requirements. It is better that inventory levels are well managed for several years prior to a sale so it is clear what inventory levels need to be. You will have the added benefits of a more orderly warehouse and a tax deduction for the inventory you scrap. If you don’t dispose of the inventory, the buyer eventually will. Why reduce the value of your business and leave the tax deduction to the buyer?
Do you pay vendors too quickly? If you don’t get a discount or other benefit for paying quickly you are helping your supplier improve his cash flow and the value of his business to the detriment of yours. Pay on time, not early!
Dispose of Unnecessary Assets
Are all of the assets on your balance sheet necessary? If you have unnecessary assets, consider selling them or writing them off. Not only will you free up space, but you will realize some tax benefits that you otherwise will be leaving for the buyer.
However, underutilized production equipment and capacity can cut both ways. Disposing of excess equipment will lower the apparent capital requirements. But a buyer might be interested not only in your customers, but in extra production capacity for his customers. Be certain that your operational data clearly demonstrate that the capacity is excess. If the buyer isn’t going to pay for the capacity, consider selling the equipment prior to the sale of your business.
You should also consider removing other assets, such as life insurance and investments, to erase any confusion as to whether the assets are integral to the business or who will own them post-close, but be mindful of any potential tax consequences. If you don’t remove the non-operating assets, you are exposing yourself to post-closing claims or eleventh-hour stickups prior to close. For example, a buyer might claim that the negotiated price included the insurance policy that you did not think you were selling with the business.
Look at every line on the balance sheet to see if assets can be reduced and working capital components such as accounts payable increased in order to decrease capital requirements.
Look at your income statement next. Improving net cash flow improves the value of your business. Different products and product lines have different margins. Is there good reason for keeping lower-margin business, such as having a full product line? Examine your lower-margin products. Consider not only the gross margin, but whether overhead could be eliminated if that product line were gone. Also examine capital requirements for that product line, such as accounts receivables and inventory. Consider firing difficult customers who are marginally profitable and reallocating the resources used to service those customers to pursue more profitable business or simply reduce capital requirements.
Be mindful of product and customer concentrations. A large percentage of sales to one customer or industry or heavy reliance on a single product can negatively impact the value of your business. But reducing customer and product concentrations is difficult and takes time. Start now. By reducing concentrations, not only will you improve the value of your business, you will sleep better at night.
Is Overhead Overdone?
Look carefully at general and administrative costs. Are you running as lean as you can? If not, make changes now. Buyers are wary of recent cost reductions. Give improvements time to stick so that buyers can see they are real.
Is Your Accounting Accurate?
Does your accounting follow GAAP? Does your cost accounting give an accurate picture? Consider investing in an audit for several years before you sell. That way, you can be sure your accounting is correct and reduce your exposure to price adjustments from a buyer who is surprised — or claims to be surprised — by what they find during due diligence.
How Do You Compare to Your Peers?
Compare your operations to industry averages. Is your gross margin higher or lower than your competitors'? Do your accounts receivable and inventory turns compare favorably? You can ask your accountants and bankers. Valuation professionals routinely compare companies to competitors and industry averages and are an excellent source of information.
Make Yourself Obsolete
Buyers are concerned about what will happen when the owner, presumably the driving force behind the business, retires. Build a solid management team that can run the business day to day. The team should have real authority and ideally be in place for at least a couple of years before you sell. An immediate benefit is reduced stress in your life since you will not have to be on call 24/7.
Taxes can have a big impact on how much of the value you keep. If you sell within ten years of converting from a C-Corp to an S-Corp you might be exposed to the built-in gains tax. This can also limit your flexibility in structuring a sale.
Sellers also complicate their lives by running personal expenses through the business. In order to get maximum value, the seller must demonstrate to buyers that these expenses are not necessary to the business, placing the seller in the tenuous position of sharing sensitive information with outsiders.
The Benefits Begin Immediately
By implementing improvements well in advance, you have time to do it right and you will enjoy increased cash flow. By making your business more efficient and putting a succession team in place, you remove day-to-day pressure from your shoulders. If you pass your business to your children, you will increase their chances of success. Your business might even run so smoothly that you decide you don’t want to sell.