Colin Thompson takes a look ways to make your business more attractive and increase its value to a potential purchaser.
All too often business owners are not well prepared when a decision is made to sell and believe their business is worth considerably more than a purchaser is prepared to pay. The timing and reasons for a business sale can be critical to determining the outcome. Unfortunately, the decision to sell is often forced upon the business by circumstances and many business owners fail to unlock the true worth of their business.
Reasons for selling.
Common reasons for a business sale fall into two categories - planned and unplanned - and include:
Planned - Retirement.
- Access to capital to fund business growth.
- The entrepreneur that grew the business recognises that the management capability required is beyond his/her skill sets.
- There are no family members to pass on the business Realisation of personal wealth to pursue other business or personal interests.
- Expectation of future profit erosion within increasingly competitive environment.
- Health issues, such as illness or death.
- Financial difficulties, either within and external to the business.
- Divorce, family split up or other change in personal circumstances.
- Partnership/shareholder dispute or divergent shareholder objectives.
-Opportunistic approaches by potential acquirers.
- Loss of a major customer, comprising a significant part of the business.
Whether a business sale has been planned for some time or is the course of action decided upon in response to particular circumstances, the outcome will almost certainly be better if the business has been well prepared for sale.
In order to ensure that your business is positioned to achieve an optimal outcome on sale, the following eight key issues should be addressed:
1. Establish a clear competitive edge.
The value of your business will be considerably enhanced if you are able to demonstrate a clear competitive advantage in a particular niche or market segment, leading to more sustainable margins, greater customer retention and an increased ability to win new business.
This means understanding where the core capabilities of the organisation and its management lie, aligning these to areas of market opportunity, and repositioning the business if necessary to develop a clear and sustainable competitive advantage within these areas. This can be a major undertaking, which may take several years to achieve. However, in the absence of a competitive advantage, potential purchasers may view your business not as a strategic acquisition, but simply as the opportunity to achieve rationalisation benefits through adding production capacity - a far less valuable proposition in an industry suffering from overcapacity.
2. Ensure adequate strength and depth of management.
Many businesses rely heavily on the business owner or a small management team. If you intend to leave the business following the sale, you will need to ensure that the business is able to operate without you and that the ongoing management has the desire, energy, ability and commitment to take the business forward in an increasingly difficult environment.
Generally, a business owner should progressively step back from the business over a period of at least 18-24 months prior to the anticipated date of sale, handing over key relationships and responsibilities to other members of the management team. Also, the reporting line to you must be established on the operations of your company in a regular time frame. By taking this action you will receive a better price for your business.
There is also a need to assess whether there are talented and committed people in the wings to become the next generation of managers, to ensure as far as possible that the business is not reliant on one or two people. If particular individuals are key to the business, it may be advisable to align their interests with yours by offering a bonus linked to a successful sale of the business, or indeed an equity stake.
3. Mitigate risk of customer losses.
If your business is overly reliant on one or two major customers, it may detract significantly from the value placed on your business by a purchaser or investor. This is particularly so if your product or service is not differentiated and/or the customer relationship is not secured through a contract or by other means, such as being the provider of an end-to-end solution closely integrated with the customer's own business processes.
In order to limit the risk of customer loss on the business and provide a purchaser with greater comfort in relation to future revenues, consideration should be given to entering into contractual arrangements with major customers, whilst greater diversification may also need to be built into the customer base to reduce the financial impact of the loss of any single customer.
4. Eliminate personal transactions.
In presenting financial information to a prospective purchaser, it is advisable to eliminate non arm's length transactions between the business and its owner (and related parties of the owner), in order that the financial statements reflect the true underlying performance of the business. For example, personal expenditure incurred by the business should cease, any transactions with the business owner or affiliates, should be on an arm's length basis, personal assets such as expensive cars or yachts, should be extracted from the business, and the employment of any family members should continue only if they are paid a market salary for duties actually undertaken within the business.
The existence of complex or undisclosed arrangements such as these not only distorts the reported financial performance of the business, but also can significantly undermine the confidence of a purchaser in the reliability of the information provided.
5. Ensure robust Management Information Systems.
Having a management information system that provides timely, accurate and relevant information both improves the quality of decision making and provides a potential purchaser with considerable comfort with regard to the way in which the business is managed. It is fundamental to costing and pricing, the purchase of supplies, stock holding, work scheduling and the overall management of profitability and cash flow. This in turn should translate into management accounts ensuring that management keeps its 'finger on the pulse’.
6. Review the state of financial records.
Of equal importance is maintaining the financial records in a healthy state and making sure that all statutory requirements are complied with within the required timeframes. Year end financial statements that are easily reconciled to monthly management accounts, debtors and creditors ledgers, tax returns, etc without any surprises provide confidence to prospective purchasers, investors and financiers.
Additional confidence or surety is further gained when a business has been regularly audited. There is certainly a sense of greater corporate governance and acceptance of the figures presented by would-be acquirers.
7. Evaluate tax planning and structuring opportunities.
At the end of the day, it is what ends up in the pocket that matters most. With every sale, there are a raft of structural considerations and taxation implications which, all other things being equal, can make a substantial difference in the net cash received.
Often these considerations are left to the very end, resulting in a less satisfactory result being achieved. Planning well in advance can assist you in ensuring that the business retains valuable tax attributes (such as tax losses), and in establishing a structure which minimises the likely tax liability on sale.
8. Build a track record of profitability and cash flow.
Finally, the most important determinant of a business's value from a purchaser's perspective is its future earning capacity and ability to generate cash. Given that past performance is often used as a predictor, in the assessment of likely future performance, it is imperative that the business can demonstrate a track record of profitability and strong cash flows. Therefore, if this has not been the case, sufficient time may be required to rectify the situation.
Warning signs to purchasers.
If your business displays one or more of the following characteristics, its value is likely to be impaired, even if there is a strong underlying business: One or two customers comprise a large proportion of revenue; all the knowledge and key customer relationships reside with the owner; no 'new blood' coming up through the ranks; accounting records in a mess and not up to date; no transparency between tax return and management accounts; extensive personal assets and expenditure within the business; fluctuating historical revenues and profits and unclear growth expectations; and no cash flow forecast and profitability projections.
Whether or not you plan on selling your business in the near future, a little planning and preparation can significantly enhance the likelihood of an optimal outcome when the time comes; bearing in mind that it may not be of your choosing. Grasp the opportunity now to make the business more attractive and increase its value to a purchaser - you have nothing to lose and everything to gain!